nv2za
As filed with the Securities and Exchange Commission on
June 22, 2006
Securities Act Registration
No. 333-132436
Investment Company Act Registration No. 811-21869
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-2
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Registration Statement
under the Securities Act of 1933 |
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Pre-Effective Amendment No. 6 |
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Post-Effective Amendment No. |
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and/or |
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Registration Statement
under the Investment Company Act of 1940 |
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Amendment No. 6 |
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Highland Credit Strategies Fund
(Exact Name of Registrant as Specified in Declaration of
Trust)
Two Galleria Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240
(Address of Principal Executive Offices)
(877) 665-1287
(Registrants telephone number, including area code)
James D. Dondero, President
Highland Credit Strategies Fund
Two Galleria Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240
(Name and Address of Agent for Service)
Copies to:
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Philip Harris, Esq.
Skadden, Arps, Slate, Meagher & Flom LLP
Four Times Square
New York, New York 10036 |
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Nora M. Jordan, Esq.
Davis Polk & Wardwell
450 Lexington Avenue
New York, New York 10017 |
Approximate date of proposed public offering:
As soon as practicable after the effective date of this
Registration Statement.
If any securities being registered on this form will be offered
on a delayed or continuous basis in reliance on Rule 415
under the Securities Act of 1933, other than securities offered
only in connection with dividend or interest reinvestment plans,
check the following
box o
It is proposed that this filing will become effective (check
appropriate box):
þ
when declared effective
pursuant to section 8(c)
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF
1933
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Proposed Maximum |
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Proposed Maximum |
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Amount of |
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Amount Being |
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Offering Price |
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Aggregate |
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Registration |
Title of Securities Being Registered |
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Registered |
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per Unit |
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Offering Price |
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Fee |
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Common Shares, $0.001 par value
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35,000,000 shares(1) |
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$20.00 |
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$700,000,000(2) |
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$74,900(3) |
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(1) |
Includes shares that may be offered to the underwriters pursuant
to an option to cover over-allotments. |
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(2) |
Estimated solely for the purpose of calculating the registration
fee. |
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(3) |
Previously paid. |
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON
SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE
DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH
SPECIFICALLY STATES THAT THE REGISTRATION STATEMENT SHALL
THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a)
OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION
STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATES AS THE
COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY
DETERMINE.
HIGHLAND CREDIT STRATEGIES FUND
CROSS REFERENCE SHEET
Part A Prospectus
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Items in Part A of Form N-2 |
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Location in Prospectus |
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Item 1.
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Outside Front Cover |
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Cover Page
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Item 2.
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Inside Front and Outside Back Cover |
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Cover Page
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Item 3.
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Fee Table and Synopsis |
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Prospectus Summary; Summary of Trust Expenses
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Item 4.
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Financial Highlights |
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Not Applicable
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Item 5.
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Plan of Distribution |
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Cover Page; Prospectus Summary; Underwriters
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Item 6.
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Selling Shareholders |
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Not Applicable
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Item 7.
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Use of Proceeds |
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Use of Proceeds; Prospectus Summary; The Trusts Investments
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Item 8.
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General Description of the Registrant |
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The Trust; The Trusts Investments; Risks; Description of
Capital Structure; Anti- Takeover Provisions in the Agreement
and Declaration of Trust; Closed-End Trust Structure;
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Item 9.
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Management |
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Management of the Trust; Custodian and Transfer Agent; Trust
Expenses
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Item 10.
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Capital Stock, Long-Term Debt, and Other Securities |
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Description of Capital Structure; Distributions; Dividend
Reinvestment Plan; Anti-Takeover Provisions in the Agreement and
Declaration of Trust; Tax Matters
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Item 11.
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Defaults and Arrears on Senior Securities |
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Not Applicable
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Item 12.
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Legal Proceedings |
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Not Applicable
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Item 13.
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Table of Contents of the Statement of Additional Information |
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Table of Contents for the Statement of Additional Information
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Part B Statement of Additional Information |
Item 14.
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Cover Page |
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Cover Page
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Item 15.
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Table of Contents |
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Cover Page
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Item 16.
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General Information and History |
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Not Applicable
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Item 17.
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Investment Objective and Policies |
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Investment Objectives and Restrictions; Investment Policies and
Techniques; Other Investment Policies and Techniques; Portfolio
Transactions
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Item 18.
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Management |
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Management of the Trust; Portfolio Transactions and Brokerage
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Item 19.
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Control Persons and Principal Holders of Securities |
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Not Applicable
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Item 20.
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Investment Advisory and Other Services |
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Management of the Trust for the Prospectus and Statement of
Additional Information; Experts
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Item 21.
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Portfolio Managers |
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Management of the Trust
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Item 22.
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Brokerage Allocation and Other Practices |
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Portfolio Transactions and Brokerage
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Item 23.
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Tax Status |
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Tax Matters; Distributions
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Item 24.
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Financial Statements |
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Financial Statements; Independent Auditors Report
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Part C Other Information |
Items 25-34 have been answered in part C of this
Registration Statement |
The information in this prospectus is
not complete and may be changed. We may not sell these
securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus
is not an offer to sell these securities and is not soliciting
an offer to buy these securities in any jurisdiction where the
offer or sale is not permitted.
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PRELIMINARY PROSPECTUS (SUBJECT TO
COMPLETION)
ISSUED JUNE 22, 2006
Shares
Highland Credit Strategies Fund
COMMON SHARES
Highland Credit Strategies Fund (the Trust) is
offering common
shares of beneficial interest. This is the initial public
offering of the Trusts common shares, and no public market
exists for its common shares.
Investment Objectives. Highland Credit Strategies Fund is
a newly organized, non-diversified, closed-end management
investment company. The Trusts investment objectives are
to provide both current income and capital appreciation. The
Trust will pursue its objectives by investing primarily in the
following categories of securities and instruments of
corporations and other business entities: (i) secured and
unsecured floating and fixed rate loans; (ii) bonds and
other debt obligations; (iii) debt obligations of stressed,
distressed and bankrupt issuers; (iv) structured products,
including but not limited to, mortgage-backed and other
asset-backed securities and collateralized debt obligations; and
(v) equities. Additionally, within the categories of
obligations and securities in which the Trust may invest,
Highland Capital Management, L.P., the Trusts investment
adviser (Highland or the Investment
Adviser), may employ various trading strategies, including
but not limited to, capital structure arbitrage, pair trades and
shorting. The Trust may also invest in these categories of
obligations and securities through the use of derivatives.
Highland will seek to achieve its capital appreciation objective
by investing in category (iii) and (v) obligations and
securities, and to a lesser extent, in category (i), (ii), and
(iv) obligations. Under normal market conditions, at least
80% of the Trusts assets will be invested in one or more
of these principal investment categories. Subject only to this
general guideline, Highland has broad discretion to allocate the
Trusts assets among these investment categories and to
change allocations as conditions warrant. The Investment Adviser
has full discretion regarding the capital markets from which it
can access investment opportunities in accordance with the
investment limitations set forth in this prospectus. A
significant portion of the Trusts assets may be invested
in securities rated below investment grade, which are commonly
referred to as junk securities. The Investment
Adviser does not anticipate a high correlation between the
performance of the Trusts portfolio and the performance of
the corporate bond and equity markets. There can be no assurance
that the Trusts investment objectives will be
achieved.
(continued on top of next page)
No Prior History. Because the Trust is newly organized,
the Trusts shares have no history of public trading.
Shares of closed-end investment companies frequently trade at a
discount from their net asset value, which may increase
investors risk of loss. This risk may be greater for
investors expecting to sell their shares in a relatively short
period after completion of the public offering. The Trust
anticipates that its common shares will be listed on the New
York Stock Exchange under the symbol HCF.
Before buying any common shares, you should read the
discussion of the material risks of investing in the Trust in
Principal Risks of the Trust beginning on
page 40 of this prospectus. Certain of the risks are
summarized in Prospectus Summary Principal Risks of
the Trust beginning on page 5.
PRICE $20.00
A SHARE
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Estimated | |
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Price to | |
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Sales | |
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Offering | |
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Proceeds | |
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Public | |
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Load(2) | |
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Expenses(3),(4) | |
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to Trust(5) | |
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Per Share
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20.00 |
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0.90 |
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0.11 |
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18.99 |
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Total(1)
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(1) |
The Trust has granted the underwriters an option to purchase
up
to additional
common shares at the price to public, less the sales load,
within 45 days of the date of this prospectus solely to
cover over-allotments, if any. If such option is exercised in
full, the total price to public, sales load, estimated offering
expenses and proceeds to the Trust will be
$ ,
$ ,
$ and
$ , respectively. See
Underwriters. |
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(2) |
Highland Capital Management, L.P. will pay a marketing and
structuring fee to Morgan Stanley & Co. Incorporated
calculated at 1.25% of the aggregate price to public of the
common shares sold by Morgan Stanley & Co.
Incorporated, including over-allotted shares. This fee is not
included in this column. See Underwriters
Additional Compensation to Be Paid by Investment Adviser to an
Underwriter. |
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(3) |
Estimated offering expenses in this column include all of the
estimated expenses (including underwriting discounts,
commissions and legal expenses) of the Preferred Share offering
which is expected to occur soon after the completion of this
offering, as described under Prospectus
Summary Preferred Shares and Borrowings. Such
Preferred Share offering expenses are estimated to be
approximately $2.1 million in total, or $0.07 per common
share sold by the Trust in this offering, assuming approximately
$165.7 million liquidation value of Preferred Shares are issued
in the Preferred Share offering and 30,430,000 common shares are
issued in this offering. Estimated offering expenses in this
column also include reimbursement to Highland by the Trust for
expenses incurred by Highland in connection with this offering.
The marketing and structuring fee referred to in footnote 2
is not reimbursable to Highland, and therefore estimated
offering expenses do not include this fee. See
Underwriters. |
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(4) |
Offering expenses paid by the Trust (other than the sales
load and the Preferred Share offering expenses referred to in
footnote 3), including expenses reimbursed by the Trust to
Highland, will not exceed $0.04 per common share sold by
the Trust in this offering. If the offering expenses referred to
in the preceding sentence exceed this amount, Highland will pay
the excess. The aggregate offering expenses (excluding the sales
load, and excluding any Preferred Share offering expenses, but
including expenses reimbursed to Highland) to be incurred by the
Trust are estimated to be $1,217,200 in total, or $0.04 per
common share sold by the Trust in this offering, assuming
30,430,000 common shares are issued in this offering. See
Underwriters. |
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(5) |
Proceeds to the Trust are calculated after total of other
expenses of issuance and distribution. |
The Securities and Exchange Commission and state securities
regulators have not approved or disapproved of these securities
or determined if this prospectus is truthful or complete. Any
representation to the contrary is a criminal offense.
The underwriters expect to deliver the common shares to
purchasers on or
about ,
2006.
MORGAN STANLEY
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E*TRADE FINANCIAL |
OPPENHEIMER & CO., INC. |
ROBERT W. BAIRD & CO. |
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STEPHENS INC. |
WELLS FARGO SECURITIES |
,
2006
(continued from top of previous page)
Investment Policies and Strategies. Under normal market
conditions, the Investment Adviser will employ, on behalf of the
Trust, investment strategies across various markets in which the
Investment Adviser holds significant investment experience:
primarily the leveraged loan, high yield, structured product and
stressed and distressed markets. The Investment Adviser has full
discretion regarding the capital markets from which it can
access investment opportunities in accordance with the
investment limitations set forth in this prospectus.
The Investment Adviser looks to implement selected trading
strategies to exploit pricing inefficiencies across the credit
markets, or debt markets, and within an individual issuers
capital structure. The Trust seeks to vary its investments by
strategy, industry, security type and credit market, but
reserves the right to re-position its portfolio among these
criteria depending on market dynamics. The Investment Adviser
manages interest rate, default, currency and systemic risks
through a variety of trading methods and market tools, including
derivative hedging instruments, as it deems appropriate.
The multi-strategy investment program to be implemented by
the Trust will allow the Investment Adviser to assess what it
considers to be the best opportunities across multiple markets
and to adjust quickly the Trusts trading strategies and
market focus to changing conditions. The Investment Adviser
intends to focus primarily on the U.S. marketplace, but may
pursue opportunities in the
non-U.S. credit or
securities markets by investing up to 20% of the Trusts
assets in
non-U.S. credit or
securities market investments.
Within the categories of obligations and securities in
which the Trust may invest, Highland may employ various trading
strategies, including but not limited to, capital structure
arbitrage, pair trades and shorting. Capital structure
arbitrage typically involves establishing long and short
positions in securities (or their derivatives) at different
tiers within an issuers capital structure in ratios
designed to maintain a generally neutral overall exposure to the
issuer while exploiting a pricing inefficiency. Some issuers may
also have more than one class of shares or an equivalent vehicle
that trades in a different market (e.g., European equities and
their American Depository Receipt counterparts). This strategy
profits from the disparity in prices between the various related
securities in anticipation that over time all tiers and classes
will become more efficiently priced relative to one another.
Pair trades involve the establishment of a long
position in one security and a short position in another
security at the same time. A pair trade attempts to minimize the
effect of larger market trends and emphasizes the performance of
one security relative to another.
You should read this prospectus, which contains important
information about the Trust, before deciding whether to invest
in the common shares, and retain it for future reference. A
Statement of Additional Information,
dated ,
2006, containing additional information about the Trust, has
been filed with the Securities and Exchange Commission (the
Commission) and is incorporated by reference in its
entirety into this prospectus. You can review the table of
contents of the Statement of Additional Information on
page 77 of this prospectus. You may request a free copy of
the Statement of Additional Information, request the
Trusts annual and semi-annual reports, request information
about the Trust and make shareholder inquiries by calling
1-877-665-1287 or by writing to the Trust at Two Galleria Tower,
13455 Noel Road, Suite 800, Dallas, Texas 75240. You may
also obtain a copy of the Statement of Additional Information
(and other information regarding the Trust) from the
Commissions Public Reference Room in Washington, D.C.
by calling 1-202-942-8090. The Commission charges a fee for
copies. The Trust does not post a copy of the Statement of
Additional Information on its web site because the Trusts
common shares are not continuously offered, which means the
Statement of Additional Information will not be updated after
completion of this offering and the information contained in the
Statement of Additional Information will become outdated. The
Trusts annual and semi-annual reports, when produced, will
be available, free of charge, at the Trusts web site
(http://www.highlandfunds.com). You can get the same information
free from the Commissions web site
(http://www.sec.gov).
The Trusts common shares do not represent a deposit
or obligation of, and are not guaranteed or endorsed by, any
bank or other insured depository institution, and are not
federally insured by the Federal Deposit Insurance Corporation,
the Federal Reserve Board or any other government agency.
The underwriters are taking the common shares on a firm
commitment basis. The underwriters may engage in transactions
that stabilize, maintain or otherwise affect the price of the
common shares. See Underwriters.
TABLE OF CONTENTS
You should rely only on the information contained or
incorporated by reference in this prospectus. We have not, and
the underwriters have not, authorized any other person to
provide you with different information. If anyone provides you
with different or inconsistent information, you should not rely
on it. We are not, and the underwriters are not, making an offer
to sell these securities in any jurisdiction where the offer or
sale is not permitted. The information contained in this
prospectus is accurate only as of the date of this prospectus,
regardless of the time of delivery of this prospectus or of any
sale of common shares. The Trust will amend this prospectus if,
during the period that this prospectus is required to be
delivered, there are any subsequent material changes.
Until ,
2006 (25 days after the date of this prospectus), all
dealers that buy, sell or trade the common shares, whether or
not participating in this offering, may be required to deliver a
prospectus. This delivery obligation is in addition to the
dealers obligation to deliver a prospectus when acting as
underwriters and with respect to their unsold allotments or
subscriptions.
PROSPECTUS SUMMARY
This is only a summary. This summary may not contain all of
the information that you should consider before investing in our
common shares. You should review the more detailed information
contained in this prospectus and in the Statement of Additional
Information.
The Trust
Highland Credit Strategies Fund is a newly organized,
non-diversified, closed-end management investment company.
Throughout this prospectus, we refer to Highland Credit
Strategies Fund simply as the Trust or as
we, us or our. See The
Trust.
The Offering
The Trust is
offering common
shares of beneficial interest at $20.00 per share through a
group of underwriters led by Morgan Stanley & Co.
Incorporated. The common shares of beneficial interest are
called common shares in the rest of this prospectus.
You must purchase at least 100 common shares ($2,000) in order
to participate in this offering. The Trust has given the
underwriters an option to purchase up
to additional
common shares to cover over-allotments, if any. Highland has
agreed to pay (i) the Trustss organizational expenses
and (ii) the offering expenses (other than the sales load
and the expenses of the Preferred Share offering which is
expected to occur soon after the completion of this offering, as
described under Preferred Shares and
Borrowings) that exceed $0.04 per common share. See
Underwriters.
Who May Want to Invest
Investors should consider their own investment goals, time
horizon and risk tolerance before investing in the Trust. An
investment in the Trust may not be appropriate for all investors
and is not intended to be a complete investment program. The
Trust may be an appropriate investment for you if you are
seeking:
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Current income and capital appreciation |
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The opportunity for attractive total returns and potential for
capital appreciation |
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Low correlation with corporate bond and equity markets |
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Exposure to credit investment opportunities through a
multi-strategy investment approach |
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Access to an experienced portfolio management team |
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Flexibility to opportunistically reposition the Trust based on
market conditions |
However, keep in mind you will need to assume the risks. See
Principal Risks of the Trust.
Investment Objectives
The Trusts investment objectives are to provide both
current income and capital appreciation. The Trust will pursue
its objectives by investing primarily in the following
categories of securities and instruments of corporations and
other business entities: (i) secured and unsecured floating
and fixed rate loans; (ii) bonds and other debt
obligations; (iii) debt obligations of stressed, distressed
and bankrupt issuers; (iv) structured products, including
but not limited to, mortgage-backed and other asset-backed
securities and collateralized debt obligations; and
(v) equities. Additionally, within the categories of
obligations and securities in which the Trust may invest,
Highland may employ various trading strategies, including but
not limited to, capital structure arbitrage, pair trades and
shorting. The Trust may also invest in these categories of
obligations and securities through the use of derivatives.
Highland will seek to achieve its capital appreciation objective
by investing in category (iii) and (v) obligations and
securities, and to a lesser extent, in category (i), (ii), and
(iv) obligations. Under normal market conditions, at least
80% of the Trusts assets will be invested in one or more
of these principal investment categories. Subject only to this
general guideline, the Investment Adviser, has broad discretion
to allocate the Trusts assets among these investment
categories and to change allocations as conditions warrant. The
Investment Adviser has full discretion regarding the capital
markets from which it
1
can access investment opportunities in accordance with the
investment limitations set forth in this prospectus. A
significant portion of the Trusts assets may be invested
in securities rated below investment grade, which are commonly
referred to as junk securities. The Investment
Adviser does not anticipate a high correlation between the
performance of the Trusts portfolio and the performance of
the corporate bond and equity markets. The investment objectives
may be changed without shareholder approval. There can be no
assurance that the Trusts investment objectives will be
achieved. See The Trusts Investments-Investment
Objectives and Policies.
Investment Policies and Strategies
Under normal market conditions, the Investment Adviser will
employ, on behalf of the Trust, investment strategies across
various markets in which the Investment Adviser holds
significant investment experience: primarily the leveraged loan,
high yield, structured products and stressed and distressed
markets. Highland makes investment decisions based on
quantitative analysis, which employs sophisticated,
data-intensive models to drive the investment process. The
Investment Adviser has full discretion regarding the capital
markets from which it can access investment opportunities in
accordance with the investment limitations set forth in this
prospectus.
The Investment Adviser looks to implement selected trading
strategies to exploit pricing inefficiencies across the credit
markets, or debt markets, and within an individual issuers
capital structure. The Trust seeks to vary its investments by
strategy, industry, security type and credit market, but
reserves the right to re-position its portfolio among these
criteria depending on market dynamics, and thus the Investment
Adviser anticipates that the Trust will experience high
portfolio turnover. The Investment Adviser manages interest
rate, default, currency and systemic risks through a variety of
trading methods and market tools, including derivative hedging
instruments, as it deems appropriate.
The multi-strategy investment program to be implemented by the
Trust will allow the Investment Adviser to assess what it
considers to be the best opportunities across multiple markets
and to adjust quickly the Trusts trading strategies and
market focus to changing conditions. The Investment Adviser
intends to focus primarily on the U.S. marketplace, but may
pursue opportunities in the
non-U.S. credit or
securities markets by investing up to 20% of the Trusts
assets in
non-U.S. credit or
securities market investments.
The Investment Adviser believes that the Trust will benefit from
Highlands industry-focused investment staff and specialist
trading skills as well as its years of investment experience
(since 1993) in leveraged loan, high yield, structured products
and stressed and distressed markets. In finding opportunities,
the Investment Adviser looks to utilize its investment staff of
approximately seventy-nine (79) credit investment
professionals who actively monitor approximately
1,200 companies. Their monitoring of the market and
existing positions assists the Investment Adviser in obtaining
timely and high-quality information on prospective investments.
Additionally, the Investment Adviser has senior professionals
that focus on individual credit markets, such as the stressed
and distressed or structured products segments. This broad staff
of industry, product and market specialists differentiates the
Investment Adviser from numerous other funds other
investment advisers that rely on a limited number of investment
professionals working in a more generalist capacity. The
Investment Adviser believes that credit investing is a
due-diligence intensive process that requires long-term
committed resources to industry, product and market
specialization so that investment decisions are proactive as
opposed to reactive in nature.
The Trust will invest and trade in listed and unlisted, public
and private, rated and unrated, debt and equity instruments and
other obligations, including structured debt and equity
instruments as well as financial derivatives. Investments may
include investments in stressed and distressed positions, which
may include publicly-traded debt and equity securities,
obligations which were privately placed with banks, insurance
companies and other lending institutions, trade claims, accounts
receivable and any other form of obligation recognized as a
claim in a bankruptcy or workout process. The Trust may invest
in securities traded in foreign countries and denominated in
foreign currencies.
As part of its investment program, the Trust may invest, from
time to time, in debt or synthetic instruments that are sold in
direct placement transactions between their issuers and their
purchasers and that
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are neither listed on an exchange, nor traded over the counter.
The Trust may also receive equity or equity-related securities
in connection with a workout transaction or may invest directly
in equity securities.
The Trust may employ currency hedges (either in the forward or
options markets) in certain circumstances to reduce currency
risk and may engage in other derivative transactions for hedging
purposes or to enhance total return. The Trust may also lend
securities and engage in short sales of securities. The Trust
plans to employ leverage in the form of Preferred Shares (as
defined below under Preferred Shares and
Borrowings), borrowing from a credit facility or both, and
the Trust may invest in the securities of companies whose
capital structures are highly leveraged.
From time to time, the Investment Adviser may also invest a
portion of the Trusts assets in short-term
U.S. Government obligations, certificates of deposit,
commercial paper and other money market instruments, including
repurchase agreements with respect to such obligations to enable
the Trust to make investments quickly and to serve as collateral
with respect to certain of its investments. A greater percentage
of Trust assets may be invested in such obligations if the
Investment Adviser believes that a defensive position is
appropriate because of the outlook for security prices or in
order to respond to adverse market, economic, business or
political conditions. From time to time cash balances in the
Trusts brokerage account may be placed in a money market
fund. See The Trusts Investments Investment
Objectives and Policies and The Trusts
Investments Investment Philosophy.
Investment Adviser and Administrator
Highland is the investment adviser and administrator. As of
March 31, 2006, Highland managed approximately
$24.5 billion in assets on behalf of investors around the
world. In return for its advisory services, the Investment
Adviser will receive an annual fee, payable monthly, in an
amount equal to 1.00% of the average weekly value of the
Trusts Managed Assets (the Advisory Fee). In
return for its administration services, Highland will receive an
annual fee, payable monthly, in an amount equal to 0.20% of the
average weekly value of Managed Assets. The Trusts
Managed Assets means the total assets of the Trust,
including any form of investment leverage, minus all accrued
expenses incurred in the normal course of operations, but not
excluding any liabilities or obligations attributable to
investment leverage obtained through (i) indebtedness of
any type (including, without limitation, borrowing through a
credit facility or the issuance of debt securities),
(ii) the issuance of preferred stock or other similar
preference securities, (iii) the reinvestment of collateral
received for securities loaned in accordance with the
Trusts investment objectives and policies, and/or
(iv) any other means. Highland, at its own expense, has the
authority to engage both a sub-adviser and a sub-administrator,
each of which may be an affiliate of Highland. See
Management of the Trust Investment Adviser and
Management of the Trust Administrator/
Sub-Administrator.
Potential Conflicts of Interest. If the Trust employs
leverage, the Investment Adviser will benefit because the
Trusts Managed Assets will increase with leverage.
Furthermore, the Investment Adviser will also benefit to the
extent that the Trusts Managed Assets are derived from the
reinvested collateral received on portfolio securities loaned.
See Management of the Trust Investment
Adviser.
Preferred Shares and Borrowings
During its first full year of operations, the Trust intends to
employ leverage (through the issuance of preferred shares of
beneficial interest (Preferred Shares), borrowing of
money or a combination) at the time the leverage is incurred in
an amount up to 30% of the Trusts total assets (including
the proceeds of all such leverage). Thereafter total leverage of
the Trust is expected to range between 20% to 50% of the
Trusts Managed Assets. The Trust may borrow from banks and
other financial institutions.
The Trust currently intends to issue Preferred Shares
approximately one to six months following the completion of this
offering. The issuance of Preferred Shares will leverage your
investment in common shares. If the Trust offers Preferred
Shares, costs of that offering will be borne immediately by
common shareholders and result in a reduction of the net asset
value of the common shares estimated to be $0.07 per common
share assuming approximately $165.7 million liquidation
value of Preferred Shares are issued in the Preferred Share
offering and 30,430,000 common shares are issued in this
offering. See Summary of Trust Expenses.
Any
3
issuance of Preferred Shares, commercial paper, notes or other
types of borrowing will have seniority over the common shares.
Any Preferred Shares issued by the Trust will pay dividends
based on short-term rates, which will be reset frequently.
Borrowings may be at a fixed or floating rate and generally will
be based on short-term rates. So long as the rate of return, net
of applicable Trust expenses, on the Trusts portfolio
investments purchased with leverage exceeds the Preferred Share
dividend rate, as reset periodically, or the interest rate on
any borrowings, the Trust will generate more return or income
than will be needed to pay such dividends or interest payments.
In this event, the excess will be available to pay higher
dividends to holders of common shares. When leverage is
employed, the net asset value and market price of the common
shares and the yield to holders of common shares will be more
volatile. Leverage creates a greater risk of loss, as well as a
potential for more gain, for the common shares than if leverage
is not used. The Trusts leveraging strategy may not be
successful. See Principal Risks of the Trust
Leverage Risk.
Distributions
Commencing with the Trusts initial dividend, the Trust
intends to make regular monthly cash dividends of all or
substantially all of its investment company taxable income to
common shareholders. Subject to market conditions, we expect to
declare the initial monthly dividend on the Trusts common
shares within approximately 45 days after completion of
this offering and to pay that initial monthly dividend
approximately 60 to 90 days after completion of this
offering. The Trust expects to pay common shareholders annually
at least 90% of its investment company taxable income. The Trust
intends to pay any capital gain distributions annually.
Various factors will affect the level of the Trusts
current income and current gains, such as its asset mix and the
Trusts use of options. To permit the Trust to maintain
more stable monthly dividends and annual distributions, the
Trust may from time to time distribute less than the entire
amount of income and gains earned in the relevant month or year,
respectively. The undistributed income and gains would be
available to supplement future distributions. As a result, the
distributions paid by the Trust for any particular period may be
more or less than the amount of income and gains actually earned
by the Trust during the applicable period. Undistributed income
and gains will add to the Trusts net asset value and,
correspondingly, distributions from undistributed income and
gains and from capital, if any, will be deducted from the
Trusts net asset value. See Distributions.
Shareholders will automatically have all dividends and
distributions reinvested in common shares issued by the Trust or
common shares of the Trust purchased in the open market in
accordance with the Trusts Dividend Reinvestment Plan
unless an election is made to receive cash. Each participant in
the Trusts Dividend Reinvestment Plan will pay a pro rata
portion of brokerage commissions incurred in connection with
open market purchases, and participants requesting a sale of
securities through the plan agent of the Trusts Dividend
Reinvestment Plan are subject to a sales fee and a brokerage
commission. See Dividend Reinvestment Plan and
Distributions.
Listing
The Trust anticipates that its common shares will be listed on
the New York Stock Exchange under the symbol HCF.
Custodian and Transfer Agent
PFPC Trust Company, located at 8800 Tinicum Blvd., 4th Floor,
Philadelphia, PA 19153, will serve as custodian for the Trust,
and in such capacity, will maintain certain financial and
accounting books and records pursuant to an agreement with the
Trust. PFPC, Inc., located at 301 Bellevue Parkway,
Wilmington, Delaware 19809, will serve as the Trusts
transfer agent. See Custodian and Transfer Agent.
Market Price of Shares
Common shares of closed-end investment companies frequently
trade at prices lower than their net asset value. The Trust
cannot assure you that its common shares will trade at a price
higher than or equal to net asset value. The Trusts net
asset value will be reduced immediately following this offering
by the sales load and the amount of the offering costs paid by
the Trust. See Use of Proceeds. In addition to net
asset value,
4
the market price of the Trusts common shares may be
affected by such factors as dividend levels, which are in turn
affected by expenses, dividend stability, liquidity and market
supply and demand. See Principal Risks of the Trust
and Description of Capital Structure in this
prospectus and Repurchase of Common Shares in the
Statement of Additional Information. The common shares are
designed primarily for long-term investors, and you should not
purchase common shares of the Trust if you intend to sell them
shortly after purchase.
Principal Risks of the Trust
The following is a summary of some of the risks associated with
an investment in the Trusts common shares. Investors
should also refer to Principal Risks of the Trust in
this prospectus for a more detailed explanation of the risks
associated with investing in the Trusts common shares.
No Operating History. The Trust is a newly
organized, non-diversified, closed-end management investment
company with no operating history.
Investment and Market Discount Risk. An investment
in the Trusts common shares is subject to investment risk,
including the possible loss of the entire amount that you
invest. As with any stock, the price of the Trusts shares
will fluctuate with market conditions and other factors. If
shares are sold, the price received may be more or less than the
original investment. Net asset value will be reduced immediately
following the initial offering by 4.50% (the amount of the sales
load) and offering expenses paid by the Trust (estimated to be
an additional 0.20%), excluding the estimated expenses of the
Preferred Share offering which is expected to occur soon after
the completion of this offering, described above under
Preferred Shares and Borrowings. Any
Preferred Share offering and the costs and expenses of any
borrowing would result in further dilution, as described above
under Preferred Shares and Borrowings.
Common shares are designed for long-term investors and should
not be treated as trading vehicles. Shares of closed-end
management investment companies frequently trade at a discount
to their net asset value. The Trusts shares may trade at a
price that is less than the initial offering price. This risk
may be greater for investors who sell their shares in a
relatively short period of time after completion of the initial
offering.
Risks of Non-Diversification and Other Focused
Strategies. While the Investment Adviser will invest in
a number of fixed-income and equity instruments issued by
different issuers and plans to employ multiple investment
strategies with respect to the Trusts portfolio, it is
possible that a significant amount of the Trusts
investments could be invested in the instruments of only a few
companies or other issuers or that at any particular point in
time one investment strategy could be more heavily weighted than
the others. The focus of the Trusts portfolio in any one
issuer would subject the Trust to a greater degree of risk with
respect to defaults by such issuer or other adverse events
affecting that issuer, and the focus of the portfolio in any one
industry or group of industries (but not to the extent of 25% of
the Trusts total assets) would subject the Trust to a
greater degree of risk with respect to economic downturns
relating to such industry. The focus of the Trusts
portfolio in any one investment strategy would subject the Trust
to a greater degree of risk than if the Trusts portfolio
were varied in its investments with respect to several
investment strategies.
Illiquidity of Investments. The investments made
by the Trust may be very illiquid, and consequently, the Trust
may not be able to sell such investments at prices that reflect
the Investment Advisers assessment of their fair value or
the amount paid for such investments by the Trust. Illiquidity
may result from the absence of an established market for the
investments as well as legal, contractual or other restrictions
on their resale by the Trust and other factors. Furthermore, the
nature of the Trusts investments, especially those in
financially stressed and distressed companies, may require a
long holding period prior to being able to determine whether the
investment will be profitable or not. There is no limit on the
amount of the Trusts portfolio that can be invested in
illiquid securities.
Risks of Investing in Senior Loans. Senior loans,
such as bank loans, are typically at the most senior level of
the capital structure, and are sometimes secured by specific
collateral, including, but not limited to, trademarks, patents,
accounts receivable, inventory, equipment, buildings, real
estate, franchises and common and preferred stock of the obligor
or its affiliates. A portion of the Trusts investments may
consist of loans and participations therein originated by banks
and other financial institutions, typically referred to as
bank loans. The Trusts investments may include
loans of a type generally incurred by borrowers in connection
with highly
5
leveraged transactions, often to finance internal growth,
acquisitions, mergers or stock purchases, or for other reasons.
As a result of the additional debt incurred by the borrower in
the course of the transaction, the borrowers
creditworthiness is often judged by the rating agencies to be
below investment grade. Such loans are typically private
corporate loans which are negotiated by one or more commercial
banks or financial institutions and syndicated among a group of
commercial banks and financial institutions. In order to induce
the lenders to extend credit and to offer a favorable interest
rate, the borrower often provides the lenders with extensive
information about its business which is not generally available
to the public.
Bank loans often contain restrictive covenants designed to limit
the activities of the borrower in an effort to protect the right
of lenders to receive timely payments of principal and interest.
Such covenants may include restrictions on dividend payments,
specific mandatory minimum financial ratios, limits on total
debt and other financial tests. Bank loans usually have shorter
terms than subordinated obligations and may require mandatory
prepayments from excess cash flow, asset dispositions and
offerings of debt and/or equity securities. The bank loans and
other debt obligations to be acquired by the Trust are likely to
be below investment grade.
The Trust may acquire interests in bank loans and other debt
obligations either directly (by way of sale or assignment) or
indirectly (by way of participation). The purchaser of an
assignment typically succeeds to all the rights and obligations
of the assigning institution and becomes a lender under the
credit agreement with respect to the debt obligation; however,
its rights can be more restricted than those of the assigning
institution, and, in any event, the Trust may not be able
unilaterally to enforce all rights and remedies under the loan
and any associated collateral. A participation interest in a
portion of a debt obligation typically results in a contractual
relationship only with the institution participating out the
interest, not with the borrower. In purchasing participations,
the Trust generally will have no right to enforce compliance by
the borrower with neither the terms of the loan agreement nor
any rights of setoff against the borrower, and the Trust may not
directly benefit from the collateral supporting the debt
obligation in which it has purchased the participation. As a
result, the Trust will be exposed to the credit risk of both the
borrower and the institution selling the participation.
Purchasers of bank loans are predominantly commercial banks,
investment trusts and investment banks. As secondary market
trading volumes increase, new bank loans frequently adopt
standardized documentation to facilitate loan trading which
should improve market liquidity. There can be no assurance,
however, that future levels of supply and demand in bank loan
trading will provide an adequate degree of liquidity or that the
current level of liquidity will continue. Because of the
provision to holders of such loans of confidential information
relating to the borrower, the unique and customized nature of
the loan agreement, the limited universe of eligible purchasers
and the private syndication of the loan, bank loans are not as
easily purchased or sold as a publicly traded security, and
historically the trading volume in the bank loan market has been
small relative to the high-yield debt market.
Second Lien Loans Risk. Second lien loans are
subject to the same risks associated with investment in senior
loans and non-investment grade securities. See
Non-Investment Grade Securities Risk. However,
second lien loans are second in right of payment to senior loans
and therefore are subject to additional risk that the cash flow
of the borrower and any property securing the loan may be
insufficient to meet scheduled payments after giving effect to
the senior secured obligations of the borrower. Second lien
loans are expected to have greater price volatility than senior
loans and may be less liquid. There is also a possibility that
originators will not be able to sell participations in second
lien loans, which would create greater credit risk exposure.
Other Secured Loans Risk. Secured loans other than
senior loans and second lien loans are subject to the same risks
associated with investment in senior loans, second lien loans
and non-investment grade securities. However, such loans may
rank lower in right of payment than any outstanding senior loans
and second lien loans of the borrower and therefore are subject
to additional risk that the cash flow of the borrower and any
property securing the loan may be insufficient to meet scheduled
payments after giving effect to the higher ranking secured
obligations of the borrower. Lower ranking secured loans are
expected to have greater price volatility than senior loans and
second lien loans and may be less liquid. There is also a
possibility that
6
originators will not be able to sell participations in lower
ranking secured loans, which would create greater credit risk
exposure.
Unsecured Loans Risk. Unsecured loans are subject
to the same risks associated with investment in senior loans,
second lien loans, other secured loans and non-investment grade
securities. However, because unsecured loans have lower priority
in right of payment to any higher ranking obligations of the
borrower and are not backed by a security interest in any
specific collateral, they are subject to additional risk that
the cash flow of the borrower and available assets may be
insufficient to meet scheduled payments after giving effect to
any higher ranking obligations of the borrower. Unsecured loans
are expected to have greater price volatility than senior loans,
second lien loans and other secured loans and may be less
liquid. There is also a possibility that originators will not be
able to sell participations in unsecured loans, which would
create greater credit risk exposure.
Risks of Investing in Obligations of Stressed, Distressed
and Bankrupt Issuers. The Trust is authorized to invest
in the securities and other obligations of stressed, distressed
and bankrupt issuers, including debt obligations that are in
covenant or payment default. There is no limit on the amount of
the Trusts portfolio that can be invested in stressed,
distressed or bankrupt issuers, and the Trust may invest for
purposes of control. Such investments generally trade
significantly below par and are considered speculative. The
repayment of defaulted obligations is subject to significant
uncertainties. Defaulted obligations might be repaid only after
lengthy workout or bankruptcy proceedings, during which the
issuer might not make any interest or other payments. Typically
such workout or bankruptcy proceedings result in only partial
recovery of cash payments or an exchange of the defaulted
obligation for other debt or equity securities of the issuer or
its affiliates, which may in turn be illiquid or speculative.
There are a number of significant risks inherent in the
bankruptcy process. First, many events in a bankruptcy are the
product of contested matters and adversary proceedings and are
beyond the control of the creditors. While creditors are
generally given an opportunity to object to significant actions,
there can be no assurance that a bankruptcy court in the
exercise of its broad powers would not approve actions that
would be contrary to the interests of the Trust. Second, a
bankruptcy filing by an issuer may adversely and permanently
affect the issuer. The issuer may lose its market position and
key employees and otherwise become incapable of restoring itself
as a viable entity. If for this or any other reason the
proceeding is converted to a liquidation, the value of the
issuer may not equal the liquidation value that was believed to
exist at the time of the investment. Third, the duration of a
bankruptcy proceeding is difficult to predict. A creditors
return on investment can be adversely affected by delays while
the plan of reorganization is being negotiated, approved by the
creditors and confirmed by the bankruptcy court and until it
ultimately becomes effective. Fourth, the administrative costs
in connection with a bankruptcy proceeding are frequently high
and would be paid out of the debtors estate prior to any
return to creditors. For example, if a proceeding involves
protracted or difficult litigation, or turns into a liquidation,
substantial assets may be devoted to administrative costs.
Fifth, bankruptcy law permits the classification of
substantially similar claims in determining the
classification of claims in a reorganization. Because the
standard for classification is vague, there exists the risk that
the Trusts influence with respect to the class of
securities or other obligations it owns can be lost by increases
in the number and amount of claims in that class or by different
classification and treatment. Sixth, in the early stages of the
bankruptcy process it is often difficult to estimate the extent
of, or even to identify, any contingent claims that might be
made. Seventh, especially in the case of investments made prior
to the commencement of bankruptcy proceedings, creditors can
lose their ranking and priority if they exercise
domination and control over a debtor and other
creditors can demonstrate that they have been harmed by such
actions. Eighth, certain claims that have priority by law (for
example, claims for taxes) may be substantial.
In any investment involving stressed and distressed debt
obligations, there exists the risk that the transaction
involving such debt obligations will be unsuccessful, take
considerable time or will result in a distribution of cash or a
new security or obligation in exchange for the stressed and
distressed debt obligations, the value of which may be less than
the Trusts purchase price of such debt obligations.
Furthermore, if an anticipated transaction does not occur, the
Trust may be required to sell its investment at a loss. Given
the substantial uncertainties concerning transactions involving
stressed and distressed debt obligations in which
7
the Trust invests, there is a potential risk of loss by the
Trust of its entire investment in any particular investment.
Investments in companies operating in workout modes or under
Chapter 11 of the Bankruptcy Code are also, in certain
circumstances, subject to certain additional liabilities which
may exceed the value of the Trusts original investment in
a company. For example, under certain circumstances, creditors
who have inappropriately exercised control over the management
and policies of a debtor may have their claims subordinated or
disallowed or may be found liable for damages suffered by
parties as a result of such actions. The Investment
Advisers active management style may present a greater
risk in this area than would a more passive approach. In
addition, under certain circumstances, payments to the Trust and
distributions by the Trust or payments on the debt may be
reclaimed if any such payment is later determined to have been a
fraudulent conveyance or a preferential payment.
The Investment Adviser on behalf of the Trust may participate on
committees formed by creditors to negotiate with the management
of financially troubled companies that may or may not be in
bankruptcy or may negotiate directly with debtors with respect
to restructuring issues. If the Trust does choose to join a
committee, the Trust would likely be only one of many
participants, all of whom would be interested in obtaining an
outcome that is in their individual best interests. There can be
no assurance that the Trust would be successful in obtaining
results most favorable to it in such proceedings, although the
Trust may incur significant legal and other expenses in
attempting to do so. As a result of participation by the Trust
on such committees, the Trust may be deemed to have duties to
other creditors represented by the committees, which might
thereby expose the Trust to liability to such other creditors
who disagree with the Trusts actions. Participation by the
Trust on such committees may cause the Trust to be subject to
certain restrictions on its ability to trade in a particular
investment and may also make the Trust an insider or
an underwriter for purposes of the federal
securities laws. Either circumstance will restrict the
Trusts ability to trade in or acquire additional positions
in a particular investment when it might otherwise desire to do
so.
Risks of Investing in High-Yield Securities. A
portion of the Trusts investments will consist of
investments that may generally be characterized as
high-yield securities or junk
securities. Such securities are typically rated below
investment grade by one or more nationally recognized
statistical rating organizations or are unrated but of
comparable credit quality to obligations rated below investment
grade, and have greater credit and liquidity risk than more
highly rated obligations. High-yield securities are generally
unsecured and may be subordinate to other obligations of the
obligor. The lower rating of high-yield securities reflects a
greater possibility that adverse changes in the financial
condition of the issuer or in general economic conditions
(including, for example, a substantial period of rising interest
rates or declining earnings) or both may impair the ability of
the issuer to make payment of principal and interest. Many
issuers of high-yield securities are highly leveraged, and their
relatively high debt to equity ratios create increased risks
that their operations might not generate sufficient cash flow to
service their obligations. Overall declines in the below
investment grade bond and other markets may adversely affect
such issuers by inhibiting their ability to refinance their
obligations at maturity.
High-yield securities are often issued in connection with
leveraged acquisitions or recapitalizations in which the issuers
incur a substantially higher amount of indebtedness than the
level at which they had previously operated. High-yield
securities that are debt instruments have historically
experienced greater default rates than has been the case for
investment grade securities. The Trust may also invest in equity
securities issued by entities whose obligations are unrated or
are rated below investment grade.
The Trust is authorized to invest in obligations of issuers
which are generally trading at significantly higher yields than
had been historically typical of the applicable issuers
obligations. Such investments may include debt obligations that
have a heightened probability of being in covenant or payment
default in the future. Such investments generally are considered
speculative. The repayment of defaulted obligations is subject
to significant uncertainties. Defaulted obligations might be
repaid only after lengthy workout or bankruptcy proceedings,
during which the issuer might not make any interest or other
payments. Typically such workout or bankruptcy proceedings
result in only partial recovery of cash payments or an exchange
of the
8
defaulted security for other debt or equity securities of the
issuer or its affiliates, which may in turn be illiquid or
speculative.
High-yield securities purchased by the Trust will be subject to
certain additional risks to the extent that such obligations may
be unsecured and subordinated to substantial amounts of senior
indebtedness, all or a significant portion of which may be
secured. Moreover, such obligations purchased by the Trust may
not be protected by financial covenants or limitations upon
additional indebtedness and are unlikely to be secured by
collateral.
Insolvency Considerations with Respect to Issuers of Debt
Obligations. Various laws enacted for the protection of
creditors may apply to the debt obligations held by the Trust.
The information in this paragraph is applicable with respect to
U.S. issuers subject to United States bankruptcy laws.
Insolvency considerations may differ with respect to other
issuers. If a court in a lawsuit brought by an unpaid creditor
or representative of creditors of an issuer of a debt
obligation, such as a trustee in bankruptcy, were to find that
the issuer did not receive fair consideration or reasonably
equivalent value for incurring the indebtedness constituting the
debt obligation and, after giving effect to such indebtedness,
the issuer (i) was insolvent, (ii) was engaged in a
business for which the remaining assets of such issuer
constituted unreasonably small capital or (iii) intended to
incur, or believed that it would incur, debts beyond its ability
to pay such debts as they mature, such court could determine to
invalidate, in whole or in part, such indebtedness as a
fraudulent conveyance, to subordinate such indebtedness to
existing or future creditors of such issuer, or to recover
amounts previously paid by such issuer in satisfaction of such
indebtedness. The measure of insolvency for purposes of the
foregoing will vary. Generally, an issuer would be considered
insolvent at a particular time if the sum of its debts were then
greater than all of its property at a fair valuation, or if the
present fair saleable value of its assets was then less than the
amount that would be required to pay its probable liabilities on
its existing debts as they became absolute and matured. There
can be no assurance as to what standard a court would apply in
order to determine whether the issuer was insolvent
after giving effect to the incurrence of the indebtedness
constituting the debt obligation or that, regardless of the
method of valuation, a court would not determine that the issuer
was insolvent upon giving effect to such incurrence.
In addition, in the event of the insolvency of an issuer of a
debt obligation, payments made on such debt obligation could be
subject to avoidance as a preference if made within
a certain period of time (which may be as long as one year)
before insolvency. Similarly, a court might apply the doctrine
of equitable subordination to subordinate the claim of a lending
institution against an issuer, to claims of other creditors of
the borrower, when the lending institution, another investor, or
any of their transferees, is found to have engaged in unfair,
inequitable, or fraudulent conduct. In general, if payments on a
debt obligation are avoidable, whether as fraudulent conveyances
or preferences, such payments can be recaptured either from the
initial recipient (such as the Trust) or from subsequent
transferees of such payments (such as the investors in the
Trust). To the extent that any such payments are recaptured from
the Trust the resulting loss will be borne by the investors.
However, a court in a bankruptcy or insolvency proceeding would
be able to direct the recapture of any such payment from such a
recipient or transferee only to the extent that such court has
jurisdiction over such recipient or transferee or its assets.
Moreover, it is likely that avoidable payments could not be
recaptured directly from any such recipient or transferee that
has given value in exchange for its note, in good faith and
without knowledge that the payments were avoidable. Although the
Investment Adviser will seek to avoid conduct that would form
the basis for a successful cause of action based upon fraudulent
conveyance, preference or equitable subordination, these
determinations are made in hindsight, and, in any event, there
can be no assurance as to whether any lending institution or
other investor from which the Trust acquired the debt
obligations engaged in any such conduct (or any other conduct
that would subject the debt obligations and the issuer to
insolvency laws) and, if it did, as to whether such creditor
claims could be asserted in a U.S. court (or in the courts
of any other country) against the Trust.
Risks of Investing in Stressed, Distressed or Bankrupt
Companies. The Trust may invest in companies that are
stressed, in distress, or bankrupt. As such, they are subject to
a multitude of legal, industry, market, economic and
governmental forces that make analysis of these companies
inherently difficult. Further, the Investment Adviser relies on
company management, outside experts, market participants and
personal experience to analyze potential investments for the
Trust. There can be no assurance that any of these sources
9
will prove credible, or that the Investment Advisers
analysis will produce conclusions that lead to profitable
investments.
Leverage Risk. The Trust intends to use leverage
through the issuance of Preferred Shares, borrowings from a
credit facility or both. The use of leverage, which can be
described as exposure to changes in price at a ratio greater
than the amount of equity invested, either through the issuance
of Preferred Shares, borrowing or other forms of market
exposure, magnifies both the favorable and unfavorable effects
of price movements in the investments made by the Trust. Insofar
as the Trust employs leverage in its investment operations, the
Trust will be subject to substantial risks of loss.
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Preferred Share Risk. Preferred Share risk is the risk
associated with the issuance of the Preferred Shares to leverage
the common shares. As described above under
Preferred Shares and Borrowings, the Trust
intends to issue Preferred Shares. If Preferred Shares are
issued, the net asset value and market value of the common
shares will be more volatile, and the yield to the holders of
common shares will tend to fluctuate with changes in the
shorter-term dividend rates on the Preferred Shares. If the
dividend rate on the Preferred Shares approaches the net rate of
return on the Trusts investment portfolio, the benefit of
leverage to the holders of the common shares would be reduced.
If the dividend rate on the Preferred Shares exceeds the net
rate of return on the Trusts portfolio, the leverage will
result in a lower rate of return to the holders of common shares
than if the Trust had not issued Preferred Shares.
In addition, the Trust will pay (and the holders of common
shares will bear) all costs and expenses relating to the
issuance and ongoing maintenance of the Preferred Shares,
including higher advisory fees. Accordingly, the Trust cannot
assure you that the issuance of Preferred Shares will result in
a higher yield or return to the holders of the common shares.
Costs of the offering of Preferred Shares, estimated to be
approximately 1.24% of the total dollar amount of the Preferred
Share offering, will be borne immediately by the Trusts
common shareholders and result in a reduction of net asset value
of the common shares. The percentage assumes approximately
$165.7 million liquidation value of Preferred Shares are
issued in the Preferred Share offering and 30,430,000 common
shares are issued in this offering.
