Prospect Street High Income Portfolio Inc.
Prospect Street Income Shares Inc.

Two Galleria Tower

13455 Noel Road, Suite 800

Dallas, Texas 75240

 

Joint Annual Meeting of Stockholders to be held June 6, 2008

 

April 23, 2008

 

Dear Stockholder:

 

You are being asked to vote on (1) a proposed reorganization of Prospect Street High Income Portfolio Inc. (“High Income Portfolio”) or Prospect Street Income Shares Inc. (“Income Shares”), as applicable (each an “Acquired Fund” and together as the “Acquired Funds”), into Highland Credit Strategies Fund (“Acquiring Fund”) (collectively, the Acquired Funds and the Acquiring Fund being referred to herein as the “Funds”) and (2) the election of directors of each Acquired Fund.

 

The Board of Directors of each Acquired Fund has called a joint annual meeting of stockholders of the Acquired Funds (the “Meeting”) to be held at Galleria Tower I, 13355 Noel Road, Suite 275 — The Chicago Room, Dallas, Texas 75240, on Friday, June 6, 2008, at 8:00 a.m. Central Time, so that stockholders can vote on an Agreement and Plan of Reorganization (“Agreement”) and the election of directors. Each Agreement provides for the participating Acquired Fund to transfer its assets to the Acquiring Fund in exchange for common shares and cash (in lieu of fractional shares) of the Acquiring Fund and the assumption by the Acquiring Fund of the Acquired Fund’s liabilities and the dissolution of the Acquired Fund under applicable state law (“Reorganization”). Although holders of preferred stock are being asked to vote on the Reorganizations, prior to a Reorganization, it is anticipated that the preferred stock of a participating Acquired Fund will be redeemed, with preferred stockholders receiving a liquidation preference of $25,000 per share plus any accumulated and unpaid dividends. As a result of a Reorganization, a common stockholder of the participating Acquired Fund will become a common shareholder of the Acquiring Fund. The attached combined Proxy Statement and Prospectus includes detailed information about the proposed Reorganization and Agreement for each Acquired Fund. After careful consideration, the Board of each Acquired Fund unanimously recommends that you support the Reorganization and vote “FOR” the applicable proposed Agreement and “FOR” each nominee for director.

 

The investment objective of each Acquired Fund is similar to that of the Acquiring Fund, although the Acquiring Fund has a greater focus on capital appreciation and each Fund’s investment policies, strategies and risks are different, particularly with respect to Income Shares and the Acquiring Fund. Highland Capital Management, L.P. is the investment adviser to each Fund.

 

Your vote is very important to us regardless of the number of shares you own. Whether or not you plan to attend the Meeting in person, please read the Proxy Statement and Prospectus and cast your vote promptly. To vote, simply date, sign and return the proxy card in the enclosed postage-paid envelope or follow the instructions on the proxy card for voting by touch-tone telephone or on the Internet.

 

It is important that your vote be received no later than the time of the Meeting.

 

Sincerely,

 

 

R. Joseph Dougherty
Chairman of the Board
Prospect Street High Income Portfolio Inc.
Prospect Street Income Shares Inc.

IMPORTANT NOTICE

 

TO STOCKHOLDERS OF
PROSPECT STREET HIGH INCOME PORTFOLIO INC.
AND
PROSPECT STREET INCOME SHARES INC.

 

QUESTIONS & ANSWERS

 

Although we recommend that you read the complete Proxy Statement and Prospectus (“Proxy Statement/Prospectus”), we have provided for your convenience a brief overview of the proposals to be voted on at an annual meeting of stockholders.

 

APPROVAL OF REORGANIZATIONS OF THE ACQUIRED FUNDS

 

 

 

 

GENERAL

 

 

PROSPECT STREET HIGH INCOME PORTFOLIO INC.
PROSPECT STREET INCOME SHARES INC.
(each, a “Fund”)

 

NOTICE OF ANNUAL MEETING OF STOCKHOLDERS

TO BE HELD JUNE 6, 2008

 

This is the formal agenda for your Fund’s stockholder meeting. It tells you what matters will be voted on and the time and place of the meeting in case you want to attend in person.

 

To the stockholders of each Fund:

 

A joint stockholder meeting for the Funds will be held at Galleria Tower I, 13355 Noel Road, Suite 275 — The Chicago Room, Dallas, Texas 75240, on Friday, June 6, 2008, at 8:00 a.m. Central Time, to consider the following:

 

1.  (A) For stockholders of Prospect Street High Income Portfolio Inc. (“High Income Portfolio”), a proposal to approve an Agreement and Plan of Reorganization between High Income Portfolio and Highland Credit Strategies Fund (the “Acquiring Fund”) pursuant to which High Income Portfolio will transfer its assets to Acquiring Fund in exchange for Acquiring Fund shares (and cash in lieu of certain fractional shares) and the Acquiring Fund’s assumption of High Income Portfolio’s liabilities and High Income Portfolio will dissolve under applicable state law. The Board of Directors of High Income Portfolio unanimously recommends that you vote FOR this proposal.

 

(B) For stockholders of Prospect Street Income Shares Inc. (“Income Shares”), a proposal to approve an Agreement and Plan of Reorganization between Income Shares and the Acquiring Fund pursuant to which Income Shares will transfer its assets to Acquiring Fund in exchange for Acquiring Fund shares (and cash in lieu of certain fractional shares) and the Acquiring Fund’s assumption of Income Shares’ liabilities and Income Shares will dissolve under applicable state law. The Board of Directors of Income Shares unanimously recommends that you vote FOR this proposal.

 

2.  (A) For stockholders of High Income Portfolio, to elect Timothy K. Hui and Scott F. Kavanaugh as Class II Directors of High Income Portfolio, each to serve for a three-year term expiring at the 2011 annual meeting and until his successor is duly elected and qualified. The Board of Directors of High Income Portfolio unanimously recommends that you vote FOR these nominees for director.

 

(B) For stockholders of Income Shares, to elect R. Joseph Dougherty as a Class I Director of Income Shares, to serve for a three-year term expiring at the 2011 annual meeting and until his successor is duly elected and qualified. The Board of Directors of Income Shares unanimously recommends that you vote FOR this nominee for director.

 

3.  Any other business that may properly come before the meeting.

 

Stockholders of record as of the close of business on April 14, 2008, are entitled to vote at the meeting or any adjournment thereof. Your attention is called to the accompanying Proxy Statement and Prospectus. Regardless of whether you plan to attend the meeting, PLEASE COMPLETE, SIGN, DATE AND RETURN THE ENCLOSED PROXY CARD PROMPTLY so that a quorum will be present and your shares may be voted. You may also vote by calling the proxy solicitor at (800) 283-8518. If you are present at the meeting, you may change your vote, if desired, at that time.

 

YOUR VOTE IS IMPORTANT, REGARDLESS OF THE NUMBER OF SHARES YOU OWN. YOU CAN VOTE EASILY AND QUICKLY BY MAIL OR BY TELEPHONE. A SELF-ADDRESSED, POSTAGE-PAID ENVELOPE HAS BEEN ENCLOSED FOR YOUR CONVENIENCE. YOU MAY ALSO VOTE BY CALLING THE NUMBER ON THE PROXY CARD. PLEASE HELP AVOID THE EXPENSE OF A FOLLOW-UP MAILING BY VOTING TODAY.

 

By order of the Boards of Directors,

 

 

M. Jason Blackburn
Secretary

 

Dated: April 23, 2008

 

PROXY STATEMENT of

Prospect Street High Income Portfolio Inc. (“High Income Portfolio”)

Prospect Street Income Shares Inc. (“Income Shares”)

(each, an “Acquired Fund”)

 

And

 

PROSPECTUS for

Common Shares of

Highland Credit Strategies Fund

(“Credit Strategies Fund” or the “Acquiring Fund”)

 

The address of the Acquired Funds and the Acquiring Fund (each, a “Fund”) is Two Galleria Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240 and the telephone number of each Fund is 1-877-665-1287.

 

* * * * * *

 

This Proxy Statement and Prospectus (“Proxy Statement/Prospectus”) contains the information stockholders of each Acquired Fund should know before voting on the proposed reorganizations (each a “Reorganization” and, together, the “Reorganizations”) and election of the nominees for director for each Acquired Fund (“Directors”). Please read it carefully and retain it for future reference. For ease of reading, “shares” and “shareholders” has been used in certain places in the Proxy Statement/Prospectus to describe, respectively, the stock of each Acquired Fund and holders of stock of each Acquired Fund.

 

How the Reorganizations Will Work

 

 

Shares of the Acquiring Fund have not been approved or disapproved by the Securities and Exchange Commission (the ‘‘SEC”). The SEC has not passed upon the accuracy or adequacy of this Proxy Statement/Prospectus. Any representation to the contrary is a criminal offense.