Similarly, any decline in the net asset value of the
Trusts investments will be borne entirely by the holders
of common shares. Therefore, if the market value of the
Trusts portfolio declines, the leverage will result in a
greater decrease in net asset value to the holders of common
shares than if the Trust were not leveraged. This greater net
asset value decrease will also tend to cause a greater decline
in the market price for the common shares. The Trust might be in
danger of failing to maintain the required asset coverage of the
Preferred Shares or of losing its ratings on the Preferred
Shares or, in an extreme case, the Trusts current
investment income might not be sufficient to meet the dividend
requirements on the Preferred Shares. In order to counteract
such an event, the Trust might need to liquidate investments in
order to fund a redemption of some or all of the Preferred
Shares. Liquidation at times of low municipal bond prices may
result in capital loss and may reduce returns to the holders of
common shares. |
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Preferred Shareholders may have Disproportionate Influence
over the Trust. If Preferred Shares are issued, holders of
Preferred Shares may have differing interests than holders of
common shares and holders of Preferred Shares may at times have
disproportionate influence over the Trusts affairs. If
Preferred Shares are issued, holders of Preferred Shares, voting
separately as a single class, would have the right to elect two
members of the board of trustees at all times. The remaining
members of the board of trustees would be elected by holders of
common shares and Preferred Shares, voting as a single class.
The Investment Company Act of 1940 (the Investment Company
Act) also requires that, in addition to any approval by
shareholders that might otherwise be required, the approval of
the holders of a majority of any outstanding Preferred Shares,
voting separately as a class, would be required to
(i) adopt any plan of reorganization that would adversely
affect the Preferred Shares and (ii) take any action
requiring a vote of security holders under Section 13(a) of
the Investment |
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Company Act, including, among other things, changes in the
Trusts subclassification as a closed-end investment
company or changes in its fundamental investment restrictions. |
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Portfolio Guidelines of Rating Agencies for Preferred Share
and/or Credit Facility. In order to obtain and maintain the
required ratings of loans from a credit facility, the Trust will
be required to comply with investment quality, diversification
and other guidelines established by Moodys and/or S&P
or the credit facility, respectively. Such guidelines will
likely be more restrictive than the restrictions otherwise
applicable to the Trust as described in this prospectus or in
the Statement of Additional Information. The Trust does not
anticipate that such guidelines would have a material adverse
effect on the Trusts holders of common shares or its
ability to achieve its investment objectives. The Trust
anticipates that any Preferred Shares that it issues would be
initially given the highest ratings by Moodys
(Aaa) or by S&P (AAA), but no
assurance can be given that such ratings will be obtained. No
minimum rating is required for the issuance of Preferred Shares
by the Trust. Moodys and S&P receive fees in
connection with their ratings issuances. |
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Credit Facility. In the event the Trust leverages through
borrowings, the Trust may enter into definitive agreements with
respect to a credit facility. The Trust may negotiate with
commercial banks to arrange a credit facility pursuant to which
the Trust would be entitled to borrow an amount equal to
approximately one-third of the Trusts total assets
(inclusive of the amount borrowed) offered hereby. Any such
borrowings would constitute financial leverage. Such a facility
is not expected to be convertible into any other securities of
the Trust. Any outstanding amounts are expected to be prepayable
by the Trust prior to final maturity without significant
penalty, and there are not expected to be any sinking fund or
mandatory retirement provisions. Outstanding amounts would be
payable at maturity or such earlier times as required by the
agreement. The Trust may be required to prepay outstanding
amounts under the facility or incur a penalty rate of interest
in the event of the occurrence of certain events of default. The
Trust would be expected to indemnify the lenders under the
facility against liabilities they may incur in connection with
the facility. The Trust may be required to pay commitment fees
under the terms of any such facility. With the use of
borrowings, there is a risk that the interest rates paid by the
Trust on the amount it borrows will be higher than the return on
the Trusts investments.
The Trust expects that such a credit facility would contain
covenants that, among other things, likely will limit the
Trusts ability to: (i) pay dividends in certain
circumstances, (ii) incur additional debt and
(iii) change its fundamental investment policies and engage
in certain transactions, including mergers and consolidations.
In addition, it may contain a covenant requiring asset coverage
ratios in addition to those required by the Investment Company
Act. The Trust may be required to pledge its assets and to
maintain a portion of its assets in cash or high-grade
securities as a reserve against interest or principal payments
and expenses. The Trust expects that any credit facility would
have customary covenant, negative covenant and default
provisions. There can be no assurance that the Trust will enter
into an agreement for a credit facility on terms and conditions
representative of the foregoing or that additional material
terms will not apply. In addition, if entered into, any such
credit facility may in the future be replaced or refinanced by
one or more credit facilities having substantially different
terms or by the issuance of Preferred Shares. |
Common Stock Risk. The Trust will have exposure to
common stocks. Although common stocks have historically
generated higher average total returns than fixed income
securities over the long-term, common stocks also have
experienced significantly more volatility in those returns and
in recent years have significantly under-performed relative to
debt securities. Therefore, the Trusts exposure to common
stocks could result in worse performance than would be the case
had the Trust been invested solely in debt securities. An
adverse event, such as an unfavorable earnings report, may
depress the value of a particular common stock held by the
Trust. Also, the price of common stocks is sensitive to general
movements in the stock market and a drop in the stock market may
depress the price of common stocks to which the Trust has
exposure. Common stock prices fluctuate for several reasons,
including changes in investors perceptions of the
financial condition of an issuer or the general condition of the
relevant stock market, or when political or economic events
affecting the
11
issuers occur. In addition, common stock prices may be
particularly sensitive to rising interest rates, as the cost of
capital rises and borrowing costs increase.
Dividend Risk. Dividends on common stock are not
fixed but are declared at the discretion of an issuers
board of directors. There is no guarantee that the issuers of
the common stocks in which the Trust invests will declare
dividends in the future or that if declared they will remain at
current levels or increase over time. See Principal Risks
of the TrustDividend Risk.
Small and Mid-Cap Securities Risk. The Trust may
invest in companies with small or medium capitalizations.
Securities issued by smaller and medium companies can be more
volatile than, and perform differently from, larger company
securities. There may be less trading in a smaller or medium
companys securities, which means that buy and sell
transactions in those securities could have a larger impact on
the securitys price than is the case with larger company
securities. Smaller and medium companies may have fewer business
lines; changes in any one line of business, therefore, may have
a greater impact on a smaller or medium companys security
price than is the case for a larger company. In addition,
smaller or medium company securities may not be well known to
the investing public.
Non-U.S. Securities
Risk. The Trust may invest up to 20% of its total assets
in
non-U.S. securities,
including emerging market securities. Investing in
non-U.S. securities
involves certain risks not involved in domestic investments,
including, but not limited to: (i) fluctuations in foreign
exchange rates; (ii) future foreign economic, financial,
political and social developments; (iii) different legal
systems; (iv) the possible imposition of exchange controls
or other foreign governmental laws or restrictions;
(v) lower trading volume; (vi) much greater price
volatility and illiquidity of certain
non-U.S. securities
markets; (vii) different trading and settlement practices;
(viii) less governmental supervision; (ix) changes in
currency exchange rates; (x) high and volatile rates of
inflation; (xi) fluctuating interest rates; (xii) less
publicly available information; and (xiii) different
accounting, auditing and financial recordkeeping standards and
requirements.
Certain countries in which the Trust may invest, especially
emerging market countries, historically have experienced, and
may continue to experience, high rates of inflation, high
interest rates, exchange rate fluctuations, large amounts of
external debt, balance of payments and trade difficulties and
extreme poverty and unemployment. Many of these countries are
also characterized by political uncertainty and instability.
These risks are especially evident in the Middle East and West
Africa. The cost of servicing external debt will generally be
adversely affected by rising international interest rates
because many external debt obligations bear interest at rates
which are adjusted based upon international interest rates. In
addition, with respect to certain foreign countries, there is a
risk of: (i) the possibility of expropriation or
nationalization of assets; (ii) confiscatory taxation;
(iii) difficulty in obtaining or enforcing a court
judgment; (iv) economic, political or social instability;
and (v) diplomatic developments that could affect
investments in those countries.
Because the Trust will invest in securities denominated or
quoted in currencies other than the U.S. dollar, changes in
foreign currency exchange rates may affect the value of
securities in the Trust and the unrealized appreciation or
depreciation of investments. Currencies of certain countries may
be volatile and therefore may affect the value of securities
denominated in such currencies, which means that the
Trusts net asset value or current income could decline as
a result of changes in the exchange rates between foreign
currencies and the U.S. dollar. Certain investments in
non-U.S. securities
also may be subject to foreign withholding taxes. These risks
often are heightened for investments in smaller, emerging
capital markets. In addition, individual foreign economies may
differ favorably or unfavorably from the U.S. economy in
such respects as: (i) growth of gross domestic product;
(ii) rates of inflation; (iii) capital reinvestment;
(iv) resources; (v) self-sufficiency; and
(vi) balance of payments position.
As a result of these potential risks, Highland may determine
that, notwithstanding otherwise favorable investment criteria,
it may not be practicable or appropriate to invest in a
particular country. The Trust may invest in countries in which
foreign investors, including Highland, have had no or limited
prior experience.
Emerging Markets Risk. The Trust may invest up to
20% of its total assets in securities of issuers based in
emerging markets. Investing in securities of issuers based in
underdeveloped emerging markets entails all of the risks of
investing in securities of
non-U.S. issuers
to a heightened degree. Emerging market countries
12
generally include every nation in the world except the United
States, Canada, Japan, Australia, New Zealand and most countries
located in Western Europe. These heightened risks include:
(i) greater risks of expropriation, confiscatory taxation,
nationalization, and less social, political and economic
stability; (ii) the smaller size of the markets for such
securities and a lower volume of trading, resulting in lack of
liquidity and in price volatility; and (iii) certain
national policies which may restrict the Trusts investment
opportunities including restrictions on investing in issuers or
industries deemed sensitive to relevant national interests.
Foreign Currency Risk. Because the Trust may
invest in securities denominated or quoted in currencies other
than the U.S. dollar, changes in foreign currency exchange
rates may affect the value of securities owned by the Trust, the
unrealized appreciation or depreciation of investments and gains
on and income from investments. Currencies of certain countries
may be volatile and therefore may affect the value of securities
denominated in such currencies, which means that the
Trusts net asset value could decline as a result of
changes in the exchange rates between foreign currencies and the
U.S. dollar. In addition, the Trust may enter into foreign
currency transactions in an attempt to enhance total return
which may further expose the Trust to the risks of foreign
currency movements and other risks.
Investments in Unseasoned Companies. The Trust may
invest in the securities of smaller, less seasoned companies.
These investments may present greater opportunities for growth,
but also involve greater risks than customarily are associated
with investments in securities of more established companies.
Some of the companies in which the Trust may invest will be
start-up companies
which may have insubstantial operational or earnings history or
may have limited products, markets, financial resources or
management depth. Some may also be emerging companies at the
research and development stage with no products or technologies
to market or approved for marketing. Securities of emerging
companies may lack an active secondary market and may be subject
to more abrupt or erratic price movements than securities of
larger, more established companies or stock market averages in
general. Competitors of certain companies may have substantially
greater financial resources than many of the companies in which
the Trust may invest.
Initial Public Offerings (IPOs) Risk. The Trust
may invest in shares of companies through IPOs. IPOs and
companies that have recently gone public have the potential to
produce substantial gains for the Trust, subject to the
Trusts option writing strategy. However, there is no
assurance that the Trust will have access to profitable IPOs.
The investment performance of the Trust during periods when it
is unable to invest significantly or at all in IPOs may be lower
than during periods when the Trust is able to do so. Securities
issued in IPOs are subject to many of the same risks as
investing in companies with smaller market capitalizations.
Securities issued in IPOs have no trading history, and
information about the companies may be available for limited
periods of time. In addition, the prices of securities sold in
IPOs may be highly volatile or may decline shortly after the IPO.
Securities Lending Risk. The Trust may lend its
portfolio securities (up to a maximum of one-third of its total
assets) to banks or dealers which meet the creditworthiness
standards established by the board of trustees of the Trust.
Securities lending is subject to the risk that loaned securities
may not be available to the Trust on a timely basis and the
Trust may, therefore, lose the opportunity to sell the
securities at a desirable price. Any loss in the market price of
securities loaned by the Trust that occurs during the term of
the loan would be borne by the Trust and would adversely affect
the Trusts performance. Also, there may be delays in
recovery, or no recovery, of securities loaned or even a loss of
rights in the collateral should the borrower of the securities
fail financially while the loan is outstanding. These risks may
be greater for
non-U.S. securities.
Risks Associated with Options on Securities. There
are several risks associated with transactions in options on
securities. For example, there are significant differences
between the securities and options markets that could result in
an imperfect correlation between these markets, causing a given
transaction not to achieve its objectives. A decision as to
whether, when and how to use options involves the exercise of
skill and judgment, and even a well conceived transaction may be
unsuccessful to some degree because of market behavior or
unexpected events.
As the writer of a covered call option, the Trust foregoes,
during the options life, the opportunity to profit from
increases in the market value of the security covering the call
option above the sum of the premium and the strike price of the
call, but has retained the risk of loss should the price of the
underlying security decline.
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As the Trust writes covered calls over more of its portfolio,
its ability to benefit from capital appreciation becomes more
limited. The writer of an option has no control over the time
when it may be required to fulfill its obligation as a writer of
the option. Once an option writer has received an exercise
notice, it cannot effect a closing purchase transaction in order
to terminate its obligation under the option and must deliver
the underlying security at the exercise price.
When the Trust writes covered put options, it bears the risk of
loss if the value of the underlying stock declines below the
exercise price minus the put premium. If the option is
exercised, the Trust could incur a loss if it is required to
purchase the stock underlying the put option at a price greater
than the market price of the stock at the time of exercise plus
the put premium the Trust received when it wrote the option.
While the Trusts potential gain in writing a covered put
option is limited to distributions earned on the liquid assets
securing the put option plus the premium received from the
purchaser of the put option, the Trust risks a loss equal to the
entire exercise price of the option minus the put premium.
Exchange-Listed Option Risks. There can be no
assurance that a liquid market will exist when the Trust seeks
to close out an option position on an options exchange. Reasons
for the absence of a liquid secondary market on an exchange
include the following: (i) there may be insufficient
trading interest in certain options; (ii) restrictions may
be imposed by an exchange on opening transactions or closing
transactions or both; (iii) trading halts, suspensions or
other restrictions may be imposed with respect to particular
classes or series of options; (iv) unusual or unforeseen
circumstances may interrupt normal operations on an exchange;
(v) the facilities of an exchange or the Options Clearing
Corporation may not at all times be adequate to handle current
trading volume; or (vi) one or more exchanges could, for
economic or other reasons, decide or be compelled at some future
date to discontinue the trading of options (or a particular
class or series of options). If trading were discontinued, the
secondary market on that exchange (or in that class or series of
options) would cease to exist. However, outstanding options on
that exchange that had been issued by the Options Clearing
Corporation as a result of trades on that exchange would
continue to be exercisable in accordance with their terms. If
the Trust were unable to close out a covered call option that it
had written on a security, it would not be able to sell the
underlying security unless the option expired without exercise.
The hours of trading for options on an exchange may not conform
to the hours during which the underlying securities are traded.
To the extent that the options markets close before the markets
for the underlying securities, significant price and rate
movements can take place in the underlying markets that cannot
be reflected in the options markets. Call options are marked to
market daily and their value will be affected by changes in the
value and dividend rates of the underlying common stocks, an
increase in interest rates, changes in the actual or perceived
volatility of the stock market and the underlying common stocks
and the remaining time to the options expiration.
Additionally, the exercise price of an option may be adjusted
downward before the options expiration as a result of the
occurrence of certain corporate events affecting the underlying
equity security, such as extraordinary dividends, stock splits,
merger or other extraordinary distributions or events. A
reduction in the exercise price of an option would reduce the
Trusts capital appreciation potential on the underlying
security.
Over-the-Counter
Option Risk. The Trust may write (sell) unlisted
(OTC or
over-the-counter)
options, and options written by the Trust with respect to
non-U.S. securities,
indices or sectors generally will be OTC options. OTC options
differ from exchange-listed options in that they are two-party
contracts, with exercise price, premium and other terms
negotiated between buyer and seller, and generally do not have
as much market liquidity as exchange-listed options. The
counterparties to these transactions typically will be major
international banks, broker-dealers and financial institutions.
The Trust may be required to treat as illiquid securities being
used to cover certain written OTC options. The OTC options
written by the Trust will not be issued, guaranteed or cleared
by the Options Clearing Corporation. In addition, the
Trusts ability to terminate the OTC options may be more
limited than with exchange-traded options. Banks, broker-dealers
or other financial institutions participating in such
transaction may fail to settle a transaction in accordance with
the terms of the option as written. In the event of default or
insolvency of the counterparty, the Trust may be unable to
liquidate an OTC option position.
14
Index Option Risk. The Trust may sell index put
and call options from time to time. The purchaser of an index
put option has the right to any depreciation in the value of the
index below the exercise price of the option on or before the
expiration date. The purchaser of an index call option has the
right to any appreciation in the value of the index over the
exercise price of the option on or before the expiration date.
Because the exercise of an index option is settled in cash,
sellers of index call options, such as the Trust, cannot provide
in advance for their potential settlement obligations by
acquiring and holding the underlying securities. The Trust will
lose money if it is required to pay the purchaser of an index
option the difference between the cash value of the index on
which the option was written and the exercise price and such
difference is greater than the premium received by the Trust for
writing the option. The value of index options written by the
Trust, which will be priced daily, will be affected by changes
in the value and dividend rates of the underlying common stocks
in the respective index, changes in the actual or perceived
volatility of the stock market and the remaining time to the
options expiration. The value of the index options also
may be adversely affected if the market for the index options
becomes less liquid or smaller. Distributions paid by the Trust
on its common shares may be derived in part from the net index
option premiums it receives from selling index put and call
options, less the cost of paying settlement amounts to
purchasers of the options that exercise their options. Net index
option premiums can vary widely over the short term and long
term.
Interest Rate Risk. Interest rate risk is the risk
that debt securities, and the Trusts net assets, may
decline in value because of changes in interest rates.
Generally, debt securities will decrease in value when interest
rates rise and increase in value when interest rates decline.
This means that the net asset value of the common shares will
fluctuate with interest rate changes and the corresponding
changes in the value of the Trusts debt security holdings.
Prepayment Risk. If interest rates fall, the
principal on bonds held by the Trust may be paid earlier than
expected. If this happens, the proceeds from a prepaid security
may be reinvested by the Trust in securities bearing lower
interest rates, resulting in a possible decline in the
Trusts income and distributions to shareholders. The Trust
may invest in pools of mortgages or other assets issued or
guaranteed by private issuers or U.S. government agencies
and instrumentalities. Mortgage-related securities are
especially sensitive to prepayment risk because borrowers often
refinance their mortgages when interest rates drop.
Asset-Backed Securities Risk. Payment of interest
and repayment of principal on asset-backed securities may be
largely dependent upon the cash flows generated by the assets
backing the securities and, in certain cases, supported by
letters of credit, surety bonds or other credit enhancements.
Asset-backed security values may also be affected by the
creditworthiness of the servicing agent for the pool, the
originator of the loans or receivables or the entities providing
the credit enhancement. In addition, the underlying assets are
subject to prepayments that shorten the securities
weighted average maturity and may lower their return.
Mortgage-Backed Securities Risk. A mortgage-backed
security, which represents an interest in a pool of assets such
as mortgage loans, will mature when all the mortgages in the
pool mature or are prepaid. Therefore, mortgage-backed
securities do not have a fixed maturity, and their expected
maturities may vary when interest rates rise or fall.
When interest rates fall, homeowners are more likely to prepay
their mortgage loans. An increased rate of prepayments on the
funds mortgage-backed securities will result in an
unforeseen loss of interest income to the Trust as the Trust may
be required to reinvest assets at a lower interest rate. Because
prepayments increase when interest rates fall, the price of
mortgage-backed securities does not increase as much as other
fixed income securities when interest rates fall.
When interest rates rise, homeowners are less likely to prepay
their mortgage loans. A decreased rate of prepayments lengthens
the expected maturity of a mortgage-backed security. Therefore,
the prices of mortgage-backed securities may decrease more than
prices of other fixed income securities when interest rates rise.
Non-Investment Grade Securities Risk. There is no
limit on the amount of the Trusts portfolio that may be
invested in below investment grade securities. Non-investment
grade securities are commonly referred to as junk
securities. Investments in lower grade securities will
expose the Trust to greater risks than if the
15
Trust owned only higher grade debt securities. Because of the
substantial risks associated with lower grade securities, you
could lose money on your investment in common shares of the
Trust, both in the short-term and the long-term. Lower grade
securities, though high yielding, are characterized by high
risk. They may be subject to certain risks with respect to the
issuing entity and to greater market fluctuations than certain
lower yielding, higher rated securities. The retail secondary
market for lower grade debt securities may be less liquid than
that of higher rated debt securities. Adverse conditions could
make it difficult at times for the Trust to sell certain
securities or could result in lower prices than those used in
calculating the Trusts net asset value.
Derivatives Risk. Derivative transactions in which
the Trust may engage for hedging and speculative purposes or to
enhance total return, including engaging in transactions such as
options, futures, swaps, foreign currency transactions including
forward foreign currency contracts, currency swaps or options on
currency and currency futures and other derivatives transactions
(Derivative Transactions), also involve certain
risks and special considerations. Derivative Transactions have
risks, including the imperfect correlation between the value of
such instruments and the underlying assets, the possible default
of the other party to the transaction or illiquidity of the
derivative instruments. Furthermore, the ability to successfully
use Derivative Transactions depends on the Investment
Advisers ability to predict pertinent market movements,
which cannot be assured. Thus, the use of Derivative
Transactions may result in losses greater than if they had not
been used, may require the Trust to sell or purchase portfolio
securities at inopportune times or for prices other than current
market values, may limit the amount of appreciation the Trust
can realize on an investment or may cause the Trust to hold a
security that it might otherwise sell. The use of foreign
currency transactions can result in the Trusts incurring
losses as a result of the imposition of exchange controls,
suspension of settlements or the inability of the Trust to
deliver or receive a specified currency. Additionally, amounts
paid by the Trust as premiums and cash or other assets held in
margin accounts with respect to Derivative Transactions are not
otherwise available to the Trust for investment purposes.
To the extent that the Trust purchases options pursuant to a
hedging strategy, the Trust will be subject to the following
additional risks. If a put or call option purchased by the Trust
is not sold when it has remaining value, and if the market price
of the underlying security remains equal to or greater than the
exercise price (in the case of a put), or remains less than or
equal to the exercise price (in the case of a call), the Trust
will lose its entire investment in the option.
Also, where a put or call option on a particular security is
purchased to hedge against price movements in a related
security, the price of the put or call option may move more or
less than the price of the related security. If restrictions on
exercise were imposed, the Trust might be unable to exercise an
option it had purchased. If the Trust were unable to close out
an option that it had purchased on a security, it would have to
exercise the option in order to realize any profit or the option
may expire worthless.
Market Risk Generally. The profitability of a
significant portion of the Trusts investment program
depends to a great extent upon correctly assessing the future
course of the price movements of securities and other
investments and the movements of interest rates. There can be no
assurance that the Investment Adviser will be able to predict
accurately these price and interest rate movements. With respect
to the investment strategies the Trust may utilize, there will
be a high degree of market risk.
Reinvestment Risk. The Trust reinvests the cash
flows received from a security. The additional income from such
reinvestment, sometimes called
interest-on-interest,
is reliant on the prevailing interest rate levels at the time of
reinvestment. There is a risk that the interest rate at which
interim cash flows can be reinvested will fall. Reinvestment
risk is greater for longer holding periods and for securities
with large, early cash flows such as high-coupon bonds.
Reinvestment risk also applies generally to the reinvestment of
the proceeds the Trust receives upon the maturity or sale of a
portfolio security.
Timing Risk. Many agency, corporate and municipal
bonds, and most mortgage-backed securities, contain a provision
that allows the issuer to call all or part of the
issue before the bonds maturity date often after 5 or
10 years. The issuer usually retains the right to refinance
the bond in the future if market interest rates decline below
the coupon rate. There are three disadvantages to the call
provision. First, the cash flow pattern of a callable bond is
not known with certainty. Second, because an issuer is more
likely to call the bonds when interest rates have dropped, the
Trust is exposed to reinvestment rate risk, i.e., the Trust may
have
16
to reinvest at lower interest rates the proceeds received when
the bond is called. Finally, the capital appreciation potential
of a bond will be reduced because the price of a callable bond
may not rise much above the price at which the issuer may call
the bond.
Inflation Risk. Inflation risk results from the
variation in the value of cash flows from a security due to
inflation, as measured in terms of purchasing power. For
example, if the Trust purchases a bond in which it can realize a
coupon rate of 5%, but the rate of inflation increases from 2%
to 6%, then the purchasing power of the cash flow has declined.
For all but adjustable bonds or floating rate bonds, the Trust
is exposed to inflation risk because the interest rate the
issuer promises to make is fixed for the life of the security.
To the extent that interest rates reflect the expected inflation
rate, floating rate bonds have a lower level of inflation risk.
Arbitrage Risks. The Trust will engage in capital
structure arbitrage and other arbitrage strategies. Arbitrage
strategies entail various risks including the risk that external
events, regulatory approvals and other factors will impact the
consummation of announced corporate events and/or the prices of
certain positions. In addition, hedging is an important feature
of capital structure arbitrage. There is no guarantee that the
Investment Adviser will be able to hedge the Trusts
portfolio in the manner necessary to employ successfully the
Trusts strategy.
Short Sales Risk. Short sales by the Trust that
are not made against the box theoretically involve
unlimited loss potential since the market price of securities
sold short may continuously increase. Short selling involves
selling securities which may or may not be owned and borrowing
the same securities for delivery to the purchaser, with an
obligation to replace the borrowed securities at a later date.
Short selling allows the Trust to profit from declines in market
prices to the extent such decline exceeds the transaction costs
and the costs of borrowing the securities. However, since the
borrowed securities must be replaced by purchases at market
prices in order to close out the short position, any
appreciation in the price of the borrowed securities would
result in a loss. There can be no assurance that the securities
necessary to cover a short position will be available for
purchase. Purchasing securities to close out the short position
can itself cause the price of the securities to rise further,
thereby exacerbating the loss. The Trust may mitigate such
losses by replacing the securities sold short before the market
price has increased significantly. Under adverse market
conditions, the Trust might have difficulty purchasing
securities to meet its short sale delivery obligations, and
might have to sell portfolio securities to raise the capital
necessary to meet its short sale obligations at a time when
fundamental investment considerations would not favor such sales.
Risks of Investing in Structured Finance
Securities. A portion of the Trusts investments
may consist of equipment trust certificates, collateralized
mortgage obligations, collateralized bond obligations,
collateralized loan obligations or similar instruments.
Structured finance securities may present risks similar to those
of the other types of debt obligations in which the Trust may
invest and, in fact, such risks may be of greater significance
in the case of structured finance securities. Moreover,
investing in structured finance securities may entail a variety
of unique risks. Among other risks, structured finance
securities may be subject to prepayment risk. In addition, the
performance of a structured finance security will be affected by
a variety of factors, including its priority in the capital
structure of the issuer thereof, and the availability of any
credit enhancement, the level and timing of payments and
recoveries on and the characteristics of the underlying
receivables, loans or other assets that are being securitized,
remoteness of those assets from the originator or transferor,
the adequacy of and ability to realize upon any related
collateral and the capability of the servicer of the securitized
assets.
Risks of Investing in Preferred Securities. There
are special risks associated with investing in preferred
securities, including:
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Deferral. Preferred securities may include provisions
that permit the issuer, at its discretion, to defer
distributions for a stated period without any adverse
consequences to the issuer. If the Trust owns a preferred
security that is deferring its distributions, the Trust may be
required to report income for tax purposes although it has not
yet received such income. |
17
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Subordination. Preferred securities are subordinated to
bonds and other debt instruments in a companys capital
structure in terms of priority to corporate income and
liquidation payments, and therefore will be subject to greater
credit risk than more senior debt instruments. |
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Liquidity. Preferred securities may be substantially less
liquid than many other securities, such as common stocks or
U.S. government securities. |
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Limited Voting Rights. Generally, preferred security
holders have no voting rights with respect to the issuing
company unless preferred dividends have been in arrears for a
specified number of periods, at which time the preferred
security holders may elect a number of trustees to the
issuers board. Generally, once all the arrearages have
been paid, the preferred security holders no longer have voting
rights. |
Risks of Investing in Synthetic Securities. In
addition to credit risks associated with holding non-investment
grade loans and high-yield debt securities, with respect to
synthetic securities the Trust will usually have a contractual
relationship only with the counterparty of such synthetic
securities, and not the Reference Obligor (as defined below) on
the Reference Obligation (as defined below). The Trust generally
will have no right to directly enforce compliance by the
Reference Obligor with the terms of the Reference Obligation nor
any rights of set-off against the Reference Obligor, nor have
any voting rights with respect to the Reference Obligation. The
Trust will not benefit directly from any collateral supporting
the Reference Obligation or have the benefit of the remedies on
default that would normally be available to a holder of such
Reference Obligation. In addition, in the event of insolvency of
its counterparty, the Trust will be treated as a general
creditor of such counterparty and will not have any claim with
respect to the credit risk of the counterparty as well as that
of the Reference Obligor. As a result, an overabundance of
synthetic securities with any one counterparty subjects the
notes to an additional degree of risk with respect to defaults
by such counterparty as well as by the Reference Obligor. The
Investment Adviser may not perform independent credit analyses
of the counterparties, any such counterparty, or an entity
guaranteeing such counterparty, individually or in the
aggregate. A Reference Obligation is the debt
security or other obligation upon which the synthetic security
is based. A Reference Obligor is the obligor on a
Reference Obligation. There is no maximum amount of Trusts
assets that may be invested in these securities.
Valuation Risk. Fair value is defined as the
amount for which assets could be sold in an orderly disposition
over a reasonable period of time, taking into account the nature
of the asset. Fair value pricing, however, involves judgments
that are inherently subjective and inexact, since fair valuation
procedures are used only when it is not possible to be sure what
value should be attributed to a particular asset or when an
event will affect the market price of an asset and to what
extent. As a result, there can be no assurance that fair value
pricing will reflect actual market value and it is possible that
the fair value determined for a security will be materially
different from the value that actually could be or is realized
upon the sale of that asset.
Exemptive Relief Consideration. The Investment
Adviser expects to apply to the Commission for exemptive relief
to enable the registered investment companies advised by the
Investment Adviser, including the Trust, to co-invest with other
accounts and funds managed by the Investment Adviser and its
affiliates in certain privately placed securities and other
situations. There are no assurances that the Investment Adviser
will receive the requested relief. If such relief is not
obtained and until it is obtained, the Investment Adviser may be
required to allocate some investments solely to the Trust and/or
other registered funds and others solely to one or more accounts
that are not registered investment companies. This could
preclude the Trust from investing in certain securities it would
otherwise be interested in and could adversely affect the speed
at which the Trust is able to invest its assets and,
consequently, the performance of the Trust.
Market Disruption and Geopolitical Risk. The
aftermath of the war in Iraq and the continuing occupation of
Iraq, instability in the Middle East and terrorist attacks in
the United States and around the world may have resulted in
market volatility and may have long-term effects on the U.S. and
worldwide financial markets and may cause further economic
uncertainties in the United States and worldwide. The Investment
Adviser does not know how long the securities markets will
continue to be affected by these events and cannot predict the
effects of the occupation or similar events in the future on the
U.S. economy and securities markets. Given the risks
described above, an investment in the common shares may not be
18
appropriate for all investors. You should carefully consider
your ability to assume these risks before making an investment
in the Trust.
Risks of Investing in a Trust with Anti-Takeover
Provisions. The Trusts Agreement and Declaration
of Trust includes provisions that could limit the ability of
other entities or persons to acquire control of the Trust or
convert the Trust to open-end status. These provisions could
deprive the holders of common shares of opportunities to sell
their common shares at a premium over the then current market
price of the common shares or at net asset value.
Key Adviser Personnel Risk. The Trusts
ability to identify and invest in attractive opportunities is
dependent upon Highland, its investment adviser. If one or more
key individuals leaves Highland, Highland may not be able to
hire qualified replacements or may require an extended time to
do so. This situation could prevent the Trust from achieving its
investment objectives.
19
SUMMARY OF TRUST EXPENSES
The following table shows Trust expenses as a percentage of net
assets attributable to common shares and assumes that the Trust
has issued Preferred Shares in the amount of 20% of the
Trusts total assets and borrowing in the amount equal to
10% of the Trusts total assets for total leverage in an
amount equal to 30% of the Trusts total assets (including
the proceeds of all such leverage):
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Percentage of | |
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Offering | |
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Price | |
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Shareholder Transaction Expenses
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Sales load paid by you
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4.50% |
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Offering expenses borne by holders of common shares, excluding
Preferred Share offering expenses
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0.20% |
(1) |
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Dividend reinvestment and cash purchase plan fees
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None |
(2) |
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Preferred Share offering expense borne by holders of common
shares
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0.34% |
(3) |
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Percentage of Net Assets | |
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Attributable to Common Shares | |
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(assumes Preferred Shares are | |
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issued)(4) | |
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Annual Expenses
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Management fees
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1.71 |
%* |
Interest payments on borrowed funds
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0.73 |
% |
Other expenses (including cost of issuing Preferred Shares)
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0.96 |
%(5) |
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Total annual expenses
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3.40 |
% |
Dividends on Preferred Shares
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1.39 |
%(6) |
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Total annual expenses and dividends on Preferred Shares
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4.79 |
% |
The purpose of the table above and example below is to help you
understand all fees and expenses that you, as a holder of common
shares, would bear directly or indirectly. The expenses shown in
the table under Other Expenses and Total
Annual Expenses are based on estimated amounts for the
Trusts first full year of operations and assume that the
Trust issues 30,430,000 common shares. If the Trust issues
fewer common shares, all other things being equal, these
expenses, as a percentage of the Trusts net assets
attributable to common shares, would increase. See
Management of the Trust and Dividend
Reinvestment Plan. Management fees are the
Trusts advisory and administration fees, which are
computed based on Managed Assets. As a result, such
fees have been converted to Net Assets for purposes
of the fee table presentation as follows: management fees,
assuming no leverage, divided by (one minus the assumed leverage
of 30% of the Trusts total assets).
EXAMPLE
The following example illustrates the expenses that you would
pay on a $1,000 investment in the common shares (including the
total sales load of $45 payable on an investment of that size,
the other estimated costs of this offering to be borne by the
Trust, which correspond to $2.00 on an investment of that size,
and the estimated costs of issuing Preferred Shares, which
correspond to $3.38 on an investment of that size), before
considering dividends paid on the Preferred Shares, and
assuming (1) that the Trust issues 30,430,000 common
shares, (2) that the Trust issues approximately
$165.7 million liquidation value of Preferred Shares in the
Preferred Share offering, (3) that the Trust borrows
approximately $82.9 million under its credit facility,
(4) that the Trust incurs total annual expenses of 3.40% of
net assets attributable to common shares (before Preferred Share
dividends) and (5) a 5% annual return:
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Example |
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1 Year | |
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3 Years | |
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5 Years | |
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10 Years | |
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Total expenses incurred
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$ |
83 |
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$ |
150 |
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$ |
218 |
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$ |
400 |
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If dividends on Preferred Shares are included, the total
expenses incurred for 1, 3, 5 and 10 years will be $96,
$187, $279 and $510, respectively.
(footnotes appear on following page)
20
The example should not be considered a representation of
future expenses. Actual expenses may be greater or less than
those assumed, and will be greater if the Trust borrows more
money than assumed in the table and example above. The example
assumes that the estimated Other Expenses set forth
in the Annual Expenses table are accurate, all dividends and
distributions are reinvested at net asset value, and reflects
all recurring and nonrecurring fees including underwriting
discounts and commissions. Moreover, the Trusts actual
rate of return may be greater or less than the hypothetical 5%
return shown in the example.
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* |
Management fees are both the investment advisory and
administrative services fees paid to Highland. |
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(1) |
The Trust has agreed to reimburse Highland for expenses incurred
by Highland in connection with this offering (other than the
marketing and structuring fee payable by Highland as described
in Underwriters Additional Compensation to Be
Paid by Investment Adviser to an Underwriter). Offering
expenses paid by the Trust (other than the sales load and the
Preferred Share offering expenses referred to in
footnote 3), including expenses reimbursed by the Trust to
Highland, will not exceed $0.04 per common share sold by
the Trust in this offering. If the offering expenses referred to
in the preceding sentence exceed this amount, Highland will pay
the excess. The aggregate offering expenses (excluding the sales
load, and excluding any Preferred Share offering expenses, but
including expenses reimbursed to Highland) to be incurred by the
Trust are estimated to be $1,217,200 in total, or $0.04 per
common share sold by the Trust in this offering, assuming
30,430,000 common shares are issued in this offering. See
Underwriters. |
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(2) |
Common shareholders will be charged a $2.50 service charge
and pay a brokerage commission of $0.05 per share sold if
they direct the Plan Agent (as defined below) to sell common
shares held in a dividend reinvestment account. Each participant
in the Trusts Dividend Reinvestment Plan will pay a
pro rata share of brokerage commissions incurred when
dividend reinvestment occurs in open-market purchases because
the net asset value per common share is greater than the market
value per common share. |
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(3) |
If the Trust offers Preferred Shares, costs of that offering,
estimated to be approximately 1.24% of the total dollar amount
of the Preferred Share offering (including underwriting
discounts, commissions and legal expenses), will be borne
immediately by the Trusts common shareholders and result
in a reduction of the net asset value of the common shares.
Assuming that the Trust issues 30,430,000 common shares and
further assuming approximately $165.7 million liquidation
value of Preferred Shares are issued in the Preferred Share
offering, these offering costs (including underwriting
discounts, commissions and legal expenses) are estimated to be
approximately $2.1 million or $0.07 per common share (0.34%
of the common share offering price). |
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(4) |
The table presented below in this footnote estimates the
Trusts annual expenses stated as percentages of the
Trusts net assets attributable to common shares. This
table assumes the Trust is the same size as in the table above,
but unlike the table above, assumes that no Preferred Shares are
issued. This will be the case, for instance, prior to the
Trusts expected issuance of Preferred Shares. The table
below also assumes that the Trust does not borrow any funds, and
therefore does not reflect any interest on borrowed funds or
other costs and expenses of borrowing. The Trust may borrow
funds, as described under Prospectus Summary
Preferred Shares and Borrowings, in which case the Trust
would have interest and other borrowing costs and expenses. The
footnote used in the table below corresponds to the footnote
appearing below this footnote (4). In accordance with these
assumptions, the Trusts expenses would be estimated to be
as follows: |
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Percentage of Net Assets Attributable to | |
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Common Shares (assumes Preferred Shares | |
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are not issued and no funds are borrowed) | |
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Annual Expenses
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Management fees
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1.20 |
%* |
Interest payments on borrowed funds
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None |
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Other expenses
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0.63 |
%(5) |
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Total annual expenses
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1.83 |
% |
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(5) |
Other Expenses includes costs associated with the
Trusts short sales on securities, including dividend
expenses in securities sold short. Assuming the issuance of
Preferred Shares and borrowing reflected in the table on
page 20, dividend expenses paid on securities sold short
are estimated to be 0.71% of the Trusts net assets
attributable to common shareholders. Assuming Preferred Shares
are not issued and assuming no borrowings, dividend expenses
paid on securities sold short are estimated to be 0.49% of the
Trusts net assets. These percentages represent estimates
for the Trusts initial year of operations, assuming that
the Trust maintains short securities positions equal to 5.0% of
its net assets assuming Preferred Shares are not issued and
7.14% of its net assets assuming the issuance of Preferred
Shares (i.e., based on the Trusts initial expected
short securities exposure). When a cash dividend is declared on
a security for which the Trust holds a short position, the Trust
incurs the obligation to pay an amount equal to that dividend to
the lender of the shorted security. Thus, the estimate for
dividend expenses paid is also based on the dividend yields of
stocks that would be sold short as part of anticipated trading
practices (which may involve avoiding dividend expenses with
respect to certain short sale transactions by closing out the
position prior to the underlying issuers ex-dividend
date). The Trusts actual dividend expenses paid on
securities sold short may be significantly higher or lower than
the estimates above due to, among other factors, the actual
extent of the Trusts short positions (which can range from
0% to 25% of total assets), the actual dividends paid |
21
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with respect to the securities
the Trust sells short, and the actual timing of the Trusts
short sale transactions, each of which is expected to vary over
time and from time to time.
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(6) |
Calculated based on an annual
dividend rate of 4.85%. Such rate is an estimate and may differ
based on varying market conditions that may exist at, if and
when the Preferred Shares are offered.
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Highland will pay Morgan Stanley & Co. Incorporated a
marketing and structuring fee in connection with this public
offering of common shares. See Underwriters
Additional Compensation to Be Paid by Investment Adviser to an
Underwriter.
22
THE TRUST
The Trust is a newly organized, non-diversified, closed-end
management investment company registered under the Investment
Company Act. The Trust was organized as a Delaware statutory
trust on March 10, 2006, pursuant to an Agreement and
Declaration of Trust governed by the laws of the State of
Delaware. The Trust has no operating history. The Trusts
principal office is located at Two Galleria Tower, 13455 Noel
Road, Suite 800, Dallas, Texas 75240 and its telephone
number is (877) 665-1287.
USE OF PROCEEDS
The net proceeds of this offering of common shares will be
approximately
$ ($ if
the underwriters exercise the over-allotment option in full)
after deducting the underwriting discounts and commissions and
estimated offering expenses, including the estimated expenses of
the Preferred Share offering which is expected to occur soon
after the completion of this offering, as described under
Prospectus SummaryPreferred Shares and
Borrowings, or $0.07 per common share, as well as
reimbursement to Highland by the Trust for approximately
$1,217,200 ($0.04 per common share) in expenses incurred by
Highland in connection with the offering (assuming 30,430,000
common shares are issued in this offering and assuming
approximately $165.7 million liquidation value of Preferred
Shares are issued in the Preferred Share offering). See
Underwriters.
The Trust will invest the net proceeds of this offering in
accordance with the Trusts investment objectives and
policies as stated below. We currently anticipate that the Trust
will be able to invest primarily in securities and other
investments that meet the Trusts investment objectives and
policies within approximately three months after the completion
of this offering. Pending such investment, it is anticipated
that the proceeds of this offering will be invested in
short-term debt securities.
23
THE TRUSTS INVESTMENTS
Investment Objectives and Policies
The Trusts investment objectives are to provide both
current income and capital appreciation. The Trust will pursue
its objectives by investing primarily in the following
categories of securities and instruments of corporations and
other business entities: (i) secured and unsecured floating
and fixed rate loans; (ii) bonds and other debt
obligations; (iii) debt obligations of stressed, distressed
and bankrupt issuers; (iv) structured products, including
but not limited to, mortgage-backed and other asset-backed
securities and collateralized debt obligations; and
(v) equities. Additionally, within the categories of
obligations and securities in which the Trust may invest,
Highland may employ various trading strategies, including but
not limited to, capital structure arbitrage, pair trades, and
shorting. The Trust may also invest in these categories of
obligations and securities through the use of derivatives.
Highland will seek to achieve its capital appreciation objective
by investing in category (iii) and (v) obligations and
securities, and to a lesser extent, in category (i), (ii), and
(iv) obligations. Under normal market conditions, at least
80% of the Trusts assets will be invested in one or more
of these principal investment categories. Subject only to this
general guideline, the Investment Adviser has broad discretion
to allocate the Trusts assets among these investment
categories and to change allocations as conditions warrant. The
Investment Adviser has full discretion regarding the capital
markets from which it can access investment opportunities in
accordance with the investment limitations set forth in this
prospectus. A significant portion of the Trusts assets may
be invested in securities rated below investment grade, which
are commonly referred to as junk securities. The
Investment Adviser does not anticipate a high correlation
between the performance of the Trusts portfolio and the
performance of the corporate bond and equity markets. The
investment objectives may be changed without shareholder
approval. There can be no assurance that the Trusts
investment objectives will be achieved.
The Investment Adviser will select investments from a wide range
of trading strategies and credit markets in order to vary the
Trusts investments and to optimize the risk-reward
parameters of the Trust. Highland does not intend to invest the
Trusts assets according to pre-determined allocations. The
investment team and other Highland personnel will use a wide
range of resources to identify attractive individual investments
and promising investment strategies for consideration in
connection with investments by the Trust. The following is a
description of the general types of securities in which the
Trust may invest. This description is merely a summary, and the
Investment Adviser has discretion to cause the Trust to invest
in other types of securities and to follow other investment
criteria and guidelines as described herein. See Portfolio
Composition below for a more complete description of the
types of securities and investments the Trust intends to make.
The Trust will invest and trade in listed and unlisted, public
and private, rated and unrated, debt and equity instruments and
other obligations, including structured debt and equity
instruments as well as financial derivatives. Investments may
include investments in stressed and distressed positions, which
may include publicly-traded debt and equity securities,
obligations that were privately placed with banks, insurance
companies and other lending institutions, trade claims, accounts
receivable and any other form of obligation recognized as a
claim in a bankruptcy or workout process. The Trust may invest
in securities traded in foreign countries and denominated in
foreign currencies.
As part of its investment program, the Trust may invest, from
time to time, in debt or synthetic instruments that are sold in
direct placement transactions between their issuers and their
purchasers and that are neither listed on an exchange, nor
traded over the counter. The Trust may also receive equity or
equity-related securities from time to time in connection with a
workout transaction or may invest directly in equity securities.
The Trust may employ currency hedges (either in the forward or
options markets) in certain circumstances to reduce currency
risk and may engage in other derivative transactions for hedging
purposes or to enhance total return. The Trust may also lend
securities and engage in short sales of securities. The Trust
plans to employ leverage in the form of Preferred Shares,
borrowing from a credit facility or both, and the Trust may
invest in the securities of companies whose capital structures
are highly leveraged.
24
From time to time, the Investment Adviser may also invest a
portion of the Trusts assets in short-term
U.S. Government obligations, certificates of deposit,
commercial paper and other money market instruments, including
repurchase agreements with respect to such obligations to enable
the Trust to make investments quickly and to serve as collateral
with respect to certain of its investments. A greater percentage
of Trust assets may be invested in such obligations if the
Investment Adviser believes that a defensive position is
appropriate because of the outlook for security prices or in
order to respond to adverse market, economic business or
political conditions. From time to time cash balances in the
Trusts brokerage account may be placed in a money market
fund.
For a more complete discussion of the Trusts portfolio
composition, see Portfolio Composition below.
Investment Philosophy
Under normal market conditions, the Investment Adviser will
employ, on behalf of the Trust, investment strategies across
various markets in which the Investment Adviser holds
significant investment experience: primarily the leveraged loan,
high yield, structured products and stressed and distressed
markets. Highland makes investment decisions based on
quantitative analysis, which employs sophisticated,
data-intensive models to drive the investment process. The
Investment Adviser has full discretion regarding the capital
markets from which it can access investment opportunities in
accordance with the investment limitations set forth in this
prospectus.
The Investment Adviser looks to implement selected trading
strategies to exploit pricing inefficiencies across the credit
markets and within an individual issuers capital
structure. The Trust seeks to vary its investments by strategy,
industry, security type and credit market, but reserves the
right to re-position its portfolio among these criteria
depending on market dynamics, and thus the Investment Adviser
anticipates that the Trust will experience high portfolio
turnover. Highland manages interest rate, default, currency and
systemic risks through a variety of trading methods and market
tools, including derivative hedging instruments, as it deems
appropriate.
The multi-strategy investment program to be implemented by the
Trust will allow the Investment Adviser to assess what it
considers to be the best opportunities across multiple markets
and to adjust quickly the Trusts trading strategies and
market focus to changing conditions. The Investment Adviser
intends to focus primarily on the U.S. marketplace, but may
pursue opportunities in the
non-U.S. credit or
securities markets by investing up to 20% of the Trusts
assets in
non-U.S. credit or
securities market investments.
The Investment Adviser believes that the Trust will benefit from
Highlands industry-focused investment staff and specialist
trading skills as well as its years of investment experience
(since 1993) in leveraged loan, high yield, structured products
and stressed and distressed markets. In finding opportunities,
the Investment Adviser looks to utilize its investment staff of
approximately seventy-nine (79) credit investment
professionals who actively monitor approximately
1,200 companies. Their monitoring of the market and
existing positions assists the Investment Adviser in obtaining
timely and high-quality information on prospective investments.
Additionally, the Investment Adviser has senior professionals
that focus on individual credit markets, such as the stressed
and distressed or structured products segments. This broad staff
of industry, product and market specialists differentiates the
Investment Adviser from numerous other funds other
investment advisers that rely on a limited number of investment
professionals working in a more generalist capacity. The
Investment Adviser believes that credit investing is a
due-diligence intensive process that requires long-term
committed resources to industry, product and market
specialization so that investment decisions are proactive as
opposed to reactive in nature.
Portfolio Composition
The Trust will pursue its objectives by investing primarily in
the following categories of securities and instruments of
corporations and other business entities: (i) secured and
unsecured floating and fixed rate loans; (ii) bonds and
other debt obligations; (iii) debt obligations of stressed,
distressed and bankrupt issuers; (iv) structured products,
including but not limited to, mortgage-backed and other
asset-backed securities and collateralized debt obligations; and
(v) equities. Additionally, within the categories of
obligations and
25
securities in which the Trust may invest, Highland may employ
various trading strategies, including but not limited to,
capital structure arbitrage, pair trades, and shorting. The
Trust may also invest in these categories of obligations and
securities through the use of derivatives. Highland will seek to
achieve its capital appreciation objective by investing in
category (iii) and (v) obligations and securities, and
to a lesser extent, in category (i), (ii), and
(iv) obligations.
Under normal market conditions, at least 80% of the Trusts
assets will be invested in one or more of these principal
investment categories. Subject only to this general guideline,
the Investment Adviser has broad discretion to allocate the
Trusts assets among these investment categories and to
change allocations as conditions warrant. The Investment Adviser
has full discretion regarding the capital markets from which it
can access investment opportunities in accordance with the
investment limitations set forth in this prospectus. In order to
pursue most effectively its opportunistic investment strategy,
the Trust will not maintain fixed duration, maturity or credit
quality policies. The Trust may invest in debt obligations of
any credit quality. The Trust may invest without limitation in
securities and obligations of domestic issuers, but may invest
only up to 20% of the assets in
non-U.S. obligors.
From time to time, the Investment Adviser may also invest a
portion of the Trusts assets in short-term
U.S. Government obligations, certificates of deposit,
commercial paper and other money market instruments, including
repurchase agreements with respect to such obligations to enable
the Trust to make investments quickly and to serve as collateral
with respect to certain of its investments. A greater percentage
of Trust assets may be invested in such obligations if the
Investment Adviser believes that a defensive position is
appropriate because of the outlook for security prices or in
order to respond to adverse market, economic, business or
political conditions. From time to time cash balances in the
Trusts brokerage account may be placed in a money market
fund.
The Trusts portfolio will be composed principally of the
following investments. Additional information relating to the
Trusts investment policies and restrictions and the
Trusts portfolio investments is contained in the Statement
of Additional Information.
Senior Loans. Senior loans hold the most senior
position in the capital structure of a business entity, are
typically secured with specific collateral and have a claim on
the general assets of the borrower that is senior to that held
by subordinated debtholders and stockholders of the borrower.
The proceeds of senior loans primarily are used to finance
leveraged buyouts, recapitalizations, mergers, acquisitions,
stock repurchases, and, to a lesser extent, to finance internal
growth and for other corporate purposes. Senior loans typically
have rates of interest which are redetermined either daily,
monthly, quarterly or semi-annually by reference to a base
lending rate, plus a premium. These base lending rates generally
are LIBOR, the prime rate offered by one or more major United
States banks (Prime Rate) or the certificate of deposit
(CD) rate or other base lending rates used by commercial
lenders.
The Trust also may purchase unsecured loans, other floating rate
debt securities such as notes, bonds and asset-backed securities
(such as securities issued by special purpose funds investing in
bank loans), investment grade and below investment grade fixed
income debt obligations and money market instruments, such as
commercial paper. The Trust also may purchase obligations issued
in connection with a restructuring pursuant to Chapter 11
of the U.S. Bankruptcy Code. While these investments are
not a primary focus of the Trust, the Trust does not have a
policy limiting such investments to a specific percentage of the
Trusts assets.
Loans and other corporate debt obligations are subject to the
risk of non-payment of scheduled interest or principal. Such
non-payment would result in a reduction of income to the Trust,
a reduction in the value of the investment and a potential
decrease in the net asset value of the Trust. There can be no
assurance that the liquidation of any collateral securing a
senior loan would satisfy a borrowers obligation in the
event of non-payment of scheduled interest or principal
payments, or that such collateral could be readily liquidated.
In the event of bankruptcy of a borrower, the Trust could
experience delays or limitations with respect to its ability to
realize the benefits of the collateral securing a senior loan.
To the extent that a senior loan is collateralized by stock in
the borrower or its subsidiaries, such stock may lose all or
substantially all of its value in the event of the bankruptcy of
a borrower. Some senior loans are subject to the risk that a
court, pursuant to fraudulent conveyance or other similar laws,
could subordinate senior loans to presently existing or future
indebtedness of
26
the borrower or take other action detrimental to the holders of
senior loans including, in certain circumstances, invalidating
such senior loans or causing interest previously paid to be
refunded to the borrower. If interest were required to be
refunded, it could negatively affect the Trusts
performance. To the extent a senior loan is subordinated in the
capital structure, it will have characteristics similar to other
subordinated debtholders, including a greater risk of nonpayment
of interest or principal.
Many loans in which the Investment Adviser anticipates the Trust
will invest, and the issuers of such loan, may not be rated by a
rating agency, will not be registered with the Securities and
Exchange Commission or any state securities commission and will
not be listed on any national securities exchange. The amount of
public information available with respect to issuers of senior
loans will generally be less extensive than that available for
issuers of registered or exchange listed securities. In
evaluating the creditworthiness of borrowers, the Investment
Adviser will consider, and may rely in part, on analyses
performed by others. The Investment Adviser does not view
ratings as the determinative factor in its investment decisions
and relies more upon its credit analysis abilities than upon
ratings. Borrowers may have outstanding debt obligations that
are rated below investment grade by a rating agency. A high
percentage of senior loans held by the Trust may be rated, if at
all, below investment grade by independent rating agencies. In
the event senior loans are not rated, they are likely to be the
equivalent of below investment grade quality. Debt securities
which are unsecured and rated below investment grade (i.e., Ba
and below by Moodys Investors Service, Inc.
(Moodys) or BB and below by
Standard & Poors Ratings Group, a division of The
McGraw-Hill Companies, Inc. (S&P)) and
comparable unrated bonds, are viewed by the rating agencies as
having speculative characteristics and are commonly known as
junk bonds. A description of the ratings of
corporate bonds by Moodys and S&P included as
Appendix A to the Statement of Additional Information.
Because senior loans are senior in a borrowers capital
structure and are often secured by specific collateral, the
Investment Adviser believes that senior loans have more
favorable loss recovery rates as compared to most other types of
below investment grade debt obligations. However, there can be
no assurance that the Trusts actual loss recovery
experience will be consistent with the Investment Advisers
prior experience or that the Trusts senior loans will
achieve any specific loss recovery rates.
No active trading market may exist for many senior loans, and
some senior loans may be subject to restrictions on resale. The
Trust is not limited in the percentage of its assets that may be
invested in senior loans and other securities deemed to be
illiquid. A secondary market may be subject to irregular trading
activity, wide bid/ask spreads and extended trade settlement
periods, which may impair the ability to realize full value on
the disposition of an illiquid senior loan, and cause a material
decline in the Trusts net asset value.
Use of Agents. Senior loans generally are arranged
through private negotiations between a borrower and a group of
financial institutions initially represented by an agent who is
usually one of the originating lenders. In larger transactions,
it is common to have several agents. Generally, however, only
one such agent has primary responsibility for ongoing
administration of a senior loan. Agents are typically paid fees
by the borrower for their services. The agent is primarily
responsible for negotiating the credit agreement which
establishes the terms and conditions of the senior loan and the
rights of the borrower and the lenders. The agent is also
responsible for monitoring collateral and for exercising
remedies available to the lenders such as foreclosure upon
collateral.
Credit agreements may provide for the termination of the
agents status in the event that it fails to act as
required under the relevant credit agreement, becomes insolvent,
enters FDIC receivership or, if not FDIC insured, enters into
bankruptcy. Should such an agent, lender or assignor with
respect to an assignment inter-positioned between the Trust and
the borrower become insolvent or enter FDIC receivership or
bankruptcy, any interest in the senior loan of such person and
any loan payment held by such person for the benefit of the
Trust should not be included in such persons or
entitys bankruptcy estate. If, however, any such amount
were included in such persons or entitys bankruptcy
estate, the Trust would incur certain costs and delays in
realizing payment or could suffer a loss of principal or
interest. In this event, the Trust could experience a decrease
in net asset value.
27
Form of Investment. The Trusts investments in
senior loans may take one of several forms, including acting as
one of the group of lenders originating a senior loan,
purchasing an assignment of a portion of a senior loan from a
third party or acquiring a participation in a senior loan. When
the Trust is a member of the originating syndicate for a senior
loan, it may share in a fee paid to the syndicate. When the
Trust acquires a participation in, or an assignment of, a senior
loan, it may pay a fee to, or forego a portion of interest
payments from, the lender selling the participation or
assignment. The Trust will act as lender, or purchase an
assignment or participation, with respect to a senior loan only
if the agent is determined by the Investment Adviser to be
creditworthy.
Original Lender. When the Trust is one of the original
lenders, it will have a direct contractual relationship with the
borrower and can enforce compliance by the borrower with terms
of the credit agreement. It also may have negotiated rights with
respect to any funds acquired by other lenders through set-off.
Original lenders also negotiate voting and consent rights under
the credit agreement. Actions subject to lender vote or consent
generally require the vote or consent of the majority of the
holders of some specified percentage of the outstanding
principal amount of the senior loan. Certain decisions, such as
reducing the interest rate, or extending the maturity of a
senior loan, or releasing collateral securing a senior loan,
among others, frequently require the unanimous vote or consent
of all lenders affected.
Assignments. When the Trust is a purchaser of an
assignment, it typically succeeds to all the rights and
obligations under the credit agreement of the assigning lender
and becomes a lender under the credit agreement with the same
rights and obligations as the assigning lender. Assignments are,
however, arranged through private negotiations between potential
assignees and potential assignors, and the rights and
obligations acquired by the purchaser of an assignment may be
more limited than those held by the assigning lender.
Participations. The Trust may also invest in
participations in senior loans. The rights of the Trust when it
acquires a participation are likely to be more limited than the
rights of an original lender or an investor who acquired an
assignment. Participation by the Trust in a lenders
portion of a senior loan typically means that the Trust has only
a contractual relationship with the lender, not with the
borrower. This means that the Trust has the right to receive
payments of principal, interest and any fees to which it is
entitled only from the lender selling the participation and only
upon receipt by the lender of payments from the borrower.
With a participation, the Trust will have no rights to enforce
compliance by the borrower with the terms of the credit
agreement or any rights with respect to any funds acquired by
other lenders through setoff against the borrower. In addition,
the Trust may not directly benefit from the collateral
supporting the senior loan because it may be treated as a
general creditor of the lender instead of a senior secured
creditor of the borrower. As a result, the Trust may be subject
to delays, expenses and risks that are greater than those that
exist when the Trust is the original lender or holds an
assignment. This means the Trust must assume the credit risk of
both the borrower and the lender selling the participation. The
Trust will consider a purchase of participations only in those
situations where the Investment Adviser considers the
participating lender to be creditworthy.
In the event of a bankruptcy or insolvency of a borrower, the
obligation of the borrower to repay the senior loan may be
subject to certain defenses that can be asserted by such
borrower against the Trust as a result of improper conduct of
the lender selling the participation. A participation in a
senior loan will be deemed to be a senior loan for the purposes
of the Trusts investment objectives and policies.
Investing in senior loans involves investment risk. Some
borrowers default on their senior loan payments. The Trust
attempts to manage this credit risk through multiple different
investments within the portfolio and ongoing analysis and
monitoring of borrowers. The Trust also is subject to market,
liquidity, interest rate and other risks. See Principal
Risks of the Trust.
Second Lien Loans. Second lien loans are loans
made by public and private corporations and other
non-governmental entities and issuers for a variety of purposes.
Second lien loans are second in right of payment to one or more
senior loans of the related borrower. Second lien loans
typically are secured by a second priority security interest or
lien to or on specified collateral securing the borrowers
obligation under the loan and typically have similar protections
and rights as senior loans. Second lien loans are not (and by
their terms
28
cannot) become subordinate in right of payment to any obligation
of the related borrower other than senior loans of such
borrower. Second lien loans, like senior loans, typically have
adjustable floating rate interest payments. Because second lien
loans are second to senior loans, they present a greater degree
of investment risk but often pay interest at higher rates
reflecting this additional risk. Such investments generally are
of below investment grade quality. Other than their subordinated
status, second lien loans have many characteristics and risks
similar to senior loans discussed above. In addition, second
lien loans of below investment grade quality share many of the
risk characteristics of non-investment grade securities. As in
the case of senior loans, the Trust may purchase interests in
second lien loans through assignments or participations.
Second lien loans are subject to the same risks associated with
investment in senior loans and non-investment grade securities.
Because second lien loans are second in right of payment to one
or more senior loans of the related borrower, they therefore are
subject to additional risk that the cash flow of the borrower
and any property securing the loan may be insufficient to meet
scheduled payments after giving effect to the senior secured
obligations of the borrower. Second lien loans are also expected
to have greater price volatility than senior loans and may be
less liquid. There is also a possibility that originators will
not be able to sell participations in second lien loans, which
would create greater credit risk exposure.
Other Secured Loans. Secured loans other than
senior loans and second lien loans are made by public and
private corporations and other non-governmental entities and
issuers for a variety of purposes. Such secured loans may rank
lower in right of payment to one or more senior loans and second
lien loans of the borrower. Such secured loans typically are
secured by a lower priority security interest or lien to or on
specified collateral securing the borrowers obligation
under the loan, and typically have more subordinated protections
and rights than senior loans and second lien loans. Secured
loans may become subordinated in right of payment to more senior
obligations of the borrower issued in the future. Such secured
loans may have fixed or adjustable floating rate interest
payments. Because such secured loans may rank lower as to right
of payment than senior loans and second lien loans of the
borrower, they may present a greater degree of investment risk
than senior loans and second lien loans but often pay interest
at higher rates reflecting this additional risk. Such
investments generally are of below investment grade quality.
Other than their more subordinated status, such investments have
many characteristics and risks similar to senior loans and
second lien loans discussed above. In addition, secured loans of
below investment grade quality share many of the risk
characteristics of non-investment grade securities. As in the
case of senior loans and second lien loans, the Trust may
purchase interests in other secured loans through assignments or
participations. Other secured loans are subject to the same
risks associated with investment in senior loans, second lien
loans and non-investment grade securities. Because such loans,
however, may rank lower in right of payment to senior loans and
second lien loans of the borrower, they may be subject to
additional risk that the cash flow of the borrower and any
property securing the loan may be insufficient to repay the
scheduled payments after giving effect to more senior secured
obligations of the borrower. Such secured loans are also
expected to have greater price volatility than senior loans and
second lien loans and may be less liquid. There is also a
possibility that originators will not be able to sell
participations in other secured loans, which would create
greater credit risk exposure.
Unsecured Loans. Unsecured loans are loans made by
public and private corporations and other non-governmental
entities and issuers for a variety of purposes. Unsecured loans
generally have lower priority in right of payment compared to
holders of secured debt of the borrower. Unsecured loans are not
secured by a security interest or lien to or on specified
collateral securing the borrowers obligation under the
loan. Unsecured loans by their terms may be or may become
subordinate in right of payment to other obligations of the
borrower, including senior loans, second lien loans and other
secured loans. Unsecured loans may have fixed or adjustable
floating rate interest payments. Because unsecured loans are
subordinate to the secured debt of the borrower, they present a
greater degree of investment risk but often pay interest at
higher rates reflecting this additional risk. Such investments
generally are of non-investment grade quality. Other than their
subordinated and unsecured status, such investments have many
characteristics and risks similar to senior loans, second lien
loans and other secured loans discussed above. In addition,
unsecured loans of non-investment grade quality share many of
the risk characteristics of non-investment grade securities. As
in the
29
case of secured loans, the Trust may purchase interests in
unsecured loans through assignments or participations.
Unsecured loans are subject to the same risks associated with
investment in senior loans, second lien loans, other secured
loans and non-investment grade securities. However, because
unsecured loans rank lower in right of payment to any secured
obligations of the borrower, they may be subject to additional
risk that the cash flow of the borrower and available assets may
be insufficient to meet scheduled payments after giving effect
to the secured obligations of the borrower. Unsecured loans are
also expected to have greater price volatility than secured
loans and may be less liquid. There is also a possibility that
loan originators will not be able to sell participations in
unsecured loans, which would create greater credit risk exposure.
Investment Grade Securities. The Trust may invest
in a wide variety of bonds that are rated or determined by the
Investment Adviser to be of investment grade quality of varying
maturities issued by U.S. corporations and other business
entities. Bonds are fixed or variable rate debt obligations,
including bills, notes, debentures, money market instruments and
similar instruments and securities. Bonds generally are used by
corporations and other issuers to borrow money from investors
for a variety of business purposes. The issuer pays the investor
a fixed or variable rate of interest and normally must repay the
amount borrowed on or before maturity. Certain bonds are
perpetual in that they have no maturity date. Some
investment grade securities, such as zero coupon bonds, do not
pay current interest, but are sold at a discount from their face
values. Although more creditworthy and generally less risky than
non-investment grade securities, investment grade securities are
still subject to market and credit risk. Market risk relates to
changes in a securitys value as a result of interest rate
changes generally. Investment grade securities have varying
levels of sensitivity to changes in interest rates and varying
degrees of credit quality. In general, bond prices rise when
interest rates fall, and fall when interest rates rise.
Longer-term bonds and zero coupon bonds are generally more
sensitive to interest rate changes. Credit risk relates to the
ability of the issuer to make payments of principal and
interest. The values of investment grade securities like those
of other debt securities may be affected by changes in the
credit rating or financial condition of an issuer. Investment
grade securities are generally considered medium-and
high-quality securities. Some, however, may possess speculative
characteristics, and may be more sensitive to economic changes
and to changes in the financial condition of issuers. The market
prices of investment grade securities in the lowest investment
grade categories may fluctuate more than higher-quality
securities and may decline significantly in periods of general
or regional economic difficulty. Like non-investment grade
securities, such investment grade securities in the lowest
investment grade categories may be thinly traded, making them
difficult to sell promptly at an acceptable price.
Other Fixed Income Securities. The Trust also may
purchase unsecured loans, other floating rate or fixed rate debt
securities such as notes, bonds and asset-backed securities
(such as securities issued by special purpose funds investing in
bank loans), investment grade and below investment grade fixed
income debt obligations and money market instruments, such as
commercial paper. The high yield securities in which the Trust
invests are rated Ba or lower by Moodys or BB or lower by
S&P or are unrated but determined by the Investment Adviser
to be of comparable quality. Debt securities rated below
investment grade are commonly referred to as junk
securities and are considered speculative with respect to
the issuers capacity to pay interest and repay principal.
Below investment grade debt securities involve greater risk of
loss, are subject to greater price volatility and are less
liquid, especially during periods of economic uncertainty or
change, than higher rated debt securities. The Trusts
fixed-income securities may have fixed or variable principal
payments and all types of interest rate and dividend payment and
reset terms, including fixed rate, adjustable rate, zero coupon,
contingent, deferred, payment in kind and auction rate features.
The Trust may invest in fixed-income securities with a broad
range of maturities.
The Trust may invest in zero coupon bonds, deferred interest
bonds and bonds or preferred stocks on which the interest is
payable-in-kind (PIK
bonds). To the extent the Trust invests in such instruments,
they will not contribute to the Trusts goal of current
income. Zero coupon and deferred interest bonds are debt
obligations which are issued at a significant discount from face
value. While zero coupon bonds do not require the periodic
payment of interest, deferred interest bonds provide for a
period of delay before the regular payment of interest begins.
PIK bonds are debt obligations that provide that the issuer
thereof may, at its option, pay interest on such bonds in cash
or in the form of additional debt obligations. Such investments
may
30
experience greater volatility in market value due to changes in
interest rates. The Trust may be required to accrue income on
these investments for federal income tax purposes and is
required to distribute its net income each year in order to
qualify for the favorable federal income tax treatment
potentially available to regulated investment companies. The
Trust may be required to sell securities to obtain cash needed
for income distributions.
Non-Investment Grade Securities. The Trust may
invest in securities rated below investment grade, such as those
rated Ba or lower by Moodys and BB or lower by S&P or
securities comparably rated by other rating agencies or in
unrated securities determined by Highland to be of comparable
quality. Securities rated Ba by Moodys are judged to have
speculative elements, their future cannot be considered as well
assured and often the protection of interest and principal
payments may be very moderate. Securities rated BB by S&P
are regarded as having predominantly speculative characteristics
and, while such obligations have less near-term vulnerability to
default than other speculative grade debt, they face major
ongoing uncertainties or exposure to adverse business, financial
or economic conditions which could lead to inadequate capacity
to meet timely interest and principal payments. Securities rated
C are regarded as having extremely poor prospects of ever
attaining any real investment standing. Securities rated D are
in default and the payment of interest and/or repayment of
principal is in arrears. The Trust may purchase securities rated
as low as D or unrated securities deemed by Highland to be of
comparable quality. When Highland believes it to be in the best
interests of the Trusts shareholders, the Trust will
reduce its investment in lower grade securities.
Lower grade securities, though high yielding, are characterized
by high risk. They may be subject to certain risks with respect
to the issuing entity and to greater market fluctuations than
certain lower yielding, higher rated securities. The secondary
market for lower grade securities may be less liquid than that
of higher rated securities. Adverse conditions could make it
difficult at times for the Trust to sell certain securities or
could result in lower prices than those used in calculating the
Trusts net asset value.
The prices of debt securities generally are inversely related to
interest rate changes; however, the price volatility caused by
fluctuating interest rates of securities also is inversely
related to the coupon of such securities. Accordingly, lower
grade securities may be relatively less sensitive to interest
rate changes than higher quality securities of comparable
maturity, because of their higher coupon. This higher coupon is
what the investor receives in return for bearing greater credit
risk. The higher credit risk associated with lower grade
securities potentially can have a greater effect on the value of
such securities than may be the case with higher quality issues
of comparable maturity, and will be a substantial factor in the
Trusts relative share price volatility.
Lower grade securities may be particularly susceptible to
economic downturns. It is likely that an economic recession
could disrupt severely the market for such securities and may
have an adverse impact on the value of such securities. In
addition, it is likely that any such economic downturn could
adversely affect the ability of the issuers of such securities
to repay principal and pay interest thereon and increase the
incidence of default for such securities.
The ratings of Moodys and S&P and the other rating
agencies represent their opinions as to the quality of the
obligations which they undertake to rate. Ratings are relative
and subjective and, although ratings may be useful in evaluating
the safety of interest and principal payments, they do not
evaluate the market value risk of such obligations. Although
these ratings may be an initial criterion for selection of
portfolio investments, Highland also will independently evaluate
these securities and the ability of the issuers of such
securities to pay interest and principal. To the extent that the
Trust invests in lower grade securities that have not been rated
by a rating agency, the Trusts ability to achieve its
investment objectives will be more dependent on Highlands
credit analysis than would be the case when the Trust invests in
rated securities.
Asset-Backed Securities. The Trust may invest a
portion of its assets in asset-backed securities. Asset-backed
securities are generally issued as pass-through certificates,
which represent undivided fractional ownership interests in an
underlying pool of assets, or as debt instruments, which are
also known as collateralized obligations, and are generally
issued as the debt of a special purpose entity organized solely
for the purpose of owning such assets and issuing such debt.
Asset-backed securities are often backed by a pool of assets
representing the obligations of a number of different parties.
Credit card receivables are generally
31
unsecured, and the debtors are entitled to the protection of a
number of state and federal consumer credit laws which give
debtors the right to set off certain amounts owed on the credit
cards, thereby reducing the balance due. Most issuers of
automobile receivables permit the servicers to retain possession
of the underlying obligations. If the servicer were to sell
these obligations to another party, there is a risk that the
purchaser would acquire an interest superior to that of the
holders of the related automobile receivables. In addition,
because of the large number of vehicles involved in a typical
issuance and technical requirements under state laws, the
trustee for the holders of the automobile receivables may not
have an effective security interest in all of the obligations
backing such receivables. Therefore, there is a possibility that
recoveries on repossessed collateral may not, in some cases, be
able to support payments on these securities.
Second Lien Loans and Debt Obligations. The Trust
may invest in loans and other debt securities that have the same
characteristics as senior loans except that such loans are
second in lien property rather than first. Such second
lien loans and securities, like senior loans, typically
have adjustable floating rate interest payments. Accordingly,
the risks associated with second lien loans are
higher than the risk of loans with first priority over the
collateral. In the event of default on a second lien
loan, the first priority lien holder has first claim to the
underlying collateral of the loan. It is possible that no
collateral value would remain for the second priority lien
holder and therefore result in a loss of investment to the Trust.
Collateralized Loan Obligations and Bond
Obligations. The Trust may invest in certain
asset-backed securities that are securitizing certain financial
assets by issuing securities in the form of negotiable paper
that are issued by a financing company (generally called a
Special Purpose Vehicle or SPV). These securitized
assets are, as a rule, corporate financial assets brought into a
pool according to specific diversification rules. The SPV is a
company founded solely for the purpose of securitizing these
claims and its only asset is the diversified asset pool. On this
basis, marketable securities are issued which, due to the
diversification of the underlying risk, generally represent a
lower level of risk than the original assets. The redemption of
the securities issued by the SPV takes place at maturity out of
the cash flow generated by the collected claims.
A collateralized loan obligation (CLO) is a
structured debt security issued by an SPV that was created to
reapportion the risk and return characteristics of a pool of
assets. The assets, typically senior loans, are used as
collateral supporting the various debt tranches issued by the
SPV. The key feature of the CLO structure is the prioritization
of the cash flows from a pool of debt securities among the
several classes of securities issued by a CLO.
The Trust may also invest in collateralized bond obligations
(CBOs), which are structured debt securities backed
by a diversified pool of high yield, public or private fixed
income securities. These may be fixed pools or may be
market value (or managed) pools of collateral. The
CBO issues debt securities that are typically separated into
tranches representing different degrees of credit quality. The
top tranche of securities has the greatest collateralization and
pays the lowest interest rate. Lower CBO tranches have a lesser
degree of collateralization quality and pay higher interest
rates intended to compensate for the attendant risks. The bottom
tranche specifically receives the residual interest payments
(i.e., money that is left over after the higher tranches have
been paid) rather than a fixed interest rate. The return on the
lower tranches of CBOs is especially sensitive to the rate of
defaults in the collateral pool. Under normal market conditions,
the Trust expects to invest in the lower tranches of CBOs.
Distressed Debt. The Trust is authorized to invest
in the securities and other obligations of distressed and
bankrupt issuers, including debt obligations that are in
covenant or payment default. Such investments generally trade
significantly below par and are considered speculative. The
repayment of defaulted obligations is subject to significant
uncertainties. Defaulted obligations might be repaid only after
lengthy workout or bankruptcy proceedings, during which the
issuer might not make any interest or other payments. Typically
such workout or bankruptcy proceedings result in only partial
recovery of cash payments or an exchange of the defaulted
obligation for other debt or equity securities of the issuer or
its affiliates, which may in turn be illiquid or speculative.
The Trust may invest in securities of a company for purposes of
gaining control.
Stressed Debt. The Trust is authorized to invest
in securities and other obligations of stressed issuers.
Stressed issuers are issuers that are not yet deemed distressed
or bankrupt and whose debt securities are trading at a discount
to par, but not yet at distressed levels. An example would be an
issuer that is in technical
32
default of its credit agreement, or undergoing strategic or
operational changes, which results in market pricing uncertainty.
Credit Default Swaps. To the extent consistent
with Subchapter M of the Internal Revenue Code of 1986, as
amended (the Code), the Trust may enter into credit
default swap agreements. The buyer in a credit
default contract is obligated to pay the seller a
periodic stream of payments over the term of the contract
provided that no event of default on an underlying reference
obligation has occurred. If an event of default occurs, the
seller must pay the buyer the par value (full
notional value) of the reference obligation in exchange for the
reference obligation. The Trust may be either the buyer or
seller in the transaction. If the Trust is a buyer and no event
of default occurs, the Trust loses its investment and recovers
nothing. However, if an event of default occurs, the buyer
receives full notional value for a reference obligation that may
have little or no value. As a seller, the Trust receives income
throughout the term of the contract, which typically is between
six months and three years, provided that there is no default
event.
Credit default swaps involve greater risks than if the Trust had
invested in the reference obligation directly. In addition to
general market risks, credit default swaps are subject to
illiquidity risk, counterparty risk and credit risks. The Trust
will enter into swap agreements only with counterparties that
are rated investment grade quality by at least one nationally
recognized statistical rating organization at the time of
entering into such transaction or whose creditworthiness is
believed by the Investment Adviser to be equivalent to such
rating. A buyer also will lose its investment and recover
nothing should no event of default occur. If an event of default
were to occur, the value of the reference obligation received by
the seller, coupled with the periodic payments previously
received, may be less than the full notional value it pays to
the buyer, resulting in a loss of value to the seller. When the
Trust acts as a seller of a credit default swap agreement it is
exposed to many of the same risks of leverage described under
Principal Risks of the Trust Leverage
Risk in this prospectus since if an event of default
occurs the seller must pay the buyer the full notional value of
the reference obligation.
Senior Loan Based Derivatives. The Trust may
obtain exposure to senior loans and baskets of senior loans
through the use of derivative instruments. Such derivative
instruments have recently become increasingly available. The
Investment Adviser reserves the right to utilize these
instruments and similar instruments that may be available in the
future. For example, the Trust may invest in a derivative
instrument known as the Select Aggregate Market Index
(SAMI), which provides investors with exposure to a
reference basket of senior loans. SAMIs are structured as
floating rate instruments. SAMIs consist of a basket of credit
default swaps whose underlying reference securities are senior
loans. While investing in SAMIs will increase the universe of
floating rate debt securities to which the Trust is exposed,
such investments entail risks that are not typically associated
with investments in other floating rate debt securities. The
liquidity of the market for SAMIs will be subject to liquidity
in the secured loan and credit derivatives markets. Investment
in SAMIs involves many of the risks associated with investments
in derivative instruments discussed generally below. The Trust
may also be subject to the risk that the counterparty in a
derivative transaction will default on its obligations.
Derivative transactions generally involve the risk of loss due
to unanticipated adverse changes in securities prices, interest
rates, the inability to close out a position, imperfect
correlation between a position and the desired hedge, tax
constraints on closing out positions and portfolio management
constraints on securities subject to such transactions. The
potential loss on derivative instruments may be substantially
greater than the initial investment therein.
Credit-Linked Notes. The Trust may invest in
credit-linked notes (CLNs) for risk management
purposes and to vary its portfolio. A CLN is a derivative
instrument. It is a synthetic obligation between two or more
parties where the payment of principal and/or interest is based
on the performance of some obligation (a reference obligation).
In addition to credit risk of the reference obligations and
interest rate risk, the buyer/seller of the CLN is subject to
counterparty risk.
Common Stocks. The Trust may acquire an interest
in common stocks in various ways, including upon the default of
a senior loan secured by such common stock or by acquiring
common stock for investment. The Trust may also acquire warrants
or other rights to purchase a borrowers common stock in
connection with the making of a senior loan. Common stocks are
shares of a corporation or other entity that entitle the holder
to a
33
pro rata share of the profits, if any, of the corporation
without preference over any other shareholder or class of
shareholders, including holders of such entitys preferred
stock and other senior equity securities. Common stock usually
carries with it the right to vote and frequently an exclusive
right to do so. In selecting common stocks for investment, the
Trust generally expects to focus primarily on the
securitys dividend paying capacity rather than on its
potential for capital appreciation.
Preferred Securities. The Trust may invest in
preferred securities. Preferred securities are equity
securities, but they have many characteristics of fixed income
securities, such as a fixed dividend payment rate and/or a
liquidity preference over the issuers common shares.
However, because preferred shares are equity securities, they
may be more susceptible to risks traditionally associated with
equity investments than the Trusts fixed income securities.
Fixed rate preferred stocks have fixed dividend rates. They can
be perpetual, with no mandatory redemption date, or issued with
a fixed mandatory redemption date. Certain issues of preferred
stock are convertible into other equity securities. Perpetual
preferred stocks provide a fixed dividend throughout the life of
the issue, with no mandatory retirement provisions, but may be
callable. Sinking fund preferred stocks provide for the
redemption of a portion of the issue on a regularly scheduled
basis with, in most cases, the entire issue being retired at a
future date. The value of fixed rate preferred stocks can be
expected to vary inversely with interest rates.
Adjustable rate preferred stocks have a variable dividend rate
which is determined periodically, typically quarterly, according
to a formula based on a specified premium or discount to the
yield on particular U.S. Treasury securities, typically the
highest base-rate yield of one of three U.S. Treasury
securities: the 90-day
Treasury bill; the
10-year Treasury note;
and either the 20-year
or 30-year Treasury
bond or other index. The premium or discount to be added to or
subtracted from this base-rate yield is fixed at the time of
issuance and cannot be changed without the approval of the
holders of the adjustable rate preferred stock. Some adjustable
rate preferred stocks have a maximum and a minimum rate and in
some cases are convertible into common stock.
Auction rate preferred stocks pay dividends that adjust based on
periodic auctions. Such preferred stocks are similar to
short-term corporate money market instruments in that an auction
rate preferred stockholder has the opportunity to sell the
preferred stock at par in an auction, normally conducted at
least every 49 days, through which buyers set the dividend
rate in a bidding process for the next period. The dividend rate
set in the auction depends on market conditions and the credit
quality of the particular issuer. Typically, the auction rate
preferred stocks dividend rate is limited to a specified
maximum percentage of an external commercial paper index as of
the auction date. Further, the terms of the auction rate
preferred stocks generally provide that they are redeemable by
the issuer at certain times or under certain conditions.
Convertible Securities. The Trusts
investment in fixed income securities may include bonds and
preferred stocks that are convertible into the equity securities
of the issuer or a related company. Depending on the
relationship of the conversion price to the market value of the
underlying securities, convertible securities may trade more
like equity securities than debt instruments.
Money Market Instruments. Money market instruments
include short-term U.S. government securities,
U.S. dollar-denominated, high quality commercial paper
(unsecured promissory notes issued by corporations to finance
their short-term credit needs), certificates of deposit,
bankers acceptances and repurchase agreements relating to
any of the foregoing. U.S. government securities include
Treasury notes, bonds and bills, which are direct obligations of
the U.S. government backed by the full faith and credit of
the United States and securities issued by agencies and
instrumentalities of the U.S. government, which may be
guaranteed by the U.S. Treasury, may be supported by the
issuers right to borrow from the U.S. Treasury or may
be backed only by the credit of the federal agency or
instrumentality itself.
U.S. Government Securities.
U.S. government securities in which the Trust invests
include debt obligations of varying maturities issued by the
U.S. Treasury or issued or guaranteed by an agency or
instrumentality of the U.S. government, including the
Federal Housing Administration, Federal Financing Bank, Farmers
Home Administration, Export-Import Bank of the United States,
Small Business Administra-
34
tion, Government National Mortgage Association (GNMA), General
Services Administration, Central Bank for Cooperatives, Federal
Farm Credit Banks, Federal Home Loan Banks, Federal Home
Loan Mortgage Corporation (FHLMC), Federal National Mortgage
Association (FNMA), Maritime Administration, Tennessee Valley
Authority, District of Columbia Armory Board, Student Loan
Marketing Association, Resolution Trust Corporation and various
institutions that previously were or currently are part of the
Farm Credit System (which has been undergoing reorganization
since 1987). Some U.S. government securities, such as
U.S. Treasury bills, Treasury notes and Treasury bonds,
which differ only in their interest rates, maturities and times
of issuance, are supported by the full faith and credit of the
United States government. Others are supported by (i) the
right of the issuer to borrow from the U.S. Treasury, such
as securities of the Federal Home Loan Banks; (ii) the
discretionary authority of the U.S. government to purchase
the agencys obligations, such as securities of the FNMA;
or (iii) only the credit of the issuer. No assurance can be
given that the U.S. government will provide financial
support in the future to U.S. government agencies,
authorities or instrumentalities that are not supported by the
full faith and credit of the United States. Securities
guaranteed as to principal and interest by the
U.S. government, its agencies, authorities or
instrumentalities include (i) securities for which the
payment of principal and interest is backed by an irrevocable
letter of credit issued by the U.S. government or any of
its agencies, authorities or instrumentalities; and
(ii) participations in loans made to
non-U.S. governments
or other entities that are so guaranteed. The secondary market
for certain of these participations is limited and therefore may
be regarded as illiquid.
Other Investment Companies. The Trust may invest
in the securities of other investment companies to the extent
that such investments are consistent with the Trusts
investment objectives and principal investment strategies and
permissible under the Investment Company Act. Under one
provision of the Investment Company Act, the Trust may not
acquire the securities of other investment companies if, as a
result, (i) more than 10% of the Trusts total assets
would be invested in securities of other investment companies,
(ii) such purchase would result in more than 3% of the
total outstanding voting securities of any one investment
company being held by the Trust or (iii) more than 5% of
the Trusts total assets would be invested in any one
investment company. Other provisions of the Investment Company
Act are less restrictive provided that the Trust is able to meet
certain conditions. These limitations do not apply to the
acquisition of shares of any investment company in connection
with a merger, consolidation, reorganization or acquisition of
substantially all of the assets of another investment company.
The Trust, as a holder of the securities of other investment
companies, will bear its pro rata portion of the other
investment companies expenses, including advisory fees.
These expenses will be in addition to the direct expenses
incurred by the Trust.
Exchange Traded Funds. Subject to the limitations
on investment in other investment companies, the Trust may
invest in exchange traded funds (ETFs). ETFs, such
as SPDRs, NASDAQ 100 Index Trading Stock (QQQs), iShares and
various country index funds, are funds whose shares are traded
on a national exchange or the National Association of Securities
Dealers Automatic Quotation System (NASDAQ). ETFs may be
based on underlying equity or fixed income securities. SPDRs,
for example, seek to provide investment results that generally
correspond to the performance of the component common stocks of
the S&P 500. ETFs do not sell individual shares directly to
investors and only issue their shares in large blocks known as
creation units. The investor purchasing a creation
unit may sell the individual shares on a secondary market.
Therefore, the liquidity of ETFs depends on the adequacy of the
secondary market. There can be no assurance that an ETFs
investment objective will be achieved. ETFs based on an index
may not replicate and maintain exactly the composition and
relative weightings of securities in the index. ETFs are subject
to the risks of investing in the underlying securities. The
Trust, as a holder of the securities of the ETF, will bear its
pro rata portion of the ETFs expenses, including advisory
fees. These expenses are in addition to the direct expenses of
the Trusts own operations.
Zero Coupon Securities. The securities in which
the Trust invests may include zero coupon securities, which are
debt obligations that are issued or purchased at a significant
discount from face value. The discount approximates the total
amount of interest the security will accrue and compound over
the period until maturity or the particular interest payment
date at a rate of interest reflecting the market rate of the
security at the time of issuance. Zero coupon securities do not
require the periodic payment of interest. These investments
benefit
35
the issuer by mitigating its need for cash to meet debt service
but generally require a higher rate of return to attract
investors who are willing to defer receipt of cash. These
investments may experience greater volatility in market value
than securities that make regular payments of interest. The
Trust accrues income on these investments for tax and accounting
purposes, which is distributable to shareholders and which,
because no cash is received at the time of accrual, may require
the liquidation of other portfolio securities to satisfy the
Trusts distribution obligations, in which case the Trust
will forego the purchase of additional income producing assets
with these funds.
Derivative Transactions. In addition to the credit
default swaps and senior loan bond derivatives discussed above
the Trust may, but is not required to, use various Derivative
Transactions described below to earn income, facilitate
portfolio management and mitigate risks. Such Derivative
Transactions are generally accepted under modern portfolio
management and are regularly used by many mutual funds and other
institutional investors. Although the Investment Adviser seeks
to use the practices to further the Trusts investment
objectives, no assurance can be given that these practices will
achieve this result. While the Trust reserves the ability to use
these Derivative Transactions, the Investment Adviser does not
anticipate that Derivative Transactions other than senior loan
bond derivatives will initially be a significant part of the
Trusts investment approach. With changes in the market or
the Investment Advisers strategy, it is possible that
these instruments may be a more significant part of the
Trusts investment approach in the future.
The Trust may purchase and sell derivative instruments such as
exchange-listed and
over-the-counter put
and call options on securities, financial futures, equity,
fixed-income and interest rate indices, and other financial
instruments, purchase and sell financial futures contracts and
options thereon, enter into various interest rate transactions
such as swaps, caps, floors or collars and enter into various
currency transactions such as currency forward contracts,
currency futures contracts, currency swaps or options on
currency or currency futures or credit transactions and credit
default swaps. The Trust also may purchase derivative
instruments that combine features of these instruments. The
Trust generally seeks to use Derivative Transactions as a
portfolio management or hedging technique to seek to protect
against possible adverse changes in the market value of senior
loans or other securities held in or to be purchased for the
Trusts portfolio, protect the value of the Trusts
portfolio, facilitate the sale of certain securities for
investment purposes, manage the effective interest rate exposure
of the Trust, protect against changes in currency exchange
rates, manage the effective maturity or duration of the
Trusts portfolio, or establish positions in the
derivatives markets as a temporary substitute for purchasing or
selling particular securities.
Derivative Transactions have risks, including the imperfect
correlation between the value of such instruments and the
underlying assets, the possible default of the other party to
the transaction or illiquidity of the derivative instruments.
Furthermore, the ability to use successfully Derivative
Transactions depends on the Investment Advisers ability to
predict pertinent market movements, which cannot be assured.
Thus, the use of Derivative Transactions may result in losses
greater than if they had not been used, may require the Trust to
sell or purchase portfolio securities at inopportune times or
for prices other than current market values, may limit the
amount of appreciation the Trust can realize on an investment,
or may cause the Trust to hold a security that it might
otherwise sell. The use of currency transactions can result in
the Trust incurring losses as a result of the imposition of
exchange controls, suspension of settlements or the inability of
the Trust to deliver or receive a specified currency.
Additionally, amounts paid by the Trust as premiums and cash or
other assets held in margin accounts with respect to Derivative
Transactions are not otherwise available to the Trust for
investment purposes.
A more complete discussion of Derivative Transactions and their
risks is contained in the Statement of Additional Information.
Swaps. Swap contracts may be purchased or sold to
obtain investment exposure and/or to hedge against fluctuations
in securities prices, currencies, interest rates or market
conditions, to change the duration of the overall portfolio or
to mitigate default risk. In a standard swap
transaction, two parties agree to exchange the returns (or
differentials in rates of return) on different currencies,
securities, baskets of currencies or securities, indices or
other instruments, which returns are calculated with respect to
a notional value, i.e., the designated reference
amount of exposure to the underlying instruments. The Trust
intends to enter into
36
swaps primarily on a net basis, i.e., the two payment streams
are netted out, with the Trust receiving or paying, as the case
may be, only the net amount of the two payments. If the other
party to a swap contract defaults, the Trusts risk of loss
will consist of the net amount of payments that the Trust is
contractually entitled to receive. The net amount of the excess,
if any, of the Trusts obligations over its entitlements
will be maintained in a segregated account by the Trusts
custodian. The Trust will not enter into a swap agreement unless
the claims-paying ability of the other party thereto is
considered to be investment grade by the Investment Adviser. If
there is a default by the other party to such a transaction, the
Trust will have contractual remedies pursuant to the agreements
related to the transaction. Swap instruments are not
exchange-listed securities and may be traded only in the
over-the-counter market.
Interest Rate Swaps. Interest rate swaps involve
the exchange by the Trust with another party of their respective
commitments to pay or receive interest (e.g., an exchange of
fixed rate payments for floating rate payments). The Trust may
use interest rate swaps for risk management purposes and as a
speculative investment.
Total Return Swaps. Total return swaps are
contracts in which one party agrees to make payments of the
total return from the designated underlying asset(s), which may
include securities, baskets of securities, or securities
indices, during the specified period, in return for receiving
payments equal to a fixed or floating rate of interest or the
total return from the other designated underlying asset(s). The
Trust may use total return swaps for risk management purposes
and as a speculative investment.
Currency Swaps. Currency swaps involve the
exchange of the two parties respective commitments to pay
or receive fluctuations with respect to a notional amount of two
different currencies (e.g., an exchange of payments with respect
to fluctuations in the value of the U.S. dollar relative to
the Japanese yen). The Trust may enter into currency swap
contracts and baskets thereof for risk management purposes and
as a speculative investment.
Short Sales. The Trust intends to attempt to limit
exposure to a possible market decline in the value of its
portfolio securities through short sales of securities that
Highland believes possess volatility characteristics similar to
those being hedged. In addition, the Trust intends to use short
sales for non-hedging purposes to pursue its investment
objectives. Subject to the requirements of the Investment
Company Act and the Code, the Trust will not make a short sale
if, after giving effect to such sale, the market value of all
securities sold short by the Trust exceeds 25% of the value of
its total assets.
A short sale is a transaction in which the Trust sells a
security it does not own in anticipation that the market price
of that security will decline. When the Trust makes a short
sale, it must borrow the security sold short from a
broker-dealer and deliver it to the buyer upon conclusion of the
sale. The Trust may have to pay a fee to borrow particular
securities and is often obligated to pay over any payments
received on such borrowed securities.
The Trusts obligation to replace the borrowed security
will be secured by collateral deposited with the broker-dealer,
usually cash, U.S. government securities or other liquid
securities. The Trust will also be required to designate on its
books and records similar collateral with its custodian to the
extent, if any, necessary so that the aggregate collateral value
is at all times at least equal to the current market value of
the security sold short. Depending on arrangements made with the
broker-dealer from which it borrowed the security regarding
payment over of any payments received by the Trust on such
security, the Trust may not receive any payments (including
interest) on its collateral deposited with such broker-dealer.
If the price of the security sold short increases between the
time of the short sale and the time the Trust replaces the
borrowed security, the Trust will incur a loss; conversely, if
the price declines, the Trust will realize a gain. Any gain will
be decreased, and any loss increased, by the transaction costs
described above. Although the Trusts gain is limited to
the price at which it sold the security short, its potential
loss is unlimited.
The Trust may also sell a security short if it owns at least an
equal amount of the security sold short or another security
convertible or exchangeable for an equal amount of the security
sold short without payment of further compensation (a short sale
against-the-box). In a
short sale
against-the-box, the
short seller is exposed
37
to the risk of being forced to deliver stock that it holds to
close the position if the borrowed stock is called in by the
lender, which would cause gain or loss to be recognized on the
delivered stock. The Trust expects normally to close its short
sales against-the-box
by delivering newly acquired stock.
Purchasing securities to close out the short position can itself
cause the price of the securities to rise further, thereby
exacerbating the loss. Short-selling exposes the Trust to
unlimited risk with respect to that security due to the lack of
an upper limit on the price to which an instrument can rise.
Although the Trust reserves the right to utilize short sales,
and currently intends to utilize short sales, Highland is under
no obligation to utilize short sales at all.
Repurchase Agreements. The Trust may invest up to
331/3
% of its assets in repurchase agreements. It may enter
into repurchase agreements with broker-dealers, member banks of
the Federal Reserve System and other financial institutions.
Repurchase agreements are loans or arrangements under which the
Trust purchases securities and the seller agrees to repurchase
the securities within a specific time and at a specific price.
The repurchase price is generally higher than the Trusts
purchase price, with the difference being income to the Trust.
Under the direction of the board of trustees, the Investment
Adviser reviews and monitors the creditworthiness of any
institution which enters into a repurchase agreement with the
Trust. The counterpartys obligations under the repurchase
agreement are collateralized with U.S. Treasury and/or
agency obligations with a market value of not less than 100% of
the obligations, valued daily. Collateral is held by the
Trusts custodian in a segregated, safekeeping account for
the benefit of the Trust. Repurchase agreements afford the Trust
an opportunity to earn income on temporarily available cash at
low risk. In the event of commencement of bankruptcy or
insolvency proceedings with respect to the seller of the
security before repurchase of the security under a repurchase
agreement, the Trust may encounter delay and incur costs before
being able to sell the security. Such a delay may involve loss
of interest or a decline in price of the security. If the court
characterizes the transaction as a loan and the Trust has not
perfected a security interest in the security, the Trust may be
required to return the security to the sellers estate and
be treated as an unsecured creditor of the seller. As an
unsecured creditor, the Trust would be at risk of losing some or
all of the principal and interest involved in the transaction.
Lending of Assets. The Trust may lend up to
331/3
% of its assets. It may lend assets to registered
broker-dealers or other institutional investors deemed by the
Investment Adviser to be of good standing under agreements which
require that the loans be secured continuously by collateral in
cash, cash equivalents or U.S. Treasury bills maintained on
a current basis at an amount at least equal to the market value
of the securities loaned. The Trust continues to receive the
equivalent of the interest or dividends paid by the issuer on
the securities loaned as well as the benefit of an increase and
the detriment of any decrease in the market value of the
securities loaned and would also receive compensation based on
investment of the collateral. The Trust would not, however, have
the right to vote any securities having voting rights during the
existence of the loan, but would call the loan in anticipation
of an important vote to be taken among holders of the securities
or of the giving or withholding of consent on a material matter
affecting the investment.
As with other extensions of credit, there are risks of delay in
recovery or even loss of rights in the collateral should the
borrower of the securities fail financially. The Trust will lend
portfolio securities only to firms that have been approved in
advance by the board of trustees, which will monitor the
creditworthiness of any such firms.
Non-U.S. Securities.
The Trust may invest up to 20% of its total assets in
non-U.S. securities,
which may include securities denominated in U.S. dollars or
in
non-U.S. currencies
or multinational currency units. The Trust may invest in
non-U.S. securities
of so-called emerging market issuers. For purposes of the Trust,
a company is deemed to be a
non-U.S. company
if it meets the following tests: (i) such company was not
organized in the United States; (ii) such companys
primary business office is not in the United States;
(iii) the principal trading market for such companys
securities is not located in the United States; (iv) less
than 50% of such companys assets are located in the United
States; or (v) 50% or more of such issuers revenues
are derived from outside the United States.
Non-U.S. securities
markets generally are not as developed or efficient as those in
the United States. Securities of some
non-U.S. issuers
are less liquid and more volatile than securities of comparable
U.S. issuers. Similarly, volume and liquidity in most
38
non-U.S. securities
markets are less than in the United States and, at times,
volatility of price can be greater than in the United States.
Because evidences of ownership of such securities usually are
held outside the United States, the Trust would be subject to
additional risks if it invested in
non-U.S. securities,
which include possible adverse political and economic
developments, seizure or nationalization of foreign deposits and
adoption of governmental restrictions which might adversely
affect or restrict the payment of principal and interest on the
non-U.S. securities
to investors located outside the country of the issuer, whether
from currency blockage or otherwise.
Since
non-U.S. securities
may be purchased with and payable in foreign currencies, the
value of these assets as measured in U.S. dollars may be
affected favorably or unfavorably by changes in currency rates
and exchange control regulations.
Options. An option on a security is a contract
that gives the holder of the option, in return for a premium,
the right to buy from (in the case of a call) or sell to (in the
case of a put) the writer of the option the security underlying
the option at a specified exercise or strike price.
The writer of an option on a security has the obligation upon
exercise of the option to deliver the underlying security upon
payment of the exercise price or to pay the exercise price upon
delivery of the underlying security. Certain options, known as
American style options may be exercised at any time
during the term of the option. Other options, known as
European style options, may be exercised only on the
expiration date of the option.
If an option written by the Trust expires unexercised, the Trust
realizes on the expiration date a capital gain equal to the
premium received by the Trust at the time the option was
written. If an option purchased by the Trust expires
unexercised, the Trust realizes a capital loss equal to the
premium paid. Prior to the earlier of exercise or expiration, an
exchange-traded option may be closed out by an offsetting
purchase or sale of an option of the same series (type,
underlying security, exercise price and expiration). There can
be no assurance, however, that a closing purchase or sale
transaction can be effected when the Trust desires. The Trust
may sell put or call options it has previously purchased, which
could result in a net gain or loss depending on whether the
amount realized on the sale is more or less than the premium and
other transaction costs paid on the put or call option when
purchased. The Trust will realize a capital gain from a closing
purchase transaction if the cost of the closing option is less
than the premium received from writing the option, or, if it is
more, the Trust will realize a capital loss. If the premium
received from a closing sale transaction is more than the
premium paid to purchase the option, the Trust will realize a
capital gain or, if it is less, the Trust will realize a capital
loss.