Rationale for the Reorganizations

 

The Board of Directors of each Acquired Fund and the Board of Trustees of the Acquiring Fund (each a “Board”) believes that reorganizing each Acquired Fund into the Acquiring Fund, a fund with a similar investment objective and having a combined portfolio with greater assets, offers you potential benefits. These potential benefits and Board considerations include:

 

 

 

Each Board also considered that if shareholders approve a Reorganization, Highland Capital Management, L.P. (“Adviser” or “Highland”) would contractually agree to waive a portion of Credit Strategies Fund’s advisory fee and administration fee for two years so that Highland would receive no additional benefit from the Reorganization for two years. The waivers are intended to offset the additional revenue Highland would receive on each Acquired Fund’s assets (calculated as of the date of its Reorganization and including the value of its preferred shares that historically have been outstanding) due to the difference between the advisory fee rates of each Acquired Fund and Credit Strategies Fund and the fact that the Acquired Funds do not pay an administration fee to Highland. However, even with the contractual fee waivers, the annual operating expenses of the combined Fund are expected to be higher than High Income Portfolio’s current annual operating expenses and, after the waivers expire, the annual operating expenses of the combined Fund are expected to be higher than either Acquired Fund’s current annual operating expenses. As of each Fund’s last fiscal year, the total annual operating expenses, as a percentage of average net assets, of High Income Portfolio, Income Shares and Credit Strategies Fund were 3.34%, 3.99% and 4.06%, respectively. Assuming each Reorganization is approved, the estimated total annual operating expenses of the combined Fund would be 4.03% of average net assets and, with the contractual fee waivers described above, the estimated net annual operating expenses of the combined Fund would be 3.88% of average net assets.

 

The Board of each Acquired Fund unanimously recommends that you vote FOR the Reorganization of your Fund into Credit Strategies Fund. For further information, please see the individual description of the proposal affecting your Fund contained in the Proxy Statement/Prospectus.

 

Who Bears the Expenses Associated with the Proxy Statement/Prospectus

 

The costs associated with the Reorganizations will be borne by each of the Acquired Funds and the Acquiring Fund in proportion to their respective net assets determined at the close of regular trading on the NYSE on the date of the Reorganizations’ closing, provided that if they close at different times, that determination will be made as of the date that the first Reorganization closes. The costs associated with the election of Directors will be borne by each of the Acquired Funds.

 

Who is Eligible to Vote

 

Shareholders of record on April 14, 2008 are entitled to attend and vote at the meeting or any adjourned meeting. Each share is entitled to one vote. Shares represented by properly executed proxy cards, unless revoked before or at the meeting, will be voted according to shareholders’ instructions. If you sign a proxy card but do not fill in a vote, your shares will be voted for the Reorganization and for the election of the nominees for Director. If any other business comes before the meeting, your shares will be voted at the discretion of the persons named as proxies.

 

The common shares of the Acquiring Fund are listed on the NYSE under the ticker symbol “HCF” and will continue to be so listed subsequent to the Reorganizations. The common shares of High Income Portfolio and Income Shares are listed on the NYSE under the ticker symbols “PHY” and “CNN,” respectively.

 

Shares of the Acquiring Fund are not deposits or obligations of, or guaranteed or endorsed by, any bank or other depository institution. These shares are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other government agency.

 

Where to Get More Information

 

 

The date of this Proxy Statement/Prospectus is April 23, 2008.

TABLE OF CONTENTS

 

 

This Proxy Statement/Prospectus is being used by each Acquired Fund’s Board to solicit proxies to be voted at the annual meeting of each Acquired Fund’s shareholders (“Meeting”). The Meeting will be held at Galleria Tower I, 13355 Noel Road, Suite 275 — The Chicago Room, Dallas, Texas 75240, on Friday, June 6, 2008, at 8:00 a.m. Central Time. At the Meeting, each Acquired Fund will consider a proposal to approve an Agreement and Plan of Reorganization providing for the Reorganization of the Acquired Fund into the Acquiring Fund and for election of Directors of each Acquired Fund. This Proxy Statement/Prospectus is being mailed to your Fund’s shareholders on or about April 23, 2008.

 

For each proposal, this Proxy Statement/Prospectus includes information that is specific to that proposal. A comparison summary is provided with respect to each proposal. You should read carefully the sections of the proxy statement related specifically to your Fund(s), the information relevant to the proposals, as well as the Appendices and the enclosed materials, because they contain details that are not in the summary.

 

The following is a summary of certain information regarding proposal 1 contained elsewhere in this Proxy Statement/Prospectus and is qualified in its entirety by reference to the more complete information contained in this Proxy Statement/Prospectus and in the Statement of Additional Information. Shareholders should read the entire Proxy Statement/Prospectus carefully.

 

The Proposed Reorganizations.  The Board of each Fund, including the Trustees/Directors who are not “interested persons” (as defined in the Investment Company Act of 1940, as amended (the “1940 Act”)) of each Fund, has unanimously approved the Agreement and Plan of Reorganization to which its Fund is a participant. If the shareholders of an Acquired Fund approve the applicable Agreement and Plan of Reorganization, then common shareholders of that Acquired Fund will receive Acquiring Fund Common Shares and cash (in lieu of certain fractional shares), and the Acquiring Fund will acquire all of the assets of the Acquired Fund and assume all of the liabilities of that Acquired Fund. The Acquired Fund will then terminate its registration under the 1940 Act and dissolve under applicable state law. The aggregate value of Acquiring Fund Common Shares and any cash you receive in a Reorganization will equal the aggregate value, taking into account your Fund’s proportionate share of the costs of the Reorganizations, of your Acquired Fund Common Shares held immediately prior to your Fund’s Reorganization. Acquired Fund common shareholders will receive cash for any Acquiring Fund fractional shares they otherwise would be entitled to receive other than with respect to shares held in a Dividend Reinvestment Plan account.

 

The closing date of each proposed Reorganization may differ, and the newly issued Acquiring Fund Common Shares may be issued on different closing dates.

 

In addition, prior to a Reorganization, preferred shareholders of an Acquired Fund will receive the liquidation preference associated with their preferred shares plus any accumulated and unpaid dividends. A Reorganization will not be completed unless, before the final shareholder vote thereon, the participating Acquired Fund commences, and irrevocably commits to complete as expeditiously as possible, the process for redeeming its preferred shares.

 

Summary of Fund Comparisons

 

Investment Objectives and Policies.  Each Acquired Fund is registered as a diversified, closed-end management investment company under the 1940 Act. The Acquiring Fund is registered as a non-diversified, closed-end management investment company under the 1940 Act. The investment objective of each Acquired Fund is similar to that of Credit Strategies Fund, although each Fund’s investment policies, strategies and risks are different, particularly with respect to Income Shares and Credit Strategies Fund. High Income Portfolio seeks to provide high current income, while seeking to preserve shareholders’ capital. Income Shares seeks to provide a high level of current income, with capital appreciation as a secondary objective. Credit Strategies Fund seeks to provide both current income and capital appreciation The Acquiring Fund seeks to provide both current income and capital

appreciation and therefore has a greater focus on capital appreciation. Highland is the investment adviser to each Fund and each Fund’s valuation policies are the same.

 

High Income Portfolio invests at least 65% of its total assets in high-yield, fixed-income securities rated in the lower categories (Ba/BB or lower) by a rating agency or nonrated fixed-income securities deemed by the Adviser to be of comparable quality. High Income Portfolio typically invests a substantially higher percentage of its assets in such securities.

 

Income Shares invests at least 50% of its total assets in debt securities rated in the four highest categories (Baa/BBB or higher) by a rating agency or nonrated debt securities deemed by the Adviser to be of comparable quality.

 

Credit Strategies Fund invests at least 80% of its assets in the following categories of securities and instruments of corporations and other business entities: (i) secured and unsecured floating and fixed rate loans; (ii) bonds and other debt obligations; (iii) debt obligations of stressed, distressed and bankrupt issuers; (iv) structured products, including but not limited to, mortgage-backed and other asset-backed securities and collateralized debt obligations; and (v) equities. A significant portion of Credit Strategies Fund’s assets may be invested in securities rated below investment grade (Ba/BB or lower), which are commonly referred to as “junk securities” or “high-yield securities.”

 

Please refer to Proposal 1 for a further comparison of investment objectives and policies.

 

Dividends and other Distributions.  Holders of common shares of Income Shares receive distributions on a quarterly basis; holders of common shares of High Income Portfolio and Credit Strategies Fund receive distributions on a monthly basis. Credit Strategies Fund’s current yield as of January 31, 2008 on a net asset value basis is higher than that of either Acquired Fund. It is expected that the shareholders of Credit Strategies Fund will not see any material change in its yield as a result of the Reorganizations, although there can be no assurance that this will be the case.

 

Holders of preferred shares of an Acquired Fund will also receive any accumulated and unpaid dividends, at the time they receive the liquidation preference of the preferred shares they hold.