Short-Term Debt Securities; Temporary Defensive Position;
Invest-Up Period. During the period in which the net
proceeds of this offering of common shares are being invested,
during periods in which Highland determines that it is
temporarily unable to follow the Trusts investment
strategy or that it is impractical to do so or pending
re-investment of proceeds received in connection with the sale
of a security, the Trust may deviate from its investment
strategy and invest all or any portion of its assets in cash or
cash equivalents. Highlands determination that it is
temporarily unable to follow the Trusts investment
strategy or that it is impractical to do so will generally occur
only in situations in which a market disruption event has
occurred and where trading in the securities selected through
application of the Trusts investment strategy is extremely
limited or absent. In such a case, shares of the Trust may be
adversely affected and the Trust may not pursue or achieve its
investment objectives.
39
PRINCIPAL RISKS OF THE TRUST
The net asset value of, and dividends paid on, the common shares
will fluctuate with and be affected by, among other things, the
risks more fully described below.
No Operating History
The Trust is a newly organized, non-diversified, closed-end
management investment company with no operating history.
Investment and Market Discount Risk
An investment in the Trusts common shares is subject to
investment risk, including the possible loss of the entire
amount that you invest. As with any stock, the price of the
Trusts shares will fluctuate with market conditions and
other factors. If shares are sold, the price received may be
more or less than the original investment. Net asset value will
be reduced immediately following the initial offering by 4.50%
(the amount of the sales load) and offering expenses paid by the
Trust (estimated to be an additional 0.20%, excluding the
estimated expenses of the Preferred Share offering which is
expected to occur soon after the completion of this offering, as
described under Prospectus Summary Preferred
Shares and Borrowings and Description of Capital
Structure Preferred Shares). Any Preferred
Share offering and the cost and expenses of any borrowing would
result in further dilution, as described under Prospectus
Summary Preferred Shares and Borrowings.
Common shares are designed for long-term investors and should
not be treated as trading vehicles. Shares of closed-end
management investment companies frequently trade at a discount
from their net asset value. The Trusts shares may trade at
a price that is less than the initial offering price. This risk
may be greater for investors who sell their shares in a
relatively short period of time after completion of the initial
offering.
Risks of Non-Diversification and other Focused Strategies
While the Investment Adviser will invest in a number of
fixed-income and equity instruments issued by different issuers
and plans to employ multiple investment strategies with respect
to the Trusts portfolio, it is possible that a significant
amount of the Trusts investment could be invested in the
instruments of only a few companies or other issuers or that at
any particular point in time one investment strategy could be
more heavily weighted than the others. The focus of the
Trusts portfolio in any one issuer would subject the Trust
to a greater degree of risk with respect to defaults by such
issuer or other adverse events affecting that issuer, and the
focus of the portfolio in any one industry or group of
industries (but not to the extent of 25% of the Trusts
assets) would subject the Trust to a greater degree of risk with
respect to economic downturns relating to such industry. The
focus of the Trusts portfolio in any one investment
strategy would subject the Trust to a greater degree of risk
than if the Trusts portfolio were varied in its
investments with respect to several investment strategies.
Illiquidity of Investments
The investments made by the Trust may be very illiquid, and
consequently, the Trust may not be able to sell such investments
at prices that reflect the Investment Advisers assessment
of their fair value or the amount paid for such investments by
the Trust. Illiquidity may result from the absence of an
established market for the investments as well as legal,
contractual or other restrictions on their resale by the Trust
and other factors. Furthermore, the nature of the Trusts
investments, especially those in financially stressed and
distressed companies, may require a long holding period prior to
being able to determine whether the investment will be
profitable or not. There is no limit on the amount of the
Trusts portfolio that can be invested in illiquid
securities.
Risks of Investing in Senior Loans
Bank loans are typically at the most senior level of the capital
structure, and are sometimes secured by specific collateral,
including, but not limited to, trademarks, patents, accounts
receivable, inventory, equipment, buildings, real estate,
franchises and common and preferred stock of the obligor or its
affiliates. A portion of the Trusts investments may
consist of loans and participations therein originated by banks
and other financial institutions, typically referred to as
bank loans. The Trusts investments may include
loans of
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a type generally incurred by borrowers in connection with highly
leveraged transactions, often to finance internal growth,
acquisitions, mergers or stock purchases, or for other reasons.
As a result of the additional debt incurred by the borrower in
the course of the transaction, the borrowers
creditworthiness is often judged by the rating agencies to be
below investment grade. Such loans are typically private
corporate loans which are negotiated by one or more commercial
banks or financial institutions and syndicated among a group of
commercial banks and financial institutions. In order to induce
the lenders to extend credit and to offer a favorable interest
rate, the borrower often provides the lenders with extensive
information about its business which is not generally available
to the public.
Bank loans often contain restrictive covenants designed to limit
the activities of the borrower in an effort to protect the right
of lenders to receive timely payments of principal and interest.
Such covenants may include restrictions on dividend payments,
specific mandatory minimum financial ratios, limits on total
debt and other financial tests. Bank loans usually have shorter
terms than subordinated obligations and may require mandatory
prepayments from excess cash flow, asset dispositions and
offerings of debt and/or equity securities. The bank loans and
other debt obligations to be acquired by the Trust are likely to
be below investment grade. For a discussion of the risks
associated with below investment-grade investments, see
High-Yield Securities below.
The Trust may acquire interests in bank loans and other debt
obligations either directly (by way of sale or assignment) or
indirectly (by way of participation). The purchaser of an
assignment typically succeeds to all the rights and obligations
of the assigning institution and becomes a lender under the
credit agreement with respect to the debt obligation; however,
its rights can be more restricted than those of the assigning
institution, and in any event, the Trust may not be able
unilaterally to enforce all rights and remedies under the loan
and any associated collateral. A participation interest in a
portion of a debt obligation typically results in a contractual
relationship only with the institution participating out the
interest, not with the borrower. In purchasing participations,
the Trust generally will have no right to enforce compliance by
the borrower with neither the terms of the loan agreement nor
any rights of setoff against the borrower, and the Trust may not
directly benefit from the collateral supporting the debt
obligation in which it has purchased the participation. As a
result, the Trust will be exposed to the credit risk of both the
borrower and the institution selling the participation.
Purchasers of bank loans are predominantly commercial banks,
investment funds and investment banks. As secondary market
trading volumes increase, new bank loans frequently adopt
standardized documentation to facilitate loan trading which
should improve market liquidity. There can be no assurance,
however, that future levels of supply and demand in bank loan
trading will provide an adequate degree of liquidity or that the
current level of liquidity will continue. Because of the
provision to holders of such loans of confidential information
relating to the borrower, the unique and customized nature of
the loan agreement, the limited universe of eligible purchasers
and the private syndication of the loan, bank loans are not as
easily purchased or sold as a publicly traded security, and
historically the trading volume in the bank loan market has been
small relative to the high-yield debt market.
Second Lien Loans Risk
Second lien loans are subject to the same risks associated with
investment in senior loans and non-investment grade securities.
However, second lien loans are second in right of payment to
senior loans and therefore are subject to additional risk that
the cash flow of the borrower and any property securing the loan
may be insufficient to meet scheduled payments after giving
effect to the senior secured obligations of the borrower. Second
lien loans are expected to have greater price volatility than
senior loans and may be less liquid. There is also a possibility
that originators will not be able to sell participations in
second lien loans, which would create greater credit risk
exposure.
Other Secured Loans Risk
Secured loans other than senior loans and second lien loans are
subject to the same risks associated with investment in senior
loans, second lien loans and non-investment grade securities.
However, such loans may
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rank lower in right of payment than any outstanding senior loans
and second lien loans of the borrower and therefore are subject
to additional risk that the cash flow of the borrower and any
property securing the loan may be insufficient to meet scheduled
payments after giving effect to the higher ranking secured
obligations of the borrower. Lower ranking secured loans are
expected to have greater price volatility than senior loans and
second lien loans and may be less liquid. There is also a
possibility that originators will not be able to sell
participations in lower ranking secured loans, which would
create greater credit risk exposure.
Unsecured Loans Risk
Unsecured loans are subject to the same risks associated with
investment in senior loans, second lien loans, other secured
loans and non-investment grade securities. However, because
unsecured loans have lower priority in right of payment to any
higher ranking obligations of the borrower and are not backed by
a security interest in any specific collateral, they are subject
to additional risk that the cash flow of the borrower and
available assets may be insufficient to meet scheduled payments
after giving effect to any higher ranking obligations of the
borrower. Unsecured loans are expected to have greater price
volatility than senior loans, second lien loans and other
secured loans and may be less liquid. There is also a
possibility that originators will not be able to sell
participations in unsecured loans, which would create greater
credit risk exposure.
Risks of Investing in Obligations of Stressed, Distressed and
Bankrupt Issuers
The Trust is authorized to invest in the securities and other
obligations of stressed, distressed and bankrupt issuers,
including debt obligations that are in covenant or payment
default. There is no limit on the amount of the Trusts
portfolio that can be invested in stressed, distressed or
bankrupt issuers, and the Trust may invest for purposes of
control. Such investments generally trade significantly below
par and are considered speculative. The repayment of defaulted
obligations is subject to significant uncertainties. Defaulted
obligations might be repaid only after lengthy workout or
bankruptcy proceedings, during which the issuer might not make
any interest or other payments. Typically such workout or
bankruptcy proceedings result in only partial recovery of cash
payments or an exchange of the defaulted obligation for other
debt or equity securities of the issuer or its affiliates, which
may in turn be illiquid or speculative.
There are a number of significant risks inherent in the
bankruptcy process. First, many events in a bankruptcy are the
product of contested matters and adversary proceedings and are
beyond the control of the creditors. While creditors are
generally given an opportunity to object to significant actions,
there can be no assurance that a bankruptcy court in the
exercise of its broad powers would not approve actions that
would be contrary to the interests of the Trust. Second, the
effect of a bankruptcy filing on an issuer may adversely and
permanently affect the issuer. The issuer may lose its market
position and key employees and otherwise become incapable of
restoring itself as a viable entity. If for this or any other
reason the proceeding is converted to a liquidation, the value
of the issuer may not equal the liquidation value that was
believed to exist at the time of the investment. Third, the
duration of a bankruptcy proceeding is difficult to predict. A
creditors return on investment can be adversely affected
by delays while the plan of reorganization is being negotiated,
approved by the creditors and confirmed by the bankruptcy court
and until it ultimately becomes effective. Fourth, the
administrative costs in connection with a bankruptcy proceeding
are frequently high and would be paid out of the debtors
estate prior to any return to creditors. For example, if a
proceeding involves protracted or difficult litigation, or turns
into a liquidation, substantial assets may be devoted to
administrative costs. Fifth, bankruptcy law permits the
classification of substantially similar claims in
determining the classification of claims in a reorganization.
Because the standard for classification is vague, there exists
the risk that the Trusts influence with respect to the
class of securities or other obligations it owns can be lost by
increases in the number and amount of claims in that class or by
different classification and treatment. Sixth, in the early
stages of the bankruptcy process it is often difficult to
estimate the extent of, or even to identify, any contingent
claims that might be made. Seventh, especially in the case of
investments made prior to the commencement of bankruptcy
proceedings, creditors can lose their ranking and priority if
they exercise domination and control over a debtor
and other creditors can demonstrate that they have been harmed
by such actions. Eighth, certain claims that have priority by
law (for example, claims for taxes) may be substantial.
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In any investment involving stressed and distressed debt
obligations, there exists the risk that the transaction
involving such debt obligations will be unsuccessful, take
considerable time or will result in a distribution of cash or a
new security or obligation in exchange for the stressed and
distressed debt obligations, the value of which may be less than
the Trusts purchase price of such debt obligations.
Furthermore, if an anticipated transaction does not occur, the
Trust may be required to sell its investment at a loss. Given
the substantial uncertainties concerning transactions involving
stressed and distressed debt obligations in which the Trust
invests, there is a potential risk of loss by the Trust of its
entire investment in any particular investment.
Investments in companies operating in workout modes or under
Chapter 11 of the Bankruptcy Code are also, in certain
circumstances, subject to certain additional liabilities which
may exceed the value of the Trusts original investment in
a company. For example, under certain circumstances, creditors
who have inappropriately exercised control over the management
and policies of a debtor may have their claims subordinated or
disallowed or may be found liable for damages suffered by
parties as a result of such actions. The Investment
Advisers active management style may present a greater
risk in this area than would a more passive approach. In
addition, under certain circumstances, payments to the Trust and
distributions by the Trust or payments on the debt may be
reclaimed if any such payment is later determined to have been a
fraudulent conveyance or a preferential payment. See
Insolvency Considerations with Respect to
Issuers Debt Obligations below.
The Investment Adviser on behalf of the Trust may participate on
committees formed by creditors to negotiate with the management
of financially troubled companies that may or may not be in
bankruptcy or may negotiate directly with debtors with respect
to restructuring issues. If the Trust does choose to join a
committee, the Trust would likely be only one of many
participants, all of whom would be interested in obtaining an
outcome that is in their individual best interests. There can be
no assurance that the Trust would be successful in obtaining
results most favorable to it in such proceedings, although the
Trust may incur significant legal and other expenses in
attempting to do so. As a result of participation by the Trust
on such committees, the Trust may be deemed to have duties to
other creditors represented by the committees, which might
thereby expose the Trust to liability to such other creditors
who disagree with the Trusts actions. Participation by the
Trust on such committees may cause the Trust to be subject to
certain restrictions on its ability to trade in a particular
investment and may also make the Trust an insider or
an underwriter for purposes of the federal
securities laws. Either circumstance will restrict the
Trusts ability to trade in or acquire additional positions
in a particular investment when it might otherwise desire to do
so.
Risks of Investing in High-Yield Securities
A portion of the Trusts investments will consist of
investments that may generally be characterized as
high-yield securities, or junk
securities. Such securities are typically rated below
investment grade by one or more nationally recognized
statistical rating organizations or are unrated but of
comparable credit quality to obligations rated below investment
grade, and have greater credit and liquidity risk than more
highly rated obligations. High-yield securities are generally
unsecured and may be subordinate to other obligations of the
obligor. The lower rating of high-yield securities reflects a
greater possibility that adverse changes in the financial
condition of the issuer or in general economic conditions
(including, for example, a substantial period of rising interest
rates or declining earnings) or both may impair the ability of
the issuer to make payment of principal and interest. Many
issuers of high-yield securities are highly leveraged, and their
relatively high debt to equity ratios create increased risks
that their operations might not generate sufficient cash flow to
service their obligations. Overall declines in the below
investment grade bond and other markets may adversely affect
such issuers by inhibiting their ability to refinance their
obligations at maturity.
High-yield securities are often issued in connection with
leveraged acquisitions or recapitalizations in which the issuers
incur a substantially higher amount of indebtedness than the
level at which they had previously operated. High-yield
securities that are debt instruments have historically
experienced greater default rates than has been the case for
investment grade securities. The Trust may also invest in equity
securities issued by entities whose obligations are unrated or
are rated below investment grade.
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The Trust is authorized to invest in obligations of issuers
which are generally trading at significantly higher yields than
had been historically typical of the applicable issuers
obligations. Such investments may include debt obligations that
have a heightened probability of being in covenant or payment
default in the future. Such investments generally are considered
speculative. The repayment of defaulted obligations is subject
to significant uncertainties. Defaulted obligations might be
repaid only after lengthy workout or bankruptcy proceedings,
during which the issuer might not make any interest or other
payments. Typically such workout or bankruptcy proceedings
result in only partial recovery of cash payments or an exchange
of the defaulted security for other debt or equity securities of
the issuer or its affiliates, which may in turn be illiquid or
speculative.
High-yield securities purchased by the Trust will be subject to
certain additional risks to the extent that such obligations may
be unsecured and subordinated to substantial amounts of senior
indebtedness, all or a significant portion of which may be
secured. Moreover, such obligations purchased by the Trust may
not be protected by financial covenants or limitations upon
additional indebtedness and are unlikely to be secured by
collateral.
Insolvency Considerations with Respect to Issuers of Debt
Obligations
Various laws enacted for the protection of creditors may apply
to the debt obligations held by the Trust. The information in
this paragraph is applicable with respect to U.S. issuers
subject to United States bankruptcy laws. Insolvency
considerations may differ with respect to other issuers. If a
court in a lawsuit brought by an unpaid creditor or
representative of creditors of an issuer of a debt obligation,
such as a trustee in bankruptcy, were to find that the issuer
did not receive fair consideration or reasonably equivalent
value for incurring the indebtedness constituting the debt
obligation and, after giving effect to such indebtedness, the
issuer (i) was insolvent, (ii) was engaged in a
business for which the remaining assets of such issuer
constituted unreasonably small capital or (iii) intended to
incur, or believed that it would incur, debts beyond its ability
to pay such debts as they mature, such court could determine to
invalidate, in whole or in part, such indebtedness as a
fraudulent conveyance, to subordinate such indebtedness to
existing or future creditors of such issuer, or to recover
amounts previously paid by such issuer in satisfaction of such
indebtedness. The measure of insolvency for purposes of the
foregoing will vary. Generally, an issuer would be considered
insolvent at a particular time if the sum of its debts were then
greater than all of its property at a fair valuation, or if the
present fair saleable value of its assets was then less than the
amount that would be required to pay its probable liabilities on
its existing debts as they became absolute and matured. There
can be no assurance as to what standard a court would apply in
order to determine whether the issuer was insolvent
after giving effect to the incurrence of the indebtedness
constituting the debt obligation or that, regardless of the
method of valuation, a court would not determine that the issuer
was insolvent upon giving effect to such incurrence.
In addition, in the event of the insolvency of an issuer of a
debt obligation, payments made on such debt obligation could be
subject to avoidance as a preference if made within
a certain period of time (which may be as long as one year)
before insolvency. Similarly, a court might apply the doctrine
of equitable subordination to subordinate the claim of a lending
institution against an issuer, to claims of other creditors of
the borrower, when the lending institution, another investor, or
any of their transferees, is found to have engaged in unfair,
inequitable, or fraudulent conduct. In general, if payments on a
debt obligation are avoidable, whether as fraudulent conveyances
or preferences, such payments can be recaptured either from the
initial recipient (such as the Trust) or from subsequent
transferees of such payments (such as the investors in the
Trust). To the extent that any such payments are recaptured from
the Trust the resulting loss will be borne by the investors.
However, a court in a bankruptcy or insolvency proceeding would
be able to direct the recapture of any such payment from such a
recipient or transferee only to the extent that such court has
jurisdiction over such recipient or transferee or its assets.
Moreover, it is likely that avoidable payments could not be
recaptured directly from any such recipient or transferee that
has given value in exchange for its investment, in good faith
and without knowledge that the payments were avoidable. Although
the Investment Adviser will seek to avoid conduct that would
form the basis for a successful cause of action based upon
fraudulent conveyance, preference or equitable subordination,
these determinations are made in hindsight, and in any event,
there can be no assurance as to whether any lending institution
or other investor from which the Trust acquired the debt
obligations engaged in any such conduct (or any other conduct
that would subject the
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debt obligations and the issuer to insolvency laws) and, if it
did, as to whether such creditor claims could be asserted in a
U.S. court (or in the courts of any other country) against
the Trust.
Risks of Investing in Stressed, Distressed or Bankrupt
Companies
The Trust may invest in companies that are stressed, in
distress, or bankrupt. As such, they are subject to a multitude
of legal, industry, market, economic and governmental forces
that make analysis of these companies inherently difficult.
Further, the Investment Adviser relies on company management,
outside experts, market participants and personal experience to
analyze potential investments for the Trust. There can be no
assurance that any of these sources will prove credible, or that
the Investment Advisers analysis will produce conclusions
that lead to profitable investments.
Leverage Risk
The Trust intends to use leverage through the issuance of
Preferred Shares, borrowings from a credit facility or both. The
use of leverage, which can be described as exposure to changes
in price at a ratio greater than the amount of equity invested,
either through the issuance of Preferred Shares, borrowing or
other forms of market exposure, magnifies both the favorable and
unfavorable effects of price movements in the investments made
by the Trust. Subject to applicable margins and other
limitations, the Trust may borrow money, or utilize other
transactions, for the purpose of leveraging its investments.
Insofar as the Trust employs leverage in its investment
operations, shareholders will be subject to substantial risks of
loss. Interest on borrowings will be a portfolio expense of the
Trust and will affect the operating results of the Trust. With
volatile instruments, downward price swings can result in margin
calls that could require liquidation of securities at
inopportune times or at prices that are not favorable to the
Trust and cause significant losses.
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Preferred Share Risk. Preferred Share risk is the risk
associated with the issuance of the Preferred Shares to leverage
the common shares. As described under Description of
Capital Structure Preferred Shares, the Trust
intends to issue Preferred Shares. If Preferred Shares are
issued, the net asset value and market value of the common
shares will be more volatile, and the yield to the holders of
common shares will tend to fluctuate with changes in the
shorter-term dividend rates on the Preferred Shares. If the
dividend rate on the Preferred Shares approaches the net rate of
return on the Trusts investment portfolio, the benefit of
leverage to the holders of the common shares would be reduced.
If the dividend rate on the Preferred Shares exceeds the net
rate of return on the Trusts portfolio, the leverage will
result in a lower rate of return to the holders of common shares
than if the Trust had not issued Preferred Shares. |
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In addition, the Trust will pay (and the holders of common
shares will bear) all costs and expenses relating to the
issuance and ongoing maintenance of the Preferred Shares,
including higher advisory fees. Accordingly, the Trust cannot
assure you that the issuance of Preferred Shares will result in
a higher yield or return to the holders of the common shares.
Costs of the offering of Preferred Shares, estimated to be
approximately 1.24% of the total dollar amount of the Preferred
Share offering, will be borne immediately by the Trust common
shareholders and result in a reduction of net asset value of the
common shares. The percentage assumes approximately
$165.7 million liquidation value of Preferred Shares are
issued in the Preferred Share offering and 30,430,000 common
shares are issued in this offering. |
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Similarly, any decline in the net asset value of the
Trusts investments will be borne entirely by the holders
of common shares. Therefore, if the market value of the
Trusts portfolio declines, the leverage will result in a
greater decrease in net asset value to the holders of common
shares than if the Trust were not leveraged. This greater net
asset value decrease will also tend to cause a greater decline
in the market price for the common shares. The Trust might be in
danger of failing to maintain the required asset coverage of the
Preferred Shares or of losing its ratings on the Preferred
Shares or, in an extreme case, the Trusts current
investment income might not be sufficient to meet the dividend
requirements on the Preferred Shares. In order to counteract
such an event, the Trust might need to liquidate investments in
order to fund a redemption of some or all of the Preferred
Shares. |
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Liquidation at times of low municipal bond prices may result in
capital loss and may reduce returns to the holders of common
shares. |
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Preferred Shareholders may have Disproportionate Influence
over the Trust. If Preferred Shares are issued, holders of
Preferred Shares may have differing interests than holders of
common shares and holders of Preferred Shares may at times have
disproportionate influence over the Trusts affairs. If
Preferred Shares are issued, holders of Preferred Shares, voting
separately as a single class, would have the right to elect two
members of the board of trustees at all times. The remaining
members of the board of trustees would be elected by holders of
common shares and Preferred Shares, voting as a single class.
The Investment Company Act also requires that, in addition to
any approval by shareholders that might otherwise be required,
the approval of the holders of a majority of any outstanding
Preferred Shares, voting separately as a class, would be
required to (i) adopt any plan of reorganization that would
adversely affect the Preferred Shares, and (ii) take any
action requiring a vote of security holders under
Section 13(a) of the Investment Company Act, including,
among other things, changes in the Trusts
subclassification as a closed-end investment company or changes
in its fundamental investment restrictions. |
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Portfolio Guidelines of Rating Agencies for Preferred Share
and/or Credit Facility. In order to obtain and maintain the
required ratings of loans from a credit facility, the Trust will
be required to comply with investment quality, diversification
and other guidelines established by Moodys and/or S&P
or the credit facility, respectively. Such guidelines will
likely be more restrictive than the restrictions otherwise
applicable to the Trust as described in this prospectus or in
the Statement of Additional Information. The Trust does not
anticipate that such guidelines would have a material adverse
effect on the Trusts holders of common shares or its
ability to achieve its investment objectives. The Trust
anticipates that any Preferred Shares that it issues would be
initially given the highest ratings by Moodys
(Aaa) or by S&P (AAA), but no
assurance can be given that such ratings will be obtained. No
minimum rating is required for the issuance of Preferred Shares
by the Trust. Moodys and S&P receive fees in
connection with their ratings issuances. |
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Credit Facility. In the event the Trust leverages through
borrowings, the Trust may enter into definitive agreements with
respect to a credit facility. The Trust may negotiate with
commercial banks to arrange a credit facility pursuant to which
the Trust would be entitled to borrow an amount equal to
approximately one-third of the Trusts total assets
(inclusive of the amount borrowed) offered hereby. Any such
borrowings would constitute financial leverage. Such a facility
is not expected to be convertible into any other securities of
the Trust. Any outstanding amounts are expected to be prepayable
by the Trust prior to final maturity without significant
penalty, and there are not expected to be any sinking fund or
mandatory retirement provisions. Outstanding amounts would be
payable at maturity or such earlier times as required by the
agreement. The Trust may be required to prepay outstanding
amounts under the facility or incur a penalty rate of interest
in the event of the occurrence of certain events of default. The
Trust would be expected to indemnify the lenders under the
facility against liabilities they may incur in connection with
the facility. The Trust may be required to pay commitment fees
under the terms of any such facility. With the use of
borrowings, there is a risk that the interest rates paid by the
Trust on the amount it borrows will be higher than the return on
the Trusts investments. |
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The Trust expects that such a credit facility would contain
covenants that, among other things, likely will limit the
Trusts ability to: (i) pay dividends in certain
circumstances, (ii) incur additional debt and
(iii) change its fundamental investment policies and engage
in certain transactions, including mergers and consolidations.
In addition, it may contain a covenant requiring asset coverage
ratios in addition to those required by the Investment Company
Act. The Trust may be required to pledge its assets and to
maintain a portion of its assets in cash or high-grade
securities as a reserve against interest or principal payments
and expenses. The Trust expects that any credit facility would
have customary covenant, negative covenant and default
provisions. There can be no assurance that the Trust will enter
into an agreement for a credit facility on terms and conditions
representative of the foregoing or that additional material
terms will not apply. In addition, if entered into, any such
credit |
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facility may in the future be replaced or refinanced by one or
more credit facilities having substantially different terms or
by the issuance of Preferred Shares. |
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Effects of Leverage. The Trust intends to use leverage
through the issuance of Preferred Shares, borrowings from a
credit facility or both. During its first full year of
operations, the Trust intends to employ leverage (by the
issuance of Preferred Shares, borrowing of money or a
combination) at the time the leverage is incurred in an amount
up to 30% of the Trusts total assets (including the
proceeds of all such leverage). Thereafter total leverage of the
Trust is expected to range between 20% to 50% of the
Trusts Managed Assets. Under the Investment Company Act,
the Trust is not permitted to issue Preferred Shares unless
immediately after such issuance the total asset value of the
Trusts portfolio is at least 200% of the liquidation value
of the outstanding Preferred Shares plus the amount of borrowing
(i.e., such liquidation value and amount of borrowing may not
exceed 50% of the Trusts total assets). In addition, the
Trust is not permitted to declare any cash distribution on its
common shares unless, at the time of such declaration, the net
asset value of the Trusts portfolio (determined after
deducting the amount of such distribution) is at least 200% of
such liquidation value plus amount of any borrowing. If
Preferred Shares are issued, the Trust intends, to the extent
possible, to purchase or redeem Preferred Shares, from time to
time, to maintain coverage of any Preferred Shares of at least
200%. If the Trust issues Preferred Shares resulting in 20%
leverage, there will be an asset coverage of the Preferred
Shares of 500%. |
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To qualify for federal income taxation as a regulated
investment company, the Trust must distribute in each
taxable year at least 90% of its net investment income
(including net interest income and net short-term gain). The
Trust also will be required to distribute annually substantially
all of its income and capital gain, if any, to avoid imposition
of a nondeductible 4% federal excise tax. If the Trust is
precluded from making distributions on the common shares because
of any applicable asset coverage requirements, the terms of the
Preferred Shares may provide that any amounts so precluded from
being distributed, but required to be distributed for the Trust
to meet the distribution requirements for qualification as a
regulated investment company, will be paid to the holders of the
Preferred Shares as a special distribution. This distribution
can be expected to decrease the amount that holders of Preferred
Shares would be entitled to receive upon redemption or
liquidation of the shares. |
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|
The Trusts willingness to issue Preferred Shares or borrow
for leverage purposes, and the amount of leverage the Trust will
assume, will depend on many factors, the most important of which
are market conditions and interest rates. Successful use of a
leveraging strategy may depend on the Investment Advisers
ability to predict correctly interest rates and market
movements, and there is no assurance that a leveraging strategy
will be successful during any period in which it is employed. |
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Assuming the utilization of leverage in the amount of 30% of the
Trusts total assets and an annual dividend rate on
Preferred Shares of 4.85% and an annual interest rate of 5.13%
on borrowings payable on such leverage based on market rates as
of the date of this prospectus, the additional income that the
Trust must earn (net of expenses) in order to cover such
dividend payments is 1.48%. The Trusts actual cost of
leverage will be based on market rates at the time the Trust
undertakes a leveraging strategy, and such actual costs of
leverage may be higher or lower than that assumed in the
previous example. |
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The following table is designed to illustrate the effect on the
return to a holder of the Trusts common shares of leverage
in the amount of approximately 30% of the Trusts total
assets, assuming hypothetical annual returns of the Trusts
portfolio of minus 10% to plus 10%. As the table shows, leverage
generally increases the return to holders of common shares when
portfolio return is positive and greater than the cost of
leverage and decreases the return when the portfolio return is
negative or less than the cost of leverage. The figures
appearing in the table are hypothetical and actual returns may
be greater or less than those appearing in the table. |
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Assumed portfolio return (net of expenses)
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(10 |
)% |
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(5 |
)% |
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0 |
% |
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|
5 |
% |
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|
10 |
% |
Corresponding common share return assuming 30% leverage
|
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(16 |
)% |
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(9 |
)% |
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(2 |
)% |
|
|
5 |
% |
|
|
12 |
% |
47
Until the Trust issues Preferred Shares or borrows money,
the common shares will not be leveraged, and the risks and
special considerations related to leverage described in this
prospectus will not apply.
Such leveraging of the common shares cannot be achieved
until the proceeds resulting from the use of leverage have been
invested in accordance with the Trusts investment
objectives and policies.
Common Stock Risk
The Trust will have exposure to common stocks. Although common
stocks have historically generated higher average total returns
than fixed income securities over the long-term, common stocks
also have experienced significantly more volatility in those
returns and in recent years have significantly under-performed
relative to debt securities. Therefore, the Trusts
exposure to common stocks could result in worse performance than
would be the case had the Trust been invested solely in debt
securities. An adverse event, such as an unfavorable earnings
report, may depress the value of a particular common stock held
by the Trust. Also, the price of common stocks is sensitive to
general movements in the stock market and a drop in the stock
market may depress the price of common stocks to which the Trust
has exposure. Common stock prices fluctuate for several reasons,
including changes in investors perceptions of the
financial condition of an issuer or the general condition of the
relevant stock market, or when political or economic events
affecting the issuers occur. In addition, common stock prices
may be particularly sensitive to rising interest rates, as the
cost of capital rises and borrowing costs increase.
Dividend Risk
Dividends on common stock are not fixed but are declared at the
discretion of an issuers board of directors. There is no
guarantee that the issuers of the common stocks in which the
Trust invests will declare dividends in the future or that if
declared they will remain at current levels or increase over
time.
Small and Mid-Cap Securities Risk
The Trust may invest in companies with small or medium
capitalizations. Securities issued by smaller and medium
companies can be more volatile than, and perform differently
from, larger company securities. There may be less trading in a
smaller or medium companys securities, which means that
buy and sell transactions in those securities could have a
larger impact on the securitys price than is the case with
larger company securities. Smaller and medium companies may have
fewer business lines; changes in any one line of business,
therefore, may have a greater impact on a smaller or medium
companys security price than is the case for a larger
company. In addition, smaller or medium company securities may
not be well known to the investing public.
Non-U.S. Securities
Risk
The Trust may invest up to 20% of its total assets in
non-U.S. securities,
including emerging market securities. Investing in
non-U.S. securities
involves certain risks not involved in domestic investments,
including, but not limited to: (i) fluctuations in foreign
exchange rates; (ii) future foreign economic, financial,
political and social developments; (iii) different legal
systems; (iv) the possible imposition of exchange controls
or other foreign governmental laws or restrictions;
(v) lower trading volume; (vi) much greater price
volatility and illiquidity of certain
non-U.S. securities
markets; (vii) different trading and settlement practices;
(viii) less governmental supervision; (ix) changes in
currency exchange rates; (x) high and volatile rates of
inflation; (xi) fluctuating interest rates; (xii) less
publicly available information; and (xiii) different
accounting, auditing and financial recordkeeping standards and
requirements.
Certain countries in which the Trust may invest, especially
emerging market countries, historically have experienced, and
may continue to experience, high rates of inflation, high
interest rates, exchange rate fluctuations, large amounts of
external debt, balance of payments and trade difficulties and
extreme poverty and unemployment. Many of these countries are
also characterized by political uncertainty and instability.
These risks are especially evident in the Middle East and West
Africa. The cost of servicing external debt will generally be
adversely affected by rising international interest rates
because many external debt obligations
48
bear interest at rates which are adjusted based upon
international interest rates. In addition, with respect to
certain foreign countries, there is a risk of: (i) the
possibility of expropriation or nationalization of assets;
(ii) confiscatory taxation; (iii) difficulty in
obtaining or enforcing a court judgment; (iv) economic,
political or social instability; and (v) diplomatic
developments that could affect investments in those countries.
Because the Trust will invest in securities denominated or
quoted in currencies other than the U.S. dollar, changes in
foreign currency exchange rates may affect the value of
securities in the Trust and the unrealized appreciation or
depreciation of investments. Currencies of certain countries may
be volatile and therefore may affect the value of securities
denominated in such currencies, which means that the
Trusts net asset value or current income could decline as
a result of changes in the exchange rates between foreign
currencies and the U.S. dollar. Certain investments in
non-U.S. securities
also may be subject to foreign withholding taxes. Dividend
income from
non-U.S. corporations
may not be eligible for the reduced rate for qualified dividend
income. These risks often are heightened for investments in
smaller, emerging capital markets. In addition, individual
foreign economies may differ favorably or unfavorably from the
U.S. economy in such respects as: (i) growth of gross
domestic product; (ii) rates of inflation;
(iii) capital reinvestment; (iv) resources;
(v) self-sufficiency; and (vi) balance of payments
position.
As a result of these potential risks, Highland may determine
that, notwithstanding otherwise favorable investment criteria,
it may not be practicable or appropriate to invest in a
particular country. The Trust may invest in countries in which
foreign investors, including Highland, have had no or limited
prior experience.
Emerging Markets Risk
The Trust may invest up to 20% of its total assets in securities
of issuers based in emerging markets. Investing in securities of
issuers based in underdeveloped emerging markets entails all of
the risks of investing in securities of
non-U.S. issuers
to a heightened degree. Emerging market countries generally
include every nation in the world except the United States,
Canada, Japan, Australia, New Zealand and most countries located
in Western Europe. These heightened risks include:
(i) greater risks of expropriation, confiscatory taxation,
nationalization, and less social, political and economic
stability; (ii) the smaller size of the markets for such
securities and a lower volume of trading, resulting in lack of
liquidity and in price volatility; and (iii) certain
national policies which may restrict the Trusts investment
opportunities including restrictions on investing in issuers or
industries deemed sensitive to relevant national interests.
Foreign Currency Risk
Because the Trust may invest in securities denominated or quoted
in currencies other than the U.S. dollar, changes in
foreign currency exchange rates may affect the value of
securities owned by the Trust, the unrealized appreciation or
depreciation of investments and gains on and income from
investments. Currencies of certain countries may be volatile and
therefore may affect the value of securities denominated in such
currencies, which means that the Trusts net asset value
could decline as a result of changes in the exchange rates
between foreign currencies and the U.S. dollar. In
addition, the Trust may enter into foreign currency transactions
in an attempt to enhance total return which may further expose
the Trust to the risks of foreign currency movements and other
risks. See Derivatives Risk below.
Investments In Unseasoned Companies
The Trust may invest in the securities of smaller, less seasoned
companies. These investments may present greater opportunities
for growth, but also involve greater risks than customarily are
associated with investments in securities of more established
companies. Some of the companies in which the Trust may invest
will be start-up
companies which may have insubstantial operational or earnings
history or may have limited products, markets, financial
resources or management depth. Some may also be emerging
companies at the research and development stage with no products
or technologies to market or approved for marketing. Securities
of emerging companies may lack an active secondary market and
may be subject to more abrupt or erratic price movements than
securities of larger, more established companies or stock market
averages in
49
general. Competitors of certain companies may have substantially
greater financial resources than many of the companies in which
the Trust may invest.
Initial Public Offerings (IPOs) Risk
The Trust may invest in shares of companies through IPOs. IPOs
and companies that have recently gone public have the potential
to produce substantial gains for the Trust, subject to the
Trusts option writing strategy. However, there is no
assurance that the Trust will have access to profitable IPOs.
The investment performance of the Trust during periods when it
is unable to invest significantly or at all in IPOs may be lower
than during periods when the Trust is able to do so. Securities
issued in IPOs are subject to many of the same risks as
investing in companies with smaller market capitalizations.
Securities issued in IPOs have no trading history, and
information about the companies may be available for limited
periods of time. In addition, the prices of securities sold in
IPOs may be highly volatile or may decline shortly after the IPO.
Securities Lending Risk
The Trust may lend its portfolio securities (up to a maximum of
one-third of its total assets) to banks or dealers which meet
the creditworthiness standards established by the board of
trustees of the Trust. Securities lending is subject to the risk
that loaned securities may not be available to the Trust on a
timely basis and the Trust may, therefore, lose the opportunity
to sell the securities at a desirable price. Any loss in the
market price of securities loaned by the Trust that occurs
during the term of the loan would be borne by the Trust and
would adversely affect the Trusts performance. Also, there
may be delays in recovery, or no recovery, of securities loaned
or even a loss of rights in the collateral should the borrower
of the securities fail financially while the loan is
outstanding. These risks may be greater for
non-U.S. securities.
Risks Associated with Options on Securities
There are several risks associated with transactions in options
on securities. For example, there are significant differences
between the securities and options markets that could result in
an imperfect correlation between these markets, causing a given
transaction not to achieve its objectives. A decision as to
whether, when and how to use options involves the exercise of
skill and judgment, and even a well conceived transaction may be
unsuccessful to some degree because of market behavior or
unexpected events.
As the writer of a covered call option, the Trust foregoes,
during the options life, the opportunity to profit from
increases in the market value of the security covering the call
option above the sum of the premium and the strike price of the
call, but has retained the risk of loss should the price of the
underlying security decline. As the Trust writes covered calls
over more of its portfolio, its ability to benefit from capital
appreciation becomes more limited. The writer of an option has
no control over the time when it may be required to fulfill its
obligation as a writer of the option. Once an option writer has
received an exercise notice, it cannot effect a closing purchase
transaction in order to terminate its obligation under the
option and must deliver the underlying security at the exercise
price.
When the Trust writes covered put options, it bears the risk of
loss if the value of the underlying stock declines below the
exercise price minus the put premium. If the option is
exercised, the Trust could incur a loss if it is required to
purchase the stock underlying the put option at a price greater
than the market price of the stock at the time of exercise plus
the put premium the Trust received when it wrote the option.
While the Trusts potential gain in writing a covered put
option is limited to distributions earned on the liquid assets
securing the put option plus the premium received from the
purchaser of the put option, the Trust risks a loss equal to the
entire exercise price of the option minus the put premium.
Exchange-Listed Option Risks
There can be no assurance that a liquid market will exist when
the Trust seeks to close out an option position. Reasons for the
absence of a liquid secondary market on an exchange include the
following: (i) there may be insufficient trading interest
in certain options; (ii) restrictions may be imposed by an
exchange on opening transactions or closing transactions or
both; (iii) trading halts, suspensions or other
restrictions may
50
be imposed with respect to particular classes or series of
options; (iv) unusual or unforeseen circumstances may
interrupt normal operations on an exchange; (v) the
facilities of an exchange or the Options Clearing Corporation
may not at all times be adequate to handle current trading
volume; or (vi) one or more exchanges could, for economic
or other reasons, decide or be compelled at some future date to
discontinue the trading of options (or a particular class or
series of options). If trading were discontinued, the secondary
market on that exchange (or in that class or series of options)
would cease to exist. However, outstanding options on that
exchange that had been issued by the Options Clearing
Corporation as a result of trades on that exchange would
continue to be exercisable in accordance with their terms. If
the Trust were unable to close out a covered call option that it
had written on a security, it would not be able to sell the
underlying security unless the option expired without exercise.
The hours of trading for options on an exchange may not conform
to the hours during which the underlying securities are traded.
To the extent that the options markets close before the markets
for the underlying securities, significant price and rate
movements can take place in the underlying markets that cannot
be reflected in the options markets. Call options are marked to
market daily and their value will be affected by changes in the
value and dividend rates of the underlying common stocks, an
increase in interest rates, changes in the actual or perceived
volatility of the stock market and the underlying common stocks
and the remaining time to the options expiration.
Additionally, the exercise price of an option may be adjusted
downward before the options expiration as a result of the
occurrence of certain corporate events affecting the underlying
equity security, such as extraordinary dividends, stock splits,
merger or other extraordinary distributions or events. A
reduction in the exercise price of an option would reduce the
Trusts capital appreciation potential on the underlying
security.
Over-the-Counter
Option Risk
The Trust may write (sell) unlisted (OTC or
over-the-counter)
options, and options written by the Trust with respect to
non-U.S. securities,
indices or sectors generally will be OTC options. OTC options
differ from exchange-listed options in that they are two-party
contracts, with exercise price, premium and other terms
negotiated between buyer and seller, and generally do not have
as much market liquidity as exchange-listed options. The
counterparties to these transactions typically will be major
international banks, broker-dealers and financial institutions.
The Trust may be required to treat as illiquid securities being
used to cover certain written OTC options. The OTC options
written by the Trust will not be issued, guaranteed or cleared
by the Options Clearing Corporation. In addition, the
Trusts ability to terminate the OTC options may be more
limited than with exchange-traded options. Banks, broker-dealers
or other financial institutions participating in such
transaction may fail to settle a transaction in accordance with
the terms of the option as written. In the event of default or
insolvency of the counterparty, the Trust may be unable to
liquidate an OTC option position.
Index Option Risk
The Trust intends to sell index put and call options from time
to time. The purchaser of an index put option has the right to
any depreciation in the value of the index below the exercise
price of the option on or before the expiration date. The
purchaser of an index call option has the right to any
appreciation in the value of the index over the exercise price
of the option on or before the expiration date. Because the
exercise of an index option is settled in cash, sellers of index
call options, such as the Trust, cannot provide in advance for
their potential settlement obligations by acquiring and holding
the underlying securities. The Trust will lose money if it is
required to pay the purchaser of an index option the difference
between the cash value of the index on which the option was
written and the exercise price and such difference is greater
than the premium received by the Trust for writing the option.
The value of index options written by the Trust, which will be
priced daily, will be affected by changes in the value and
dividend rates of the underlying common stocks in the respective
index, changes in the actual or perceived volatility of the
stock market and the remaining time to the options
expiration. The value of the index options also may be adversely
affected if the market for the index options becomes less liquid
or smaller. Distributions paid by the Trust on its common shares
may be derived in part from the net index option premiums it
receives from selling index put and call options, less the
51
cost of paying settlement amounts to purchasers of the options
that exercise their options. Net index option premiums can vary
widely over the short term and long term.
Interest Rate Risk
Interest rate risk is the risk that debt securities, and the
Trusts net assets, may decline in value because of changes
in interest rates. Generally, debt securities will decrease in
value when interest rates rise and increase in value when
interest rates decline. This means that the net asset value of
the common shares will fluctuate with interest rate changes and
the corresponding changes in the value of the Trusts debt
security holdings.
Prepayment Risk
If interest rates fall, the principal on debt held by the Trust
may be paid earlier than expected. If this happens, the proceeds
from a prepaid security may be reinvested by the Trust in
securities bearing lower interest rates, resulting in a possible
decline in the Trusts income and distributions to
shareholders. The Trust may invest in pools of mortgages and
other assets issued or guaranteed by private issuers or
U.S. government agencies and instrumentalities.
Mortgage-related securities are especially sensitive to
prepayment risk because borrowers often refinance their
mortgages when interest rates drop.
Asset-Backed Securities Risk
Payment of interest and repayment of principal on asset-backed
securities may be largely dependent upon the cash flows
generated by the assets backing the securities and, in certain
cases, supported by letters of credit, surety bonds or other
credit enhancements.
Asset-backed security
values may also be affected by the creditworthiness of the
servicing agent for the pool, the originator of the loans or
receivables or the entities providing the credit enhancement. In
addition, the underlying assets are subject to prepayments that
shorten the securities weighted average maturity and may
lower their return.
Mortgage-Backed Securities Risk
A mortgage-backed security, which represents an interest in a
pool of assets such as mortgage loans, will mature when all the
mortgages in the pool mature or are prepaid. Therefore,
mortgage-backed
securities do not have a fixed maturity, and their expected
maturities may vary when interest rates rise or fall.
When interest rates fall, homeowners are more likely to prepay
their mortgage loans. An increased rate of prepayments on the
funds mortgage-backed securities will result in an
unforeseen loss of interest income to the Trust as the Trust may
be required to reinvest assets at a lower interest rate. Because
prepayments increase when interest rates fall, the price of
mortgage-backed securities does not increase as much as other
fixed income securities when interest rates fall.
When interest rates rise, homeowners are less likely to prepay
their mortgage loans. A decreased rate of prepayments lengthens
the expected maturity of a
mortgage-backed
security. Therefore, the prices of
mortgage-backed
securities may decrease more than prices of other fixed income
securities when interest rates rise.
Non-Investment Grade Securities Risk
There is no limit on the amount of the Trusts portfolio
that may be invested in below investment grade securities.
Non-investment grade securities are commonly referred to as
junk securities. Investments in lower grade
securities will expose the Trust to greater risks than if the
Trust owned only higher grade debt securities. Because of the
substantial risks associated with lower grade securities, you
could lose money on your investment in common shares of the
Trust, both in the short-term and the long-term. Lower grade
securities, though high yielding, are characterized by high
risk. They may be subject to certain risks with respect to the
issuing entity and to greater market fluctuations than certain
lower yielding, higher rated securities. The retail secondary
market for lower grade debt securities may be less liquid than
that of higher
52
rated debt securities. Adverse conditions could make it
difficult at times for the Trust to sell certain securities or
could result in lower prices than those used in calculating the
Trusts net asset value.
Derivatives Risk
Derivative Transactions in which the Trust may engage for
hedging and speculative purposes or to enhance total return,
including engaging in transactions such as options, futures,
swaps, foreign currency transactions, forward foreign currency
contracts, currency swaps or options on currency futures and
other derivatives transactions, also involve certain risks and
special considerations. Derivative Transactions have risks,
including the imperfect correlation between the value of such
instruments and the underlying assets, the possible default of
the other party to the transaction or illiquidity of the
derivative instruments. Furthermore, the ability to successfully
use Derivative Transactions depends on the Investment
Advisers ability to predict pertinent market movements,
which cannot be assured. Thus, the use of Derivative
Transactions may result in losses greater than if they had not
been used, may require the Trust to sell or purchase portfolio
securities at inopportune times or for prices other than current
market values, may limit the amount of appreciation the Trust
can realize on an investment or may cause the Trust to hold a
security that it might otherwise sell. The use of foreign
currency transactions can result in the Trusts incurring
losses as a result of the imposition of exchange controls,
suspension of settlements or the inability of the Trust to
deliver or receive a specified currency. Additionally, amounts
paid by the Trust as premiums and cash or other assets held in
margin accounts with respect to Derivative Transactions are not
otherwise available to the Trust for investment purposes.
To the extent that the Trust purchases options pursuant to a
hedging strategy, the Trust will be subject to the following
additional risks. If a put or call option purchased by the Trust
is not sold when it has remaining value, and if the market price
of the underlying security remains equal to or greater than the
exercise price (in the case of a put), or remains less than or
equal to the exercise price (in the case of a call), the Trust
will lose its entire investment in the option.
Also, where a put or call option on a particular security is
purchased to hedge against price movements in a related
security, the price of the put or call option may move more or
less than the price of the related security. If restrictions on
exercise were imposed, the Trust might be unable to exercise an
option it had purchased. If the Trust were unable to close out
an option that it had purchased on a security, it would have to
exercise the option in order to realize any profit or the option
may expire worthless.
Market Risk Generally
The profitability of a significant portion of the Trusts
investment program depends to a great extent upon correctly
assessing the future course of the price movements of securities
and other investments and the movements of interest rates. There
can be no assurance that the Investment Adviser will be able to
predict accurately these price and interest rate movements. With
respect to the investment strategies the Trust may utilize,
there will be a high degree of market risk.
Reinvestment Risk
The Trust reinvests the cash flows received from a security. The
additional income from such reinvestment, sometimes called
interest-on-interest,
is reliant on the prevailing interest rate levels at the time of
reinvestment. There is a risk that the interest rate at which
interim cash flows can be reinvested will fall. Reinvestment
risk is greater for longer holding periods and for securities
with large, early cash flows such as high-coupon bonds.
Reinvestment risk also applies generally to the reinvestment of
the proceeds the Trust receives upon the maturity or sale of a
portfolio security.
Timing Risk
Many agency, corporate and municipal bonds, and most
mortgage-backed securities, contain a provision that allows the
issuer to call all or part of the issue before the
bonds maturity date, often after 5 or 10 years. The
issuer usually retains the right to refinance the bond in the
future if market interest rates decline below
53
the coupon rate. There are three disadvantages to the call
provision. First, the cash flow pattern of a callable bond is
not known with certainty. Second, because an issuer is more
likely to call the bonds when interest rates have dropped, the
Trust is exposed to reinvestment rate risk, i.e., the Trust may
have to reinvest at lower interest rates the proceeds received
when the bond is called. Finally, the capital appreciation
potential of a bond will be reduced because the price of a
callable bond may not rise much above the price at which the
issuer may call the bond.
Inflation Risk
Inflation risk results from the variation in the value of cash
flows from a security due to inflation, as measured in terms of
purchasing power. For example, if the Trust purchases a bond in
which it can realize a coupon rate of 5%, but the rate of
inflation increases from 2% to 6%, then the purchasing power of
the cash flow has declined. For all but adjustable bonds or
floating rate bonds, the Trust is exposed to inflation risk
because the interest rate the issuer promises to make is fixed
for the life of the security. To the extent that interest rates
reflect the expected inflation rate, floating rate bonds have a
lower level of inflation risk.
Arbitrage Risks
The Trust will engage in capital structure arbitrage and other
arbitrage strategies. Arbitrage strategies entail various risks
including the risk that external events, regulatory approvals
and other factors will impact the consummation of announced
corporate events and/or the prices of certain positions. In
addition, hedging is an important feature of capital structure
arbitrage. There is no guarantee that the Investment Adviser
will be able to hedge the Trusts portfolio in the manner
necessary to employ successfully the Trusts strategy.
Short Sales Risk
Short sales by the Trust that are not made against the
box (that is when the Trust has an offsetting long
position in the asset that is selling short) theoretically
involve unlimited loss potential since the market price of
securities sold short may continuously increase. Short selling
involves selling securities which may or may not be owned and
borrowing the same securities for delivery to the purchaser,
with an obligation to replace the borrowed securities at a later
date. Short selling allows the Trust to profit from declines in
market prices to the extent such decline exceeds the transaction
costs and the costs of borrowing the securities. However, since
the borrowed securities must be replaced by purchases at market
prices in order to close out the short position, any
appreciation in the price of the borrowed securities would
result in a loss. Purchasing securities to close out the short
position can itself cause the price of the securities to rise
further, thereby exacerbating the loss. The Trust may mitigate
such losses by replacing the securities sold short before the
market price has increased significantly. Under adverse market
conditions, the Trust might have difficulty purchasing
securities to meet its short sale delivery obligations, and
might have to sell portfolio securities to raise the capital
necessary to meet its short sale obligations at a time when
fundamental investment considerations would not favor such sales.
Risks of Investing in Structured Finance Securities
A portion of the Trusts investments may consist of
equipment trust certificates, collateralized mortgage
obligations, collateralized bond obligations, collateralized
loan obligations or similar instruments. Structured finance
securities may present risks similar to those of the other types
of debt obligations in which the Trust may invest and, in fact,
such risks may be of greater significance in the case of
structured finance securities. Moreover, investing in structured
finance securities may entail a variety of unique risks. Among
other risks, structured finance securities may be subject to
prepayment risk. In addition, the performance of a structured
finance security will be affected by a variety of factors,
including its priority in the capital structure of the issuer
thereof, and the availability of any credit enhancement, the
level and timing of payments and recoveries on and the
characteristics of the underlying receivables, loans or other
assets that are being securitized, remoteness of those assets
from the originator or transferor, the adequacy of and ability
to realize upon any related collateral and the capability of the
servicer of the securitized assets.
54
Risks of Investing in Preferred Securities
There are special risks associated with investing in preferred
securities, including:
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Deferral. Preferred securities may include provisions
that permit the issuer, at its discretion, to defer
distributions for a stated period without any adverse
consequences to the issuer. If the Trust owns a preferred
security that is deferring its distributions, the Trust may be
required to report income for tax purposes although it has not
yet received such income. |
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Subordination. Preferred securities are subordinated to
bonds and other debt instruments in a companys capital
structure in terms of priority to corporate income and
liquidation payments, and therefore will be subject to greater
credit risk than more senior debt instruments. |
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Liquidity. Preferred securities may be substantially less
liquid than many other securities, such as common stocks or
U.S. government securities. |
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Limited Voting Rights. Generally, preferred security
holders have no voting rights with respect to the issuing
company unless preferred dividends have been in arrears for a
specified number of periods, at which time the preferred
security holders may elect a number of trustees to the
issuers board. Generally, once all the arrearages have
been paid, the preferred security holders no longer have voting
rights. |
Risks of Investing in Derivative Instruments
Derivative instruments, or derivatives, include
futures, options, swaps, structured securities and other
instruments and contracts that are derived from, or the value of
which is related to, one or more underlying securities,
financial benchmarks, currencies or indices. Derivatives allow
an investor to hedge or speculate upon the price movements of a
particular security, financial benchmark currency or index at a
fraction of the cost of investing in the underlying asset. The
value of a derivative depends largely upon price movements in
the underlying asset. Therefore, many of the risks applicable to
trading the underlying asset are also applicable to derivatives
of such asset. However, there are a number of other risks
associated with derivatives trading. For example, because many
derivatives are leveraged, and thus provide
significantly more market exposure than the money paid or
deposited when the transaction is entered into, a relatively
small adverse market movement can not only result in the loss of
the entire investment, but may also expose the Trust to the
possibility of a loss exceeding the original amount invested.
Derivatives may also expose investors to liquidity risk, as
there may not be a liquid market within which to close or
dispose of outstanding derivatives contracts, and to
counterparty risk. The counterparty risk lies with each party
(the counterparty) with whom the Trust contracts for
the purpose of making derivative investments. In the event of
the counterpartys default, the Trust will only rank as an
unsecured creditor and risks the loss of all or a portion of the
amounts it is contractually entitled to receive.
Risks of Investing in Swaps
Investments in swaps involve the exchange with another party of
their respective commitments. Use of swaps subjects the Trust to
risk of default by the counterparty. If there is a default by
the counterparty to such a transaction, there may be contractual
remedies pursuant to the agreements related to the transaction
although contractual remedies may not be sufficient in the event
the counterparty is insolvent. However, the swap market has
grown substantially in recent years with a large number of banks
and investment banking firms acting both as principals and
agents utilizing standardized swap documentation. As a result,
the swap market has become relatively liquid in comparison with
the markets for other similar instruments which are traded in
the interbank market. The Trust may enter into credit default
swaps, currency swaps or other swaps which may be surrogates for
other instruments such as currency forwards or options.
Risks of Investing in Synthetic Securities
In addition to credit risks associated with holding
non-investment grade loans and high-yield debt securities, with
respect to synthetic securities the Trust will usually have a
contractual relationship only with
55
the counterparty of such synthetic securities, and not the
Reference Obligor (as defined below) on the Reference Obligation
(as defined below). The Trust generally will have no right to
directly enforce compliance by the Reference Obligor with the
terms of the Reference Obligation nor any rights of set-off
against the Reference Obligor, nor have any voting rights with
respect to the Reference Obligation. The Trust will not benefit
directly from any collateral supporting the Reference Obligation
or have the benefit of the remedies on default that would
normally be available to a holder of such Reference Obligation.
In addition, in the event of insolvency of its counterparty, the
Trust will be treated as a general creditor of such counterparty
and will not have any claim with respect to the credit risk of
the counterparty as well as that of the Reference Obligor. As a
result, an overabundance of synthetic securities with any one
counterparty subjects the notes to an additional degree of risk
with respect to defaults by such counterparty as well as by the
Reference Obligor. The Investment Adviser may not perform
independent credit analyses of the counterparties, any such
counterparty, or an entity guaranteeing such counterparty,
individually or in the aggregate. A Reference
Obligation is the debt security or other obligation upon
which the synthetic security is based. A Reference
Obligor is the obligor on a Reference Obligation. There is
no maximum amount of Trusts assets that may be invested in
these securities.
Tax Risk
The Trust may invest in derivative instruments, such as swaps,
and other instruments, in order to obtain investment exposure to
its principal investment categories or for other purposes. The
Trust intends only to invest in such instruments to an extent
and in a manner consistent with the Trusts qualification
as a regulated investment company for federal income tax
purposes. If the Trust were to fail to qualify as a regulated
investment company in any year, then the Trust would be subject
to federal (and state) income tax on its net income and capital
gains at regular corporate income tax rates (without a deduction
for distributions to shareholders). Trust income distributed to
common shareholders would also be taxable to shareholders as
ordinary dividend income to the extent attributable to the
Trusts earnings and profits. Accordingly, in such event,
the Trusts ability to achieve its investment objectives
would be adversely affected, and common shareholders would be
subject to the risk of diminished investment returns.
Valuation Risk
Fair value is defined as the amount for which assets could be
sold in an orderly disposition over a reasonable period of time,
taking into account the nature of the asset. Fair value pricing,
however, involves judgments that are inherently subjective and
inexact, since fair valuation procedures are used only when it
is not possible to be sure what value should be attributed to a
particular asset or when an event will affect the market price
of an asset and to what extent. As a result, there can be no
assurance that fair value pricing will reflect actual market
value and it is possible that the fair value determined for a
security will be materially different from the value that
actually could be or is realized upon the sale of that asset.
Exemptive Relief Consideration
The Investment Adviser expects to apply to the Commission for
exemptive relief to enable the registered investment companies
advised by the Investment Adviser, including the Trust, to
co-invest with other accounts and funds managed by the
Investment Adviser and its affiliates in certain privately
placed securities and other situations. There are no assurances
that the Investment Adviser will receive the requested relief.
If such relief is not obtained and until it is obtained, the
Investment Adviser may be required to allocate some investments
solely to the Trust and/or other registered funds and others
solely to one or more accounts that are not registered
investment companies. This could preclude the Trust from
investing in certain securities it would otherwise be interested
in and could adversely affect the speed at which the Trust is
able to invest its assets and, consequently, the performance of
the Trust.
Market Disruption and Geopolitical Risk
The aftermath of the war in Iraq and the continuing occupation
of Iraq, instability in the Middle East and terrorist attacks in
the United States and around the world may have resulted in
market volatility and may
56
have long-term effects on the U.S. and worldwide financial
markets and may cause further economic uncertainties in the
United States and worldwide. The Investment Adviser does not
know how long the securities markets will continue to be
affected by these events and cannot predict the effects of the
occupation or similar events in the future on the
U.S. economy and securities markets. Given the risks
described above, an investment in the common shares may not be
appropriate for all investors. You should carefully consider
your ability to assume these risks before making an investment
in the Trust.
Risks of Investing in a Trust with Anti-Takeover
Provisions
The Trusts Agreement and Declaration of Trust includes
provisions that could limit the ability of other entities or
persons to acquire control of the Trust or convert the Trust to
open-end status. These provisions could deprive the holders of
common shares of opportunities to sell their common shares at a
premium over the then current market price of the common shares
or at net asset value.
Key Adviser Personnel Risk
The Trusts ability to identify and invest in attractive
opportunities is dependent upon Highland, its investment
adviser. If one or more key individuals leaves Highland,
Highland may not be able to hire qualified replacements or may
require an extended time to do so. This situation could prevent
the Trust from achieving its investment objectives.
57
MANAGEMENT OF THE TRUST
Trustees and Officers
The board of trustees is responsible for the overall management
of the Trust, including supervision of the duties performed by
Highland. There are five trustees of the Trust.
Four of the trustees are not interested persons
(as defined in the Investment Company Act) of the Trust. The
name and business address of the trustees and officers of the
Trust and their principal occupations and other affiliations
during the past five years are set forth under Management
of the Trust in the Statement of Additional Information.
Investment Adviser
Highland acts as the Trusts investment adviser. Highland
is located at Two Galleria Tower, 13455 Noel Road,
Suite 800, Dallas, Texas 75240. As of March 31, 2006,
the Investment Adviser managed approximately $24.5 billion
in assets on behalf of investors around the world. Highland is
controlled by James Dondero and Mark Okada, by virtue of their
respective share ownership, and its general partner, Strand
Advisors, Inc., of which Mr. Dondero is the sole
stockholder. Messrs. Dondero and Okada have managed
portfolios together since 1990.
Responsibilities. The Investment Adviser provides
the following services to the Trust: (i) furnishes an
investment program for the Trust; (ii) determines, subject
to the overall supervision and review of the board of trustees,
the investments to be purchased, held, sold or exchanged by the
Trust and the portion, if any, of the assets of the Trust to be
held uninvested; (iii) makes changes in the investments of
the Trust; and (iv) votes, exercises consents and exercises
all other rights pertaining to such investments. Subject to the
foregoing, the Investment Adviser, at its own expense, will have
the authority to engage one or more sub-advisers in connection
with the portfolio management of the Trust, which sub-advisers
may be affiliates of the Adviser; provided, however, that the
Adviser shall remain responsible to the Trust with respect to
its duties and obligations set forth in the investment advisory
agreement.
Compensation. In return for its advisory services,
the Investment Adviser will receive an annual fee, payable
monthly, in an amount equal to 1.00% of the average weekly value
of the Trusts Managed Assets (the Advisory
Fee). The accrued fees will be payable monthly as promptly
as possible after the end of each month during which the
investment advisory agreement is in effect. The Investment
Adviser may waive a portion of its fees. A discussion regarding
the basis for the approval of the investment advisory agreement
by the Trusts board will be available in the Trusts
report to shareholders for the period ending June 30, 2006.
Potential Conflicts of Interest. If the Trust
employs leverage, the Investment Adviser will benefit because
the Trusts Managed Assets will increase with leverage.
Furthermore, the Investment Adviser will also benefit to the
extent that the Trusts Managed Assets are derived from the
reinvested collateral received on portfolio securities loaned.
In addition to the Advisory Fee of Highland, the Trust pays all
other costs and expenses of its operations, including, but not
limited to, compensation of its trustees (other than those
affiliated with Highland), custodian, transfer and dividend
disbursing agent expenses, legal fees, listing fees and
expenses, expenses of independent auditors, expenses of
preparing, printing and distributing shareholder reports,
notices, proxy statements and reports to governmental agencies,
and reimbursement of actual expenses of the Investment Adviser
or others for registration and maintenance of the Trusts
registrations with the Commission and other jurisdictions and
taxes, if any.
Administrator/
Sub-Administrator
Under an administration agreement dated May 19, 2006,
Highland provides administration services to the Trust, provides
executive and other personnel necessary to administer the Trust
and furnishes office space. Highland will receive an annual fee,
payable monthly, in an amount equal to 0.20% of the average
weekly value of the Trusts Managed Assets. The accrued
fees will be payable monthly as promptly as possible after the
end of each month during which this Agreement is in effect.
Highland may waive a portion of its fees.
58
Under a separate sub-administration agreement, dated
May 19, 2006, Highland has delegated certain administrative
functions to PFPC, Inc., at an annual rate, payable by
Highland, of 0.01% of the average weekly value of the
Trusts Managed Assets.
Portfolio Managers
The Trusts portfolio will initially be managed by Patrick
Daugherty, James Dondero, Mark Okada and Kurtis Plumer. The
investment decisions are not subject to the oversight, approval
or ratification of a committee.
Kurtis Plumer, CFA. Mr. Plumer is a Senior Portfolio
Manager and co-head of the Distressed Group at Highland where he
is responsible for managing the sourcing, investing and
monitoring process. He has over 14 years of experience in
distressed, high yield bond and leveraged loan products. Prior
to joining Highland in 1999, Mr. Plumer was a distressed
high yield bond trader at Lehman Brothers in New York, where he
managed a $250 million portfolio invested in global
distressed securities. While at Lehman, he also traded emerging
market sovereign bonds. Prior to joining Lehman Brothers,
Mr. Plumer was a corporate finance banker at NationsBanc
Capital Markets, Inc. (now Bank of America Capital Markets,
Inc.) where he focused on M&A and financing transactions for
the banks clients. Mr. Plumer earned a BBA in
Economics and Finance from Baylor University and an MBA in
Strategy and Finance from the Kellogg School at Northwestern
University. Mr. Plumer is a Chartered Financial Analyst.
James Dondero, CFA, CPA, CMA. Mr. Dondero is a founder and
President of Highland. Formerly, Mr. Dondero served as
Chief Investment Officer of Protective Lifes GIC
subsidiary and helped grow the business from concept to over
$2 billion between 1989 and 1993. His portfolio management
experience includes mortgage-backed securities, investment grade
corporates, leveraged bank loans, emerging markets, derivatives,
preferred stocks and common stocks. From 1985 to 1989, he
managed approximately $1 billion in fixed income funds for
American Express. Prior to American Express, he completed his
financial training at Morgan Guaranty Trust Company.
Mr. Dondero is a Beta Gamma Sigma graduate of the
University of Virginia, 1984 with degrees in Accounting and
Finance. Mr. Dondero is a Certified Public Accountant,
Chartered Financial Analyst and a Certified Management
Accountant.
Mark Okada, CFA. Mr. Okada is a founder and Chief
Investment Officer of Highland. He is responsible for overseeing
Highlands investment activities for its various funds and
has over 19 years of experience in the leveraged finance
market. Formerly, Mr. Okada served as Manager of Fixed
Income for Protective Lifes GIC subsidiary from 1990 to
1993. He was primarily responsible for the bank loan portfolio
and other risk assets. Protective was one of the first non-bank
entrants into the syndicated loan market. From 1986 to 1990, he
served as Vice President for Hibernia National Bank, managing
over $1 billion of high yield bank loans. Mr. Okada is
an honors graduate of the University of California Los Angeles
with degrees in Economics and Psychology. He completed his
credit training at Mitsui and is a Chartered Financial Analyst.
Mr. Okada is also Chairman of the Board of Directors of
Common Grace Ministries Inc.
Patrick H. Daugherty. Mr. Daugherty is Head of Special
Situations Investing at Highland. His responsibilities include
managing the Distressed Investments Group and co-managing the
Private Equity Investments Group. He has formerly served as
General Counsel to Highland. Prior to joining Highland in April
of 1998, Mr. Daugherty served as Vice President in the
Corporate Finance Group at Bank of America Capital Markets, Inc
(formerly NationsBanc Capital Markets, Inc.) where he originated
and structured leveraged transactions of mid-cap companies
located in the Southwest. Prior to joining Bank of America,
Mr. Daugherty was an Associate with the law firm of Baker,
Brown, Sharman and Parker in Houston, Texas where he worked with
banks and financial institutions in the liquidation of various
Resolution Trust Corporation portfolios. Mr. Daugherty has
over 15 years of experience in distressed, high yield and
corporate restructuring. He has been involved in over 100
restructurings and held steering committee positions in over 40
bankruptcies. He received a BBA in Finance from The University
of Texas at Austin and a Juris Doctor from The University of
Houston School of Law. Mr. Daughertys professional
certifications include membership in the Texas Bar Association
and the American Bar Association in 1992.
59
The Statement of Additional Information provides additional
information about the portfolio managers compensation,
other accounts managed by the portfolio managers and the
portfolio managers ownership of securities issued by the
Trust.
NET ASSET VALUE
The net asset value of the common shares of the Trust will be
computed based upon the value of the Trusts portfolio
securities and other assets. Net asset value per common share
will be determined daily on each day that the New York Stock
Exchange is open for business as of the close of the regular
trading session on the New York Stock Exchange. The Trust
calculates net asset value per common share by subtracting
liabilities (including accrued expenses or dividends) from the
total assets of the Trust (the value of the securities plus cash
or other assets, including interest accrued but not yet
received) and dividing the result by the total number of
outstanding common shares of the Trust.
Valuations
The Trust will use the following valuation methods to determine
either current market value for investments for which market
quotations are available, or if not available, the fair value,
as determined in good faith pursuant to policies and procedures
approved by the board of trustees:
|
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(i) |
The market value of each security listed or traded on any
recognized securities exchange or automated quotation system
will be the last reported sale price at the relevant valuation
date on the composite tape or on the principal exchange on which
such security is traded. If no sale is reported on that date,
the Investment Adviser utilizes, when available, pricing
quotations from principal market makers. Such quotations may be
obtained from third-party pricing services or directly from
investment brokers and dealers in the secondary market.
Generally, the Trusts loan and bond positions are not
traded on exchanges and consequently are valued based on market
prices received from third-party pricing services or
broker-dealer sources. |
|
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(ii) |
Dividends declared but not yet received, and rights in respect
of securities which are quoted ex-dividend or ex-rights, will be
recorded at the fair value thereof, as determined by the
Investment Adviser, which may (but need not) be the value so
determined on the day such securities are first quoted
ex-dividend or ex- rights. |
|
|
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(iii) |
Listed options, or
over-the-counter
options for which representative brokers quotations are
available, will be valued in the same manner as listed or
over-the-counter
securities as hereinabove provided. Premiums for the sale of
such options written by the Trust will be included in the assets
of the Trust, and the market value of such options shall be
included as a liability. |
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(iv) |
The Trusts non-marketable investments will generally be
valued in such manner as the Investment Adviser determines in
good faith to reflect their fair values under procedures
established by, and under the general supervision and
responsibility of, the Trusts board of trustees. The
pricing of all assets that are fair valued in this manner will
be subsequently reported to and ratified by the Trusts
board of trustees. |
When determining the fair value of an asset, the Investment
Adviser will seek to determine the price that the Trust might
reasonably expect to receive from the current sale of that asset
in an arms-length transaction. Fair value determinations
shall be based upon all available factors that the Investment
Adviser deems relevant.
60
DISTRIBUTIONS
Commencing with the Trusts initial dividend, the Trust
intends to make regular monthly cash dividends of all or
substantially all of its investment company taxable income to
common shareholders. Subject to market conditions, we expect to
declare the initial monthly dividend on the Trusts common
shares within approximately 45 days after completion of
this offering and to pay that initial monthly dividend
approximately 60 to 90 days after completion of this
offering. The Trust expects to pay common shareholders annually
at least 90% of its investment company taxable income. The Trust
intends to pay any capital gain distributions annually.
Various factors will affect the level of the Trusts
current income and current gains, such as its asset mix, and the
Trusts use of options. To permit the Trust to maintain
more stable monthly dividends and annual distributions, the
Trust may from time to time distribute less than the entire
amount of income and gains earned in the relevant month or year,
respectively. The undistributed income and gains would be
available to supplement future distributions. As a result, the
distributions paid by the Trust for any particular period may be
more or less than the amount of income and gains actually earned
by the Trust during the applicable period. Undistributed income
and gains will add to the Trusts net asset value and,
correspondingly, distributions from undistributed income and
gains and from capital, if any, will be deducted from the
Trusts net asset value. Shareholders will automatically
have all dividends and distributions reinvested in common shares
of the Trust issued by the Trust or purchased in the open market
in accordance with the Trusts Dividend Reinvestment Plan
unless an election is made to receive cash. Each participant in
the Trusts Dividend Reinvestment Plan will pay a pro rata
portion of brokerage commissions incurred in connection with
open market purchases, and participants requesting a sale of
securities through the plan agent of the Dividend Reinvestment
Plan are subject to a sales fee and a brokerage commission. See
Dividend Reinvestment Plan.
61
DIVIDEND REINVESTMENT PLAN
Unless the registered owner of common shares elects to receive
cash by contacting the Plan Agent, all dividends declared for
your common shares of the Trust will be automatically reinvested
by PFPC, Inc. (the Plan Agent), agent for
shareholders in administering the Trusts Dividend
Reinvestment Plan (the Plan), in additional common
shares of the Trust. If a registered owner of common shares
elects not to participate in the Plan, you will receive all
dividends in cash paid by check mailed directly to you (or, if
the shares are held in street or other nominee name, then to
such nominee) by PFPC, Inc., as dividend disbursing agent.
You may elect not to participate in the Plan and to receive all
dividends in cash by sending written instructions or by
contacting PFPC, Inc., as dividend disbursing agent, at the
address set forth below. Participation in the Plan is completely
voluntary and may be terminated or resumed at any time without
penalty by contacting the Plan Agent before the dividend record
date; otherwise such termination or resumption will be effective
with respect to any subsequently declared dividend or other
distribution. Some brokers may automatically elect to receive
cash on your behalf and may re-invest that cash in additional
common shares of the Trust for you.
The Plan Agent will open an account for each common shareholder
under the Plan in the same name in which such common
shareholders common shares are registered. Whenever the
Trust declares a dividend or other distribution (together, a
dividend) payable in cash, non-participants in the
Plan will receive cash and participants in the Plan will receive
the equivalent in common shares. The common shares will be
acquired by the Plan Agent for the participants accounts,
depending upon the circumstances described below, either
(i) through receipt of additional unissued but authorized
common shares from the Trust (newly issued common
shares) or (ii) by purchase of outstanding common
shares on the open market (open-market purchases) on
the New York Stock Exchange or elsewhere.
If, on the payment date for any dividend, the market price per
common share plus estimated brokerage commissions is greater
than the net asset value per common share (such condition being
referred to herein as market premium), the Plan
Agent will invest the dividend amount in newly issued common
shares, including fractions, on behalf of the participants. The
number of newly issued common shares to be credited to each
participants account will be determined by dividing the
dollar amount of the dividend by the net asset value per common
share on the payment date; provided that, if the net asset value
per common share is less than 95% of the market price per common
share on the payment date, the dollar amount of the dividend
will be divided by 95% of the market price per common share on
the payment date.
If, on the payment date for any dividend, the net asset value
per common share is greater than the market value per common
share plus estimated brokerage commissions (such condition being
referred to herein as market discount), the Plan
Agent will invest the dividend amount in common shares acquired
on behalf of the participants in open-market purchases.
In the event of a market discount on the payment date for any
dividend, the Plan Agent will have until the last business day
before the next date on which the common shares trade on an
ex-dividend basis or 120 days after the payment
date for such dividend, whichever is sooner (the last
purchase date), to invest the dividend amount in common
shares acquired in open-market purchases. It is contemplated
that the Trust will pay monthly dividends. Therefore, the period
during which open-market purchases can be made will exist only
from the payment date of each dividend through the date before
the ex-dividend date of the third month of the
quarter. If, before the Plan Agent has completed its open-market
purchases, the market price of a common share exceeds the net
asset value per common share, the average per common share
purchase price paid by the Plan Agent may exceed the net asset
value of the common shares, resulting in the acquisition of
fewer common shares than if the dividend had been paid in newly
issued common shares on the dividend payment date. Because of
the foregoing difficulty with respect to open market purchases,
if the Plan Agent is unable to invest the full dividend amount
in open market purchases during the purchase period or if the
market discount shifts to a market premium during the purchase
period, the Plan Agent may cease making open-market purchases
and may invest the uninvested portion of the dividend amount in
newly issued common shares at the net asset value per common
share at the close of business on the last purchase date;
provided that, if the net asset value per common share is less
than 95% of the market price per common share
62
on the payment date, the dollar amount of the dividend will be
divided by 95% of the market price per common share on the
payment date.
The Plan Agent maintains all shareholders accounts in the
Plan and furnishes written confirmation of all transactions in
the accounts, including information needed by shareholders for
tax records. Common shares in the account of each Plan
participant will be held by the Plan Agent on behalf of the Plan
participant, and each shareholder proxy will include those
shares purchased or received pursuant to the Plan. The Plan
Agent will forward all proxy solicitation materials to
participants and vote proxies for shares held under the Plan in
accordance with the instructions of the participants.
In the case of shareholders such as banks, brokers or nominees
which hold shares for others who are the beneficial owners, the
Plan Agent will administer the Plan on the basis of the number
of common shares certified from time to time by the record
shareholders name and held for the account of beneficial
owners who participate in the Plan.
There will be no brokerage charges with respect to common shares
issued directly by the Trust. However, each participant will pay
a pro rata share of brokerage commissions incurred in connection
with open-market purchases. The automatic reinvestment of
dividends will not relieve participants of any federal, state or
local income tax that may be payable (or required to be
withheld) on such dividends. Accordingly, any taxable dividend
received by a participant that is reinvested in additional
common shares will be subject to federal (and possibly state and
local) income tax even though such participant will not receive
a corresponding amount of cash with which to pay such taxes. See
Tax Matters. Participants who request a sale of
shares through the Plan Agent are subject to a $2.50 sales
fee and pay a brokerage commission of $0.05 per share sold.
The Trust reserves the right to amend or terminate the Plan.
There is no direct service charge to participants in the Plan;
however, the Trust reserves the right to amend the Plan to
include a service charge payable by the participants.
All correspondence concerning the Plan should be directed to the
Plan Agent at PFPC, Inc., 301 Bellevue Parkway,
Wilmington, Delaware 19809; telephone
(877) 665-1287.
63
DESCRIPTION OF CAPITAL STRUCTURE
Common Shares
The Trust is a statutory trust organized under the laws of
Delaware pursuant to an Agreement and Declaration of Trust dated
as of March 10, 2006. The Trust is authorized to issue an
unlimited number of common shares of beneficial interest, par
value $0.001 per share. Each common share has one vote and,
when issued and paid for in accordance with the terms of this
offering, will be fully paid and non-assessable, except that the
trustees shall have the power to cause shareholders to pay
expenses of the Trust by setting off charges due from
shareholders from declared but unpaid dividends or distributions
owed the shareholders and/or by reducing the number of common
shares owned by each respective shareholder. The Trust currently
is not aware of any expenses that will be paid pursuant to this
provision, except to the extent fees payable under its Dividend
Reinvestment Plan are deemed to be paid pursuant to this
provision.
The Trust intends to hold annual meetings of shareholders so
long as the common shares are listed on a national securities
exchange and such meetings are required as a condition to such
listing. All common shares are equal as to dividends, assets and
voting privileges and have no conversion, preemptive or other
subscription rights. The Trust will send annual and semi-annual
reports, including financial statements, to all holders of its
shares.
The Trust has no present intention of offering any additional
shares other than the Preferred Shares and common shares issued
under the Trusts Dividend Reinvestment Plan. Any
additional offerings of shares will require approval by the
Trusts board of trustees. Any additional offering of
common shares will be subject to the requirements of the
Investment Company Act, which provides that shares may not be
issued at a price below the then current net asset value,
exclusive of sales load, except in connection with an offering
to existing holders of common shares or with the consent of a
majority of the Trusts outstanding voting securities.
The Trust anticipates that its common shares will be listed on
the New York Stock Exchange under the symbol HCF.
Net asset value will be reduced immediately following the
offering of common shares by the amount of the sales load and
offering costs paid by the Trust. See Summary of
Trust Expenses.
Unlike open-end funds, closed-end funds like the Trust do not
continuously offer shares and do not provide daily redemptions.
Rather, if a shareholder determines to buy additional common
shares or sell shares already held, the shareholder may do so by
trading through a broker on the New York Stock Exchange or
otherwise. Shares of closed-end investment companies frequently
trade on an exchange at prices lower than net asset value.
Because the market value of the common shares may be influenced
by such factors as dividend levels (which are in turn affected
by expenses), dividend stability, net asset value, relative
demand for and supply of such shares in the market, general
market and economic conditions and other factors beyond the
control of the Trust, the Trust cannot assure you that common
shares will trade at a price equal to or higher than net asset
value in the future. The common shares are designed primarily
for long-term investors and you should not purchase the common
shares if you intend to sell them soon after purchase. See the
Statement of Additional Information under Repurchase of
Common Shares.
Preferred Shares
The Agreement and Declaration of Trust provides that the
Trusts board of trustees may authorize and issue Preferred
Shares with rights as determined by the board of trustees, by
action of the board of trustees without the approval of the
holders of the common shares. Holders of common shares have no
preemptive right to purchase any Preferred Shares that might be
issued. Whenever Preferred Shares are outstanding, the holders
of common shares will not be entitled to receive any
distributions from the Trust unless all accrued dividends on
Preferred Shares have been paid, unless asset coverage (as
defined in the Investment Company Act) with respect to Preferred
Shares would be at least 200% after giving effect to the
distributions and unless certain other requirements imposed by
any rating agencies rating the Preferred Shares have been met.
The Trust intends to issue Preferred Shares as part of its
leverage strategy in one to six months following the completion
of this offering. If Preferred Shares are issued, the Trust
currently intends to issue Preferred
64
Shares representing approximately 20% of the Trusts total
assets (including the proceeds of all such leverage) immediately
after the Preferred Shares are issued. The board of trustees
also reserves the right to change the foregoing percentage
limitation and may issue Preferred Shares to the extent
permitted by the Investment Company Act, which currently limits
the aggregate liquidation preference of all outstanding
Preferred Shares to 50% of the value of the Trusts Managed
Assets less liabilities and indebtedness of the Trust. We cannot
assure you, however, that any Preferred Shares will be issued.
Although the terms of any Preferred Shares, including dividend
rate, liquidation preference and redemption provisions, will be
determined by the board of trustees, subject to applicable law
and the Agreement and Declaration of Trust, it is likely that
the Preferred Shares will be structured to carry a relatively
short-term dividend rate reflecting interest rates on short-term
bonds, by providing for the periodic redetermination of the
dividend rate at relatively short intervals through an auction,
remarketing or other procedure. The Trust also believes that it
is likely that the liquidation preference, voting rights and
redemption provisions of the Preferred Shares will be similar to
those stated below.
Liquidation Preference. In the event of any
voluntary or involuntary liquidation, dissolution or winding up
of the Trust, the holders of Preferred Shares will be entitled
to receive a preferential liquidating distribution, which is
expected to equal the original purchase price per Preferred
Share plus accrued and unpaid dividends, whether or not
declared, before any distribution of assets is made to holders
of common shares. After payment of the full amount of the
liquidating distribution to which they are entitled, the holders
of Preferred Shares will not be entitled to any further
participation in any distribution of assets by the Trust.
Voting Rights. The Investment Company Act requires
that the holders of any Preferred Shares, voting separately as a
single class, have the right to elect at least two trustees at
all times. The remaining trustees will be elected by holders of
common shares and Preferred Shares, voting together as a single
class. In addition, subject to the prior rights, if any, of the
holders of any other class of senior securities outstanding, the
holders of any Preferred Shares have the right to elect a
majority of the trustees of the Trust at any time two
years dividends on any Preferred Shares are unpaid. The
Investment Company Act also requires that, in addition to any
approval by shareholders that might otherwise be required, the
approval of the holders of a majority of any outstanding
Preferred Shares, voting separately as a class, would be
required to (i) adopt any plan of reorganization that would
adversely affect the Preferred Shares, and (ii) take any
action requiring a vote of security holders under
Section 13(a) of the Investment Company Act, including,
among other things, changes in the Trusts
subclassification as a closed-end investment company or changes
in its fundamental investment restrictions. As a result of these
voting rights, the Trusts ability to take any such actions
may be impeded to the extent that there are any Preferred Shares
outstanding. The board of trustees presently intends that,
except as otherwise indicated in this prospectus and except as
otherwise required by applicable law, holders of Preferred
Shares will have equal voting rights with holders of common
shares (one vote per share, unless otherwise required by the
Investment Company Act) and will vote together with holders of
common shares as a single class.
The affirmative vote of the holders of a majority of the
outstanding Preferred Shares, voting as a separate class, will
be required to amend, alter or repeal any of the preferences,
rights or powers of holders of Preferred Shares so as to affect
materially and adversely such preferences, rights or powers, or
to increase or decrease the authorized number of Preferred
Shares. The class vote of holders of Preferred Shares described
above will in each case be in addition to any other vote
required to authorize the action in question.
Redemption, Purchase and Sale of Preferred Shares by the
Trust. The terms of the Preferred Shares are expected to
provide that (i) they are redeemable by the Trust in whole
or in part at the original purchase price per share plus accrued
dividends per share, (ii) the Trust may tender for or
purchase Preferred Shares and (iii) the Trust may
subsequently resell any shares so tendered for or purchased. Any
redemption or purchase of Preferred Shares by the Trust will
reduce the leverage applicable to the common shares, while any
resale of shares by the Trust will increase that leverage.
The discussion above describes the possible offering of
Preferred Shares by the Trust. If the board of trustees
determines to proceed with such an offering, the terms of the
Preferred Shares may be the same as, or different from, the
terms described above, subject to applicable law and the
Trusts Agreement and
65
Declaration of Trust. The board of trustees, without the
approval of the holders of common shares, may authorize an
offering of Preferred Shares or may determine not to authorize
such an offering and may fix the terms of the Preferred Shares
to be offered.
Other Shares
The board of trustees (subject to applicable law and the
Trusts Agreement and Declaration of Trust) may authorize
an offering, without the approval of the holders of either
common shares or Preferred Shares, of other classes of shares,
or other classes or series of shares, as they determine to be
necessary, desirable or appropriate, having such terms, rights,
preferences, privileges, limitations and restrictions as the
board of trustees see fit. The Trust currently does not expect
to issue any other classes of shares, or series of shares,
except for the common shares and the Preferred Shares.
Credit Facility
In the event the Trust leverages through borrowings, the Trust
may enter into definitive agreements with respect to a credit
facility. The Trust may negotiate with commercial banks to
arrange a credit facility pursuant to which the Trust would be
entitled to borrow an amount equal to approximately one-third
(331/3
%) of the Trusts total assets (inclusive of the
amount borrowed) offered hereby. Any such borrowings would
constitute financial leverage. Such a facility is not expected
to be convertible into any other securities of the Trust. Any
outstanding amounts are expected to be prepayable by the Trust
prior to final maturity without significant penalty, and there
are not expected to be any sinking fund or mandatory retirement
provisions. Outstanding amounts would be payable at maturity or
such earlier times as required by the agreement. The Trust may
be required to prepay outstanding amounts under the facility or
incur a penalty rate of interest in the event of the occurrence
of certain events of default. The Trust would be expected to
indemnify the lenders under the facility against liabilities
they may incur in connection with the facility. The Trust may be
required to pay commitment fees under the terms of any such
facility. With the use of borrowings, there is a risk that the
interest rates paid by the Trust on the amount it borrows will
be higher than the return on the Trusts investments.
In addition, the Trust expects that such a credit facility would
contain covenants that, among other things, likely will limit
the Trusts ability to: (i) pay dividends in certain
circumstances, (ii) incur additional debt and
(iii) change its fundamental investment policies and engage
in certain transactions, including mergers and consolidations.
In addition, it may contain a covenant requiring asset coverage
ratios in addition to those required by the Investment Company
Act. The Trust may be required to pledge its assets and to
maintain a portion of its assets in cash or high-grade
securities as a reserve against interest or principal payments
and expenses. The Trust expects that any credit facility would
have customary covenant, negative covenant and default
provisions. There can be no assurance that the Trust will enter
into an agreement for a credit facility on terms and conditions
representative of the foregoing or that additional material
terms will not apply. In addition, if entered into, any such
credit facility may in the future be replaced or refinanced by
one or more credit facilities having substantially different
terms or by the issuance of Preferred Shares.
66
ANTI-TAKEOVER PROVISIONS IN THE AGREEMENT AND DECLARATION OF
TRUST
The Agreement and Declaration of Trust includes provisions that
could have the effect of limiting the ability of other entities
or persons to acquire control of the Trust or to change the
composition of its board of trustees. This could have the effect
of depriving shareholders of an opportunity to sell their shares
at a premium over prevailing market prices by discouraging a
third party from seeking to obtain control over the Trust. Such
attempts could have the effect of increasing the expenses of the
Trust and disrupting the normal operation of the Trust. The
board of trustees is divided into three classes, with the terms
of one class expiring at each annual meeting of shareholders. At
each annual meeting, one class of trustees is elected to a
three-year term. This provision could delay for up to two years
the replacement of a majority of the board of trustees. A
trustee may be removed from office (for cause, and not without
cause) by the action of a majority of the remaining trustees
followed by a vote of the holders of at least 75% of the shares
then entitled to vote for the election of the respective trustee.
In addition, the Trusts Agreement and Declaration of Trust
requires the favorable vote of a majority of the Trusts
board of trustees followed by the favorable vote of the holders
of at least 75% of the outstanding shares of each affected class
or series of the Trust, voting separately as a class or series,
to approve, adopt or authorize certain transactions with 5% or
greater holders of a class or series of shares and their
associates, unless the transaction has been approved by at least
80% of the trustees, in which case a majority of the
outstanding voting securities (as defined in the
Investment Company Act) of the Trust shall be required. For
purposes of these provisions, a 5% or greater holder of a class
or series of shares (a Principal Shareholder) refers
to any person who, whether directly or indirectly and whether
alone or together with its affiliates and associates,
beneficially owns 5% or more of the outstanding shares of all
outstanding classes or series of shares of beneficial interest
of the Trust.
The 5% holder transactions subject to these special approval
requirements are: the merger or consolidation of the Trust or
any subsidiary of the Trust with or into any Principal
Shareholder; the issuance of any securities of the Trust to any
Principal Shareholder for cash, except pursuant to any automatic
dividend reinvestment plan; the sale, lease or exchange of all
or any substantial part of the assets of the Trust to any
Principal Shareholder, except assets having an aggregate fair
market value of less than 2% of the total assets of the Trust,
aggregating for the purpose of such computation all assets sold,
leased or exchanged in any series of similar transactions within
a twelve-month period; or the sale, lease or exchange to the
Trust or any subsidiary of the Trust, in exchange for securities
of the Trust, of any assets of any Principal Shareholder, except
assets having an aggregate fair market value of less than 2% of
the total assets of the Trust, aggregating for purposes of such
computation all assets sold, leased or exchanged in any series
of similar transactions within a twelve-month period.
To convert the Trust to an open-end investment company, the
Trusts Agreement and Declaration of Trust requires the
favorable vote of a majority of the board of the trustees
followed by the favorable vote of the holders of at least 75% of
the outstanding shares of each affected class or series of
shares of the Trust, voting separately as a class or series,
unless such amendment has been approved by at least 80% of the
trustees, in which case a majority of the outstanding
voting securities (as defined in the Investment Company
Act) of the Trust shall be required. The foregoing vote would
satisfy a separate requirement in the Investment Company Act
that any conversion of the Trust to an open-end investment
company be approved by the shareholders. If approved in the
foregoing manner, conversion of the Trust to an open-end
investment company could not occur until 90 days after the
shareholders meeting at which such conversion was approved
and would also require at least 30 days prior notice
to all shareholders. Following any such conversion, it is
possible that certain of the Trusts investment policies
and strategies would have to be modified to assure sufficient
portfolio liquidity. In the event of conversion, the common
shares would cease to be listed on the New York Stock Exchange
or other national securities exchanges or market systems.
Shareholders of an open-end investment company may require the
company to redeem their shares at any time, except in certain
circumstances as authorized by or under the Investment Company
Act, at their net asset value, less such redemption charge, if
any, as might be in effect at the time of a redemption. The
Trust expects to pay all such redemption requests in cash, but
reserves the right to pay redemption requests in a combination
of cash or securities. If such partial payment in securities
were made, investors may incur brokerage costs in converting
67
such securities to cash. If the Trust were converted to an
open-end fund, it is likely that new shares would be sold at net
asset value plus a sales load. The board of trustees believes,
however, that the closed-end structure is desirable in light of
the Trusts investment objectives and policies. Therefore,
you should assume that it is not likely that the board of
trustees would vote to convert the Trust to an open-end fund.
For the purposes of calculating a majority of the
outstanding voting securities under the Trusts
Agreement and Declaration of Trust, each class and series of the
Trust shall vote together as a single class, except to the
extent required by the Investment Company Act or the
Trusts Agreement and Declaration of Trust, with respect to
any class or series of shares. If a separate class vote is
required, the applicable proportion of shares of the class or
series, voting as a separate class or series, also will be
required.
The Declaration of Trust also provides that the Trust may be
liquidated upon the approval of 80% of the trustees.
The board of trustees has determined that provisions with
respect to the board of trustees and the shareholder voting
requirements described above, which voting requirements are
greater than the minimum requirements under Delaware law or the
Investment Company Act, are in the best interest of shareholders
generally. Reference should be made to the Trusts
Agreement and Declaration of Trust, on file with the Commission
for the full text of these provisions.
68
CLOSED-END FUND STRUCTURE
The Trust is a non-diversified, closed-end management investment
company with no operating history (commonly referred to as a
closed-end fund). Closed-end funds differ from open-end funds
(which are generally referred to as mutual funds) in that
closed-end funds generally list their shares for trading on a
stock exchange and do not redeem their shares at the request of
the shareholder. This means that if you wish to sell your shares
of a closed-end fund you must trade them on the market like any
other stock at the prevailing market price at that time. In a
mutual fund, if the shareholder wishes to sell shares of the
fund, the mutual fund will redeem or buy back the shares at
net asset value (less a redemption fee, if
applicable, or contingent deferred sales charge, if applicable).
Also, mutual funds generally offer new shares on a continuous
basis to new investors, and closed-end funds generally do not.
The continuous inflows and outflows of assets in a mutual fund
can make it difficult to manage a mutual funds
investments. By comparison, closed-end funds are generally able
to stay more fully invested in securities that are consistent
with their investment objective and also have greater
flexibility to make certain types of investments and to use
certain investment strategies, such as financial leverage and
investments in illiquid securities.
Shares of closed-end funds frequently trade at a discount to
their net asset value. Because of this possibility and the
recognition that any such discount may not be in the interest of
shareholders, the Trusts board of trustees might consider
from time to time engaging in open-market repurchases, tender
offers for shares or other programs intended to reduce the
discount. We cannot guarantee or assure, however, that the
Trusts board of trustees will decide to engage in any of
these actions. Nor is there any guarantee or assurance that such
actions, if undertaken, would result in the shares trading at a
price equal or close to net asset value per share. The board of
trustees might also consider converting the Trust to an open-end
mutual fund, which would also require a vote of the shareholders
of the Trust.
69
REPURCHASE OF COMMON SHARES
Shares of closed-end investment companies often trade at a
discount to their net asset value, and the Trusts common
shares may also trade at a discount to their net asset value,
although it is possible that they may trade at a premium above
net asset value. The market price of the Trusts common
shares will be determined by such factors as relative demand for
and supply of such common shares in the market, the Trusts
net asset value, general market and economic conditions and
other factors beyond the control of the Trust. See Net
Asset Value. Although the Trusts common shareholders
will not have the right to redeem their common shares, the Trust
may take action to repurchase common shares in the open market
or make tender offers for its common shares. This may have the
effect of reducing any market discount from net asset value.
There is no assurance that, if action is undertaken to
repurchase or tender for common shares, such action will result
in the common shares trading at a price which approximates their
net asset value. Although share repurchases and tenders could
have a favorable effect on the market price of the Trusts
common shares, you should be aware that the acquisition of
common shares by the Trust will decrease the capital of the
Trust and, therefore, may have the effect of increasing the
Trusts expense ratio and decreasing the asset coverage
with respect to any Preferred Shares outstanding or borrowings.
Any share repurchases or tender offers will be made in
accordance with requirements of the Securities Exchange Act of
1934, as amended, the Investment Company Act and the principal
stock exchange on which the common shares are traded.
70
TAX MATTERS
The following discussion summarizes certain U.S. federal
income tax considerations affecting the Trust and its
shareholders that are U.S. persons as defined for
U.S. federal income tax purposes. For more information,
please see the Statement of Additional Information, under
Tax Matters. Because each shareholders tax
situation is unique, ask your tax professional about the tax
consequences to you of an investment in the Trust.
The Trust intends to qualify annually as a regulated investment
company under the Internal Revenue Code. Accordingly, the Trust
generally will not be subject to U.S. federal income tax on
income and gains that the Trust distributes to its shareholders.
Distributions paid to you by the Trust from its net realized
long-term capital gains, if any, that the Trust designates as
capital gains dividends (capital gain dividends) are
taxable as long-term capital gains, regardless of how long you
have held your common shares. All other dividends paid to you by
the Trust (including dividends from short-term capital gains)
from its current or accumulated earnings and profits
(ordinary income dividends) are generally subject to
tax as ordinary income.
In general, the Trust does not expect that a significant portion
of its ordinary income dividends will be treated as qualified
dividend income, which is eligible for taxation at the rates
applicable to long-term capital gains in the case of individual
shareholders, or that a corporate shareholder will be able to
claim a dividends received reduction with respect to any
significant portion of Trust distributions.
Dividends and other taxable distributions are taxable to you
even if they are reinvested in additional common shares of the
Trust. Dividends and other distributions paid by the Trust are
generally treated as received by you at the time the dividend or
distribution is made. If, however, the Trust pays you a dividend
in January that was declared in the previous October, November
or December and you were the shareholder of record on a
specified date in one of such months, then such dividend will be
treated for tax purposes as being paid by the Trust and received
by you on December 31 of the year in which the dividend was
declared.
The price of common shares purchased at any time may reflect the
amount of a forthcoming distribution. If you purchase common
shares just prior to a distribution, you will receive a
distribution that will be taxable to you even though it
represents in part a return of your invested capital.
The Trust will send you information after the end of each year
setting forth the amount and tax status of any distributions
paid to you by the Trust. Ordinary income dividends and capital
gain dividends may also be subject to state and local taxes.
If you sell or otherwise dispose of common shares of the Trust
(including exchange them for common shares of another fund), you
will generally recognize a gain or loss in an amount equal to
the difference between your tax basis in such common shares of
the Trust and the amount you receive in exchange for such common
shares. If you hold your common shares as capital assets, any
such gain or loss generally will be long-term capital gain or
loss if you have held such common shares for more than one year
at the time of sale.
The Trust may be required to withhold, for U.S. federal
backup withholding tax purposes, a portion of the dividends,
distributions and redemption proceeds payable to a shareholder
who fails to provide the Trust (or its agent) with the
shareholders correct taxpayer identification number (in
the case of an individual, generally, such individuals
social security number) or to make the required certification,
or who has been notified by the Internal Revenue Service that
such shareholder is subject to backup withholding. Certain
shareholders are exempt from backup withholding. Backup
withholding is not an additional tax and any amount withheld may
be refunded or credited against your U.S. federal income
tax liability, if any, provided that you furnish the required
information to the IRS.
The discussions set forth herein and in the Statement of
Additional Information do not constitute tax advice, and you are
urged to consult your own tax advisor to determine the specific
U.S. federal, state, local and foreign tax consequences to
you of investing in the Trust.
71
UNDERWRITERS
Under the terms and subject to the conditions contained in the
underwriting agreement dated the date of this prospectus, the
underwriters named below, for whom Morgan Stanley & Co.
Incorporated is acting as representative, have severally agreed
to purchase, and the Trust has agreed to sell to them,
severally, the number of common shares indicated below.
|
|
|
|
|
|
|
Number of | |
Name |
|
Common Shares | |
|
|
| |
Morgan Stanley & Co. Incorporated
|
|
|
|
|
E*TRADE Securities LLC
|
|
|
|
|
Oppenheimer & Co., Inc.
|
|
|
|
|
Robert W. Baird & Co. Incorporated
|
|
|
|
|
Stephens Inc.
|
|
|
|
|
Wells Fargo Securities, LLC
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
The underwriters are offering the common shares subject to their
acceptance of the common shares from the Trust and subject to
prior sale. The underwriting agreement provides that the
obligations of the several underwriters to pay for and accept
delivery of the common shares offered by this prospectus are
subject to the approval of legal matters by their counsel and to
certain other conditions. The underwriters are obligated to take
and pay for all of the common shares offered by this prospectus
if any such common shares are taken. However, the underwriters
are not required to take or pay for the common shares covered by
the underwriters over allotment option described below.