 

Purchase and Sale.  Purchase and sale procedures for the common shares of the Funds are similar. Investors typically purchase and sell common shares of the Funds on the NYSE through a registered broker-dealer. Each Acquired Fund’s series of preferred shares are purchased and sold at separate auctions conducted on a regular basis (unless a Fund elects, subject to certain conditions, to declare a special dividend period). Credit Strategies Fund does not have any preferred shares and does not plan to have any immediately after the Reorganizations.

 

Redemption Procedures.  Redemption procedures for the Funds are similar. The common shares of each Fund have no redemption rights. However, the Board of each Fund may consider open market share repurchases of, or tendering for, common shares to seek to reduce or eliminate any discount in the market place of the common shares from the NAV thereof. Each Fund’s ability to repurchase, or tender for, its common shares may be limited by the 1940 Act asset coverage requirements and, in the Acquired Funds’ case, by any rating agency requirements required due to the issuance of preferred shares.

 

Provided certain conditions are met, the preferred shares are redeemable at the option of each Acquired Fund, at a price equal to $25,000 per share plus, in each case, accumulated and unpaid dividends (including additional dividends, if any) on the redemption date. As noted above, the preferred shares will be redeemed prior to each Reorganization.

 

Expenses.  With the contractual fee waivers offered by Highland, the estimated annual operating expenses of Credit Strategies Fund may be lower than the current annual operating expenses of Income Shares, although they are expected to be higher than High Income Portfolio’s current annual operating expenses. The higher expenses are due, in part, to Credit Strategies Fund leveraging by borrowing pursuant to a credit facility rather than by issuing preferred shares. While the use of a credit facility has been more expensive, it provides Credit Strategies Fund greater flexibility to change the amount of its leverage depending on market conditions. Over time, this flexibility may enable Credit Strategies Fund to achieve greater performance, although there is no guarantee or assurance as to the future performance of Credit Strategies Fund.

Leverage.  Each Acquired Fund employs leverage through the issuance of preferred shares. The Acquiring Fund employs leverage through borrowings through a credit facility. As of March 31, 2008, the leverage as a percentage of total assets of High Income Portfolio, Income Shares and Credit Strategies Fund was 31.7%, 35.4% and 29.5%, respectively.

 

Performance and Premium/Discount Profile.  Each Acquired Fund has been in existence for more than ten years. The Acquiring Fund commenced investment operations in June 2006 and has a limited operating history and history of public trading.

 

Credit Strategies Fund’s 1-year performance as of December 31, 2007 on a net asset value basis is better than Income Shares and its overall historical premium/discount profile is better than that of each Acquired Fund. However, more recently, Credit Strategies Fund’s common shares have traded at a larger discount from NAV than the common shares of either Acquired Fund. The Acquiring Fund also completed a rights offering on January 28, 2008. There is no guarantee or assurance as to the future performance of Credit Strategies Fund. In addition, although Credit Strategies Fund should provide increased liquidity to shareholders of each Acquired Fund due to its substantially larger trading market, there can be no assurance that will be the case.

 

Background and Reasons for the Proposed Reorganizations.  The Reorganizations seek to combine two smaller funds (High Income Portfolio and Income Shares) into one larger fund (Credit Strategies Fund) to achieve certain economies of scale and other operational efficiencies. The Reorganizations will combine the assets of these Funds by reorganizing the Acquired Funds with and into the Acquiring Fund. The Board of each Acquired Fund, based upon its evaluation of all relevant information, anticipates that the common shareholders of its respective Acquired Fund should benefit from its Reorganization. The Board of the Acquiring Fund, based upon its evaluation of all relevant information, anticipates that each Reorganization should benefit holders of Acquiring Fund Common Shares. The combined Fund resulting from the Reorganizations will have a larger asset base than any of the Funds has currently; certain fixed administrative costs, such as costs of, legal expenses, audit fees and other expenses, will be spread across this larger asset base, thereby potentially lowering those costs for common shareholders of the combined Fund. However, it is not expected that these economies of scale will be substantial.

 

In addition, if shareholders approve the Reorganization(s), Highland would contractually agree to waive a portion of Credit Strategies Fund’s advisory fee and administration fee for two years so that Highland would receive no additional benefit from the Reorganization(s) for two years. The waivers are intended to offset the additional revenue Highland would receive on each Acquired Fund’s assets (calculated as of the date of its reorganization) due to the difference between the advisory fee rates of each Acquired Fund and Credit Strategies Fund and the fact that the Acquired Funds do not pay an administration fee to Highland. Assuming Income Shares’ shareholders approve its Reorganization and the Reorganization took place on January 31, 2008, the amount of such waivers over two years would be $1,223,194. Assuming High Income Portfolio’s shareholders approve its Reorganization and the Reorganization took place on January 31, 2008, the amount of such waivers over two years would be $1,425,446. All shareholders of the combined Fund would benefit from such waivers.

 

The Board of each Acquired Fund has determined that participation in the applicable Reorganization is in the best interests of the Fund and that the interests of its shareholders will not be diluted as a result of that Reorganization. Similarly, the Acquiring Fund’s Board has determined that participation in each Reorganization is in the best interests of its common shareholders and that the interests of such shareholders will not be diluted as a result of each Reorganization. Preferred shareholders of the Acquired Funds will not participate in the Reorganizations. As noted above, the preferred shares will be redeemed prior to each Reorganization. In addition, as a result of the Reorganizations, shareholders of each Fund, particularly the shareholders of the Acquired Funds, will have a smaller percentage of ownership in the larger combined Fund than they did in any of the separate Funds.

 

Rationale for the Reorganizations.  The Board of each Fund believes that reorganizing each Acquired Fund into the Acquiring Fund, a fund with a similar investment objective, and having a combined portfolio with greater assets, offers you potential benefits. These potential benefits and Board considerations include:

 

 

Each Board also considered that if shareholders approve a Reorganization, Highland would contractually agree to waive a portion of Credit Strategies Fund’s advisory fee and administration fee for two years so that Highland would receive no additional benefit from the Reorganization for two years. The waivers are intended to offset the additional revenue Highland would receive on each Acquired Fund’s assets (calculated as of the date of its Reorganization and including the value of its preferred shares that historically have been outstanding) due to the difference between the advisory fee rates of each Acquired Fund and Credit Strategies Fund and the fact that the Acquired Funds do not pay an administration fee to Highland. However, even with the contractual fee waivers, the annual operating expenses of the combined Fund are expected to be higher than High Income Portfolio’s current annual operating expenses and, after the waivers expire, the annual operating expenses of the combined Fund are expected to be higher than either Acquired Fund’s current annual operating expenses. As of each Fund’s last fiscal year, the total annual operating expenses, as a percentage of average net assets, of High Income Portfolio, Income Shares and Credit Strategies Fund were 3.34%, 3.99% and 4.06%, respectively. Assuming each Reorganization is approved, the estimated total annual operating expenses of the combined Fund would be 4.03% of average net assets and, with the contractual fee waivers described above, the estimated net annual operating expenses of the combined Fund would be 3.88% of average net assets.

 

The Board of each Acquired Fund unanimously recommends that you vote FOR the Reorganization of your Fund into Credit Strategies Fund. For further information, please see the individual description of the proposal affecting your Fund contained in the Proxy Statement/Prospectus.

 

Expenses Associated with the Reorganizations.  The costs associated with the Reorganizations will be borne by each of the Acquired Funds and the Acquiring Fund in proportion to their respective net assets determined at the close of regular trading on the NYSE on the date of the Reorganizations’ closing, provided that if they close at different times, that determination will be made as of the date that the first Reorganization closes.

 

Tax Consequences.  Each Reorganization is intended to qualify as a “reorganization” within the meaning of Section 368(a)(1) of the Internal Revenue Code of 1986, as amended (“Code”). If the Reorganizations so qualify, in general, shareholders of the Acquired Funds will recognize no gain or loss upon the receipt solely of shares of the Acquiring Fund in connection with the Reorganizations. However, shareholders of the Acquired Funds may recognize gain or loss with respect to cash they receive pursuant to the Reorganization in lieu of fractional Acquiring Fund shares. Additionally, the Acquired Funds will recognize no gain or loss as a result of the Reorganization or as a result of their dissolution. Neither the Acquiring Fund nor its shareholders will recognize any gain or loss in connection with the Reorganizations.

 

Required Vote.  Shareholder approval of each Reorganization requires, with respect to each respective Acquired Fund, the vote of: (1) the holders of at least a majority of the common and preferred shares entitled to vote, voting as a single class; and (2) the holders of at least a majority of the preferred shares entitled to vote, voting as a separate class.

 

The Board of each Acquired Fund unanimously recommends that you vote FOR your Fund’s proposed Reorganization.