The underwriters initially propose to offer part of the common
shares directly to the public at the initial offering price
listed on the cover page of this prospectus and part to certain
dealers at a price that represents a concession not in excess of
$0.60 a share under the initial offering price. Any underwriter
may allow, and such dealers may reallow, a concession not in
excess of $0.10 a share to the other underwriters or to certain
dealers. After the initial offering of the common shares, the
offering price and other selling terms may from time to time be
varied by the representative. The underwriting discounts and
commissions (sales load) of $0.90 a share are equal to 4.5% of
the initial offering price. Investors must pay for any common
shares purchased on or
before ,
2006.
The Trust has granted to the underwriters an option, exercisable
for 45 days from the date of this prospectus, to purchase
up to an aggregate
of common
shares at the initial offering price per common share listed on
the cover page of this prospectus, less underwriting discounts
and commissions. The underwriters may exercise this option
solely for the purpose of covering over allotments, if any, made
in connection with the offering of the common shares offered by
this prospectus. To the extent the option is exercised, each
underwriter will become obligated, subject to limited
conditions, to purchase approximately the same percentage of the
additional common shares as the number listed next to the
underwriters name in the preceding table bears to the
total number of common shares listed next to the names of all
underwriters in the preceding table. If the underwriters
over allotment option is exercised in full, the total price to
the public would be
$ ,
the total underwriters discounts and commissions (sales
load) would be
$ ,
the estimated offering expenses would be
$ and
the total proceeds to the Trust would be
$ .
72
The following table summarizes the public offering price of the
common shares, underwriting discounts and commissions (sales
load), estimated offering expenses and proceeds to the Trust.
The information assumes either no exercise or full exercise by
the underwriters of their over-allotment option.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per Share | |
|
Total | |
|
|
| |
|
| |
|
|
Without | |
|
With | |
|
Without | |
|
With | |
|
|
Over-allotment | |
|
Over-allotment | |
|
Over-allotment | |
|
Over-allotment | |
|
|
| |
|
| |
|
| |
|
| |
Public offering price
|
|
$ |
20.00 |
|
|
$ |
20.00 |
|
|
$ |
|
|
|
$ |
|
|
Underwriting discounts and commissions (sales load)
|
|
$ |
0.90 |
|
|
$ |
0.90 |
|
|
$ |
|
|
|
$ |
|
|
Estimated offering expenses
|
|
$ |
0.11 |
|
|
$ |
0.11 |
|
|
$ |
|
|
|
$ |
|
|
Proceeds, after expenses, to the Trust
|
|
$ |
18.99 |
|
|
$ |
18.99 |
|
|
$ |
|
|
|
$ |
|
|
Expenses payable by the Trust in the table above include the
estimated expenses, including underwriting discounts,
commissions and legal expenses, of the Preferred Share offering
which is expected to occur soon after the completion of this
offering, as described under Prospectus
SummaryPreferred Shares and Borrowings and
Description of Capital StructurePreferred
Shares. For purposes of the table above, it is assumed
that the Trust will issue an aggregate of 30,430,000 common
shares in this offering and Preferred Shares having an aggregate
liquidation value of approximately $165.7 million are
issued in the Preferred Share offering. On this basis, such
Preferred Share offering expenses are estimated to be
approximately $2.1 million in total, or $0.07 per common
share sold by the Trust in this offering. If the Trust issues
more (fewer) Preferred Shares than the amount assumed, then the
total Preferred Share offering expenses would be greater than
(less than) reflected in the table above. Also, if the
percentage of the Trusts Managed Assets represented by the
Preferred Shares is greater than (less than) assumed, then the
expenses of the Preferred Share offering per common share would
be greater than (less than) reflected in the table above.
Expenses payable by the Trust in the table above also include
reimbursement to the Investment Adviser by the Trust for
expenses incurred by the Investment Adviser in connection with
this offering, as described in the next paragraph. The marketing
and structuring fee described below under Additional
Compensation to Be Paid by Investment Adviser to an
Underwriter is not reimbursable to the Investment Adviser,
and is therefore not reflected in expenses payable by the Trust
in the table above.
The Trust has agreed to reimburse the Investment Adviser for
expenses incurred by the Investment Adviser in connection with
this offering, other than the marketing and structuring fee
payable by the Investment Adviser described below under
Additional Compensation to Be Paid by Investment
Adviser to an Underwriter. Offering expenses paid by the
Trust (other than underwriting discounts and commissions and any
Preferred Share offering expenses), including expenses
reimbursed by the Trust to the Investment Adviser, will not
exceed $0.04 per common share sold by the Trust in this
offering. If the offering expenses referred to in the preceding
sentence exceed this amount, the Investment Adviser will pay the
excess. The aggregate offering expenses (excluding the
underwriting discounts and commissions, and excluding any
Preferred Share offering expenses, but including expenses
reimbursed to the Investment Adviser) to be incurred by the
Trust are estimated to be $1,217,200 in total, or $0.04 per
common share sold by the Trust in this offering.
The underwriters have informed the Trust that they do not intend
sales to discretionary accounts to exceed five percent of the
total number of common shares offered by them.
In order to meet requirements for the New York Stock Exchange,
the underwriters have undertaken to sell lots of 100 or more
shares to a minimum of 2,000 beneficial owners. The minimum
investment requirement is 100 common shares ($2,000).
The Trust anticipates that its common shares will be listed on
the New York Stock Exchange, subject to official notice of
issuance, under the symbol HCF.
73
The Trust has agreed that, without the prior written consent of
Morgan Stanley & Co. Incorporated on behalf of the
underwriters, it will not, during the period ending
180 days after the date of this prospectus:
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offer, pledge, sell, contract to sell, sell any option or
contract to purchase, purchase any option or contract to sell,
grant any option, right or warrant to purchase, lend, or
otherwise transfer or dispose of, directly or indirectly, any
common shares or any securities convertible into or exercisable
or exchangeable for common shares, or |
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enter into any swap or other arrangement that transfers to
another, in whole or in part, any of the economic consequences
of ownership of the common shares, |
whether any such transaction described above is to be settled by
delivery of common shares or such other securities, in cash or
otherwise; or file any registration statement with the
Securities and Exchange Commission relating to the offering of
any common shares or any securities convertible into or
exercisable or exchangeable for common shares. These
lock-up agreements will
not apply to the common shares to be sold pursuant to the
underwriting agreement or any common shares issued pursuant to
the Trusts Dividend Reinvestment Plan.
In order to facilitate the offering of the common shares, the
underwriters may engage in transactions that stabilize, maintain
or otherwise affect the price of the common shares. The
underwriters currently expect to sell more common shares than
they are obligated to purchase under the underwriting agreement,
creating a short position in the common shares for their own
account. A short sale is covered if the short position is no
greater than the number of common shares available for purchase
by the underwriters under the over allotment option (exercisable
for 45 days from the date of this prospectus). The
underwriters can close out a covered short sale by exercising
the over allotment option or purchasing common shares in the
open market. In determining the source of common shares to close
out a covered short sale, the underwriters will consider, among
other things, the open market price of the common shares
compared to the price available under the over allotment option.
The underwriters may also sell common shares in excess of the
over allotment option, creating a naked short position. The
underwriters must close out any naked short position by
purchasing common shares in the open market. A naked short
position is more likely to be created if the underwriters are
concerned that there may be downward pressure on the price of
the common shares in the open market after pricing that could
adversely affect investors who purchase in the offering. As an
additional means of facilitating the offering, the underwriters
may bid for, and purchase, common shares in the open market to
stabilize the price of the common shares. Finally, the
underwriting syndicate may also reclaim selling concessions
allowed to an underwriter or a dealer for distributing the
common shares in the offering, if the syndicate repurchases
previously distributed common shares in transactions to cover
syndicate short positions or to stabilize the price of the
common shares. Any of these activities may raise or maintain the
market price of the common shares above independent market
levels or prevent or retard a decline in the market price of the
common shares. The underwriters are not required to engage in
these activities, and may end any of these activities at any
time.
Prior to this offering, there has been no public or private
market for the common shares or any other securities of the
Trust. Consequently, the offering price for the common shares
was determined by negotiation among the Trust, the Investment
Adviser and the representative. There can be no assurance,
however, that the price at which the common shares trade after
this offering will not be lower than the price at which they are
sold by the underwriters or that an active trading market in the
common shares will develop and continue after this offering.
The Trust anticipates that the representative and certain other
underwriters may from time to time act as brokers and dealers in
connection with the execution of its portfolio transactions
after they have ceased to be underwriters and, subject to
certain restrictions, may act as such brokers while they are
underwriters.
In connection with this offering, certain of the underwriters or
selected dealers may distribute prospectuses electronically.
We and the underwriters have agreed to indemnify each other
against certain liabilities, including liabilities under the
Securities Act of 1933.
74
The address of Morgan Stanley & Co. Incorporated is
1585 Broadway, New York, New York 10036.
Additional Compensation to Be Paid by Investment Adviser to
an Underwriter
In connection with this transaction, Morgan Stanley & Co.
Incorporated will be paid a marketing and structuring fee by the
Investment Adviser (and not the Trust) equal to 1.25% of the
aggregate price to the public of the common shares sold by
Morgan Stanley & Co. Incorporated (including shares
over-allotted by Morgan Stanley & Co. Incorporated
regardless of whether the over-allotment option is exercised),
and which will total
$ .
The marketing and structuring fee paid to Morgan Stanley &
Co. Incorporated will not
exceed %
of the total price to public of the common shares sold in this
offering. In contrast to the underwriting discounts and
commissions (earned under the underwriting agreement by the
underwriting syndicate as a group), the marketing and
structuring fee will be earned by and paid to Morgan Stanley
& Co. Incorporated by the Investment Adviser for advice to
the Investment Adviser on the design, structuring and corporate
finance of, and marketing assistance with respect to, the Trust
and the distribution of its common shares. When approving the
underwriting agreement, the board of trustees of the Trust
discussed the marketing and structuring fee, but noted that it
was not payable pursuant to the underwriting agreement and also
noted that it was payable by the Investment Adviser and not by
the Trust, and that it was not reimbursable by the Trust to the
Investment Adviser.
The sum total of all compensation to the underwriters in
connection with this public offering of common shares, including
sales load and marketing and structuring fees, will not exceed
9% of the total price to the public of the common shares sold in
this offering.
75
CUSTODIAN AND TRANSFER AGENT
The Custodian of the assets of the Trust will be PFPC Trust
Company (8800 Tinicum Blvd., 4th Floor,
Philadelphia, PA 19153; telephone
(877) 665-1287).
The Custodian will perform custodial, fund accounting and
portfolio accounting services. PFPC, Inc.
(301 Bellevue Parkway, Wilmington, Delaware 19809;
telephone
(877) 665-1287)
will serve as the Trusts transfer agent with respect to
its common shares.
LEGAL OPINIONS
Certain legal matters in connection with the common shares will
be passed upon for the Trust by Skadden, Arps, Slate,
Meagher & Flom LLP, New York, New York and for the
underwriters by Davis Polk & Wardwell, New York, New
York.
PRIVACY PRINCIPLES OF THE TRUST
The Trust is committed to maintaining the privacy of its
shareholders and to safeguarding their non-public personal
information. The following information is provided to help you
understand what personal information the Trust collects, how the
Trust protects that information and why, in certain cases, the
Trust may share information with select other parties.
Generally, the Trust does not receive any non-public personal
information relating to its shareholders, although certain
non-public personal information of its shareholders may become
available to the Trust. The Trust does not disclose any
non-public personal information about its shareholders or former
shareholders to anyone, except as permitted by law or as is
necessary in order to service shareholder accounts (for example,
to a transfer agent or third party administrator).
The Trust restricts access to non-public personal information
about its shareholders to employees of the Trusts
Investment Adviser and its affiliates with a legitimate business
need for the information. The Trust maintains physical,
electronic and procedural safeguards designed to protect the
non-public personal information of its shareholders.
76
TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL
INFORMATION
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77
Highland Credit Strategies Fund
The information
in this Statement of Additional Information is not complete and
may be changed. We may not sell these securities until the
registration statement filed with the Securities and Exchange
Commission is effective. This Statement of Additional
Information is not an offer to sell these securities and is not
soliciting an offer to buy these securities in any jurisdiction
where the offer or sale is not
permitted.
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Subject to Completion
Preliminary Statement of Additional
Information
Dated June 22, 2006
HIGHLAND CREDIT
STRATEGIES FUND
STATEMENT OF ADDITIONAL INFORMATION
Highland Credit Strategies Fund (the Trust) is a
newly organized, non-diversified, closed-end management
investment company registered under the Investment Company Act
with no operating history. This Statement of Additional
Information registered under the Investment Company Act does not
constitute a prospectus, but should be read in conjunction with
the prospectus relating thereto
dated ,
2006. This Statement of Additional Information does not include
all information that a prospective investor should consider
before purchasing common shares, and investors should obtain and
read the prospectus prior to purchasing such shares. A copy of
the prospectus may be obtained without charge by calling
1-877-665-1287. You may also obtain a copy of the prospectus on
the Securities and Exchange Commissions web site
(http://www.sec.gov). Capitalized terms used but not defined in
this Statement of Additional Information have the meanings
ascribed to them in the prospectus.
TABLE OF CONTENTS
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This Statement of Additional Information is
dated ,
2006.
USE OF PROCEEDS
Pending investment in securities that meet the Trusts
investment objectives and policies, the net proceeds of this
offering will be invested in short-term debt securities of the
type described under Investment Policies and
Techniques Short-Term Debt Securities. We
currently anticipate that the Trust will be able to invest
primarily in securities that meet the Trusts investment
objectives and policies within approximately three months after
the completion of this offering.
B-2
INVESTMENT RESTRICTIONS
Except as described below, the Trust, as a fundamental policy,
may not, without the approval of the holders of a majority
of the outstanding(1) common shares and any Preferred
Shares, if any, voting together as a single class, and of the
holders of a majority of the outstanding preferred shares, if
any, voting as a separate class:
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(1) invest 25% or more of the value of its total assets in
any single industry or group of industries; |
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(2) issue senior securities or borrow money other than as
permitted by the Investment Company Act or pledge its assets
other than to secure such issuances or in connection with
hedging transactions, short sales, securities lending, when
issued and forward commitment transactions and similar
investment strategies; |
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(3) make loans of money or property to any person, except
through loans of portfolio securities up to a maximum of
331/3%
of the Trusts total assets, the purchase of debt
securities, including bank loans (senior loans) and
participations therein, or the entry into repurchase agreements
up to a maximum of
331/3
% of the Trusts total assets; |
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(4) underwrite the securities of other issuers, except to
the extent that, in connection with the disposition of portfolio
securities or the sale of its own securities, the Trust may be
deemed to be an underwriter; |
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(5) purchase or sell real estate, except that the Trust may
invest in securities of companies that deal in real estate or
are engaged in the real estate business, including real estate
investment trusts and real estate operating companies, and
instruments secured by real estate or interests therein and the
Trust may acquire, hold and sell real estate acquired through
default, liquidation, or other distributions of an interest in
real estate as a result of the Trusts ownership of such
other assets; or |
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(6) purchase or sell commodities or commodity contracts for
any purposes except as, and to the extent, permitted by
applicable law without the Trust becoming subject to
registration with the Commodity Futures Trading Commission (the
CFTC) as a commodity pool. |
As currently relevant to the Trust, the Investment Company Act
requires an asset coverage of 200% for a closed-end fund issuing
preferred shares and for borrowings exceeding 5% of the
Trusts assets (excluding temporary borrowings).
The Trust is also subject to the following non-fundamental
restrictions and policies, which may be changed by the board of
trustees and without shareholder approval. The Trust may not:
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(1) make any short sale of securities except in conformity
with applicable laws, rules and regulations and unless after
giving effect to such sale, the market value of all securities
sold short does not exceed 25% of the value of the Trusts
total assets and the Trusts aggregate short sales of a
particular class of securities of an issuer does not exceed 25%
of the then outstanding securities of that class. The Trust may
also make short sales against the box without
respect to such limitations. In this type of short sale, at the
time of the sale, the Trust owns or has the immediate and
unconditional right to acquire at no additional cost the
identical security; and |
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(2) purchase securities of open-end or closed-end
investment companies except in compliance with the Investment
Company Act or any exemptive relief obtained thereunder. Under
the Investment Company Act, the Trust may invest up to 10% of
its total assets in the aggregate in shares of other investment
companies and up to 5% of its total assets in any one investment
company, provided the investment does not represent more than 3%
of the voting stock of the acquired investment company at the
time such shares are purchased. As a shareholder in any
investment company, the Trust will bear its |
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(1) |
When used with respect to shares of the Trust, majority of
the outstanding shares means (i) 67% or more of the
shares present at a meeting, if the holders of more than 50% of
the shares are present or represented by proxy, or
(ii) more than 50% of |
the shares, whichever is less.
B-3
ratable share of that investment companys expenses, and
will remain subject to payment of the Advisory Fees and other
expenses with respect to assets so invested. Holders of common
shares will therefore be subject to duplicative expenses to the
extent the Trust invests in other investment companies. In
addition, the securities of other investment companies may be
leveraged and will therefore be subject to the risks of
leverage. The net asset value and market value of leveraged
shares will be more volatile and the yield to shareholders will
tend to fluctuate more than the yield generated by unleveraged
shares.
In addition, to comply with the federal tax requirements for
qualification as a registered investment company, the
Trusts investments must meet certain diversification
requirements. See Tax Matters.
The percentage limitations applicable to the Trusts
portfolio described in the prospectus and this Statement of
Additional Information apply only at the time of investment,
except that the percentage limitation with respect to borrowing
applies at all times, and the Trust will not be required to sell
securities due to subsequent changes in the value of securities
it owns.
B-4
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the
Trusts investment objectives, policies and techniques that
are described in the prospectus.
Short-Term Debt Securities
For temporary defensive purposes or to keep cash on hand, the
Trust may invest up to 100% of its total assets in cash
equivalents and short-term debt securities. Short-term debt
investments are defined to include, without limitation, the
following:
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(1) U.S. Government securities, including bills, notes
and bonds differing as to maturity and rates of interest that
are either issued or guaranteed by the U.S. Treasury or by
U.S. Government agencies or instrumentalities.
U.S. Government securities include securities issued by
(a) the Federal Housing Administration, Farmers Home
Administration, Export-Import Bank of the United States, Small
Business Administration, and Government National Mortgage
Association, whose securities are supported by the full faith
and credit of the United States; (b) the Federal Home
Loan Banks, Federal Intermediate Credit Banks, and
Tennessee Valley Authority, whose securities are supported by
the right of the agency to borrow from the U.S. Treasury;
(c) the Federal National Mortgage Association, whose
securities are supported by the discretionary authority of the
U.S. Government to purchase certain obligations of the
agency or instrumentality; and (d) the Student Loan
Marketing Association, whose securities are supported only by
its credit. While the U.S. Government provides financial
support to such U.S. Government-sponsored agencies or
instrumentalities, no assurance can be given that it always will
do so since it is not so obligated by law. The
U.S. Government, its agencies and instrumentalities do not
guarantee the market value of their securities. Consequently,
the value of such securities may fluctuate. |
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(2) Certificates of deposit issued against funds deposited
in a bank or a savings and loan association. Such certificates
are for a definite period of time, earn a specified rate of
return, and are normally negotiable. The issuer of a certificate
of deposit agrees to pay the amount deposited plus interest to
the bearer of the certificate on the date specified thereon.
Certificates of deposit purchased by the Trust may not be fully
insured by the Federal Deposit Insurance Corporation. |
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(3) Repurchase agreements, which involve purchases of debt
securities. At the time the Trust purchases securities pursuant
to a repurchase agreement, it simultaneously agrees to resell
and redeliver such securities to the seller, who also
simultaneously agrees to buy back the securities at a fixed
price and time. This assures a predetermined yield for the Trust
during its holding period, since the resale price is always
greater than the purchase price and reflects an agreed-upon
market rate. Such actions afford an opportunity for the Trust to
invest temporarily available cash. The Trust may enter into
repurchase agreements only with respect to obligations of the
U.S. Government, its agencies or instrumentalities;
certificates of deposit; or bankers acceptances in which
the Trust may invest. Repurchase agreements may be considered
loans to the seller, collateralized by the underlying
securities. The risk to the Trust is limited to the ability of
the seller to pay the agreed-upon sum on the repurchase date; in
the event of default, the repurchase agreement provides that the
Trust is entitled to sell the underlying collateral. If the
value of the collateral declines after the agreement is entered
into, and if the seller defaults under a repurchase agreement
when the value of the underlying collateral is less than the
repurchase price, the Trust could incur a loss of both principal
and interest. Highland monitors the value of the collateral at
the time the action is entered into and at all times during the
term of the repurchase agreement. Highland does so in an effort
to determine that the value of the collateral always equals or
exceeds the agreed-upon repurchase price to be paid to the
Trust. If the seller were to be subject to a federal bankruptcy
proceeding, the ability of the Trust to liquidate the collateral
could be delayed or impaired because of certain provisions of
the bankruptcy laws. |
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(4) Commercial paper, which consists of short-term
unsecured promissory notes, including variable rate master
demand notes issued by corporations to finance their current
operations. Master demand notes are direct lending arrangements
between the Trust and a corporation. There is no secondary
market for such notes. However, they are redeemable by the Trust
at any time. Highland will consider the |
B-5
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financial condition of the corporation (e.g., earning power,
cash flow and other liquidity ratios) and will continually
monitor the corporations ability to meet all of its
financial obligations, because the Trusts liquidity might
be impaired if the corporation were unable to pay principal and
interest on demand. Investments in commercial paper will be
limited to commercial paper rated in the highest categories by a
major rating agency and which mature within one year of the date
of purchase or carry a variable or floating rate of interest. |
Equity Securities
The Trust may invest in equity securities including preferred
stocks, convertible securities, warrants and depository receipts.
Preferred Stock. Preferred stock has a preference
over common stock in liquidation (and generally dividends as
well) but is subordinated to the liabilities of the issuer in
all respects. As a general rule, the market value of preferred
stock with a fixed dividend rate and no conversion element
varies inversely with interest rates and perceived credit risk,
while the market price of convertible preferred stock generally
also reflects some element of conversion value. Because
preferred stock is junior to debt securities and other
obligations of the issuer, deterioration in the credit quality
of the issuer will cause greater changes in the value of a
preferred stock than in a more senior debt security with similar
stated yield characteristics. Unlike interest payments on debt
securities, preferred stock dividends are payable only if
declared by the issuers board of directors. Preferred
stock also may be subject to optional or mandatory redemption
provisions.
Convertible Securities. A convertible security is
a bond, debenture, note, preferred stock or other security that
may be converted into or exchanged for a prescribed amount of
common stock or other equity security of the same or a different
issuer within a particular period of time at a specified price
or formula. A convertible security entitles the holder to
receive interest paid or accrued on debt or the dividend paid on
preferred stock until the convertible security matures or is
redeemed, converted or exchanged. Before conversion, convertible
securities have characteristics similar to nonconvertible income
securities in that they ordinarily provide a stable stream of
income with generally higher yields than those of common stocks
of the same or similar issuers, but lower yields than comparable
nonconvertible securities. The value of a convertible security
is influenced by changes in interest rates, with investment
value declining as interest rates increase and increasing as
interest rates decline. The credit standing of the issuer and
other factors also may have an effect on the convertible
securitys investment value. Convertible securities rank
senior to common stock in a corporations capital structure
but are usually subordinated to comparable nonconvertible
securities. Convertible securities may be subject to redemption
at the option of the issuer at a price established in the
convertible securitys governing instrument.
Warrants. Warrants, which are privileges issued by
corporations enabling the owners to subscribe to and purchase a
specified number of shares of the corporation at a specified
price during a specified period of time. Subscription rights
normally have a short life span to expiration. The purchase of
warrants involves the risk that the Trust could lose the
purchase value of a right or warrant if the right to subscribe
to additional shares is not exercised prior to the
warrants expiration. Also, the purchase of warrants
involves the risk that the effective price paid for the warrant
added to the subscription price of the related security may
exceed the value of the subscribed securitys market price
such as when there is no movement in the level of the underlying
security.
Depository Receipts. The Trust may invest in both
sponsored and unsponsored American Depository Receipts
(ADRs), European Depository Receipts
(EDRs), Global Depository Receipts
(GDRs) and other similar global instruments. ADRs
typically are issued by an American bank or trust company and
evidence ownership of underlying securities issued by a
non-U.S. corporation.
EDRs, which are sometimes referred to as Continental Depository
Receipts, are receipts issued in Europe, typically by
non-U.S. banks and
trust companies, that evidence ownership of either
non-U.S. or
U.S. underlying securities. GDRs are depository receipts
structured like global debt issues to facilitate trading on an
international basis. Unsponsored ADR, EDR and GDR programs are
organized independently and without the cooperation of the
issuer of the underlying securities. As a result, available
information concerning the issuer may not be as current as
B-6
for sponsored ADRs, EDRs and GDRs, and the prices of unsponsored
ADRs, EDRs and GDRs may be more volatile than if such
instruments were sponsored by the issuer. Investments in ADRs,
EDRs and GDRs may present additional investment considerations
of
non-U.S. securities.
Variable and Floating Rate Instruments
The Trust may purchase rated and unrated variable and floating
rate instruments. These instruments may include variable amount
master demand notes that permit the indebtedness thereunder to
vary in addition to providing for periodic adjustments in the
interest rate. The Trust may invest in leveraged inverse
floating rate debt instruments (Inverse Floaters).
The interest rate of an Inverse Floater resets in the opposite
direction from the market rate of interest to which it is
indexed. An Inverse Floater may be considered to be leveraged to
the extent that its interest rate varies by a magnitude that
exceeds the magnitude of the change in the index rate of
interest. The higher degree of leverage inherent in Inverse
Floaters is associated with greater volatility in their market
values. Issuers of unrated variable and floating rate
instruments must satisfy the same criteria as set forth above
for the Trust. The absence of an active secondary market with
respect to particular variable and floating rate instruments,
however, could make it difficult for the Trust to dispose of a
variable or floating rate instrument if the issuer defaulted on
its payment obligation or during periods when the Trust is not
entitled to exercise its demand rights.
With respect to purchasable variable and floating rate
instruments, Highland will consider the earning power, cash
flows and liquidity ratios of the issuers and guarantors of such
instruments and, if the instruments are subject to a demand
feature, will monitor their financial status to meet payment on
demand. Such instruments may include variable amount master
demand notes that permit the indebtedness thereunder to vary in
addition to providing for periodic adjustments in the interest
rate. The absence of an active secondary market with respect to
particular variable and floating rate instruments could make it
difficult for the Trust to dispose of a variable or floating
rate note if the issuer defaulted on its payment obligation or
during periods that the Trust is not entitled to exercise its
demand rights, and the Trust could, for these or other reasons,
suffer a loss, with respect to such instruments. In determining
average-weighted portfolio maturity, an instrument will be
deemed to have a maturity equal to either the period remaining
until the next interest rate adjustment or the time the Trust
involved can recover payment of principal as specified in the
instrument, depending on the type of instrument involved.
Derivative Transactions and Risk Management
Consistent with its investment objectives and policies set forth
in the prospectus and in addition to its option strategy, the
Trust may also enter into certain risk management transactions.
In particular, the Trust may purchase and sell futures
contracts, exchange listed and
over-the-counter put
and call options on securities, equity and other indices and
futures contracts, forward foreign currency contracts, and may
enter into various interest rate transactions. Derivative
Transactions may be used to attempt to protect against possible
changes in the market value of the Trusts portfolio
resulting from fluctuations in the securities markets and
changes in interest rates, to protect the Trusts
unrealized gains in the value of its portfolio securities, to
facilitate the sale of such securities for investment purposes
and to establish a position in the securities markets as a
temporary substitute for purchasing particular securities. Any
or all of these Derivative Transactions may be used at any time.
There is no particular strategy that requires use of one
technique rather than another. Use of any Derivative Transaction
is a function of market conditions. The ability of the Trust to
manage them successfully will depend on Highlands ability
to predict pertinent market movements as well as sufficient
correlation among the instruments, which cannot be assured. The
Derivative Transactions that the Trust may use are described
below. Although the Trust recognizes it is not likely that it
will use certain of these strategies in light of its investment
policies, it nevertheless describes them here because the Trust
may seek to use these strategies in certain circumstances.
Futures Contracts and Options on Futures Contracts.
In connection with its Derivative Transactions and other
risk management strategies, the Trust may also enter into
contracts for the purchase or sale for future delivery
(futures contracts) of securities, aggregates of
securities or indices or prices thereof, other
B-7
financial indices and U.S. government debt securities or
options on the above. The Trust will engage in such transactions
only for bona fide risk management and other portfolio
management purposes.
Forward Foreign Currency Contracts. The Trust may
enter into forward currency contracts to purchase or sell
foreign currencies for a fixed amount of U.S. dollars or
another foreign currency. A forward currency contract involves
an obligation to purchase or sell a specific currency at a
future date, which may be any fixed number of days from the date
of the forward currency contract agreed upon by the parties, at
a price set at the time the forward currency contract is entered
into. Forward currency contracts are traded directly between
currency traders (usually large commercial banks) and their
customers.
The Trust may engage in various forward currency contract
strategies:
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The Trust may purchase a forward currency contract to lock in
the U.S. dollar price of a security denominated in a
foreign currency that the Trust intends to acquire. The Trust
may sell a forward currency contract to lock in the
U.S. dollar equivalent of the proceeds from the anticipated
sale of a security or a dividend or interest payment denominated
in a foreign currency. |
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The Trust may also use forward currency contracts to shift the
Trusts exposure to foreign currency exchange rate changes
from one currency to another. For example, if the Trust owns
securities denominated in a foreign currency and Highland
believes that currency will decline relative to another
currency, the Trust might enter into a forward currency contract
to sell the appropriate amount of the first foreign currency
with payment to be made in the second currency. |
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The Trust may also purchase forward currency contracts to
enhance income when Highland anticipates that the foreign
currency will appreciate in value but securities denominated in
that currency do not present attractive investment opportunities. |
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The Trust may also use forward currency contracts to offset
against a decline in the value of existing investments
denominated in a foreign currency. Such a transaction would tend
to offset both positive and negative currency fluctuations, but
would not offset changes in security values caused by other
factors. |
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The Trust could also enter into a forward currency contract to
sell another currency expected to perform similarly to the
currency in which the Trusts existing investments are
denominated. This type of transaction could offer advantages in
terms of cost, yield or efficiency, but may not offset currency
exposure as effectively as a simple forward currency transaction
to sell U.S. dollars. This type of transaction may result
in losses if the currency sold does not perform similarly to the
currency in which the Trusts existing investments are
denominated. |
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The Trust may also use forward currency contracts in one
currency or a basket of currencies to attempt to offset against
fluctuations in the value of securities denominated in a
different currency if Highland anticipates that there will be a
correlation between the two currencies. |
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The cost to the Trust of engaging in forward currency contracts
varies with factors such as the currency involved, the length of
the contract period and the market conditions then prevailing.
Because forward currency contracts are usually entered into on a
principal basis, no fees or commissions are involved. |
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When the Trust enters into a forward currency contract, it
relies on the counterparty to make or take delivery of the
underlying currency at the maturity of the contract. Failure by
the counterparty to do so would result in the loss of some or
all of any expected benefit of the transaction. Secondary
markets generally do not exist for forward currency contracts,
with the result that closing transactions generally can be made
for forward currency contracts only by negotiating directly with
the counterparty. Thus, there can be no assurance that the Trust
will in fact be able to close out a forward currency contract at
a favorable price prior to maturity. In addition, in the event
of insolvency of the counterparty, the Trust might be unable to
close out a forward currency contract. In either event, the
Trust would continue to be subject to market risk with respect
to the position, and would continue to be required to maintain a
position in securities denominated in the foreign currency or to
maintain |
B-8
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cash or liquid assets in a segregated account. The precise
matching of forward currency contract amounts and the value of
the securities involved generally will not be possible because
the value of such securities, measured in the foreign currency,
will change after the forward currency contract has been
established. Thus, the Trust might need to purchase or sell
foreign currencies in the spot (cash) market to the extent
such foreign currencies are not covered by forward currency
contracts. The projection of short-term currency market
movements is extremely difficult, and the successful execution
of a short-term strategy is highly uncertain. |
Calls on Securities, Indices and Futures Contracts.
In addition to its option strategy, in order to enhance
income or reduce fluctuations on net asset value, the Trust may
sell or purchase call options (calls) on securities
and indices based upon the prices of futures contracts and debt
or equity securities that are traded on U.S. and
non-U.S. securities
exchanges and in the
over-the-counter
markets. A call option gives the purchaser of the option the
right to buy, and obligates the seller to sell, the underlying
security, futures contract or index at the exercise price at any
time or at a specified time during the option period. All such
calls sold by the Trust must be covered as long as
the call is outstanding (i.e., the Trust must own the instrument
subject to the call or other securities or assets acceptable for
applicable segregation and coverage requirements). A call sold
by the Trust exposes the Trust during the term of the option to
possible loss of opportunity to realize appreciation in the
market price of the underlying security, index or futures
contract and may require the Trust to hold an instrument which
it might otherwise have sold. The purchase of a call gives the
Trust the right to buy a security, futures contract or index at
a fixed price. Calls on futures on securities must also be
covered by assets or instruments acceptable under applicable
segregation and coverage requirements.
Puts on Securities, Indices and Futures Contracts.
In addition to its option strategy, the Trust may
purchase put options (puts) that relate to
securities (whether or not it holds such securities in its
portfolio), indices or futures contracts. For the same purposes,
the Trust may also sell puts on securities, indices or futures
contracts on such securities if the Trusts contingent
obligations on such puts are secured by segregated assets
consisting of cash or liquid debt securities having a value not
less than the exercise price. In selling puts, there is a risk
that the Trust may be required to buy the underlying security at
a price higher than the current market price.
Interest Rate Transactions. Among the Derivative
Transactions in which the Trust may enter into are interest rate
swaps and the purchase or sale of interest rate caps and floors.
The Trust expects to enter into these transactions primarily to
preserve a return or spread on a particular investment or
portion of its portfolio as a duration management technique or
to protect against any increase in the price of securities the
Trust anticipates purchasing at a later date. The Trust intends
to use these transactions for risk management purposes and not
as a speculative investment. The Trust will not sell interest
rate caps or floors that it does not own. Interest rate swaps
involve the exchange by the Trust with another party of their
respective commitments to pay or receive interest, e.g., an
exchange of floating rate payments for fixed rate payments with
respect to a notional amount of principal. The purchase of an
interest rate cap entitles the purchaser, to the extent that a
specified index exceeds a predetermined interest rate, to
receive payments of interest on a notional principal amount from
the party selling such interest rate cap. The purchase of an
interest rate floor entitles the purchaser, to the extent that a
specified index falls below a predetermined interest rate, to
receive payments of interest on a notional principal amount from
the party selling such interest rate floor.
The Trust may enter into interest rate swaps, caps and floors on
either an asset based or liability-based basis, depending on
whether it is offsetting volatility with respect to its assets
or liabilities, and will usually enter into interest rate swaps
on a net basis, i.e., the two payment streams are netted out,
with the Trust receiving or paying, as the case may be, only the
net amount of the two payments on the payment dates. Inasmuch as
these Derivative Transactions are incurred into for good faith
risk management purposes. Highland and the Trust believe such
obligations do not constitute senior securities, and,
accordingly will not treat them as being subject to its
borrowing restrictions. The Trust will accrue the net amount of
the excess, if any, of the Trusts obligations over its
entitlements with respect to each interest rate swap on a daily
basis and will designate on its books and records with a
custodian an amount of cash or liquid high grade securities
having an aggregate net asset value at all times at least equal
to the accrued excess. The Trust will not enter into any
interest rate swap, cap or floor transaction unless the
unsecured senior debt or the claims paying
B-9
ability of the other party thereto is rated in the highest
rating category of at least one nationally recognized
statistical rating organization at the time of entering into
such transaction. If there is a default by the other party to
such a transaction, the Trust will have contractual remedies
pursuant to the agreements related to the transaction. The swap
market has grown substantially in recent years with a large
number of banks and investment banking firms acting both as
principals and as agents utilizing standardized swap
documentation. Caps and floors are more recent innovations for
which standardized documentation has not yet been developed and,
accordingly, they are less liquid than swaps.
Credit Derivatives. The Trust may engage in credit
derivative transactions. There are two broad categories of
credit derivatives: default price risk derivatives and market
spread derivatives. Default price risk derivatives are linked to
the price of reference securities or loans after a default by
the issuer or borrower, respectively. Market spread derivatives
are based on the risk that changes in market factors, such as
credit spreads, can cause a decline in the value of a security,
loan or index.
There are three basic transactional forms for credit
derivatives: swaps, options and structured instruments. The use
of credit derivatives is a highly specialized activity which
involves strategies and risks different from those associated
with ordinary portfolio security transactions. If Highland is
incorrect in its forecasts of default risks, market spreads or
other applicable factors, the investment performance of the
Trust would diminish compared with what it would have been if
these techniques were not used. Moreover, even if Highland is
correct in its forecasts, there is a risk that a credit
derivative position may correlate imperfectly with the price of
the asset or liability being purchased. There is no limit on the
amount of credit derivative transactions that may be entered
into by the Trust. The Trusts risk of loss in a credit
derivative transaction varies with the form of the transaction.
For example, if the Trust purchases a default option on a
security, and if no default occurs with respect to the security,
the Trusts loss is limited to the premium it paid for the
default option. In contrast, if there is a default by the
grantor of a default option, the Trusts loss will include
both the premium that it paid for the option and the decline in
value of the underlying security that the default option
protects.
Below under General Characteristics of Risks of Derivative
Transactions is further information about the
characteristics, risks and possible benefits of Derivative
Transactions and the Trusts other policies and limitations
(which are not fundamental policies) relating to investment in
futures contracts and options. The principal risks relating to
the use of futures contracts and other Derivative Transactions
are: (i) less than perfect correlation between the prices
of the instrument and the market value of the securities in the
Trusts portfolio; (ii) possible lack of a liquid
secondary market for closing out a position in such instruments;
(iii) losses resulting from interest rate or other market
movements not anticipated by Highland; and (iv) the
obligation to meet additional variation margin or other payment
requirements, all of which could result in the Trust being in a
worse position than if such techniques had not been used.
Certain provisions of the Code may restrict or affect the
ability of the Trust to engage in Derivative Transactions. See
Tax Matters.
General Characteristics and Risks of Derivative
Transactions
In order to manage the risk of its securities portfolio, or to
enhance income or gain as described in the prospectus, the Trust
will engage in Derivative Transactions. The Trust will engage in
such activities in the Investment Advisers discretion, and
may not necessarily be engaging in such activities when
movements in interest rates that could affect the value of the
assets of the Trust occur. The Trusts ability to pursue
certain of these strategies may be limited by applicable
regulations of the CFTC. Certain Derivative Transactions may
give rise to taxable income.
Put and Call Options on Securities and Indices
The Trust may purchase and sell put and call options on
securities and indices. A put option gives the purchaser of the
option the right to sell and the writer the obligation to buy
the underlying security at the exercise price during the option
period. The Trust may also purchase and sell options on
securities indices (index options). Index options
are similar to options on securities except that, rather than
taking or making
B-10
delivery of securities underlying the option at a specified
price upon exercise, an index option gives the holder the right
to receive cash upon exercise of the option if the level of the
securities index upon which the option is based is greater, in
the case of a call, or less, in the case of a put, than the
exercise price of the option. The purchase of a put option on a
security could protect the Trusts holdings in a security
or a number of securities against a substantial decline in the
market value. A call option gives the purchaser of the option
the right to buy and the seller the obligation to sell the
underlying security or index at the exercise price during the
option period or for a specified period prior to a fixed date.
The purchase of a call option on a security could protect the
Trust against an increase in the price of a security that it
intended to purchase in the future. In the case of either put or
call options that it has purchased, if the option expires
without being sold or exercised, the Trust will experience a
loss in the amount of the option premium plus any related
commissions. When the Trust sells put and call options, it
receives a premium as the seller of the option. The premium that
the Trust receives for selling the option will serve as a
partial offset, in the amount of the option premium, against
changes in the value of the securities in its portfolio. During
the term of the option, however, a covered call seller has, in
return for the premium on the option, given up the opportunity
for capital appreciation above the exercise price of the option
if the value of the underlying security increases, but has
retained the risk of loss should the price of the underlying
security decline. Conversely, a secured put seller retains the
risk of loss should the market value of the underlying security
decline below the exercise price of the option, less the premium
received on the sale of the option. The Trust is authorized to
purchase and sell exchange listed options and
over-the-counter
options (OTC Options) which are privately negotiated
with the counterparty. Listed options are issued by the Options
Clearing Corporation (OCC) which guarantees the
performance of the obligations of the parties to such options.
The Trusts ability to close out its position as a
purchaser or seller of an exchange listed put or call option is
dependent upon the existence of a liquid secondary market on
option exchanges. Among the possible reasons for the absence of
a liquid secondary market on an exchange are:
(i) insufficient trading interest in certain options;
(ii) restrictions on transactions imposed by an exchange;
(iii) trading halts, suspensions or other restrictions
imposed with respect to particular classes or series of options
or underlying securities; (iv) interruption of the normal
operations on an exchange; (v) inadequacy of the facilities
of an exchange or OCC to handle current trading volume; or
(vi) a decision by one or more exchanges to discontinue the
trading of options (or a particular class or series of options),
in which event the secondary market on that exchange (or in that
class or series of options) would cease to exist, although
outstanding options on that exchange that had been listed by the
OCC as a result of trades on that exchange would generally
continue to be exercisable in accordance with their terms. OTC
Options are purchased from or sold to dealers, financial
institutions or other counterparties which have entered into
direct agreements with the Trust. With OTC Options, such
variables as expiration date, exercise price and premium will be
agreed upon between the Trust and the counterparty, without the
intermediation of a third party such as the OCC. If the
counterparty fails to make or take delivery of the securities
underlying an option it has written, or otherwise settle the
transaction in accordance with the terms of that option as
written, the Trust would lose the premium paid for the option as
well as any anticipated benefit of the transaction.
The hours of trading for options on securities may not conform
to the hours during which the underlying securities are traded.
To the extent that the option markets close before the markets
for the underlying securities, significant price movements can
take place in the underlying markets that cannot be reflected in
the option markets.
Futures Contracts and Related Options
Characteristics. The Trust may sell financial
futures contracts or purchase put and call options on such
futures as an offset against anticipated market movements. The
sale of a futures contract creates an obligation by the Trust,
as seller, to deliver the specific type of financial instrument
called for in the contract at a specified future time for a
specified price. Options on futures contracts are similar to
options on securities except that an option on a futures
contract gives the purchaser the right in return for the premium
paid to assume a position in a futures contract (a long position
if the option is a call and a short position if the option is a
put).
B-11
Margin Requirements. At the time a futures
contract is purchased or sold, the Trust must allocate cash or
securities as a deposit payment (initial margin). It
is expected that the initial margin that the Trust will pay may
range from approximately 1% to approximately 5% of the value of
the securities or commodities underlying the contract. In
certain circumstances, however, such as periods of high
volatility, the Trust may be required by an exchange to increase
the level of its initial margin payment. Additionally, initial
margin requirements may be increased generally in the future by
regulatory action. An outstanding futures contract is valued
daily and the payment in case of variation margin
may be required, a process known as marking to the
market. Transactions in listed options and futures are
usually settled by entering into an offsetting transaction, and
are subject to the risk that the position may not be able to be
closed if no offsetting transaction can be arranged.
Limitations on Use of Futures and Options on Futures.
The Trusts use of futures and options on futures
will in all cases be consistent with applicable regulatory
requirements and in particular the rules and regulations of the
CFTC. The Trust currently may enter into such transactions
without limit for bona fide strategic purposes, including risk
management and duration management and other portfolio
strategies. The Trust may also engage in transactions in futures
contracts or related options for non-strategic purposes to
enhance income or gain provided that the Trust will not enter
into a futures contract or related option (except for closing
transactions) for purposes other than bona fide strategic
purposes, or risk management including duration management if,
immediately thereafter, the sum of the amount of its initial
deposits and premiums on open contracts and options would exceed
5% of the Trusts liquidation value, i.e., net assets
(taken at current value); provided, however, that in the case of
an option that is
in-the-money at the
time of the purchase, the
in-the-money amount may
be excluded in calculating the 5% limitation. The above policies
are non-fundamental and may be changed by the Trusts board
of trustees at any time. Also, when required, an account of cash
equivalents designated on the books and records will be
maintained and marked to market on a daily basis in an amount
equal to the market value of the contract.
Segregation and Cover Requirements. Futures
contracts, interest rate swaps, caps, floors and collars, short
sales, reverse repurchase agreements and dollar rolls, and
listed or OTC options on securities, indices and futures
contracts sold by the Trust are generally subject to earmarking
and coverage requirements of either the CFTC or the SEC, with
the result that, if the Trust does not hold the security or
futures contract underlying the instrument, the Trust will be
required to designate on its books and records an ongoing basis,
cash, U.S. government securities, or other liquid high
grade debt obligations in an amount at least equal to the
Trusts obligations with respect to such instruments.
Such Amounts Fluctuate as the Obligations Increase or
Decrease. The earmarking requirement can result in the
Trust maintaining securities positions it would otherwise
liquidate, segregating assets at a time when it might be
disadvantageous to do so or otherwise restrict portfolio
management.
Derivative Transactions Present Certain Risks.
With respect to Derivative Transactions and risk
management, the variable degree of correlation between price
movements of strategic instruments and price movements in the
position being offset create the possibility that losses using
the strategy may be greater than gains in the value of the
Trusts position. The same is true for such instruments
entered into for income or gain. In addition, certain
instruments and markets may not be liquid in all circumstances.
As a result, in volatile markets, the Trust may not be able to
close out a transaction without incurring losses substantially
greater than the initial deposit. Although the contemplated use
of these instruments predominantly for Derivative Transactions
should tend to minimize the risk of loss due to a decline in the
value of the position, at the same time they tend to limit any
potential gain which might result from an increase in the value
of such position. The ability of the Trust to successfully
utilize Derivative Transactions will depend on the Investment
Advisers and the sub-advisers ability to predict
pertinent market movements and sufficient correlations, which
cannot be assured. Finally, the daily deposit requirements in
futures contracts that the Trust has sold create an on going
greater potential financial risk than do options transactions,
where the exposure is limited to the cost of the initial
premium. Losses due to the use of Derivative Transactions will
reduce net asset value.
Regulatory Considerations. The Trust has claimed
an exclusion from the term commodity pool operator
under the Commodity Exchange Act and, therefore, is not subject
to registration or regulation as a commodity pool operator under
the Commodity Exchange Act.
B-12
OTHER INVESTMENT POLICIES AND TECHNIQUES
Restricted and Illiquid Securities
Certain of the Trusts investments may be illiquid.
Illiquid securities are subject to legal or contractual
restrictions on disposition or lack an established secondary
trading market. The sale of restricted and illiquid securities
often requires more time and results in higher brokerage charges
or dealer discounts and other selling expenses than does the
sale of securities eligible for trading on national securities
exchanges or in the
over-the-counter
markets. Restricted securities may sell at a price lower than
similar securities that are not subject to restrictions on
resale.
When-Issued and Forward Commitment Securities
The Trust may purchase securities on a when-issued
basis and may purchase or sell securities on a forward
commitment basis in order to acquire the security or to
offset against anticipated changes in interest rates and prices.
When such transactions are negotiated, the price, which is
generally expressed in yield terms, is fixed at the time the
commitment is made, but delivery and payment for the securities
take place at a later date. When-issued securities and forward
commitments may be sold prior to the settlement date, but the
Trust will enter into when-issued and forward commitments only
with the intention of actually receiving or delivering the
securities, as the case may be. If the Trust disposes of the
right to acquire a when-issued security prior to its acquisition
or disposes of its right to deliver or receive against a forward
commitment, it might incur a gain or loss. At the time the Trust
enters into a transaction on a when-issued or forward commitment
basis, it will designate on its books and records cash or liquid
debt securities equal to at least the value of the when-issued
or forward commitment securities. The value of these assets will
be monitored daily to ensure that their marked to market value
will at all times equal or exceed the corresponding obligations
of the Trust. There is always a risk that the securities may not
be delivered and that the Trust may incur a loss. Settlements in
the ordinary course, which may take substantially more than five
business days, are not treated by the Trust as when-issued or
forward commitment transactions and accordingly are not subject
to the foregoing restrictions.
Pay-in-kind Bonds
The Trust may invest in
Pay-in-kind, or
PIK bonds. PIK bonds are bonds which pay interest
through the issuance of additional debt or equity securities.
Similar to zero coupon obligations, PIK bonds also carry
additional risk as holders of these types of securities realize
no cash until the cash payment date unless a portion of such
securities is sold and, if the issuer defaults, the Trust may
obtain no return at all on its investment. The market price of
PIK bonds is affected by interest rate changes to a greater
extent, and therefore tends to be more volatile, than that of
securities which pay interest in cash. Additionally, current
federal tax law requires the holder of certain PIK bonds to
accrue income with respect to these securities prior to the
receipt of cash payments. To maintain its qualification as a
regulated investment company and avoid liability for federal
income and excise taxes, the Trust may be required to distribute
income accrued with respect to these securities and may have to
dispose of portfolio securities under disadvantageous
circumstances in order to generate cash to satisfy these
distribution requirements.
Brady Bonds
The Trusts emerging market debt securities may include
emerging market governmental debt obligations commonly referred
to as Brady Bonds. Brady Bonds are debt securities, generally
denominated in U.S. dollars, issued under the framework of
the Brady Plan, an initiative announced by U.S. Treasury
Secretary Nicholas F. Brady in 1989 as a mechanism for debtor
nations (primarily emerging market countries) to restructure
their outstanding external indebtedness (generally, commercial
bank debt). Brady Bonds are created through the exchange of
existing commercial bank loans to foreign entities for new
obligations in connection with debt restructuring. A significant
amount of the Brady Bonds that the Trust may purchase have no or
limited collateralization, and the Trust will be relying for
payment of interest and (except in the case of principal
collateralized Brady Bonds) principal primarily on the
willingness and ability of the foreign government to
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make payment in accordance with the terms of the Brady Bonds. A
substantial portion of the Brady Bonds and other sovereign debt
securities in which the Trust may invest are likely to be
acquired at a discount.
Mezzanine Investments
The Trust may invest in certain high yield securities known as
mezzanine investments, which are subordinated debt securities
which are generally issued in private placements in connection
with an equity security (e.g., with attached warrants). Such
mezzanine investments may be issued with or without registration
rights. Similar to other high yield securities, maturities of
mezzanine investments are typically seven to ten years, but the
expected average life is significantly shorter at three to five
years. Mezzanine investments are usually unsecured and
subordinate to other obligations of the issuer.
Loan Participations and Assignments
The Trust may invest in fixed and floating rate loans
(Loans) arranged through private negotiations
between a corporation or foreign government and one or more
financial institutions (Lenders). The Trusts
investments in Loans are expected in most instances to be in the
form of participations in Loans (Participations) and
assignments of all or a portion of Loans
(Assignments) from third parties. Participations
typically will result in the Trust having a contractual
relationship only with the Lender not the borrower. The Trust
will have the right to receive payments of principal, interest
and any fees to which it is entitled only from the Lender
selling the Participation and the Trust and only upon receipt by
the Lender of the payments by the borrower. In connection with
purchasing Participations, the Trust generally has no direct
right to enforce compliance by the borrower with the terms of
the loan agreement relating to the Loan, nor any rights of
set-off against the borrower, and the Trust may not directly
benefit from any collateral supporting the Loan in which is has
purchased the Participation. As a result the Trust will assume
the credit risk of both the borrower and the Lender that is
selling the Participation. In the event of the insolvency of the
Lender selling a Participation, the Trust may be treated as a
general creditor of the Lender and may not benefit from any
set-off between the Lender and the borrower. The Trust will
acquire Participations only if the Lender interpositioned
between the Trust and the borrower is determined by Highland to
be creditworthy. When the Trust purchases Assignments from
Lenders, the Trust will acquire direct rights against the
borrower on the Loan. However, since Assignments are arranged
through private negotiations between potential assignees and
assignors, the rights and obligations acquired by the Trust as
the purchaser of an Assignment may differ from, and be more
limited than, those held by the assigning Lender.
The Trust may have difficulty disposing of Assignments and
Participations. Because there is no liquid market for such
securities, the Trust anticipates that such securities could be
sold only to a limited number of institutional investors. The
lack of a liquid secondary market will have an adverse impact on
the value of such securities and on the Trusts ability to
dispose of particular Assignments or Participations when
necessary to meet the Trusts liquidity needs or in
response to a specific economic event, such as a deterioration
in the creditworthiness of the borrower. The lack of a liquid
secondary market for Assignments and Participations also may
make it more difficult for the Trust to assign a value to those
securities for purposes of valuing the Trusts portfolio
and calculating its net asset value.
Structured Investments
The Trust may invest a portion of its assets in interests in
entities organized and operated solely for the purpose of
restructuring the investment characteristics of securities. This
type of restructuring involves the deposit with or purchase by
an entity, such as a corporation or a trust, of specified
instruments and the issuance by that entity of one or more
classes of securities (Structured Investments)
backed by, or representing interests in the underlying
instruments. The cash flow on the underlying instruments may be
apportioned among the newly issued Structured Investments to
create securities with different investment characteristics such
as varying maturities, payment priorities and interest rate
provisions, and the extent of the payments made with respect to
Structured Investments is dependent on the extent of the cash
flow on the underlying instruments. Because Structured
Investments of the type in which the Trust anticipates it will
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invest typically involve no credit enhancement, their credit
risk generally will be equivalent to that of the underlying
instruments.
The Trust is permitted to invest in a class of Structured
Investments that is either subordinated or not subordinated to
the right of payment of another class. Subordinated Structured
Investments typically have higher yields and present greater
risks than unsubordinated Structured Investments.
Certain issuers of Structured Investments may be deemed to be
investment companies as defined in the Investment
Company Act. As a result, the Trusts investment in these
Structured Investments may be limited by the restrictions
contained in the Investment Company Act. Structured Investments
are typically sold in private placement transaction, and there
currently is no active trading market for Structured Investments.
Project Loans
The Trust may invest in project loans, which are fixed income
securities of issuers whose revenues are primarily derived from
mortgage loans to multi-family, nursing home and other real
estate development projects. The principal payments on these
mortgage loans will be insured by agencies and authorities of
the U.S. Government.
Zero Coupons and Deferred Payment Obligations
The Trust may invest in zero-coupon bonds, which are normally
issued at a significant discount from face value and do not
provide for periodic interest payments. Zero-coupon bonds may
experience greater volatility in market value than similar
maturity debt obligations which provide for regular interest
payments. Additionally, current federal tax law requires the
holder of certain zero-coupon bonds to accrue income with
respect to these securities prior to the receipt of cash
payments. To maintain its qualification as a regulated
investment company and to potentially avoid liability for
federal income and excise taxes, the Trust may be required to
distribute income accrued with respect to these securities and
may have to dispose of Trust securities under disadvantageous
circumstances in order to generate cash to satisfy these
distribution requirements.
The Trust may invest in Deferred Payment Securities. Deferred
Payment Securities are securities that remain Zero-Coupon
Securities until a predetermined date, at which time the stated
coupon rate becomes effective and interest becomes payable at
regular intervals. Deferred Payment Securities are subject to
greater fluctuations in value and may have lesser liquidity in
the event of adverse market conditions than comparably rated
securities paying cash interest at regular interest payment
periods.
B-15
MANAGEMENT OF THE TRUST
Trustees
The board of trustees provides broad oversight over the
operations and affairs of the Trust and protects the interests
of shareholders. The board of trustees has overall
responsibility to manage and control the business affairs of the
Trust, including the complete and exclusive authority to
establish policies regarding the management, conduct and
operation of the Trusts business. The names and ages of
the trustees and officers of the Trust, the year each was first
elected or appointed to office, their principal business
occupations during the last five years, the number of funds
overseen by each trustee and other directorships or trusteeships
they hold are shown below. The business address of the Trust,
Highland and their board members and officers is Two Galleria
Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240,
unless otherwise specified below.
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Number of |
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Principal |
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Portfolios in |
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Term of Office and |
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Occupation(s) |
|
Highland Fund |
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|
Position |
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Length of Time |
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During Past |
|
Complex Overseen |
|
Other Directorships/ |
Name and Age |
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with Trust |
|
Served(1) |
|
Five Years |
|
by Trustee(2) |
|
Trusteeships Held |
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INDEPENDENT TRUSTEES |
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Bryan A. Ward
(Age 51)
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Trustee |
|
3 years and Trustee since May 19, 2006 |
|
Senior Manager, Accenture, LLP since January 2002; Special
Projects Advisor, Accenture, LLP with focus on the oil and gas
industry, September 1998 to December 2001. |
|
11 |
|
None |
Scott Kavanaugh
(Age 45)
|
|
Trustee |
|
3 years and Trustee since May 19, 2006 |
|
Private Investor; Executive at Provident Funding Mortgage
Corporation, February 2003 to July 2003; Executive Vice
President, Director and Treasurer, Commercial Capital Bank,
January 2000 to February 2003; Managing Principal and Chief
Operating Officer, Financial Institutional Partners Mortgage
Company and the Managing Principal and President of Financial
Institutional Partners, LLC, (an investment banking firm), April
1998 to February 2003. |
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11 |
|
None |
B-16
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Number of |
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Principal |
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Portfolios in |
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Term of Office and |
|
Occupation(s) |
|
Highland Fund |
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|
Position |
|
Length of Time |
|
During Past |
|
Complex Overseen |
|
Other Directorships/ |
Name and Age |
|
with Trust |
|
Served(1) |
|
Five Years |
|
by Trustee(2) |
|
Trusteeships Held |
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|
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|
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|
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James F. Leary
(Age 76)
|
|
Trustee |
|
3 years and Trustee since May 19, 2006 |
|
Managing Director, Benefit Capital Southwest, Inc., (a financial
consulting firm) since January 1999. |
|
11 |
|
Board Member of Capstone Series Fund, Inc. (3 portfolios);
Pacesetter/MVHC Inc. (small business investment company);
Director of Homeowners of America Insurance Co., Irving, Texas |
Timothy Hui
(Age 58)
|
|
Trustee |
|
3 years and Trustee since May 19, 2006 |
|
Assistant Provost for Graduate Education since July 2004;
Assistant Provost for Educational Resources, July 2001 to
June 2004, Philadelphia Biblical University. |
|
11 |
|
None |
INTERESTED TRUSTEE(3) |
R. Joseph Dougherty
(Age 35)
|
|
Trustee and Senior Vice President |
|
3 years and Trustee since March 10, 2006 |
|
Senior Portfolio Manager of the Investment Adviser since 2000. |
|
11 |
|
None |
OFFICERS(4) |
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Principal |
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|
Term of Office and |
|
Occupation(s) |
|
|
|
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|
|
Position |
|
Length of Time |
|
During Past |
|
|
|
|
Name and Age |
|
with Trust |
|
Served |
|
Five Years |
|
|
|
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|
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|
|
|
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James D. Dondero
(Age 43)
|
|
Chief Executive Officer and President |
|
Indefinite Term and Officer since May 19, 2006 |
|
President and Director of Strand Advisors, Inc., the General
Partner of the Investment Adviser. |
|
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|
|
Mark Okada
(Age 44)
|
|
Executive Vice President |
|
Indefinite Term and Officer since May 19, 2006 |
|
Officer of Strand Advisors, Inc., the General Partner of the
Investment Adviser; Chief Investment Officer of the Investment
Adviser. |
|
|
|
|
R. Joseph Dougherty
(Age 36)
|
|
Senior Vice President |
|
Indefinite Term and Officer since May 19, 2006 |
|
Senior Portfolio Manager of the Investment Adviser since 2000. |
|
|
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|
B-17
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Principal |
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|
Term of Office and |
|
Occupation(s) |
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|
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|
Position |
|
Length of Time |
|
During Past |
|
|
|
|
Name and Age |
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with Trust |
|
Served |
|
Five Years |
|
|
|
|
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|
|
|
|
|
|
|
|
|
|
M. Jason Blackburn
(Age 30)
|
|
Chief Financial Officer (Principal Accounting Officer),
Treasurer and Secretary |
|
Indefinite Term and Officer since May 19, 2006 |
|
Assistant Controller of the Investment Adviser since November
2001; Accountant, KPMG LLP, September 1999 to October 2001. |
|
|
|
|
Michael S. Minces
(Age 31)
|
|
Chief Compliance Officer |
|
Indefinite Term and Officer since May 19, 2006 |
|
Chief Compliance Officer of the Investment Adviser since August
2004; Associate, Akin Gump Strauss Hauer & Feld LLP
(law firm), October 2003 to August 2004; Associate, Skadden,
Arps, Slate, Meagher & Flom LLP (law firm), October
2000 to March 2003. |
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|
|
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|
|
(1) |
After a Trustees initial term, each Trustee is expected to
serve a three-year term concurrent with the class of Trustees
for which he serves. Messrs. Leary and Ward, as Class I
Trustees, are expected to stand for re-election in 2007; Messrs.
Hui and Kavanaugh, as Class II Trustees, are expected to stand
for re-election in 2008; and Mr. Dougherty, the sole Class III
Trustee, is expected to stand for re-election in 2009. |
|
(2) |
The Highland Fund Complex consists of the following funds:
Highland Credit Strategies Fund, Highland Floating Rate Limited
Liability Company, Highland Floating Rate Fund, Highland
Floating Rate Advantage Fund, Highland Institutional Floating
Rate Income Fund, Highland Corporate Opportunities Fund,
Restoration Opportunities Fund, Prospect
Street®
High Income Portfolio Inc., Prospect
Street®
Income Shares Inc., Highland Equity Opportunities Fund, and
Highland Real Estate Fund (each a Highland Fund and
collectively the Highland Funds). |
|
|
(3) |
Mr. Dougherty is deemed to be an interested
person of the Trust under the Investment Company Act
because of his position with the Investment Adviser. |
|
(4) |
Each officer serves in the same capacity for each of the
Highland Funds. |
Compensation of Trustees
The fees and expenses of the Independent Trustees of the Trust
are paid by the Trust. The trustees who are members of the
Highland organization receive no compensation from the Trust. It
is estimated that the Independent Trustees will receive from the
Trust the amounts set forth below for the Trusts calendar
year ending December 31, 2006, assuming the Trust will have
been in existence for the full calendar year.
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|
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|
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|
|
Aggregate | |
|
|
|
|
Compensation | |
|
Total Compensation from the Trust | |
Name of Trustee |
|
from the Trust | |
|
and Highland Fund Complex(1) | |
|
|
| |
|
| |
Interested Trustee
|
|
|
|
|
|
|
|
|
|
R. Joseph Dougherty
|
|
|
$0 |
|
|
$ |
0 |
|
Independent Trustees
|
|
|
|
|
|
|
|
|
|
Bryan A. Ward
|
|
$ |
7,500 |
|
|
$ |
97,500 |
|
|
Scott F. Kavanaugh
|
|
$ |
7,500 |
|
|
$ |
97,500 |
|
|
James F. Leary
|
|
$ |
7,500 |
|
|
$ |
97,500 |
|
|
Timothy K. Hui
|
|
$ |
7,500 |
|
|
$ |
97,500 |
|
|
|
(1) |
Estimates the total compensation to be earned by that person
during the calendar year ending December 31, 2006 from the
registered investment companies advised by Highland. |
B-18
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|
|
Dollar Range | |
|
Aggregate Dollar Range of Equity | |
|
|
of Equity | |
|
Securities Overseen by Trustees | |
|
|
Securities in | |
|
in the Family of Registered | |
Name of Trustee |
|
the Trust(1) | |
|
Investment Companies(1) | |
|
|
| |
|
| |
Interested Trustee
|
|
|
|
|
|
|
|
|
|
R. Joseph Dougherty
|
|
$ |
0 |
|
|
|
Over $100,000 |
|
Independent Trustees
|
|
|
|
|
|
|
|
|
|
Bryan A. Ward
|
|
$ |
0 |
|
|
|
$1,000 - $10,000 |
|
|
Scott F. Kavanaugh
|
|
$ |
0 |
|
|
|
$10,001 - $50,000 |
|
|
James F. Leary
|
|
$ |
0 |
|
|
|
$10,001 - $50,000 |
|
|
Timothy K. Hui
|
|
$ |
0 |
|
|
|
$1,000 - $10,000 |
|
|
|
(1) |
As of May 19, 2006, the trustees do not own shares in the
Trust as the Trust has no operating history. |
Committees
In connection with the board of trustees responsibility
for the overall management and supervision of the Trusts
affairs, the trustees meet periodically throughout the year to
oversee the Trusts activities, review contractual
arrangements with service providers for the Trust and review the
Trusts performance. To fulfill these duties, the Trust
will have four committees: an Audit Committee, a Nominating
Committee, a Litigation Committee and a Qualified Legal
Compliance Committee.
The Audit Committee consists of Bryan Ward, Scott Kavanaugh,
James Leary and Timothy Hui. The Audit Committee acts according
to the Audit Committee charter. Scott Kavanaugh has been
appointed as Chairman of the Audit Committee. The Audit
Committee is responsible for (i) oversight of the
Trusts accounting and financial reporting processes and
the audits of the Trusts financial statements and
(ii) providing assistance to the board of trustees of the
Trust in connection with its oversight of the integrity of the
Trusts financial statements, the Trusts compliance
with legal and regulatory requirements and the independent
registered public accounting firms qualifications,
independence and performance. The board of trustees of the Trust
has determined that the Trust has one audit committee financial
expert serving on its Audit Committee, Mr. Leary, who is
independent for the purpose of the definition of audit committee
financial expert as applicable to the Trust.
The Nominating Committees function is to canvass, recruit,
interview, solicit and nominate trustees. The Nominating
Committee will consider recommendations for nominees from
shareholders sent to the Secretary of the Trust, Two Galleria
Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240. A
nomination submission must include all information relating to
the recommended nominee that is required to be disclosed in
solicitations or proxy statements for the election of trustees,
as well as information sufficient to evaluate the factors listed
above. Nomination submissions must be accompanied by a written
consent of the individual to stand for election if nominated by
the Board of trustees and to serve if elected by the
shareholders, and such additional information must be provided
regarding the recommended nominee as reasonably requested by the
Nominating Committee. The Nominating Committee is comprised of
Messrs. Ward, Kavanaugh, Leary and Hui.
The Litigation Committees function is to seek to address
any potential conflicts of interest between or among the Trust
and the Investment Adviser in connection with any potential or
existing litigation or other legal proceeding relating to
securities held by the Trust and the Investment Adviser or
another client of the Investment Adviser. The Litigation
Committee comprised of Messrs. Ward, Kavanaugh, Leary and Hui.
The Qualified Legal Compliance Committee (the QLCC)
is charged with compliance with Rules 205.2(k) and 205.3(c)
of the Code of Federal Regulations regarding alternative
reporting procedures for attorneys representing the Trust who
appear and practice before the Commission on behalf of the
Trust. The QLCC is comprised of Messrs. Ward, Kavanaugh, Leary
and Hui.
B-19
As the Trust is a closed-end investment company with no prior
investment operations, no meetings of the above committees have
been held in the current fiscal year with the exception of the
initial Audit Committee meeting at which all Audit Committee
members were present.
Prior to this offering, all of the outstanding shares of the
Trust were owned by Highland Capital Management Services, Inc.,
an affiliate of Highland.
Proxy Voting Policies and Procedures
The board of trustees of the Trust has delegated the voting of
proxies for Trust securities to Highland pursuant to
Highlands proxy voting policies and procedures. Under
these policies and procedures, Highland will vote proxies
related to Trust securities in the best interests of the Trust
and its shareholders. A copy of Highlands proxy voting
policies and procedures is attached as Appendix B to this
Statement of Additional Information. The Funds proxy
voting record for the most recent
12-month period ending
December 31 will be available (i) without charge, upon
request, by calling
1-877-665-1287 and
(ii) on the Commissions web site (http://www.sec.gov).
Codes of Ethics
The Trust and the Investment Adviser have adopted codes of
ethics under Rule 17j-1 of the Investment Company Act.
These codes permit personnel subject to the codes to invest in
securities, including securities that may be purchased or held
by the Trust. These codes can be reviewed and copied at the
Commissions Public Reference Room in Washington, D.C.
Information on the operation of the Public Reference Room may be
obtained by calling the Commission at 1-202-551-8090. The codes
of ethics are available on the EDGAR Database on the
Commissions web site (http://www.sec.gov), and copies of
these codes may be obtained, after paying a duplicating fee, by
electronic request at the following
e-mail address:
publicinfo@sec.gov, or by writing the Commissions Public
Reference Section, Washington, D.C.
20549-0102.
Administration Services
Pursuant to the Trusts administration services agreement,
Highland will perform the following services: (i) prepare
monthly security transaction listings; (ii) supply various
normal and customary Trust statistical data as requested on an
ongoing basis; (iii) prepare for execution and file the
Trusts federal and state tax returns; prepare a fiscal tax
provision in coordination with the annual audit; prepare an
excise tax provision; and prepare all relevant 1099
calculations; (iv) coordinate contractual relationships and
communications between the Trust and its contractual service
providers; (v) coordinate printing of the Trusts
annual and semi-annual shareholder reports; (vi) prepare
income and capital gain distributions; (vii) prepare the
semiannual and annual financial statements; (viii) monitor
the Trusts compliance with Internal Revenue Code,
Commission and prospectus requirements; (ix) prepare,
coordinate with the Trusts counsel and coordinate the
filing with the Commission: semi-annual reports on
Form N-SAR and
Form N-CSR;
Form N-Q; and
Form N-PX based
upon information provided by the Trust, assist in the
preparation of Forms 3, 4 and 5 pursuant to Section 16
of the Securities Exchange Act of 1934, as amended, and
Section 30(f) of the Investment Company Act for the
officers and trustees of the Trust, such filings to be based on
information provided by those persons; (x) assist in the
preparation of notices of meetings of shareholders;
(xi) assist in obtaining the fidelity bond and
trustees and officers/errors and omissions insurance
policies for the Trust in accordance with the requirements of
Rule 17g-1 and 17d-1(d)(7) under the Investment Company Act
as such bond and policies are approved by the Trusts board
of trustees; (xii) monitor the Trusts assets to
assure adequate fidelity bond coverage is maintained;
(xiii) draft agendas and resolutions for quarterly and
special board meetings; (xiv) coordinate the preparation,
assembly and distribution of board materials; (xv) attend
board meetings and draft minutes thereof; (xvi) maintain
the Trusts calendar to assure compliance with various
filing and board approval deadlines; (xvii) furnish the
Trust office space in the offices of Highland, or in such other
place or places as may be agreed upon from time to time, and all
necessary office facilities, simple business equipment,
supplies, utilities and telephone service for managing the
affairs and investments of the Trust; (xviii) assist the
Trust in the handling of SEC examinations and responses thereto;
(xix) perform clerical, bookkeeping and all other
administrative services
B-20
not provided by the Trusts other service providers;
(xx) determine or oversee the determination and publication
of the Trusts net asset value in accordance with the
Trusts policy as adopted from time to time by the Board of
Trustees; (xxi) oversee the maintenance by the Trusts
custodian and transfer agent and dividend disbursing agent of
certain books and records of the Trust as required under
Rule 31a-1(b)(2)(iv)
of the Investment Company Act and maintain (or oversee
maintenance by such other persons as approved by the board of
trustees) such other books and records required by law or for
the proper operation of the Trust; (xxii) prepare such
information and reports as may be required by any stock exchange
or exchanges on which the Trusts shares are listed;
(xxiii) determine the amounts available for distribution as
dividends and distributions to be paid by the Trust to its
shareholders; prepare and arrange for the printing of dividend
notices to shareholders; and provide the Trusts dividend
disbursing agent and custodian with such information as is
required for such parties to effect the payment of dividends and
distributions and to implement the Trusts dividend
reinvestment plan; (xxiv) serve as liaison between the
Trust and each of its service providers; and (xxv) perform
such additional administrative duties relating to the
administration of the Trust as may subsequently be agreed upon
in writing between the Trust and Highland. Highland shall have
the authority to engage a sub-administrator in connection with
the administrative services of the Trust, which
sub-administrator may be an affiliate of Highland; provided,
however, that Highland shall remain responsible to the Trust
with respect to its duties and obligations set forth in the
administration services agreement.
Portfolio Managers
The portfolio managers of the Trust are Kurtis Plumer, James
Dondero, Mark Okada and Patrick Daugherty.
As of March 31, 2006, Kurtis Plumer managed the following
client accounts:
|
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|
|
|
|
|
|
|
|
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|
|
|
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|
|
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|
Number of | |
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|
|
|
|
|
|
|
Accounts | |
|
Assets | |
|
|
|
|
|
|
Subject to a | |
|
Subject to a | |
|
|
Number of | |
|
Assets of | |
|
Performance | |
|
Performance | |
Type of Account |
|
Accounts | |
|
Accounts | |
|
Fee | |
|
Fee | |
|
|
| |
|
| |
|
| |
|
| |
Registered Investment Companies
|
|
|
2 |
|
|
|
$82 million |
|
|
|
2 |
|
|
|
$82 million |
|
Other Pooled Investment Vehicles
|
|
|
5 |
|
|
|
$1,658 million |
|
|
|
3 |
|
|
|
$1,156 million |
|
Other Accounts
|
|
|
0 |
|
|
|
$0 |
|
|
|
0 |
|
|
|
$0 |
|
As of March 31, 2006, James Dondero managed the following
client accounts:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of | |
|
|
|
|
|
|
|
|
Accounts | |
|
Assets | |
|
|
|
|
|
|
Subject to a | |
|
Subject to a | |
|
|
Number of | |
|
Assets of | |
|
Performance | |
|
Performance | |
Type of Account |
|
Accounts | |
|
Accounts | |
|
Fee | |
|
Fee | |
|
|
| |
|
| |
|
| |
|
| |
Registered Investment Companies
|
|
|
2 |
|
|
|
$82 million |
|
|
|
2 |
|
|
|
$82 million |
|
Other Pooled Investment Vehicles
|
|
|
10 |
|
|
|
$4,327 million |
|
|
|
9 |
|
|
|
$4,277 million |
|
Other Accounts
|
|
|
0 |
|
|
|
$0 |
|
|
|
0 |
|
|
|
$0 |
|
B-21
As of March 31, 2006, Mark Okada managed the following
client accounts:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of | |
|
|
|
|
|
|
|
|
Accounts | |
|
Assets | |
|
|
|
|
|
|
Subject to a | |
|
Subject to a | |
|
|
Number of | |
|
Assets of | |
|
Performance | |
|
Performance | |
Type of Account |
|
Accounts | |
|
Accounts | |
|
Fee | |
|
Fee | |
|
|
| |
|
| |
|
| |
|
| |
Registered Investment Companies
|
|
|
7 |
|
|
|
$4,561 million |
|
|
|
0 |
|
|
|
$0 million |
|
Other Pooled Investment Vehicles
|
|
|
26 |
|
|
|
$13,824 million |
|
|
|
18 |
|
|
|
$11,225 million |
|
Other Accounts
|
|
|
0 |
|
|
|
$0 |
|
|
|
0 |
|
|
|
$0 |
|
As of March 31, 2006, Patrick Daugherty managed the
following client accounts:
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|
|
|
|
|
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|
|
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|
|
|
|
|
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|
|
Number of | |
|
|
|
|
|
|
|
|
Accounts | |
|
Assets | |
|
|
|
|
|
|
Subject to a | |
|
Subject to a | |
|
|
Number of | |
|
Assets of | |
|
Performance | |
|
Performance | |
Type of Account |
|
Accounts | |
|
Accounts | |
|
Fee | |
|
Fee | |
|
|
| |
|
| |
|
| |
|
| |
Registered Investment Companies
|
|
|
2 |
|
|
|
$82 million |
|
|
|
2 |
|
|
|
$82 million |
|
Other Pooled Investment Vehicles
|
|
|
4 |
|
|
|
$3,032 million |
|
|
|
2 |
|
|
|
$2,530 million |
|
Other Accounts
|
|
|
0 |
|
|
|
$0 |
|
|
|
0 |
|
|
|
$0 |
|
The Investment Adviser has built a professional working
environment, a firm-wide compliance culture and compliance
procedures and systems designed to protect against potential
incentives that may favor one account over another. The
Investment Adviser has adopted policies and procedures that
address the allocation of investment opportunities, execution of
portfolio transactions, personal trading by employees and other
potential conflicts of interest that are designed to ensure that
all client accounts are treated equitably over time.
Nevertheless, the Investment Adviser furnishes advisory services
to numerous clients in addition to the Trust, and the Investment
Adviser may, consistent with applicable law, make investment
recommendations to other clients or accounts (including accounts
which are hedge funds or have performance or higher fees paid to
the Investment Adviser, or in which portfolio managers have a
personal interest in the receipt of such fees), which may be the
same as or different from those made to the Trust. In addition,
the Investment Adviser, its affiliates and any officer,
director, stockholder or employee may or may not have an
interest in the securities whose purchase and sale the
Investment Adviser recommends to the Trust. Actions with respect
to securities of the same kind may be the same as or different
from the action which the Investment Adviser, or any of its
affiliates, or any officer, director, stockholder, employee or
any member of their families may take with respect to the same
securities. Moreover, the Investment Adviser may refrain from
rendering any advice or services concerning securities of
companies of which any of the Investment Advisers (or its
affiliates) officers, directors or employees are directors
or officers, or companies as to which the Investment Adviser or
any of its affiliates or the officers, directors and employees
of any of them has any substantial economic interest or
possesses material non-public information. In addition to its
various policies and procedures designed to address these
issues, the Investment Adviser includes disclosure regarding
these matters to its clients in both its Form ADV and
investment advisory agreements.
The Investment Adviser, its affiliates or their officers and
employees serve or may serve as officers, directors or
principals of entities that operate in the same or related lines
of business or of investment funds managed by affiliates of the
Investment Adviser. Accordingly, these individuals may have
obligations to investors in those entities or funds or to other
clients, the fulfillment of which might not be in the best
interests of the Trust. As a result, the Investment Adviser will
face conflicts in the allocation of investment opportunities to
the Trust and other funds and clients. In order to enable such
affiliates to fulfill their fiduciary duties to each of the
clients for which they have responsibility, the Investment
Adviser will endeavor to allocate investment opportunities in a
fair and equitable manner which may, subject to applicable
regulatory
B-22
constraints, involve pro rata co-investment by the Trust and
such other clients or may involve a rotation of opportunities
among the Trust and such other clients.
While the Investment Adviser does not believe there will be
frequent conflicts of interest, if any, the Investment Adviser
and its affiliates have both subjective and objective procedures
and policies in place designed to manage the potential conflicts
of interest between the Investment Advisers fiduciary
obligations to the Trust and their similar fiduciary obligations
to other clients so that, for example, investment opportunities
are allocated in a fair and equitable manner among the Trust and
such other clients. An investment opportunity that is suitable
for multiple clients of the Investment Adviser and its
affiliates may not be capable of being shared among some or all
of such clients due to the limited scale of the opportunity or
other factors, including regulatory restrictions imposed by the
Investment Company Act. There can be no assurance that the
Investment Advisers or its affiliates efforts to
allocate any particular investment opportunity fairly among all
clients for whom such opportunity is appropriate will result in
an allocation of all or part of such opportunity to the Trust.
Not all conflicts of interest can be expected to be resolved in
favor of the Trust.
Under current Commission regulations, the Trust may be
prohibited from co-investing with any unregistered fund managed
now or in the future by the Investment Adviser in certain
private placements in which the Investment Adviser negotiates
non-pricing terms. The Trust intends to file for exemptive
relief from the Commission to enable it to co-invest with other
unregistered funds managed by the Investment Adviser.
Compensation
The Investment Advisers financial arrangements with its
portfolio managers, its competitive compensation and its career
path emphasis at all levels reflect the value senior management
places on key resources. Compensation may include a variety of
components and may vary from year to year based on a number of
factors including the relative performance of a portfolio
managers underlying account, the combined performance of
the portfolio managers underlying accounts, and the relative
performance of the portfolio managers underlying accounts
measured against other employees. The principal components of
compensation include a base salary, a discretionary bonus,
various retirement benefits and one or more of the incentive
compensation programs established by the Investment Adviser such
as Option It Plan and the Long-Term Incentive Plan.
Base Compensation
Generally, portfolio managers receive base compensation based on
their seniority and/or their position with the firm, which may
include the amount of assets supervised and other management
roles within the firm.
Discretionary Compensation
In addition to base compensation, portfolio managers may receive
discretionary compensation, which can be a substantial portion
of total compensation. Discretionary compensation can include a
discretionary cash bonus as well as one or more of the following:
Option It Plan. The purpose of this plan is to
attract and retain the highest quality employees for positions
of substantial responsibility, and to provide additional
incentives to a select group of management or highly compensated
employees of Highland so as to promote the success of the
Highland.
Long Term Incentive Plan. The purpose of this plan
is to create positive morale and teamwork, to attract and retain
key talent, and to encourage the achievement of common goals.
This plan seeks to reward participating employees based on the
increased value of Highland through the use of Long-Term
Incentive Units.
Senior portfolio managers who perform additional management
functions may receive additional compensation in these other
capacities. Compensation is structured such that key
professionals benefit from remaining with the firm.
B-23
Securities Ownership of Portfolio Managers
The Trust is a newly organized investment company. Accordingly,
as of the date of this Statement of Additional Information, none
of the portfolio managers beneficially owns any securities
issued by the Trust.
Other
On June 1, 2006, Highland Capital Management Services,
Inc., an affiliate of Highland, invested seed capital of
$100,000.
B-24
PORTFOLIO TRANSACTIONS AND BROKERAGE
In placing portfolio transactions for the Trust, the Investment
Adviser will give primary consideration to securing the most
favorable price and efficient execution. Consistent with this
policy, the Investment Adviser may consider the financial
responsibility, research and investment information and other
services provided by brokers or dealers who may effect or be a
party to any such transaction or other transactions to which
other clients of the Investment Adviser may be a party. Neither
the Trust nor the Investment Adviser has adopted a formula for
allocation of the Trusts investment transaction business.
The Investment Adviser has access to supplemental investment and
market research and security and economic analysis provided by
brokers who may execute brokerage transactions at a higher cost
to the Trust than would otherwise result when allocating
brokerage transactions to other brokers on the basis of seeking
the most favorable price and efficient execution. The Investment
Adviser, therefore, is authorized to place orders for the
purchase and sale of securities for the Trust with such brokers,
subject to review by the Trusts board of trustees from
time to time with respect to the extent and continuation of this
practice. The services provided by such brokers may be useful or
beneficial to the Investment Adviser in connection with its
services to other clients.
On occasions when the Investment Adviser deems the purchase or
sale of a security to be in the best interest of the Trust as
well as other clients, the Investment Adviser, to the extent
permitted by applicable laws and regulations, may, but shall be
under no obligation to, aggregate the securities to be so sold
or purchased in order to obtain the most favorable price or
lower brokerage commissions and efficient execution. In such
event, allocation of the securities so purchased or sold, as
well as the expenses incurred in the transaction, will be made
by the Investment Adviser in the manner it considers to be the
most equitable and consistent with its fiduciary obligations to
the Trust and to such other clients.
B-25
REPURCHASE OF COMMON SHARES
The Trust is a closed-end management investment company and as
such its shareholders will not have the right to cause the Trust
to redeem their shares. Instead, the Trusts common shares
will trade in the open market at a price that will be a function
of several factors, including dividend levels (which are in turn
affected by expenses), net asset value, call protection,
dividend stability, relative demand for and supply of such
shares in the market, general market and economic conditions and
other factors. Because shares of a closed-end investment company
may frequently trade at prices lower than net asset value, the
Trusts board of trustees may consider action that might be
taken to reduce or eliminate any material discount from net
asset value in respect of common shares, which may include the
repurchase of such shares in the open market or in private
transactions, the making of a tender offer for such shares, or
the conversion of the Trust to an open-end investment company.
The board of trustees may decide not to take any of these
actions. In addition, there can be no assurance that share
repurchases or tender offers, if undertaken, will reduce market
discount.
Notwithstanding the foregoing, at any time when the Trusts
Preferred Shares are outstanding or there are outstanding
borrowings, the Trust may not purchase, redeem or otherwise
acquire any of its common shares unless (i) all accrued
Preferred Shares dividends have been paid and (ii) at the
time of such purchase, redemption or acquisition, the net asset
value of the Trusts portfolio (determined after deducting
the acquisition price of the common shares) is at least 200% of
the liquidation value of the outstanding Preferred Shares
(expected to equal the original purchase price per share plus
any accrued and unpaid dividends thereon). Any service fees
incurred in connection with any tender offer made by the Trust
will be borne by the Trust and will not reduce the stated
consideration to be paid to tendering shareholders.
Subject to its investment restrictions, the Trust may borrow to
finance the repurchase of shares or to make a tender offer.
Interest on any borrowings to finance share repurchase
transactions or the accumulation of cash by the Trust in
anticipation of share repurchases or tenders will reduce the
Trusts net income. Any share repurchase, tender offer or
borrowing that might be approved by the Trusts board of
trustees would have to comply with the Securities Exchange Act
of 1934, as amended, the Investment Company Act and the rules
and regulations thereunder.
Although the decision to take action in response to a discount
from net asset value will be made by the board of trustees at
the time it considers such issue, it is the boards present
policy, which may be changed by the board of trustees, not to
authorize repurchases of common shares or a tender offer for
such shares if: (1) such transactions, if consummated,
would (a) result in the delisting of the common shares from
the New York Stock Exchange, or (b) impair the Trusts
status as a regulated investment company under the Code (which
would make the Trust a taxable entity, causing the Trusts
income to be taxed at the corporate level in addition to the
taxation of shareholders who receive dividends from the Trust),
or as a registered closed-end investment company under the
Investment Company Act; (2) the Trust would not be able to
liquidate portfolio securities in an orderly manner and
consistent with the Trusts investment objectives and
policies in order to repurchase shares; or (3) there is, in
the boards judgment, any (a) material legal action or
proceeding instituted or threatened challenging such
transactions or otherwise materially adversely affecting the
Trust, (b) general suspension of or limitation on prices
for trading securities on the New York Stock Exchange,
(c) declaration of a banking moratorium by federal or state
authorities or any suspension of payment by United States or New
York banks, (d) material limitation affecting the Trust or
the issuers of its portfolio securities by federal or state
authorities on the extension of credit by lending institutions
or on the exchange of foreign currency, (e) commencement of
war, armed hostilities or other international or national
calamity directly or indirectly involving the United States or
(f) other event or condition which would have a material
adverse effect (including any adverse tax effect) on the Trust
or its shareholders if shares were repurchased. The board of
trustees may in the future modify these conditions in light of
experience.
The repurchase by the Trust of its shares at prices below net
asset value will result in an increase in the net asset value of
those shares that remain outstanding. However, there can be no
assurance that share repurchases or tender offers at or below
net asset value will result in the Trusts shares trading
at a price equal to their net asset value. Nevertheless, the
fact that the Trusts shares may be the subject of
repurchase or
B-26
tender offers from time to time, or that the Trust may be
converted to an open-end investment company, may reduce any
spread between market price and net asset value that might
otherwise exist.
Before deciding whether to take any action if the common shares
trade below net asset value, the Trusts board of trustees
would likely consider all relevant factors, including the extent
and duration of the discount, the liquidity of the Trusts
portfolio, the impact of any action that might be taken on the
Trust or its shareholders and market considerations. Based on
these considerations, even if the Trusts shares should
trade at a discount, the board of trustees may determine that,
in the interest of the Trust and its shareholders, no action
should be taken.
B-27
TAX MATTERS
The following discussion summarizes certain U.S. federal
income tax considerations affecting the Trust and the purchase,
ownership and disposition of the Trusts common shares by
shareholders that are U.S. persons, as defined for
U.S. federal income tax purposes. This discussion is based
upon current provisions of the Internal Revenue Code of 1986, as
amended (the Code), the regulations promulgated
thereunder and judicial and administrative authorities, all of
which are subject to change or differing interpretations by the
courts or the Internal Revenue Service (the IRS),
possibly with retroactive effect. No attempt is made to present
a detailed explanation of all U.S. federal tax concerns
affecting the Trust and its shareholders (including shareholders
owning large positions in the Trust).
The discussions set forth herein and in the prospectus do not
constitute tax advice, and you are urged to consult your own tax
advisor to determine the specific U.S. federal, state,
local and foreign tax consequences to you of investing in the
Trust.
Taxation of the Trust
The Trust intends to elect to be treated and to qualify annually
as a regulated investment company under Subchapter M of the
Code. Accordingly, the Trust must, among other things, meet the
following requirements regarding the source of its income and
the diversification of its assets:
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(i) The Trust must derive in each taxable year at least 90%
of its gross income from the following sources:
(a) dividends, interest (including tax-exempt interest),
payments with respect to certain securities loans, and gains
from the sale or other disposition of stock, securities or
foreign currencies, or other income (including but not limited
to gain from options, futures and forward contracts) derived
with respect to its business of investing in such stock,
securities or foreign currencies; and (b) interests in
qualified publicly traded partnerships (as defined
in the Code). |
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(ii) The Trust must diversify its holdings so that, at the
end of each quarter of each taxable year: (a) at least 50%
of the market value of the Trusts total assets is
represented by cash and cash items, U.S. government
securities, the securities of other regulated investment
companies and other securities, with such other securities
limited, in respect of any one issuer, to an amount not greater
than 5% of the value of the Trusts total assets and not
more than 10% of the outstanding voting securities of such
issuer and (b) not more than 25% of the market value of the
Trusts total assets is invested in the securities (other
than U.S. government securities and the securities of other
regulated investment companies) of: (I) any one issuer,
(II) any two or more issuers that the Trust controls and
that are determined to be engaged in the same business or
similar or related trades or businesses or (III) any one or
more qualified publicly traded partnerships (as
defined in the Code). |
As a regulated investment company, the Trust generally will not
be subject to U.S. federal income tax on income and gains
that the Trust distributes to its shareholders provided that it
distributes each taxable year at least the sum of: (i) 90%
of the Trusts investment company taxable income (which
includes, among other items, dividends, interest and the excess
of any net short-term capital gain over net long-term capital
loss and other taxable income, other than any net long-term
capital gain, reduced by deductible expenses) determined without
regard to the deduction for dividends paid and (ii) 90% of
the Trusts net tax-exempt interest (the excess of its
gross tax-exempt interest over certain disallowed deductions).
The Trust intends to distribute substantially all of such income
each year. The Trust will be subject to income tax at regular
corporation rates on any taxable income or gains that it does
not distribute to its shareholders.
The Code imposes a 4% nondeductible excise tax on the Trust to
the extent the Trust does not distribute by the end of any
calendar year at least the sum of: (i) 98% of its ordinary
income (not taking into account any capital gain or loss) for
the calendar year and (ii) 98% of its capital gain in
excess of its capital loss (adjusted for certain ordinary
losses) for a one-year period generally ending on
October 31 of the calendar year (unless an election is made
to use the Trusts fiscal year). In addition, the minimum
amounts that must be distributed in any year to avoid the excise
tax will be increased or decreased to reflect any
under-distribution or over-distribution, as the case may be,
from the previous year. While the Trust intends to
B-28
distribute any income and capital gain in the manner necessary
to minimize imposition of the 4% excise tax, there can be no
assurance that sufficient amounts of the Trusts taxable
income and capital gain will be distributed to avoid entirely
the imposition of the excise tax. In that event, the Trust will
be liable for the excise tax only on the amount by which it does
not meet the foregoing distribution requirement.
If for any taxable year the Trust does not qualify as a
regulated investment company, all of its taxable income
(including its net capital gain) will be subject to tax at
regular corporate rates without any deduction for distributions
to shareholders, and such distributions will be taxable to the
shareholders as ordinary dividends to the extent of the
Trusts current or accumulated earnings and profits.
Provided that shareholders satisfy certain holding period and
other requirements with respect to their common shares, such
dividends would be eligible (i) to be treated as qualified
dividend income in the case of shareholders taxed as individuals
and (ii) for the dividends-received deduction in the case
of shareholders taxed as corporations. The Trust could be
required to recognize unrealized gains, pay taxes and make
distributions (which could be subject to interest charges)
before requalifying for taxation as a regulated investment
company. If the Trust fails to qualify as a regulated investment
company in any year, it must pay out its earnings and profits
accumulated in that year in order to qualify again as a
regulated investment company. If the Trust fails to qualify as a
regulated investment company for a period greater than two
taxable years, the Trust may be required to recognize and pay
tax on any net built-in gains with respect to certain of its
assets (i.e., the excess of the aggregate gains, including items
of income, over aggregate losses that would have been realized
with respect to such assets if the Trust had been liquidated)
or, alternatively, to elect to be subject to taxation on such
built-in gain recognized for a period of ten years, in order to
qualify as a regulated investment company in a subsequent year.
Certain of the Trusts investment practices are subject to
special and complex U.S. federal income tax provisions that
may, among other things: (i) treat dividends that would
otherwise constitute qualified dividend income as non-qualified
dividend income, (ii) treat dividends that would otherwise
be eligible for the corporate dividends-received deduction as
ineligible for such treatment, (iii) disallow, suspend or
otherwise limit the allowance of certain losses or deductions,
(iv) convert lower-taxed, long-term capital gain into
higher-taxed, short-term capital gain or ordinary income,
(v) convert an ordinary loss or deduction into a capital
loss (the deductibility of which is more limited) or
(vi) cause the Trust to recognize income or gain without a
corresponding receipt of cash.
If the Trust purchases common shares in certain foreign
investment entities, called passive foreign investment companies
(PFICs), the Trust may be subject to
U.S. federal income tax on a portion of any excess
distribution or gain from the disposition of such common
shares even if such income is distributed as a taxable dividend
by the Trust to the shareholders. Additional charges in the
nature of interest may be imposed on the Trust in respect of
deferred taxes arising from such distributions or gains.
Elections may be available to the Trust to mitigate the effect
of this tax, but such elections generally accelerate the
recognition of income without the receipt of cash. Dividends
paid by PFICs will not be qualified dividend income.
If the Trust invests in the common shares of a PFIC, or any
other investment that produces income that is not matched by a
corresponding cash distribution to the Trust, such as
investments in debt securities that have original issue
discount, the Trust could be required to recognize income that
it has not yet received. Any such income would be treated as
income earned by the Trust and therefore would be subject to the
distribution requirements of the Code. This might prevent the
Trust from distributing 90% of its net investment income as is
required in order to avoid Trust-level U.S. federal income
taxation on all of its income, or might prevent the Trust from
distributing enough ordinary income and capital gain net income
to avoid completely the imposition of the excise tax. To avoid
this result, the Trust may be required to borrow money or
dispose of securities to be able to make required distributions
to the shareholders.
Dividend, interest and other income received by the Trust from
investments outside the United States may be subject to
withholding and other taxes imposed by foreign countries. Tax
treaties between the United States and other countries may
reduce or eliminate such taxes. The Trust does not expect that
it will be eligible to elect to treat any foreign taxes it pays
as paid by its shareholders, who therefore will not be entitled
B-29
to credits for such taxes on their own tax returns. Foreign
taxes paid by a Trust will reduce the return from the
Trusts investments.
Taxation of Shareholders
The Trust will determine either to distribute or to retain for
reinvestment all or part of its net capital gain. If any such
gain is retained, the Trust will be subject to a corporate
income tax (currently at a maximum rate of 35%) on such retained
amount. In that event, the Trust expects to designate the
retained amount as undistributed capital gain in a notice to its
shareholders, each of whom: (i) will be required to include
in income for U.S. federal tax purposes as long-term
capital gain its share of such undistributed amounts,
(ii) will be entitled to credit its proportionate share of
the tax paid by the Trust against its U.S. federal income
tax liability and to claim refunds to the extent that the credit
exceeds such liability and (iii) will increase its basis in
its common shares of the Trust by an amount equal to 65% of the
amount of undistributed capital gain included in such
shareholders gross income.
Distributions paid to you by the Trust from its net realized
long-term capital gains, if any, that the Trust designates as
capital gains dividends (capital gain dividends) are
taxable as long-term capital gains, regardless of how long you
have held your common shares. All other dividends paid to you by
the Trust (including dividends from short-term capital gains)
from its current or accumulated earnings and profits
(ordinary income dividends) are generally subject to
tax as ordinary income. The Trust does not expect that a
corporate shareholder will be able to claim a dividends received
deduction with respect to any significant portion of the Trust
distributions.
Special rules apply, however, to ordinary income dividends paid
to individuals with respect to taxable years beginning on or
before December 31, 2010. If you are an individual, any
such ordinary income dividend that you receive from the Trust
generally will be eligible for taxation at the rates applicable
to long-term capital gains (currently at a maximum rate of 15%)
to the extent that: (i) the ordinary income dividend is
attributable to qualified dividend income (i.e.,
generally dividends paid by U.S. corporations and certain
foreign corporations) received by the Trust, (ii) the Trust
satisfies certain holding period and other requirements with
respect to the stock on which such qualified dividend income was
paid and (iii) you satisfy certain holding period and other
requirements with respect to your common shares. Ordinary income
dividends subject to these special rules are not actually
treated as capital gains, however, and thus will not be included
in the computation of your net capital gain and generally cannot
be used to offset any capital losses. In general, the Trust does
not expect that a significant portion of its ordinary income
dividends will be treated as qualified dividend income.
Any distributions you receive that are in excess of the
Trusts current or accumulated earnings and profits will be
treated as a tax-free return of capital to the extent of your
adjusted tax basis in your common shares, and thereafter as
capital gain from the sale of common shares. The amount of any
Trust distribution that is treated as a tax-free return of
capital will reduce your adjusted tax basis in your common
shares, thereby increasing your potential gain or reducing your
potential loss on any subsequent sale or other disposition of
your common shares.
Dividends and other taxable distributions are taxable to you
even if they are reinvested in additional common shares of the
Trust. Dividends and other distributions paid by the Trust are
generally treated under the Code as received by you at the time
the dividend or distribution is made. If, however, the Trust
pays you a dividend in January that was declared in the previous
October, November or December and you were the shareholder of
record on a specified date in one of such months, then such
dividend will be treated for tax purposes as being paid by the
Trust and received by you on December 31 of the year in
which the dividend was declared.
The price of common shares purchased at any time may reflect the
amount of a forthcoming distribution. If you purchase common
shares just prior to a distribution, you will receive a
distribution that will be taxable to you even though it
represents in part a return of your invested capital.
B-30
The Trust will send you information after the end of each year
setting forth the amount and tax status of any distributions
paid to you by the Trust. Ordinary income dividends and capital
gain dividends may also be subject to state and local taxes.
If you sell or otherwise dispose of common shares of the Trust
(including by exchanging them for common shares of another
fund), you will generally recognize a gain or loss in an amount
equal to the difference between your tax basis in such common
shares of the Trust and the amount you receive upon disposition
of such common shares. If you hold your common shares as capital
assets, any such gain or loss will be long-term capital gain or
loss if you have held such common shares for more than one year
at the time of sale. Any loss upon the sale or exchange of
common shares held for six months or less will be treated as
long-term capital loss to the extent of any capital gain
dividends received (including amounts credited as an
undistributed capital gain dividend) by you with respect to such
common shares. Any loss you realize on a sale or exchange of
common shares will be disallowed if you acquire other common
shares (whether through the automatic reinvestment of dividends
or otherwise) within a
61-day period beginning
30 days before and ending 30 days after your sale or
exchange of the common shares. In such case, your tax basis in
the common shares acquired will be adjusted to reflect the
disallowed loss.
Current law taxes both long-term and short-term capital gain of
corporations at the rates applicable to ordinary income. For
non-corporate taxpayers, short-term capital gain is currently
taxed at rates applicable to ordinary income (currently at a
maximum of 35%) while long-term capital gain generally is taxed
at a maximum rate of 15%.
Shareholders may be entitled to offset their capital gain
dividends with capital loss. The Code contains a number of
statutory provisions affecting when capital loss may be offset
against capital gain and limiting the use of loss from certain
investments and activities. Accordingly, shareholders that have
capital losses are urged to consult their tax advisors.
The Trust may be required to withhold, for U.S. federal
backup withholding tax purposes, a portion of the dividends,
distributions and redemption proceeds payable to a shareholder
who fails to provide the Trust (or its agent) with the
shareholders correct taxpayer identification number (in
the case of an individual, generally, such individuals
social security number) or to make the required certification,
or who has been notified by the IRS that such shareholder is
subject to backup withholding. Corporate shareholders and
certain other shareholders are exempt from backup withholding.
Backup withholding is not an additional tax and any amount
withheld may be refunded or credited against your
U.S. federal income tax liability, if any, provided that
you furnish the required information to the IRS.
B-31
EXPERTS
The Statement of Assets and Liabilities of the Trust as of
June 8, 2006 and related Statement of Operations and
Statement of Changes in Net Assets for the period June 1,
2006 (commencement of operations) to June 8, 2006 appearing
in this Statement of Additional Information have been audited by
PricewaterhouseCoopers LLP, independent registered public
accounting firm, as set forth in their report thereon appearing
elsewhere herein, and is included in reliance upon such report
given upon the authority of such firm as experts in accounting
and auditing. PricewaterhouseCoopers LLP, located at 2001
Ross Avenue, Suite 1800, Dallas, Texas 75201 provides
accounting and auditing services to the Trust.