RISK FACTORS AND SPECIAL CONSIDERATIONS RELATED TO PROPOSAL 1

 

Because each of Credit Strategies Fund and High Income Portfolio, under normal market conditions, invests a substantial amount of its assets in below investment grade securities (Income Shares also invests in below investment grade securities but to a lesser extent), any general risks inherent in such investments are equally applicable to Credit Strategies Fund and High Income Portfolio and will apply to Credit Strategies Fund after the Reorganizations. The general risks of investing in Credit Strategies Fund are described below and the general risks that are unique to an Acquired Fund are indicated as such below. The Reorganizations themselves are not expected to adversely affect the right of common shareholders of any of the Funds. Preferred shareholders of the Acquired Funds will not participate in the Reorganizations. As noted above, the preferred shares will be redeemed prior to each Reorganization. For information regarding the percentage limitations, if any, of an investment described in the risks listed below, see “Comparison of the Funds: Investment Objectives and Policies.”

 

Limited Operating History.  Credit Strategies Fund is a recently organized, non-diversified, closed-end management investment company. It commenced investment operations in June 2006 and has a limited operating history and history of public trading that investors can use to evaluate its investment performance and volatility.

 

This does not apply to either Acquired Fund since they are not recently organized.

 

Investment and Market Discount Risk.  An investment in Credit Strategies Fund’s common shares is subject to investment risk, including the possible loss of the entire amount that you invest. As with any stock, the price of Credit Strategies Fund’s shares will fluctuate with market conditions and other factors. If shares are sold, the price received may be more or less than the original investment. Common shares are designed for long-term investors and should not be treated as trading vehicles. Shares of closed-end management investment companies frequently trade at a discount to their NAV.

 

Risks of Non-Diversification and Other Focused Strategies.  While the Adviser will invest in a number of fixed-income and equity instruments issued by different issuers and plans to employ multiple investment strategies with respect to Credit Strategies Fund’s portfolio, it is possible that a significant amount of Credit Strategies Fund’s investments could be invested in the instruments of only a few companies or other issuers or that at any particular point in time one investment strategy could be more heavily weighted than the others. The focus of Credit Strategies Fund’s portfolio in any one issuer would subject Credit Strategies Fund to a greater degree of risk with respect to defaults by such issuer or other adverse events affecting that issuer, and the focus of the portfolio in any one industry or group of industries (but not to the extent of 25% of Credit Strategies Fund’s total assets) would subject Credit Strategies Fund to a greater degree of risk with respect to economic downturns relating to such industry. The focus of Credit Strategies Fund’s portfolio in any one investment strategy would subject Credit Strategies Fund to a greater degree of risk than if Credit Strategies Fund’s portfolio were varied in its investments with respect to several investment strategies.

 

The general risks of non-diversification do not apply to each Acquired Fund since they are diversified, closed-end management investment companies under the 1940 Act.

 

Illiquidity of Investments.  The investments made by Credit Strategies Fund may be illiquid, and consequently, Credit Strategies Fund may not be able to sell such investments at prices that reflect the Adviser’s assessment of their fair value or the amount paid for such investments by Credit Strategies Fund. Illiquidity may result from the absence of an established market for the investments as well as legal, contractual or other restrictions on their resale by Credit Strategies Fund and other factors. Furthermore, the nature of Credit Strategies Fund’s investments, especially those in financially stressed and distressed companies, may require a long holding period prior to being able to determine whether the investment will be profitable or not. There is no limit on the amount of Credit Strategies Fund’s portfolio that can be invested in illiquid securities.

Credit Strategies Fund has no limit on the amount of assets that can be invested in illiquid securities. As such, the general risks of investing in illiquid securities are greater for Credit Strategies Fund than each Acquired Fund, which have limits on investing in illiquid securities.

 

Risks of Investing in Senior Loans.  Senior loans, such as bank loans, are typically at the most senior level of the capital structure, and are sometimes secured by specific collateral, including, but not limited to, trademarks, patents, accounts receivable, inventory, equipment, buildings, real estate, franchises and common and preferred stock of the obligor or its affiliates. A portion of Credit Strategies Fund’s investments may consist of loans and participations therein originated by banks and other financial institutions, typically referred to as “bank loans.” Credit Strategies Fund’s investments may include loans of a type generally incurred by borrowers in connection with highly leveraged transactions, often to finance internal growth, acquisitions, mergers or stock purchases, or for other reasons. As a result of the additional debt incurred by the borrower in the course of the transaction, the borrower’s creditworthiness is often judged by the rating agencies to be below investment grade. Such loans are typically private corporate loans which are negotiated by one or more commercial banks or financial institutions and syndicated among a group of commercial banks and financial institutions. In order to induce the lenders to extend credit and to offer a favorable interest rate, the borrower often provides the lenders with extensive information about its business which is not generally available to the public.

 

Bank loans often contain restrictive covenants designed to limit the activities of the borrower in an effort to protect the right of lenders to receive timely payments of principal and interest. Such covenants may include restrictions on dividend payments, specific mandatory minimum financial ratios, limits on total debt and other financial tests. Bank loans usually have shorter terms than subordinated obligations and may require mandatory prepayments from excess cash flow, asset dispositions and offerings of debt and/or equity securities. The bank loans and other debt obligations to be acquired by Credit Strategies Fund are likely to be below investment grade.

 

Credit Strategies Fund may acquire interests in bank loans and other debt obligations either directly (by way of sale or assignment) or indirectly (by way of participation). The purchaser of an assignment typically succeeds to all the rights and obligations of the assigning institution and becomes a lender under the credit agreement with respect to the debt obligation; however, its rights can be more restricted than those of the assigning institution, and, in any event, Credit Strategies Fund may not be able unilaterally to enforce all rights and remedies under the loan and any associated collateral. A participation interest in a portion of a debt obligation typically results in a contractual relationship only with the institution participating out the interest, not with the borrower. In purchasing participations, Credit Strategies Fund generally will have no right to enforce compliance by the borrower with either the terms of the loan agreement or any rights of setoff against the borrower, and Credit Strategies Fund may not directly benefit from the collateral supporting the debt obligation in which it has purchased the participation. As a result, Credit Strategies Fund will be exposed to the credit risk of both the borrower and the institution selling the participation.

 

Purchasers of bank loans are predominantly commercial banks, investment trusts and investment banks. As secondary market trading volumes increase, new bank loans frequently adopt standardized documentation to facilitate loan trading, which should improve market liquidity. There can be no assurance, however, that future levels of supply and demand in bank loan trading will provide an adequate degree of liquidity or that the current level of liquidity will continue. Because of the provision to holders of such loans of confidential information relating to the borrower, the unique and customized nature of the loan agreement, the limited universe of eligible purchasers and the private syndication of the loan, bank loans are not as easily purchased or sold as a publicly traded security, and historically the trading volume in the bank loan market has been small relative to the high-yield debt market.

 

Credit Strategies Fund can invest a greater percentage of its assets in senior loans than each Acquired Fund. As such, the general risks of investing in senior loans are greater for Credit Strategies Fund than each Acquired Fund.

 

Second Lien Loans Risk.  Second lien loans are subject to the same risks associated with investment in senior loans and non-investment grade securities. See “Non-Investment Grade Securities Risk.” However, second lien loans are second in right of payment to senior loans and therefore are subject to additional risk that the cash flow of

the borrower and any property securing the loan may be insufficient to meet scheduled payments after giving effect to the senior secured obligations of the borrower. Second lien loans are expected to have greater price volatility than senior loans and may be less liquid. There is also a possibility that originators will not be able to sell participations in second lien loans, which would create greater credit risk exposure.

 

Credit Strategies Fund can invest a greater percentage of its assets in second liens than each Acquired Fund. As such, the general risks of investing in second liens are greater for Credit Strategies Fund than each Acquired Fund.

 

Other Secured Loans Risk.  Secured loans other than senior loans and second lien loans are subject to the same risks associated with investment in senior loans, second lien loans and non-investment grade securities. However, such loans may rank lower in right of payment than any outstanding senior loans and second lien loans of the borrower and therefore are subject to additional risk that the cash flow of the borrower and any property securing the loan may be insufficient to meet scheduled payments after giving effect to the higher ranking secured obligations of the borrower. Lower ranking secured loans are expected to have greater price volatility than senior loans and second lien loans and may be less liquid. There is also a possibility that originators will not be able to sell participations in lower ranking secured loans, which would create greater credit risk exposure.

 

Credit Strategies Fund can invest a greater percentage of its assets in other secured loans than each Acquired Fund. As such, the general risks of investing in other secured loans are greater for Credit Strategies Fund than each Acquired Fund.

 

Unsecured Loans Risk.  Unsecured loans are subject to the same risks associated with investment in senior loans, second lien loans, other secured loans and non-investment grade securities. However, because unsecured loans have lower priority in right of payment to any higher ranking obligations of the borrower and are not backed by a security interest in any specific collateral, they are subject to additional risk that the cash flow of the borrower and available assets may be insufficient to meet scheduled payments after giving effect to any higher ranking obligations of the borrower. Unsecured loans are expected to have greater price volatility than senior loans, second lien loans and other secured loans and may be less liquid. There is also a possibility that originators will not be able to sell participations in unsecured loans, which would create greater credit risk exposure.

 

Credit Strategies Fund can invest a greater percentage of its assets in unsecured loans than each Acquired Fund. As such, the general risks of investing in unsecured loans are greater for Credit Strategies Fund than each Acquired Fund.

 

Risks of Investing in Obligations of Stressed, Distressed and Bankrupt Issuers.  Credit Strategies Fund is authorized to invest in the securities and other obligations of stressed, distressed and bankrupt issuers, including debt obligations that are in covenant or payment default. There is no limit on the amount of Credit Strategies Fund’s portfolio that can be invested in stressed, distressed or bankrupt issuers, and Credit Strategies Fund may invest for purposes of control. Such investments generally trade significantly below par and are considered speculative. The repayment of defaulted obligations is subject to significant uncertainties. Defaulted obligations might be repaid only after lengthy workout or bankruptcy proceedings, during which the issuer might not make any interest or other payments. Typically such workout or bankruptcy proceedings result in only partial recovery of cash payments or an exchange of the defaulted obligation for other debt or equity securities of the issuer or its affiliates, which may in turn be illiquid or speculative.

 

There are a number of significant risks inherent in the bankruptcy process. First, many events in a bankruptcy are the product of contested matters and adversary proceedings and are beyond the control of the creditors. While creditors are generally given an opportunity to object to significant actions, there can be no assurance that a bankruptcy court in the exercise of its broad powers would not approve actions that would be contrary to the interests of Credit Strategies Fund. Second, a bankruptcy filing by an issuer may adversely and permanently affect the issuer. The issuer may lose its market position and key employees and otherwise become incapable of restoring itself as a viable entity. If for this or any other reason the proceeding is converted to a liquidation, the value of the issuer may not equal the liquidation value that was believed to exist at the time of the investment. Third, the duration of a bankruptcy proceeding is difficult to predict. A creditor’s return on investment can be adversely affected by

delays while the plan of reorganization is being negotiated, approved by the creditors and confirmed by the bankruptcy court and until it ultimately becomes effective. Fourth, the administrative costs in connection with a bankruptcy proceeding are frequently high and would be paid out of the debtor’s estate prior to any return to creditors. For example, if a proceeding involves protracted or difficult litigation, or turns into a liquidation, substantial assets may be devoted to administrative costs. Fifth, bankruptcy law permits the classification of “substantially similar” claims in determining the classification of claims in a reorganization. Because the standard for classification is vague, there exists the risk that Credit Strategies Fund’s influence with respect to the class of securities or other obligations it owns can be lost by increases in the number and amount of claims in that class or by different classification and treatment. Sixth, in the early stages of the bankruptcy process it is often difficult to estimate the extent of, or even to identify, any contingent claims that might be made. Seventh, especially in the case of investments made prior to the commencement of bankruptcy proceedings, creditors can lose their ranking and priority if they exercise “domination and control” over a debtor and other creditors can demonstrate that they have been harmed by such actions. Eighth, certain claims that have priority by law (for example, claims for taxes) may be substantial.

 

In any investment involving stressed and distressed debt obligations, there exists the risk that the transaction involving such debt obligations will be unsuccessful, take considerable time or will result in a distribution of cash or a new security or obligation in exchange for the stressed and distressed debt obligations, the value of which may be less than Credit Strategies Fund’s purchase price of such debt obligations. Furthermore, if an anticipated transaction does not occur, Credit Strategies Fund may be required to sell its investment at a loss. Given the substantial uncertainties concerning transactions involving stressed and distressed debt obligations in which Credit Strategies Fund invests, there is a potential risk of loss by Credit Strategies Fund of its entire investment in any particular investment.

 

Investments in companies undergoing a workout or operating under Chapter 11 of the Bankruptcy Code are also, in certain circumstances, subject to certain additional liabilities which may exceed the value of Credit Strategies Fund’s original investment in a company. For example, under certain circumstances, creditors who have inappropriately exercised control over the management and policies of a debtor may have their claims subordinated or disallowed or may be found liable for damages suffered by parties as a result of such actions. The Adviser’s active management style may present a greater risk in this area than would a more passive approach. In addition, under certain circumstances, payments to Credit Strategies Fund and distributions by Credit Strategies Fund or payments on the debt may be reclaimed if any such payment is later determined to have been a fraudulent conveyance or a preferential payment.

 

The Adviser, on behalf of Credit Strategies Fund, may participate on committees formed by creditors to negotiate with the management of financially troubled companies that may or may not be in bankruptcy or may negotiate directly with debtors with respect to restructuring issues. If Credit Strategies Fund does choose to join a committee, Credit Strategies Fund would likely be only one of many participants, all of whom would be interested in obtaining an outcome that is in their individual best interests. There can be no assurance that Credit Strategies Fund would be successful in obtaining results most favorable to it in such proceedings, although Credit Strategies Fund may incur significant legal and other expenses in attempting to do so. As a result of participation by Credit Strategies Fund on such committees, Credit Strategies Fund may be deemed to have duties to other creditors represented by the committees, which might thereby expose Credit Strategies Fund to liability to such other creditors who disagree with Credit Strategies Fund’s actions. Participation by Credit Strategies Fund on such committees may cause Credit Strategies Fund to be subject to certain restrictions on its ability to trade in a particular investment and may also make Credit Strategies Fund an “insider” or an “underwriter” for purposes of the federal securities laws. Either circumstance will restrict Credit Strategies Fund’s ability to trade in or acquire additional positions in a particular investment when it might otherwise desire to do so.

 

Risks of Investing in High-Yield Securities.  A portion of Credit Strategies Fund’s investments will consist of investments that may generally be characterized as “high-yield securities” or “junk securities.” Such securities are typically rated below investment grade by one or more nationally recognized statistical rating organizations or are unrated but of comparable credit quality to obligations rated below investment grade, and have greater credit and liquidity risk than more highly rated obligations. High-yield securities are generally unsecured and may be subordinate to other obligations of the obligor. The lower rating of high-yield securities reflects a greater possibility

that adverse changes in the financial condition of the issuer or in general economic conditions (including, for example, a substantial period of rising interest rates or declining earnings) or both may impair the ability of the issuer to make payment of principal and interest. Many issuers of high-yield securities are highly leveraged, and their relatively high debt to equity ratios create increased risks that their operations might not generate sufficient cash flow to service their obligations. Overall declines in the below investment grade bond and other markets may adversely affect such issuers by inhibiting their ability to refinance their obligations at maturity.

 

High-yield securities are often issued in connection with leveraged acquisitions or recapitalizations in which the issuers incur a substantially higher amount of indebtedness than the level at which they had previously operated. High-yield securities that are debt instruments have historically experienced greater default rates than has been the case for investment grade securities. Credit Strategies Fund may also invest in equity securities issued by entities whose obligations are unrated or are rated below investment grade.

 

Credit Strategies Fund is authorized to invest in obligations of issuers which are generally trading at significantly higher yields than had been historically typical of the applicable issuer’s obligations. Such investments may include debt obligations that have a heightened probability of being in covenant or payment default in the future. Such investments generally are considered speculative. The repayment of defaulted obligations is subject to significant uncertainties. Defaulted obligations might be repaid only after lengthy workout or bankruptcy proceedings, during which the issuer might not make any interest or other payments. Typically such workout or bankruptcy proceedings result in only partial recovery of cash payments or an exchange of the defaulted security for other debt or equity securities of the issuer or its affiliates, which may in turn be illiquid or speculative.

 

High-yield securities purchased by Credit Strategies Fund will be subject to certain additional risks to the extent that such obligations may be unsecured and subordinated to substantial amounts of senior indebtedness, all or a significant portion of which may be secured. Moreover, such obligations purchased by Credit Strategies Fund may not be protected by financial covenants or limitations upon additional indebtedness and are unlikely to be secured by collateral.

 

Credit Strategies Fund can invest a greater percentage of its assets in high-yield securities than Income Shares. As such, the general risks of investing in high-yield securities are greater for Credit Strategies Fund than Income Shares.