ADDITIONAL INFORMATION
A Registration Statement on
Form N-2,
including amendments thereto, relating to the shares offered
hereby, has been filed by the Trust with the Securities and
Exchange Commission (the Commission),
Washington, D.C. The prospectus and this Statement of
Additional Information do not contain all of the information set
forth in the Registration Statement, including any exhibits and
schedules thereto. For further information with respect to the
Trust and the shares offered hereby, reference is made to the
Registration Statement. Statements contained in the prospectus
and this Statement of Additional Information as to the contents
of any contract or other document referred to are not
necessarily complete and in each instance reference is made to
the copy of such contract or other document filed as an exhibit
to the Registration Statement, each such statement being
qualified in all respects by such reference. A copy of the
Registration Statement may be inspected without charge at the
Commissions principal office in Washington, D.C., and
copies of all or any part thereof may be obtained from the
Commission upon the payment of certain fees prescribed by the
Commission.
B-32
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees and Shareholder of Highland Credit
Strategies Fund:
In our opinion, the accompanying statement of assets and
liabilities and the related statements of operations and of
changes in net assets present fairly, in all material respects,
the financial position of Highland Credit Strategies Fund (the
Fund) at June 8, 2006, and the results of its
operations and the changes in its net assets for the period from
June 1, 2006 (commencement of operations) through
June 8, 2006 in conformity with accounting principles
generally accepted in the United States of America. These
financial statements (hereafter referred to as financial
statements) are the responsibility of the Funds
management; our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit
of these statements in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles
used and significant estimates made by management, and
evaluating the overall financial statement presentation. We
believe that our audit provides a reasonable basis for our
opinion.
PricewaterhouseCoopers
Dallas, Texas
June 8, 2006
F-1
HIGHLAND CREDIT STRATEGIES FUND
STATEMENT OF ASSETS AND LIABILITIES
AS OF JUNE 8, 2006
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ASSETS:
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Cash
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$ |
100,000 |
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LIABILITIES:
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NET ASSETS:
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$ |
100,000 |
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COMPONENTS OF NET ASSETS:
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Common shares of beneficial interest at par
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$ |
5 |
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Paid in Capital in excess of par
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$ |
99,995 |
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NET ASSETS
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$ |
100,000 |
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Common shares of beneficial interest issued and outstanding
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5,235.602 |
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Net asset value per share, par value $0.001, unlimited shares
authorized
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$ |
19.10 |
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See Notes to Financial Statements
F-2
HIGHLAND CREDIT STRATEGIES FUND
STATEMENT OF OPERATIONS
Period from June 1, 2006 (commencement of operations)
through June 8, 2006
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INVESTMENT INCOME
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$ |
0 |
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EXPENSES
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$ |
0 |
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NET INVESTMENT INCOME
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$ |
0 |
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See Notes to Financial Statements
F-3
HIGHLAND CREDIT STRATEGIES FUND
STATEMENT OF CHANGES IN NET ASSETS
Period from June 1, 2006 (commencement of operations)
through June 8, 2006
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INCREASE IN NET ASSETS
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Operations:
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NET INVESTMENT INCOME
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$ |
0 |
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NET CHANGE IN NET ASSETS RESULTING FROM OPERATIONS
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$ |
0 |
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Capital Share Transactions:
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NET PROCEEDS FROM THE ISSUANCE OF COMMON SHARES
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$ |
100,000 |
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TOTAL INCREASE
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$ |
100,000 |
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NET ASSETS
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Beginning of period
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$ |
0 |
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End of period
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$ |
100,000 |
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See Notes to Financial Statements
F-4
HIGHLAND CREDIT STRATEGIES FUND
NOTES TO FINANCIAL STATEMENTS
Highland Credit Strategies Fund (the Trust) was
organized as a Delaware statutory trust on March 10, 2006,
and is registered as a non-diversified, closed-end management
investment company under the Investment Company Act of 1940, as
amended, and the Securities Act of 1933, as amended. The Trust
had no operations other than a sale of 5,235.602 common shares
of beneficial interest to Highland Capital Management Services,
Inc.
Highland Capital Management, L.P. (the Adviser) has
agreed to pay all organizational expenses and to pay all
offering costs (other than sales load and the expenses of the
Preferred Share offering) that exceed $.04 per Common Share.
The Trusts investment objectives are to provide both
current income and capital appreciation.
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NOTE 2: |
ACCOUNTING POLICIES |
The Trusts financial statements are prepared in accordance
with accounting principles generally accepted in the United
States of America. This requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statement. Actual
results could differ from these estimates.
The Trusts share of offering costs will be charged to Paid
in Capital at the time such common shares of beneficial interest
are issued.
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NOTE 3: |
INVESTMENT ADVISORY AND OTHER AGREEMENT |
The Trusts Board of Trustees approved the investment
advisory agreement between the Adviser and the Trust at a
meeting on March 19, 2006 pursuant to which the Trust has
agreed to pay an investment advisory fee, payable on a monthly
basis, at an annual rate of 1.00% of the average weekly value of
the Trusts Managed Assets. The Trusts Managed
Assets will be an amount equal to the total assets of the
Trust, including any form of investment leverage, minus all
accrued expenses incurred in the normal course of operations,
but not excluding any liabilities or obligations attributable to
investment leverage obtained through (i) indebtedness of
any type (including, without limitation, borrowing through a
credit facility or the issuance of debt securities),
(ii) the issuance of preferred stock or other similar
preference securities, (iii) the reinvestment of collateral
received for securities loaned in accordance with the
Trusts investment objectives and policies, and/or
(iv) any other means.
The Trusts Board of Trustees approved the administration
services agreement between the Adviser and the Trust at a
meeting on March 19, 2006 pursuant to which the Trust has
agreed to pay the Adviser an annual fee, payable monthly, in an
amount equal to 0.20% of the average weekly value of the
Trusts Managed Assets.
The Trusts Board of Trustees approved the
sub-administration services agreement between the Adviser and
PFPC, Inc. (PFPC) at a meeting on March 19,
2006 pursuant which the Adviser has retained PFPC to provide
administration, bookkeeping and pricing services to the Trust.
As compensation for its services, the Adviser has agreed to pay
PFPC an annual administration fee payable monthly, in an amount
equal to 0.01% of the average weekly value of the Trusts
Managed Assets.
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NOTE 4: |
FEDERAL INCOME TAXES |
The Trust intends to comply with the requirements of the
Internal Revenue Code applicable to regulated investment
companies and to distribute all of its taxable income, including
any net realized gain on investments, to its shareholders.
Therefore, no federal income tax provision is required.
F-5
APPENDIX A
RATINGS OF INVESTMENTS
Standard & Poors CorporationA brief
description of the applicable Standard & Poors
Corporation (S&P) rating symbols and their
meanings (as published by S&P) follows:
ISSUE CREDIT RATING DEFINITIONS
A Standard & Poors issue credit rating is a
current opinion of the creditworthiness of an obligor with
respect to a specific financial obligation, a specific class of
financial obligations, or a specific financial program
(including ratings on medium-term note programs and commercial
paper programs). It takes into consideration the
creditworthiness of guarantors, insurers, or other forms of
credit enhancement on the obligation and takes into account the
currency in which the obligation is denominated. The issue
credit rating is not a recommendation to purchase, sell, or hold
a financial obligation, inasmuch as it does not comment as to
market price or suitability for a particular investor.
Issue credit ratings are based on current information furnished
by the obligors or obtained by Standard & Poors
from other sources it considers reliable. Standard &
Poors does not perform an audit in connection with any
credit rating and may, on occasion, rely on unaudited financial
information. Credit ratings may be changed, suspended, or
withdrawn as a result of changes in, or unavailability of, such
information, or based on other circumstances.
Issue credit ratings can be either long-term or short-term.
Short-term ratings are generally assigned to those obligations
considered short-term in the relevant market. In the U.S., for
example, that means obligations with an original maturity of no
more than 365 days, including commercial paper, are
considered short-term. Short-term ratings are also used to
indicate the creditworthiness of an obligor with respect to put
features on long-term obligations. The result is a dual rating,
in which the short-term rating addresses the put feature, in
addition to the usual long-term rating. Medium-term notes are
assigned long-term ratings.
Long-Term Issue Credit Ratings
Issue credit ratings are based, in varying degrees, on the
following considerations:
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Likelihood of paymentcapacity and willingness of the
obligor to meet its financial commitment on an obligation in
accordance with the terms of the obligation; |
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Nature of and provisions of the obligation; and |
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Protection afforded by, and relative position of, the obligation
in the event of bankruptcy, reorganization, or other arrangement
under the laws of bankruptcy and other laws affecting
creditors rights. |
The issue rating definitions are expressed in terms of default
risk. As such, they pertain to senior obligations of an entity.
Junior obligations are typically rated lower than senior
obligations, to reflect the lower priority in bankruptcy, as
noted above. (Such differentiation applies when an entity has
both senior and subordinated obligations, secured and unsecured
obligations, or operating company and holding company
obligations.) Accordingly, in the case of junior debt, the
rating may not conform exactly with the category definition.
An obligation rated AAA has the highest rating
assigned by Standard & Poors. The obligors
capacity to meet its financial commitment on the obligation is
extremely strong.
An obligation rated AA differs from the
highest-rated obligations only to a small degree. The
obligors capacity to meet its financial commitment on the
obligation is very strong.
A-1
An obligation rated A is somewhat more susceptible
to the adverse effects of changes in circumstances and economic
conditions than obligations in higher-rated categories. However,
the obligors capacity to meet its financial commitment on
the obligation is still strong.
An obligation rated BBB exhibits adequate protection
parameters. However, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity of
the obligor to meet its financial commitment on the obligation.
Obligations rated BB, B,
CCC, CC, and C are regarded
as having significant speculative characteristics.
BB indicates the least degree of speculation and
C the highest. While such obligations will likely
have some quality and protective characteristics, these may be
outweighed by large uncertainties or major exposures to adverse
conditions.
An obligation rated BB is less vulnerable to
nonpayment than other speculative issues. However, it faces
major ongoing uncertainties or exposure to adverse business,
financial, or economic conditions which could lead to the
obligors inadequate capacity to meet its financial
commitment on the obligation.
An obligation rated B is more vulnerable to
nonpayment than obligations rated BB, but the
obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial, or
economic conditions will likely impair the obligors
capacity or willingness to meet its financial commitment on the
obligation.
An obligation rated CCC is currently vulnerable to
nonpayment, and is dependent upon favorable business, financial,
and economic conditions for the obligor to meet its financial
commitment on the obligation. In the event of adverse business,
financial, or economic conditions, the obligor is not likely to
have the capacity to meet its financial commitment on the
obligation.
An obligation rated CC is currently highly
vulnerable to nonpayment.
A subordinated debt or preferred stock obligation rated
C is currently highly vulnerable to nonpayment. The
C rating may be used to cover a situation where a
bankruptcy petition has been filed or similar action taken, but
payments on this obligation are being continued. A C
also will be assigned to a preferred stock issue in arrears on
dividends or sinking fund payments, but that is currently paying.
An obligation rated D is in payment default. The
D rating category is used when payments on an
obligation are not made on the date due even if the applicable
grace period has not expired, unless Standard &
Poors believes that such payments will be made during such
grace period. The D rating also will be used upon
the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized.
A-2
The ratings from AA to CCC may be
modified by the addition of a plus (+) or minus (-) sign to show
relative standing within the major rating categories.
This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that
Standard & Poors does not rate a particular
obligation as a matter of policy.
Short-Term Issue Credit Ratings
A short-term obligation rated
A-1 is
rated in the highest category by Standard &
Poors. The obligors capacity to meet its financial
commitment on the obligation is strong. Within this category,
certain obligations are designated with a plus sign (+). This
indicates that the obligors capacity to meet its financial
commitment on these obligations is extremely strong.
A short-term obligation rated
A-2 is
somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than obligations in higher
rating categories. However, the obligors capacity to meet
its financial commitment on the obligation is satisfactory.
A short-term obligation rated
A-3
exhibits adequate protection parameters. However, adverse
economic conditions or changing circumstances are more likely to
lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
A short-term obligation rated B is regarded as
having significant speculative characteristics. Ratings of
B-1,
B-2, and
B-3 may be
assigned to indicate finer distinctions within the B
category. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major
ongoing uncertainties which could lead to the obligors
inadequate capacity to meet its financial commitment on the
obligation.
A short-term obligation rated
B-1 is
regarded as having significant speculative characteristics, but
the obligor has a relatively stronger capacity to meet its
financial commitments over the short-term compared to other
speculative-grade obligors.
A short-term obligation rated
B-2 is
regarded as having significant speculative characteristics, and
the obligor has an average speculative-grade capacity to meet
its financial commitments over the short-term compared to other
speculative-grade obligors.
A short-term obligation rated
B-3 is
regarded as having significant speculative characteristics, and
the obligor has a relatively weaker capacity to meet its
financial commitments over the short-term compared to other
speculative-grade obligors.
A-3
A short-term obligation rated C is currently
vulnerable to nonpayment and is dependent upon favorable
business, financial, and economic conditions for the obligor to
meet its financial commitment on the obligation.
A short-term obligation rated D is in payment
default. The D rating category is used when payments
on an obligation are not made on the date due even if the
applicable grace period has not expired, unless
Standard & Poors believes that such payments will
be made during such grace period. The D rating also
will be used upon the filing of a bankruptcy petition or the
taking of a similar action if payments on an obligation are
jeopardized.
Active Qualifiers (Currently applied and/or outstanding)
This subscript is used for issues in which the credit factors,
terms, or both, that determine the likelihood of receipt of
payment of interest are different from the credit factors, terms
or both that determine the likelihood of receipt of principal on
the obligation. The i subscript indicates that the
rating addresses the interest portion of the obligation only.
The i subscript will always be used in conjunction
with the p subscript, which addresses likelihood of
receipt of principal. For example, a rated obligation could be
assigned ratings of AAAp NRi indicating that the
principal portion is rated AAA and the interest
portion of the obligation is not rated.
Ratings qualified with L apply only to amounts
invested up to federal deposit insurance limits.
This subscript is used for issues in which the credit factors,
the terms, or both, that determine the likelihood of receipt of
payment of principal are different from the credit factors,
terms or both that determine the likelihood of receipt of
interest on the obligation. The p subscript
indicates that the rating addresses the principal portion of the
obligation only. The p subscript will always be used
in conjunction with the i subscript, which addresses
likelihood of receipt of interest. For example, a rated
obligation could be assigned ratings of AAAp N.R.i
indicating that the principal portion is rated AAA
and the interest portion of the obligation is not rated.
Ratings with a pi subscript are based on an analysis
of an issuers published financial information, as well as
additional information in the public domain. They do not,
however, reflect in-depth meetings with an issuers
management and are therefore based on less comprehensive
information than ratings without a pi subscript.
Ratings with a pi subscript are reviewed annually
based on a new years financial statements, but may be
reviewed on an interim basis if a major event occurs that may
affect the issuers credit quality.
The letters pr indicate that the rating is
provisional. A provisional rating assumes the successful
completion of the project financed by the debt being rated and
indicates that payment of debt service requirements is largely
or entirely dependent upon the successful, timely completion of
the project. This rating, however, while addressing credit
quality subsequent to completion of the project, makes no
comment on the likelihood of or the risk of default upon failure
of such completion. The investor should exercise his own
judgment with respect to such likelihood and risk.
A-4
Preliminary
Preliminary ratings are assigned to issues, including financial
programs, in the following circumstances.
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Preliminary ratings may be assigned to obligations, most
commonly structured and project finance issues, pending receipt
of final documentation and legal opinions. Assignment of a final
rating is conditional on the receipt and approval by
Standard & Poors of appropriate documentation.
Changes in the information provided to Standard &
Poors could result in the assignment of a different
rating. In addition, Standard & Poor s reserves
the right not to issue a final rating. |
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Preliminary ratings are assigned to Rule 415 Shelf
Registrations. As specific issues, with defined terms, are
offered from the master registration, a final rating may be
assigned to them in accordance with Standard &
Poors policies. The final rating may differ from the
preliminary rating. |
This symbol indicates termination structures that are designed
to honor their contracts to full maturity or, should certain
events occur, to terminate and cash settle all their contracts
before their final maturity date.
Inactive Qualifiers (No longer applied or outstanding)
This symbol indicated continuance of the ratings is contingent
upon Standard & Poor s receipt of an executed
copy of the escrow agreement or closing documentation confirming
investments and cash flows. Discontinued use in August 1998.
This qualifier was used to provide additional information to
investors that the bank may terminate its obligation to purchase
tendered bonds if the long-term credit rating of the issuer is
below an investment-grade level and/or the issuers bonds
are deemed taxable. Discontinued use in January 2001.
A q subscript indicates that the rating is based
solely on quantitative analysis of publicly available
information. Discontinued use in April 2001.
The r modifier was assigned to securities containing
extraordinary risks, particularly market risks, that are not
covered in the credit rating. The absence of an r
modifier should not be taken as an indication that an obligation
will not exhibit extraordinary non-credit related risks.
Standard & Poors discontinued the use of the
r modifier for most obligations in June 2000 and for
the balance of obligations (mainly structured finance
transactions) in November 2002.
Moodys Investors Service, Inc. A brief
description of the applicable Moodys Investors Service,
Inc. (Moodys) rating symbols and their
meanings (as published by Moodys) follows:
Long-Term Obligation Ratings
Moodys long-term obligation ratings are opinions of the
relative credit risk of a fixed income obligations with an
original maturity of one year or more. They address the
possibility that a financial obligation will not be honored as
promised. Such ratings reflect both the likelihood of default
and any financial loss suffered in the event of default.
A-5
Moodys Long-Term Rating Definitions:
Obligations rated Aaa are judged to be of the highest quality,
with minimal credit risk.
Obligations rated Aa are judged to be of high quality and are
subject to very low credit risk.
Obligations rated A are considered upper medium-grade and are
subject to low credit risk.
Obligations rated Baa are subject to moderate credit risk. They
are considered medium-grade and as such may possess certain
speculative characteristics.
Obligations rated Ba are judged to have speculative elements and
are subject to substantial credit risk.
Obligations rated B are considered speculative and are subject
to high credit risk.
Obligations rated Caa are judged to be of poor standing and are
subject to very high credit risk.
Obligations rated Ca are highly speculative and are likely in,
or very near, default, with some prospect of recovery of
principal and interest.
Obligations rated C are the lowest rated class of bonds and are
typically in default, with little prospect for recovery of
principal or interest.
Note: Moodys appends numerical modifiers 1, 2,
and 3 to each generic rating classification from Aa through Caa.
The modifier 1 indicates that the obligation ranks in the higher
end of its generic rating category; the modifier 2 indicates a
mid-range ranking; and the modifier 3 indicates a ranking in the
lower end of that generic rating category.
Medium-Term Note Ratings
Moodys assigns long-term ratings to individual debt
securities issued from medium-term note (MTN) programs, in
addition to indicating ratings to MTN programs themselves. Notes
issued under MTN programs with such indicated ratings are rated
at issuance at the rating applicable to all parí passu
notes issued under the same program, at the programs
relevant indicated rating, provided such notes do not exhibit
any of the characteristics listed below:
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Notes containing features that link interest or principal to the
credit performance of any third party or parties (i.e.,
credit-linked notes); |
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Notes allowing for negative coupons, or negative principal |
A-6
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Notes containing any provision that could obligate the investor
to make any additional payments |
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Notes containing provisions that subordinate the claim. |
For notes with any of these characteristics, the rating of the
individual note may differ from the indicated rating of the
program.
For credit-linked securities, Moodys policy is to
look through to the credit risk of the underlying
obligor. Moodys policy with respect to non-credit linked
obligations is to rate the issuers ability to meet the
contract as stated, regardless of potential losses to investors
as a result of non-credit developments. In other words, as long
as the obligation has debt standing in the event of bankruptcy,
we will assign the appropriate debt class level rating to the
instrument.
Market participants must determine whether any particular note
is rated, and if so, at what rating level. Moodys
encourages market participants to contact Moodys Ratings
Desks or visit www.moodys.com directly if they have questions
regarding ratings for specific notes issued under a medium-term
note program. Unrated notes issued under an MTN program may be
assigned an NR (not rated) symbol.
Short-Term Ratings:
Moodys short-term ratings are opinions of the ability of
issuers to honor short-term financial obligations. Ratings may
be assigned to issuers, short-term programs or to individual
short-term debt instruments. Such obligations generally have an
original maturity not exceeding thirteen months, unless
explicitly noted.
Moodys employs the following designations to indicate the
relative repayment ability of rated issuers:
Issuers (or supporting institutions) rated
Prime-1 have a superior
ability to repay short-term debt obligations.
Issuers (or supporting institutions) rated Prime-2 have a strong
ability to repay short-term debt obligations.
Issuers (or supporting institutions) rated Prime-3 have an
acceptable ability to repay short-term obligations.
Issuers (or supporting institutions) rated Not Prime do not fall
within any of the Prime rating categories.
Note: Canadian issuers rated P-1 or P-2 have their
short-term ratings enhanced by the senior most long-term rating
of the issuer, its guarantor or support provider.
A-7
APPENDIX B
PROXY VOTING POLICIES AND PROCEDURES
HIGHLAND CAPITAL MANAGEMENT, L.P.
1. Application; General Principles
1.1 These guidelines apply to securities held in Client accounts
as to which the above-captioned investment adviser (the
Company) has voting authority, directly or
indirectly. Indirect voting authority exists where the
Companys voting authority is implied by a general
delegation of investment authority without reservation of proxy
voting authority.
1.2 The Company shall vote proxies in respect of securities
owned by or on behalf of a Client in the Clients best
economic interests and without regard to the interests of the
Company or any other Client of the Company.
2. Voting; Procedures
2.1 To provide centralized management of the proxy voting
process, the Company shall establish a Proxy Voting Committee.
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2.1.1 The Proxy Voting Committee shall be comprised of at least
the following persons: one or more portfolio managers and one or
more representatives of the legal/compliance area. |
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2.1.2 The Proxy Voting Committee shall: |
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supervise the proxy voting process, including the identification
of material conflicts of interest involving the Company and the
proxy voting process in respect of securities owned by or on
behalf of such Clients; |
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determine how to vote proxies relating to issues not covered by
these guidelines; and |
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determine when the Company may deviate from these guidelines. |
2.2 Unless the Proxy Voting Committee otherwise determines (and
documents the basis for its decision) or as otherwise provided
below, the Proxy Voting Committee shall cause proxies to be
voted in a manner consistent with the proxy voting guidelines
attached as Appendix A hereto (the Guidelines).
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2.2.1 Where a material conflict of interest has been identified
and the matter is covered by the Guidelines, the Proxy Voting
Committee shall cause proxies to be voted in accordance with the
Guidelines. |
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2.2.2 For Clients that are registered investment companies
(Funds), where a material conflict of interest has
been identified and the matter is not covered by the Guidelines,
the Company shall disclose the conflict and the Proxy Voting
Committees determination of the manner in which to vote to
the Funds Board of Directors. The Proxy Voting
Committees determination shall take into account only the
interests of the Fund, and the Proxy Voting Committee shall
document the basis for the decision and furnish the
documentation to the Board of Directors. |
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2.2.3 For Clients other than Funds, where a material conflict of
interest has been identified and the matter is not covered by
the Guidelines, the Proxy Voting Committee shall disclose the
conflict to the Client and advise the Client that its securities
will be voted only upon the Clients written direction. |
2.3 The Company may determine not to vote proxies in respect of
securities of any issuer if it determines it would be in its
Clients overall best interests not to vote. Such
determination may apply in respect of all Client holdings of the
securities or only certain specified Clients, as the Company
deems appropriate under the circumstances. As examples, the
Proxy Voting Committee may determine: (a) not to recall
securities on loan if, in its judgment, the negative
consequences to Clients of disrupting the securities lending
program would outweigh the benefits of voting in the particular
instance or (b) not to vote certain foreign securities
positions
B-1
if, in its judgment, the expense and administrative
inconvenience outweighs the benefits to Clients of voting the
securities.
2.4 The Companys Covered Persons (as defined
in the Funds and the Companys Policies and
Procedures Designed to Detect and Prevent Insider Trading and to
Comply with Rule 17j-1 of the Investment Company Act of
1940, as amended (each, a Code of Ethics)) will not
vote proxies in respect of securities in which such Covered
Persons (and certain other persons as described in the Code of
Ethics) have a beneficial interest contrary to the
Companys votes on behalf of Clients.
3. Conflicts of Interest
3.1 Voting the securities of an issuer where the following
relationships or circumstances exist are deemed to give rise to
a material conflict of interest for purposes of these Guidelines:
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3.1.1 The issuer is a Client of the Company accounting for more
than 5% of the Companys annual revenues. |
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3.1.2 The issuer is an entity that reasonably could be expected
to pay the Company more than $1 million through the end of
the Companys next two full fiscal years. |
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3.1.3 The issuer is an entity in which an officer or director of
the Company or a
relative1
of any such person is or was an officer, director or employee,
or such person or relative otherwise has received more than
$150,000 in fees, compensation and other payment from the issuer
during the Companys last three fiscal years. |
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3.1.4 The matter under consideration could reasonably be
expected to result in a financial benefit to the Company of at
least $1 million through the end of the Companys next
two full fiscal years (for example, a vote to increase an
investment advisory fee for a mutual fund advised by the Company
or an affiliate). |
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3.1.5 Another Client or prospective Client of the Company,
directly or indirectly, conditions future engagement of the
Company on voting proxies in respect of any Clients
securities on a particular matter in a particular way. |
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3.1.6 Any other circumstance where the Companys duty to
serve its Clients interests, typically referred to as its
duty of loyalty, could be compromised. |
3.2 Notwithstanding the foregoing, a conflict of interest
described in Section 3.1 shall not be considered material
for the purposes of these Guidelines in respect of a specific
vote or circumstance if:
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3.2.1 The securities in respect of which the Company has the
power to vote account for less than 1% of the issuers
outstanding voting securities, but only if: (i) such
securities do not represent one of the 10 largest holdings of
such issuers outstanding voting securities and
(ii) such securities do not represent more than 2% of the
Clients holdings with the Company. |
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3.2.2 The matter to be voted on relates to a restructuring of
the terms of existing securities or the issuance of new
securities or a similar matter arising out of the holding of
securities, other than common equity, in the context of a
bankruptcy or threatened bankruptcy of the issuer. |
4. Recordkeeping and Retention
4.1 The Company shall retain records relating to the voting of
proxies, including:
|
|
|
4.1.1 Copies of these Guidelines and any amendments thereto. |
|
|
4.1.2 A copy of each proxy statement that the Company receives
regarding Client securities. |
|
|
4.1.3 Records of each vote cast by the Company on behalf of
Clients. |
|
|
1 |
For the purposes of these Guidelines, relative
includes the following family members: spouse, minor children or
stepchildren or children or stepchildren |
sharing the persons home.
B-2
|
|
|
4.1.4 A copy of any documents created by the Company that were
material to making a decision how to vote or that memorializes
the basis for that decision. |
|
|
4.1.5 A copy of each written request for information on how the
Company voted proxies on behalf of the Client, and a copy of any
written response by the Company to any (oral or written) request
for information on how the Company voted. |
4.2 These records shall be maintained and preserved in an easily
accessible place for a period of not less than five years from
the end of the Companys fiscal year during which the last
entry was made in the records, the first two years in an
appropriate office of the Company.
4.3 The Company may rely on proxy statements filed on the
SECs EDGAR system or on proxy statements and records of
votes cast by the Company maintained by a third party, such as a
proxy voting service (provided the Company had obtained an
undertaking from the third party to provide a copy of the proxy
statement or record promptly on request).
Revised: September 30, 2004
B-3
APPENDIX A TO THE PROXY VOTING
POLICIES AND PROCEDURES
PROPOSAL GUIDELINE
1. DIRECTOR RELATED ISSUES
|
|
|
Majority of Independent Directors: |
|
Vote for shareholder proposals that request that the
board be comprised of a majority of independent directors. |
|
Independent Committees: |
|
Vote for shareholder proposals that request that the
board audit, compensation and/or nominating committees include
independent directors exclusively. |
|
Adopt Director Term Limits: |
|
Vote against shareholder proposals to limit the tenure of
independent directors. |
|
Uncontested Election of Directors: |
|
Votes on individual director nominees are made on a
case-by-case basis. |
|
Contested Election of Directors: |
|
Votes in a contested election of directors are evaluated on a
case-by-case basis. |
|
Classified Board: |
|
Vote for proposals to declassify the board of directors. |
|
Director and Officer Liability Protection: |
|
Vote against proposals to limit or eliminate entirely
director and officer liability for(i) a breach of the duty
of loyalty, (ii) acts or omissions not in good faith or
involving intentional misconduct or knowing violations of the
law, (iii) acts involving the unlawful purchases or
redemptions of stock, (iv) the receipt of improper personal
benefits. |
|
Director and Officer Indemnification: |
|
Vote against indemnification proposals that would expand
coverage beyond just legal expenses to acts, such as negligence,
that are more serious violations of fiduciary obligations than
mere carelessness. |
|
Alter Size of the Board: |
|
Vote for proposals that seek to fix the size of the board. |
|
|
|
Vote case-by-case on proposals that seek to change the
size or range of the board. |
|
|
|
Vote against proposals that give management the ability
to alter the size of the board without shareholder approval. |
2. AUDITORS
|
|
|
Elect Auditors/ Ensure Auditor Independence: |
|
Vote for proposals that would allow shareholders to elect
the auditors. |
|
Ratification of Auditors: |
|
Vote for proposals to ratify auditors, unless there is
reason to believe that the independent auditor has rendered an
opinion that is neither accurate nor indicative of the
companys financial position. |
3. EXECUTIVE AND DIRECTOR COMPENSATION
|
|
|
Increase Disclosure of Executive Compensation: |
|
Vote for shareholder proposals seeking increased
disclosure on executive compensation (such as the preparation of
a formal report on executive compensation practices and
policies). |
B-4
|
|
|
Performance-Based Options/ Indexed Options: |
|
Vote for shareholder proposals to link executive pay to
performance, including the use of indexed options and other
indicators. |
|
Stock-Based Incentive Plans |
|
Votes with respect to compensation plans should be determined on
a case-by-case basis. |
|
Outside Director Stock Awards/ Options in Lieu of Cash: |
|
Vote case-by-case on proposals that seek to pay outside
directors a portion of their compensation in stock rather than
cash. |
4. CAPITAL STRUCTURE
|
|
|
Common Stock Authorization: |
|
Review on a case-by-case basis proposals to increase the
number of shares of common stock authorized for issue. |
|
Reverse Stock Splits: |
|
Review on a case-by-case basis management proposals to
implement a reverse stock split. We will generally vote for a
reverse stock split if management provides a reasonable
justification for the split. |
|
Share Repurchase Programs: |
|
Vote for management proposals to institute open-market
share repurchase plans in which all shareholders may participate
on equal terms. |
|
Blank Check Preferred Authorization: |
|
Vote against most proposals to create blank check
preferred stock. |
5. VOTING STRUCTURE
|
|
|
Adopt Cumulative Voting: |
|
Vote case-by-case on shareholder proposals to permit
cumulative voting. Vote for shareholder proposals to
adopt cumulative voting at companies with no women or minority
members on the board. |
|
Reduce Supermajority Vote Requirements: |
|
Vote for proposals to lower supermajority shareholder
vote requirements for charter and bylaw amendments. |
|
|
|
Vote for proposals to lower supermajority vote
requirements for mergers and other significant business
combinations. |
6. MERGER AND CORPORATE RESTRUCTURINGS
|
|
|
Mergers and Acquisitions: |
|
Votes on mergers and acquisitions are considered on a
case-by-case basis. |
|
Corporate Restructuring: |
|
Votes on corporate restructuring proposals, including minority
squeeze-outs, leveraged buyouts, spin-offs, liquidations, and
asset sales, are considered on a case-by-case basis. |
|
Spin-offs: |
|
Votes on spin-offs are considered on a case-by-case basis
with consideration toward the tax and regulatory advantages,
planned use of sale proceeds, market focus, and managerial
incentives. |
|
Voting on Reincorporation Proposals: |
|
Proposals to change a companys state of incorporation are
examined on a case-by-case basis by reviewing
managements rationale for the proposal, changes to the
charter/bylaws, and differences in the state laws governing the
corporations. |
B-5
7. PROXY CONTEST DEFENSES/ TAKEOVER DEFENSES
|
|
|
Shareholder Ability to Call Special Meetings: |
|
Vote against proposals to restrict or prohibit
shareholder ability to call special meetings. |
|
Shareholder Ability to Act by Written Consent: |
|
Vote against proposals to restrict or prohibit
shareholder ability to take action by written consent. |
|
Remove Anti-takeover Provisions: |
|
Vote for shareholder proposals that seek to remove
anti-takeover provisions. |
8. SOCIAL RESPONSIBILITY ISSUES
|
|
|
Social Responsibility Issues: |
|
Vote on social responsibility issues on a case-by-case
basis, but attempt to ensure that management reasonably responds
to social issues where economic performance does not appear to
be an issue. |
B-6
Part C
Other Information
|
|
Item 25. |
Financial Statements And Exhibits |
Financial Statements
Part A None.
Part B Report of Independent Registered
Accounting Firm, Statement of Assets and Liabilities, Statement
of Operations and Statement of Changes in Net Assets and Notes
to Financial Statements.
|
|
|
|
|
EXHIBITS |
|
|
|
|
|
|
(a) |
|
|
Agreement and Declaration of Trust(1) |
|
(b) |
|
|
By-Laws(1) |
|
(c) |
|
|
Not applicable |
|
(d) |
|
|
Form of Specimen Certificate(1) |
|
(e) |
|
|
Form of Dividend Reinvestment Plan(1) |
|
(f) |
|
|
Not applicable |
|
(g) |
|
|
Form of Investment Advisory Agreement(1) |
|
(h) |
|
|
Form of Underwriting Agreement(1) |
|
(i) |
|
|
Not applicable |
|
(j) |
|
|
Form of Custodian Services Agreement(1) |
|
(k)(1) |
|
|
Form of Transfer Agency Services Agreement(1) |
|
(k)(2) |
|
|
Form of Administration Services Agreement(1) |
|
(k)(3) |
|
|
Form of Sub-Administration Services Agreement(1) |
|
(k)(4) |
|
|
Form of Accounting Services Agreement(1) |
|
(k)(5) |
|
|
Form of Marketing and Structuring Fee Agreement(1) |
|
(l) |
|
|
Opinion and Consent of Counsel to the Trust(2) |
|
(m) |
|
|
Not applicable |
|
(n) |
|
|
Independent Registered Public Accounting Firm Consent(2) |
|
(o) |
|
|
Not applicable |
|
(p) |
|
|
Subscription Agreement(1) |
|
(q) |
|
|
Not applicable |
|
(r)(1) |
|
|
Code of Ethics of the Trust(1) |
|
(r)(2) |
|
|
Code of Ethics of the Investment Adviser(1) |
|
(s) |
|
|
Powers of Attorney(1) |
|
|
(1) |
Previously filed. |
|
(2) |
Filed herewith. |
|
|
Item 26. |
Marketing Arrangements |
Reference is made to the Form of Underwriting Agreement for the
Registrants shares of beneficial interest filed herewith
to this Registration Statement.
C-1
|
|
Item 27. |
Other Expenses Of Issuance And Distribution |
The following table sets forth the estimated expenses to be
incurred in connection with the offering described in this
registration statement:
|
|
|
|
|
SEC registration and filing fees
|
|
$ |
74,900 |
|
NYSE listing fee
|
|
$ |
40,000 |
|
Printing (other than certificates)
|
|
$ |
436,000 |
|
Engraving and printing certificates
|
|
$ |
18,000 |
|
Accounting fees and expenses related to the offering
|
|
$ |
7,500 |
|
Legal fees and expenses related to the offering
|
|
$ |
580,000 |
|
NASD fee
|
|
$ |
70,500 |
|
Miscellaneous (i.e. travel) related to the offering
|
|
$ |
200,000 |
|
|
|
|
|
Total
|
|
$ |
1,426,900 |
|
|
|
|
|
Highland has agreed to pay (i) the Trusts
organizational expenses and (ii) the offering expenses
(other than the sales load and the expenses of the Preferred
Share offering which is expected to occur soon after the
completion of this offering) that exceed $0.04 per common share.
|
|
Item 28. |
Persons Controlled By Or under Common Control With The
Registrant |
None.
|
|
Item 29. |
Number Of Holders Of Shares |
As of June 20, 2006
|
|
|
|
|
|
|
Number Of | |
Title Of Class |
|
Record Holders | |
|
|
| |
Shares of Beneficial Interest
|
|
|
1 |
|
Article V of the Registrants Agreement and
Declaration of Trust provides as follows:
|
|
|
5.1 No Personal Liability of Shareholders, Trustees,
etc. No Shareholder of the Trust shall be subject in such
capacity to any personal liability whatsoever to any Person in
connection with Trust Property or the acts, obligations or
affairs of the Trust. Shareholders shall have the same
limitation of personal liability as is extended to stockholders
of a private corporation for profit incorporated under the
Delaware General Corporation Law. No trustee or officer of the
Trust shall be subject in such capacity to any personal
liability whatsoever to any Person, save only liability to the
Trust or its Shareholders arising from bad faith, willful
misfeasance, gross negligence or reckless disregard for his duty
to such Person; and, subject to the foregoing exception, all
such Persons shall look solely to the Trust Property for
satisfaction of claims of any nature arising in connection with
the affairs of the Trust. If any Shareholder, trustee or
officer, as such, of the Trust, is made a party to any suit or
proceeding to enforce any such liability, subject to the
foregoing exception, he shall not, on account thereof, be held
to any personal liability. Any repeal or modification of this
Section 5.1 shall not adversely affect any right or
protection of a trustee or officer of the Trust existing at the
time of such repeal or modification with respect to acts or
omissions occurring prior to such repeal or modification. |
|
|
5.2 Mandatory Indemnification. (a) The Trust
hereby agrees to indemnify each person who at any time serves as
a trustee or officer of the Trust (each such person being an
indemnitee) against any liabilities and expenses,
including amounts paid in satisfaction of judgments, in
compromise or as fines and penalties, and reasonable counsel
fees reasonably incurred by such indemnitee in connection with
the defense or disposition of any action, suit or other
proceeding, whether civil or criminal, before any court |
C-2
|
|
|
or administrative or investigative body in which he may be or
may have been involved as a party or otherwise or with which he
may be or may have been threatened, while acting in any capacity
set forth in this Article V by reason of his having acted
in any such capacity, except with respect to any matter as to
which he shall not have acted in good faith in the reasonable
belief that his action was in the best interest of the Trust or,
in the case of any criminal proceeding, as to which he shall
have had reasonable cause to believe that the conduct was
unlawful, provided, however, that no indemnitee shall be
indemnified hereunder against any liability to any person or any
expense of such indemnitee arising by reason of (i) willful
misfeasance, (ii) bad faith, (iii) gross negligence,
or (iv) reckless disregard of the duties involved in the
conduct of his position (the conduct referred to in such
clauses (i) through (iv) being sometimes referred to
herein as disabling conduct). Notwithstanding the
foregoing, with respect to any action, suit or other proceeding
voluntarily prosecuted by any indemnitee as plaintiff,
indemnification shall be mandatory only if the prosecution of
such action, suit or other proceeding by such indemnitee
(1) was authorized by a majority of the trustees or
(2) was instituted by the indemnitee to enforce his or her
rights to indemnification hereunder in a case in which the
indemnitee is found to be entitled to such indemnification. The
rights to indemnification set forth in this Declaration shall
continue as to a person who has ceased to be a trustee or
officer of the Trust and shall inure to the benefit of his or
her heirs, executors and personal and legal representatives. No
amendment or restatement of this Declaration or repeal of any of
its provisions shall limit or eliminate any of the benefits
provided to any person who at any time is or was a trustee or
officer of the Trust or otherwise entitled to indemnification
hereunder in respect of any act or omission that occurred prior
to such amendment, restatement or repeal. |
|
|
(b) Notwithstanding the foregoing, no indemnification shall
be made hereunder unless there has been a determination
(i) by a final decision on the merits by a court or other
body of competent jurisdiction before whom the issue of
entitlement to indemnification hereunder was brought that such
indemnitee is entitled to indemnification hereunder or,
(ii) in the absence of such a decision, by (1) a
majority vote of a quorum of those trustees who are neither
interested persons of the Trust (as defined in
Section 2(a)(19) of the Investment Company Act) nor parties
to the proceeding (Disinterested Non-Party
Trustees), that the indemnitee is entitled to
indemnification hereunder, or (2) if such quorum is not
obtainable or even if obtainable, if such majority so directs,
independent legal counsel in a written opinion concludes that
the indemnitee should be entitled to indemnification hereunder.
All determinations to make advance payments in connection with
the expense of defending any proceeding shall be authorized and
made in accordance with the immediately succeeding
paragraph (c) below. |
|
|
(c) The Trust shall make advance payments in connection
with the expenses of defending any action with respect to which
indemnification might be sought hereunder if the Trust receives
a written affirmation by the indemnitee of the indemnitees
good faith belief that the standards of conduct necessary for
indemnification have been met and a written undertaking to
reimburse the Trust unless it is subsequently determined that
the indemnitee is entitled to such indemnification and if a
majority of the trustees determine that the applicable standards
of conduct necessary for indemnification appear to have been
met. In addition, at least one of the following conditions must
be met: (i) the indemnitee shall provide adequate security
for his undertaking, (ii) the Trust shall be insured
against losses arising by reason of any lawful advances, or
(iii) a majority of a quorum of the Disinterested Non-Party
Trustees, or if a majority vote of such quorum so direct,
independent legal counsel in a written opinion, shall conclude,
based on a review of readily available facts (as opposed to a
full trial-type inquiry), that there is substantial reason to
believe that the indemnitee ultimately will be found entitled to
indemnification. |
|
|
(d) The rights accruing to any indemnitee under these
provisions shall not exclude any other right which any person
may have or hereafter acquire under this Declaration, the
By-Laws of the Trust, any statute, agreement, vote of
stockholders or trustees who are disinterested
persons (as defined in Section 2(a)(19) of the
Investment Company Act) or any other right to which he or she
may be lawfully entitled. |
|
|
(e) Subject to any limitations provided by the Investment
Company Act and this Declaration, the Trust shall have the power
and authority to indemnify and provide for the advance payment
of expenses to employees, agents and other Persons providing
services to the Trust or serving in any capacity at the |
C-3
|
|
|
request of the Trust to the full extent corporations organized
under the Delaware General Corporation Law may indemnify or
provide for the advance payment of expenses for such Persons,
provided that such indemnification has been approved by a
majority of the trustees. |
|
|
5.3 No Bond Required of Trustees. No trustee shall,
as such, be obligated to give any bond or other security for the
performance of any of his duties hereunder. |
|
|
5.4 No Duty of Investigation; Notice in Trust
Instruments, etc. No purchaser, lender, transfer agent or
other person dealing with the trustees or with any officer,
employee or agent of the Trust shall be bound to make any
inquiry concerning the validity of any transaction purporting to
be made by the trustees or by said officer, employee or agent or
be liable for the application of money or property paid, loaned,
or delivered to or on the order of the trustees or of said
officer, employee or agent. Every obligation, contract,
undertaking, instrument, certificate, Share, other security of
the Trust, and every other act or thing whatsoever executed in
connection with the Trust shall be conclusively taken to have
been executed or done by the executors thereof only in their
capacity as trustees under this Declaration or in their capacity
as officers, employees or agents of the Trust. The trustees may
maintain insurance for the protection of the Trust Property, its
Shareholders, trustees, officers, employees and agents in such
amount as the trustees shall deem adequate to cover possible
tort liability, and such other insurance as the trustees in
their sole judgment shall deem advisable or is required by the
Investment Company Act. |
|
|
5.5 Reliance on Experts, etc. Each trustee and
officer or employee of the Trust shall, in the performance of
its duties, be fully and completely justified and protected with
regard to any act or any failure to act resulting from reliance
in good faith upon the books of account or other records of the
Trust, upon an opinion of counsel, or upon reports made to the
Trust by any of the Trusts officers or employees or by any
advisor, administrator, manager, distributor, selected dealer,
accountant, appraiser or other expert or consultant selected
with reasonable care by the trustees, officers or employees of
the Trust, regardless of whether such counsel or expert may also
be a trustee. |
|
|
Insofar as indemnification for liabilities arising under the
Securities Act of 1933, may be permitted to trustees, officers
and controlling persons of the Trust, pursuant to the foregoing
provisions or otherwise, the Trust has been advised that in the
opinion of the Commission such indemnification is against public
policy as expressed in the Securities Act of 1933 and is,
therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment
by the Trust of expenses incurred or paid by a trustee, officer
or controlling person of the Trust in the successful defense of
any action, suit or proceeding) is asserted by such trustee,
officer or controlling person in connection with the securities
being registered, the Trust will, unless in the opinion of its
counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question
whether such indemnification by it is against public policy as
expressed in the Securities Act of 1933 and will be governed by
the final adjudication of such issue. Reference is made to
Section 8 of the underwriting agreement attached as
Exhibit (h), which is incorporated herein by reference and
discusses the rights, responsibilities and limitations with
respect to indemnity and contribution. |
|
|
Item 31. |
Business And Other Connections Of Investment
Advisor |
Highland Capital Management, L.P. has not engaged in any other
substantial business since January 1, 2003 other than that
disclosed under Management of the Trust in each of
the prospectus and the Statement of Additional Information.
Information as to other businesses, professions, vocations or
employment of a substantial nature engaged in by each partner
and executive officer of Highland Capital Management, L.P. is
set forth in its Form ADV, as filed on the Commissions
website (File
No. 801-54874) and
is incorporated herein by reference.
|
|
Item 32. |
Location Of Accounts And Records |
The Trusts accounts, books and other documents are
currently located at the offices of the Registrant,
c/o Highland Capital Management, L.P., Two Galleria Tower,
13455 Noel Road, Suite 800, Dallas, Texas 75240 and at
the offices of the Registrants Custodian and Transfer
Agent.
C-4
|
|
Item 33. |
Management Services |
Not Applicable.
(1) The Trust hereby undertakes to suspend the offering of
its units until it amends its prospectus if (a) subsequent
to the effective date of its Registration Statement, the net
asset value declines more than 10 percent from its net
asset value as of the effective date of the Registration
Statement or (b) the net asset value increases to an amount
greater than its net proceeds as stated in the prospectus.
(2) Not applicable.
(3) Not applicable.
(4) Not applicable.
(5) (a) For the purposes of determining any liability
under the Securities Act of 1933, the information omitted from
the form of prospectus filed as part of a registration statement
in reliance upon Rule 430A and contained in the form of
prospectus filed by the Registrant under Rule 497
(h) under the Securities Act of 1933 shall be deemed to be
part of the Registration Statement as of the time it was
declared effective.
(b) For the purpose of determining any liability under the
Securities Act of 1933, each post-effective amendment that
contains a form of prospectus shall be deemed to be a new
registration statement relating to the securities offered
therein, and the offering of the securities at that time shall
be deemed to be the initial bona fide offering thereof.
(6) The Registrant undertakes to send by first class mail
or other means designed to ensure equally prompt delivery within
two business days of receipt of a written or oral request, any
Statement of Additional Information.
C-5
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and
the Investment Company Act of 1940, the Registrant has duly
caused this Registration Statement to be signed on its behalf by
the undersigned, thereunto duly authorized, in the City of
Dallas, and State of Texas, on the 22nd day of June 2006.
|
|
|
/s/ James D. Dondero* |
|
|
|
James D. Dondero |
|
Chief Executive Officer and President |
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons
in the capacities set forth below on the 22nd day of June
2006.
|
|
|
|
|
Name |
|
Title |
|
|
|
|
/s/ R. Joseph Dougherty*
R.
Joseph Dougherty |
|
Trustee |
|
/s/ Timothy Hui*
Timothy
Hui |
|
Trustee |
|
/s/ Scott Kavanaugh*
Scott
Kavanaugh |
|
Trustee |
|
/s/ James Leary*
James
Leary |
|
Trustee |
|
/s/ Bryan Ward*
Bryan
Ward |
|
Trustee |
|
/s/ James D. Dondero*
James
D. Dondero |
|
Chief Executive Officer and President |
|
/s/ M. Jason Blackburn
M.
Jason Blackburn |
|
Chief Financial Officer
(Principal Accounting Officer), Treasurer and Secretary |
|
*By: |
|
/s/ M. Jason Blackburn
M.
Jason Blackburn
Attorney-in-Fact
June 22, 2006 |
|
|
C-6
INDEX TO EXHIBITS
|
|
|
|
|
EXHIBITS |
|
|
|
|
|
|
(a) |
|
|
Agreement and Declaration of Trust(1) |
|
(b) |
|
|
By-Laws(1) |
|
(c) |
|
|
Not applicable |
|
(d) |
|
|
Form of Specimen Certificate(1) |
|
(e) |
|
|
Form of Dividend Reinvestment Plan(1) |
|
(f) |
|
|
Not applicable |
|
(g) |
|
|
Form of Investment Advisory Agreement(1) |
|
(h) |
|
|
Form of Underwriting Agreement(1) |
|
(i) |
|
|
Not applicable |
|
(j) |
|
|
Form of Custodian Services Agreement(1) |
|
(k)(1) |
|
|
Form of Transfer Agency Services Agreement(1) |
|
(k)(2) |
|
|
Form of Administration Services Agreement(1) |
|
(k)(3) |
|
|
Form of Sub-Administration Services Agreement(1) |
|
(k)(4) |
|
|
Form of Accounting Services Agreement(1) |
|
(k)(5) |
|
|
Form of Marketing and Structuring Fee Agreement(1) |
|
(l) |
|
|
Opinion and Consent of Counsel to the Trust(2) |
|
(m) |
|
|
Not applicable |
|
(n) |
|
|
Independent Registered Public Accounting Firm Consent(2) |
|
(o) |
|
|
Not applicable |
|
(p) |
|
|
Subscription Agreement(1) |
|
(q) |
|
|
Not applicable |
|
(r)(1) |
|
|
Code of Ethics of the Trust(1) |
|
(r)(2) |
|
|
Code of Ethics of the Investment Adviser(1) |
|
(s) |
|
|
Powers of Attorney(1) |
|
|
(1) |
Previously filed. |
|
(2) |
Filed herewith. |