 

Insolvency Considerations with Respect to Issuers of Debt Obligations.  Various laws enacted for the protection of creditors may apply to the debt obligations held by Credit Strategies Fund. The information in this paragraph is applicable with respect to U.S. issuers subject to United States bankruptcy laws. Insolvency considerations may differ with respect to other issuers. If a court in a lawsuit brought by an unpaid creditor or representative of creditors of an issuer of a debt obligation, such as a trustee in bankruptcy, were to find that the issuer did not receive fair consideration or reasonably equivalent value for incurring the indebtedness constituting the debt obligation and, after giving effect to such indebtedness, the issuer (i) was insolvent, (ii) was engaged in a business for which the remaining assets of such issuer constituted unreasonably small capital or (iii) intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature, such court could determine to invalidate, in whole or in part, such indebtedness as a fraudulent conveyance, to subordinate such indebtedness to existing or future creditors of such issuer, or to recover amounts previously paid by such issuer in satisfaction of such indebtedness. The measure of insolvency for purposes of the foregoing will vary. Generally, an issuer would be considered insolvent at a particular time if the sum of its debts were then greater than all of its property at a fair valuation, or if the present fair saleable value of its assets was then less than the amount that would be required to pay its probable liabilities on its existing debts as they became absolute and matured. There can be no assurance as to what standard a court would apply in order to determine whether the issuer was “insolvent” after giving effect to the incurrence of the indebtedness constituting the debt obligation or that, regardless of the method of valuation, a court would not determine that the issuer was “insolvent” upon giving effect to such incurrence. In addition, in the event of the insolvency of an issuer of a debt obligation, payments made on such debt obligation could be subject to avoidance as a “preference” if made within a certain period of time (which may be as long as one year) before insolvency. Similarly, a court might apply the doctrine of equitable subordination to subordinate the claim of a lending institution against an issuer, to claims of other creditors of the borrower, when the lending institution, another investor, or any of their transferees, is found to have engaged in unfair, inequitable, or fraudulent

conduct. In general, if payments on a debt obligation are avoidable, whether as fraudulent conveyances or preferences, such payments can be recaptured either from the initial recipient (such as the Fund) or from subsequent transferees of such payments (such as investors in the Fund). To the extent that any such payments are recaptured from Credit Strategies Fund the resulting loss will be borne by the investors. However, a court in a bankruptcy or insolvency proceeding would be able to direct the recapture of any such payment from such a recipient or transferee only to the extent that such court has jurisdiction over such recipient or transferee or its assets. Moreover, it is likely that avoidable payments could not be recaptured directly from any such recipient or transferee that has given value in exchange for its note, in good faith and without knowledge that the payments were avoidable. Although the Adviser will seek to avoid conduct that would form the basis for a successful cause of action based upon fraudulent conveyance, preference or equitable subordination, these determinations are made in hindsight, and, in any event, there can be no assurance as to whether any lending institution or other investor from which Credit Strategies Fund acquired the debt obligations engaged in any such conduct (or any other conduct that would subject the debt obligations and the issuer to insolvency laws) and, if it did, as to whether such creditor claims could be asserted in a U.S. court (or in the courts of any other country) against Credit Strategies Fund.

 

Risks of Investing in Stressed, Distressed or Bankrupt Companies.  Credit Strategies Fund may invest in companies that are stressed, in distress, or bankrupt. As such, they are subject to a multitude of legal, industry, market, economic and governmental forces that make analysis of these companies inherently difficult. Further, the Adviser relies on company management, outside experts, market participants and personal experience to analyze potential investments for Credit Strategies Fund. There can be no assurance that any of these sources will prove credible, or that the Adviser’s analysis will produce conclusions that lead to profitable investments.

 

Leverage Risk.  Credit Strategies Fund has the ability to use leverage through the issuance of preferred shares, borrowings from a credit facility or both. Credit Strategies Fund currently leverages through borrowings from a credit facility and has no present intention of issuing preferred shares. The use of leverage, which can be described as exposure to changes in price at a ratio greater than the amount of equity invested, either through the issuance of preferred shares, borrowings or other forms of market exposure, magnifies both the favorable and unfavorable effects of price movements in the investments made by Credit Strategies Fund. Insofar as Credit Strategies Fund continues to employ leverage in its investment operations, Credit Strategies Fund will be subject to substantial risks of loss.

 

 

The Loan Agreement has customary covenant, negative covenant and default provisions. This credit facility with Scotia is not convertible into any other securities of Credit Strategies Fund. Outstanding amounts would be payable at maturity or such earlier times as required by the Loan Agreement. Credit Strategies Fund may be required to prepay outstanding amounts under the credit facility or incur a penalty rate of interest in the event of the occurrence of certain events of default. Credit Strategies Fund is expected to indemnify the lenders under the credit facility against certain liabilities they may incur in connection with the credit facility. Credit Strategies Fund is required to pay commitment fees under the terms of any such facility. With the use of borrowings, there is a risk that the interest rates paid by Credit Strategies Fund on the amount it

borrows will be higher than the return on Credit Strategies Fund’s investments. The credit facility with Scotia may in the future be replaced or refinanced by one or more credit facilities having substantially different terms or by the issuance of preferred shares.

 

 

In addition, Credit Strategies Fund will pay (and the holders of common shares will bear) all costs and expenses relating to the issuance and ongoing maintenance of the preferred shares, including higher advisory fees. Accordingly, Credit Strategies Fund cannot assure you that the issuance of preferred shares will result in a higher yield or return to the holders of the common shares.

 

Similarly, any decline in the NAV of Credit Strategies Fund’s investments will be borne entirely by the holders of common shares. Therefore, if the market value of Credit Strategies Fund’s portfolio declines, the leverage will result in a greater decrease in NAV to the holders of common shares than if Credit Strategies Fund were not leveraged. This greater NAV decrease will also tend to cause a greater decline in the market price for the common shares. Credit Strategies Fund might be in danger of failing to maintain the required asset coverage of the preferred shares or of losing its ratings on the preferred shares or, in an extreme case, Credit Strategies Fund’s current investment income might not be sufficient to meet the dividend requirements on the preferred shares. In order to counteract such an event, Credit Strategies Fund might need to liquidate investments in order to fund a redemption of some or all of the preferred shares. Liquidation at times of low prices may result in capital loss and may reduce returns to the holders of common shares.

 

 

Credit Strategies Fund currently uses leverage through borrowings from a credit facility and each Acquired Fund currently uses leverage through the issuance of preferred shares. As discussed above, the general risks of leverage are somewhat different for a credit facility as compared to preferred shares.

 

Common Stock Risk.  Credit Strategies Fund will have exposure to common stocks. Although common stocks have historically generated higher average total returns than fixed income securities over the long-term, common stocks also have experienced significantly more volatility in those returns. Therefore, Credit Strategies Fund’s exposure to common stocks could result in worse performance than would be the case had Credit Strategies Fund been invested solely in debt securities. An adverse event, such as an unfavorable earnings report, may depress the value of a particular common stock held by Credit Strategies Fund. Also, the price of common stocks is sensitive to general movements in the stock market and a drop in the stock market may depress the price of common stocks to which Credit Strategies Fund has exposure. Common stock prices fluctuate for several reasons, including changes in investors’ perceptions of the financial condition of an issuer or the general condition of the relevant stock market, or when political or economic events affecting the issuers occur. In addition, common stock prices may be particularly sensitive to rising interest rates, as the cost of capital rises and borrowing costs increase.

 

Credit Strategies Fund can invest a greater percentage of its assets in common stocks than each Acquired Fund. As such, the general risks of investing in common stocks are greater for Credit Strategies Fund than each Acquired Fund.

 

Dividend Risk.  Dividends on common stock are not fixed but are declared at the discretion of an issuer’s board of directors. There is no guarantee that the issuers of the common stocks in which Credit Strategies Fund invests will declare dividends in the future or that if declared they will remain at current levels or increase over time.

 

Credit Strategies Fund can invest a greater percentage of its assets in common stocks than each Acquired Fund. As such, the general risks related to dividends is greater for Credit Strategies Fund than each Acquired Fund.

 

Small and Mid-Cap Securities Risk.  Credit Strategies Fund may invest in companies with small or medium capitalizations. Securities issued by smaller and medium companies can be more volatile than, and perform differently from, larger company securities. There may be less trading in a smaller or medium company’s securities, which means that buy and sell transactions in those securities could have a larger impact on the security’s price than is the case with larger company securities. Smaller and medium companies may have fewer business lines; changes in any one line of business, therefore, may have a greater impact on a smaller or medium company’s security price than is the case for a larger company. In addition, smaller or medium company securities may not be well known to the investing public.

 

Credit Strategies Fund can invest a greater percentage of its assets in common stocks than each Acquired Fund. As such, the general risks of investing in small and mid-cap securities are greater for Credit Strategies Fund than each Acquired Fund.

 

Non-U.S. Securities Risk.  Credit Strategies Fund may invest up to 20% of its total assets in non-U.S. securities, including emerging market securities. Investing in non-U.S. securities involves certain risks not involved in domestic investments, including, but not limited to: (i) fluctuations in foreign exchange rates; (ii) future foreign economic, financial, political and social developments; (iii) different legal systems; (iv) the possible imposition of exchange controls or other foreign governmental laws or restrictions; (v) lower trading volume; (vi) much greater price volatility and illiquidity of certain non-U.S. securities markets; (vii) different trading and settlement practices; (viii) less governmental supervision; (ix) changes in currency exchange rates; (x) high and volatile rates of inflation; (xi) fluctuating interest rates; (xii) less publicly available information; and (xiii) different accounting, auditing and financial recordkeeping standards and requirements.

 

Certain countries in which Credit Strategies Fund may invest, especially emerging market countries, historically have experienced, and may continue to experience, high rates of inflation, high interest rates, exchange rate fluctuations, large amounts of external debt, balance of payments and trade difficulties and extreme poverty and unemployment. Many of these countries are also characterized by political uncertainty and instability. These risks

are especially evident in the Middle East and West Africa. The cost of servicing external debt will generally be adversely affected by rising international interest rates because many external debt obligations bear interest at rates which are adjusted based upon international interest rates. In addition, with respect to certain foreign countries, there is a risk of: (i) the possibility of expropriation or nationalization of assets; (ii) confiscatory taxation; (iii) difficulty in obtaining or enforcing a court judgment; (iv) economic, political or social instability; and (v) diplomatic developments that could affect investments in those countries.

 

Because Credit Strategies Fund will invest in securities denominated or quoted in currencies other than the U.S. dollar, changes in foreign currency exchange rates may affect the value of securities in Credit Strategies Fund and the unrealized appreciation or depreciation of investments. Currencies of certain countries may be volatile and therefore may affect the value of securities denominated in such currencies, which means that Credit Strategies Fund’s NAV or current income could decline as a result of changes in the exchange rates between foreign currencies and the U.S. dollar. Certain investments in non-U.S. securities also may be subject to foreign withholding taxes. These risks often are heightened for investments in smaller, emerging capital markets. In addition, individual foreign economies may differ favorably or unfavorably from the U.S. economy in such respects as: (i) growth of gross domestic product; (ii) rates of inflation; (iii) capital reinvestment; (iv) resources; (v) self-sufficiency; and (vi) balance of payments position.

 

As a result of these potential risks, Highland may determine that, notwithstanding otherwise favorable investment criteria, it may not be practicable or appropriate to invest in a particular country. Credit Strategies Fund may invest in countries in which foreign investors, including Highland, have had no or limited prior experience.

 

The general risks of investing in non-U.S. securities are greater for Credit Strategies Fund than High Income Portfolio since High Income Portfolio can invest up to 10% of its total assets in foreign securities. The general risks of investing in non-U.S. securities do not apply to Income Shares since it generally does not invest in non-U.S. securities.

 

Emerging Markets Risk.  Credit Strategies Fund may invest up to 20% of its total assets in securities of issuers based in emerging markets. Investing in securities of issuers based in underdeveloped emerging markets entails all of the risks of investing in securities of non-U.S. issuers to a heightened degree. Emerging market countries generally include every nation in the world except the United States, Canada, Japan, Australia, New Zealand and most countries located in Western Europe. These heightened risks include: (i) greater risks of expropriation, confiscatory taxation, nationalization, and less social, political and economic stability; (ii) the smaller size of the markets for such securities and a lower volume of trading, resulting in lack of liquidity and in price volatility; and (iii) certain national policies which may restrict Credit Strategies Fund’s investment opportunities including restrictions on investing in issuers or industries deemed sensitive to relevant national interests.

 

The general risks of investing in non-U.S. securities are greater for Credit Strategies Fund than High Income Portfolio since High Income Portfolio can invest up to 10% of its total assets in foreign securities. The general risks of investing in non-U.S. securities do not apply to Income Shares since it generally does not invest in non-U.S. securities.

 

The general risks of investing in emerging markets do not apply to each Acquired Fund since they generally do not invest in emerging markets.

 

Foreign Currency Risk.  Because Credit Strategies Fund may invest in securities denominated or quoted in currencies other than the U.S. dollar, changes in foreign currency exchange rates may affect the value of securities owned by Credit Strategies Fund, the unrealized appreciation or depreciation of investments and gains on and income from investments. Currencies of certain countries may be volatile and therefore may affect the value of securities denominated in such currencies, which means that Credit Strategies Fund’s NAV could decline as a result of changes in the exchange rates between foreign currencies and the U.S. dollar. These risks often are heightened for investments in smaller, emerging capital markets. In addition, Credit Strategies Fund may enter into foreign currency transactions in an attempt to enhance total return which may further expose Credit Strategies Fund to the risks of foreign currency movements and other risks. The use of foreign currency transactions can result in Credit

Strategies Fund incurring losses as a result of the imposition of exchange controls, suspension of settlements or the inability of Credit Strategies Fund to deliver or receive a specified currency.

 

The general risks related to foreign currency is greater for Credit Strategies Fund than High Income Portfolio since High Income Portfolio can invest up to 10% of its total assets in foreign securities. The general risks related to foreign currency do not apply to Income Shares since it generally does not invest in non-U.S. securities.

 

Investments in Unseasoned Companies.  Credit Strategies Fund may invest in the securities of smaller, less seasoned companies. These investments may present greater opportunities for growth, but also involve greater risks than customarily are associated with investments in securities of more established companies. Some of the companies in which Credit Strategies Fund may invest will be start-up companies which may have insubstantial operational or earnings history or may have limited products, markets, financial resources or management depth. Some may also be emerging companies at the research and development stage with no products or technologies to market or approved for marketing. Securities of emerging companies may lack an active secondary market and may be subject to more abrupt or erratic price movements than securities of larger, more established companies or stock market averages in general. Competitors of certain companies may have substantially greater financial resources than many of the companies in which Credit Strategies Fund may invest.

 

Initial Public Offerings (IPOs) Risk.  Credit Strategies Fund may invest in shares of companies through IPOs. IPOs and companies that have recently gone public have the potential to produce substantial gains for Credit Strategies Fund. However, there is no assurance that Credit Strategies Fund will have access to profitable IPOs. The investment performance of Credit Strategies Fund during periods when it is unable to invest significantly or at all in IPOs may be lower than during periods when Credit Strategies Fund is able to do so. Securities issued in IPOs are subject to many of the same risks as investing in companies with smaller market capitalizations. Securities issued in IPOs have no trading history, and information about the companies may be available for limited periods of time. In addition, the prices of securities sold in IPOs may be highly volatile or may decline shortly after the IPO.

 

Securities Lending Risk.  Credit Strategies Fund may lend its portfolio securities (up to a maximum of one-third of its total assets) to banks or dealers which meet the creditworthiness standards established by the Board. Securities lending is subject to the risk that loaned securities may not be available to Credit Strategies Fund on a timely basis and Credit Strategies Fund may, therefore, lose the opportunity to sell the securities at a desirable price. Any loss in the market price of securities loaned by Credit Strategies Fund that occurs during the term of the loan would be borne by Credit Strategies Fund and would adversely affect Credit Strategies Fund’s performance. Also, there may be delays in recovery, or no recovery, of securities loaned or even a loss of rights in the collateral should the borrower of the securities fail financially while the loan is outstanding. Although Credit Strategies Fund generally has the ability to recall loaned securities pursuant to a securities lending arrangement in the event that a shareholder vote is held, there is a risk that any delay in recovery of such security will result in the holder of such security being unable to vote. All of the aforementioned risks may be greater for non-U.S. securities.

 

Risks Associated with Options on Securities.  There are several risks associated with transactions in options on securities. For example, there are significant differences between the securities and options markets that could result in an imperfect correlation between these markets, causing a given transaction not to achieve its objectives. A decision as to whether, when and how to use options involves the exercise of skill and judgment, and even a well conceived transaction may be unsuccessful to some degree because of market behavior or unexpected events.

 

As the writer of a covered call option, Credit Strategies Fund foregoes, during the option’s life, the opportunity to profit from increases in the market value of the security covering the call option above the sum of the premium and the strike price of the call, but has retained the risk of loss should the price of the underlying security decline. As Credit Strategies Fund writes covered calls over more of its portfolio, its ability to benefit from capital appreciation becomes more limited. The writer of an option has no control over the time when it may be required to fulfill its obligation as a writer of the option. Once an option writer has received an exercise notice, it cannot effect a closing purchase transaction in order to terminate its obligation under the option and must deliver the underlying security at the exercise price.

When Credit Strategies Fund writes covered put options, it bears the risk of loss if the value of the underlying stock declines below the exercise price minus the put premium. If the option is exercised, Credit Strategies Fund could incur a loss if it is required to purchase the stock underlying the put option at a price greater than the market price of the stock at the time of exercise plus the put premium Credit Strategies Fund received when it wrote the option. While Credit Strategies Fund’s potential gain in writing a covered put option is limited to distributions earned on the liquid assets securing the put option plus the premium received from the purchaser of the put option, Credit Strategies Fund risks a loss equal to the entire exercise price of the option minus the put premium.

 

The general risks of investing in options on securities do not apply to each Acquired Fund since they generally do not invest in options on securities.

 

Exchange-Listed Option Risks.  There can be no assurance that a liquid market will exist when Credit Strategies Fund seeks to close out an option position on an options exchange. Reasons for the absence of a liquid secondary market on an exchange include the following: (i) there may be insufficient trading interest in certain options; (ii) restrictions may be imposed by an exchange on opening transactions or closing transactions or both; (iii) trading halts, suspensions or other restrictions may be imposed with respect to particular classes or series of options; (iv) unusual or unforeseen circumstances may interrupt normal operations on an exchange; (v) the facilities of an exchange or the Options Clearing Corporation may not at all times be adequate to handle current trading volume; or (vi) one or more exchanges could, for economic or other reasons, decide or be compelled at some future date to discontinue the trading of options (or a particular class or series of options). If trading were discontinued, the secondary market on that exchange (or in that class or series of options) would cease to exist. However, outstanding options on that exchange that had been issued by the Options Clearing Corporation as a result of trades on that exchange would continue to be exercisable in accordance with their terms. If Credit Strategies Fund were unable to close out a covered call option that it had written on a security, it would not be able to sell the underlying security unless the option expired without exercise.

 

The hours of trading for options on an exchange may not conform to the hours during which the underlying securities are traded. To the extent that the options markets close before the markets for the underlying securities, significant price and rate movements can take place in the underlying markets that cannot be reflected in the options markets. Call options are marked to market daily and their value will be affected by changes in the value and dividend rates of the underlying common stocks, an increase in interest rates, changes in the actual or perceived volatility of the stock market and the underlying common stocks and the remaining time to the options’ expiration. Additionally, the exercise price of an option may be adjusted downward before the option’s expiration as a result of the occurrence of certain corporate events affecting the underlying equity security, such as extraordinary dividends, stock splits, merger or other extraordinary distributions or events. A reduction in the exercise price of an option would reduce Credit Strategies Fund’s capital appreciation potential on the underlying security.

 

The general risks of investing in exchange-listed options do not apply to each Acquired Fund since they generally do not invest in exchange-listed options.

 

Over-the-Counter Option Risk.  Credit Strategies Fund may write (sell) unlisted (“OTC” or “over-the-counter”) options, and options written by Credit Strategies Fund with respect to non-U.S. securities, indices or sectors generally will be OTC options. OTC options differ from exchange-listed options in that they are two-party contracts, with exercise price, premium and other terms negotiated between buyer and seller, and generally do not have as much market liquidity as exchange-listed options. The counterparties to these transactions typically will be major international banks, broker-dealers and financial institutions. Credit Strategies Fund may be required to treat as illiquid those securities being used to cover certain written OTC options. The OTC options written by Credit Strategies Fund will not be issued, guaranteed or cleared by the Options Clearing Corporation. In addition, Credit Strategies Fund’s ability to terminate the OTC options may be more limited than with exchange-traded options. Banks, broker-dealers or other financial institutions participating in such transaction may fail to settle a transaction in accordance with the terms of the option as written. In the event of default or insolvency of the counterparty, Credit Strategies Fund may be unable to liquidate an OTC option position.

The general risks of investing in over-the-counter options do not apply to each Acquired Fund since they generally do not invest in over-the-counter options.

 

Index Option Risk.  Credit Strategies Fund may sell index put and call options from time to time. The purchaser of an index put option has the right to any depreciation in the value of the index below the exercise price of the option on or before the expiration date. The purchaser of an index call option has the right to any appreciation in the value of the index over the exercise price of the option on or before the expiration date. Because the exercise of an index option is settled in cash, sellers of index call options, such as Credit Strategies Fund, cannot provide in advance for their potential settlement obligations by acquiring and holding the underlying securities. Credit Strategies Fund will lose money if it is required to pay the purchaser of an index option the difference between the cash value of the index on which the option was written and the exercise price and such difference is greater than the premium received by Credit Strategies Fund for writing the option. The value of index options written by Credit Strategies Fund, which will be priced daily, will be affected by changes in the value and dividend rates of the underlying common stocks in the respective index, changes in the actual or perceived volatility of the stock market and the remaining time to the options’ expiration. The value of the index options also may be adversely affected if the market for the index options becomes less liquid or smaller. Distributions paid by Credit Strategies Fund on its common shares may be derived in part from the net index option premiums it receives from selling index put and call options, less the cost of paying settlement amounts to purchasers of the options that exercise their options. Net index option premiums can vary widely over the short term and long term.

 

The general risks of investing in index options do not apply to each Acquired Fund since they generally do not invest in index options.

 

Interest Rate Risk.  Interest rate risk is the risk that debt securities, and Credit Strategies Fund’s net assets, may decline in value because of changes in interest rates. Generally, debt securities will decrease in value when interest rates rise and increase in value when interest rates decline. This means that the NAV of the common shares will fluctuate with interest rate changes and the corresponding changes in the value of Credit Strategies Fund’s debt security holdings.

 

Prepayment Risk.  If interest rates fall, the principal on bonds held by Credit Strategies Fund may be paid earlier than expected. If this happens, the proceeds from a prepaid security may be reinvested by Credit Strategies Fund in securities bearing lower interest rates, resulting in a possible decline in Credit Strategies Fund’s income and distributions to shareholders. Credit Strategies Fund may invest in pools of mortgages or other assets issued or guaranteed by private issuers or U.S. government agencies and instrumentalities. Mortgage-related securities are especially sensitive to prepayment risk because borrowers often refinance their mortgages when interest rates drop.

 

Asset-Backed Securities Risk.  Payment of interest and repayment of principal on asset-backed securities may be largely dependent upon the cash flows generated by the assets backing the securities and, in certain cases, supported by letters of credit, surety bonds or other credit enhancements. Asset-backed security values may also be affected by the creditworthiness of the servicing agent for the pool, the originator of the loans or receivables or the entities providing the credit enhancement. In addition, the underlying assets are subject to prepayments that shorten the securities’ weighted average maturity and may lower their return.

 

The general risks of investing in asset-backed securities do not apply to each Acquired Fund since they generally do not invest in asset-backed securities.

 

Mortgage-Backed Securities Risk.  A mortgage-backed security, which represents an interest in a pool of assets such as mortgage loans, will mature when all the mortgages in the pool mature or are prepaid. Therefore, mortgage-backed securities do not have a fixed maturity, and their expected maturities may vary when interest rates rise or fall.

 

When interest rates fall, homeowners are more likely to prepay their mortgage loans. An increased rate of prepayments on Credit Strategies Fund’s mortgage-backed securities will result in an unforeseen loss of interest income to Credit Strategies Fund as Credit Strategies Fund may be required to reinvest assets at a lower interest rate. Because prepayments increase when interest rates fall, the price of mortgage-backed securities does not increase as much as other fixed income securities when interest rates fall.

When interest rates rise, homeowners are less likely to prepay their mortgage loans. A decreased rate of prepayments lengthens the expected maturity of a mortgage-backed security. Therefore, the prices of mortgage-backed securities may decrease more than prices of other fixed income securities when interest rates rise.

 

Timely payment of interest and principal of mortgage backed securities may be supported by various forms of private insurance or guarantees, including individual loan, title, pool and hazard insurance purchased by the issuer. There can be no assurance that the private insurers can meet their obligations under the policies. An unexpectedly high rate of defaults on the mortgages held by a mortgage pool may adversely affect the value of a mortgage-backed security and could result in losses to Credit Strategies Fund. The risk of such defaults is generally higher in the case of mortgage pools that include sub-prime mortgages. Sub-prime mortgages refer to loans made to borrowers with weakened credit histories or with a lower capacity to make timely payments on their mortgages.

 

The general risks of investing in mortgage-backed securities do not apply to each Acquired Fund since they generally do not invest in mortgage-backed securities.

 

Non-Investment Grade Securities Risk.  There is no limit on the amount of Credit Strategies Fund’s portfolio that may be invested in below investment grade securities. Non-investment grade securities are commonly referred to as “junk securities.” Investments in lower grade securities will expose Credit Strategies Fund to greater risks than if Credit Strategies Fund owned only higher grade debt securities. Because of the substantial risks associated with lower grade securities, you could lose money on your investment in common shares of Credit Strategies Fund, both in the short-term and the long-term. Lower grade securities, though high yielding, are characterized by high risk. They may be subject to certain risks with respect to the issuing entity and to greater market fluctuations than certain lower yielding, higher rated securities. The retail secondary market for lower grade debt securities may be less liquid than that of higher rated debt securities. Adverse conditions could make it difficult at times for Credit Strategies Fund to sell certain securities or could result in lower prices than those used in calculating Credit Strategies Fund’s NAV.

 

Credit Strategies Fund can invest a greater percentage of its assets in non-investment grade securities than Income Shares. As such, the general risks of investing in non-investment grade securities are greater for Credit Strategies Fund than Income Shares.

 

Derivatives Risk.  Derivative transactions in which Credit Strategies Fund may engage for hedging and speculative purposes or to enhance total return, including engaging in transactions such as options, futures, swaps, foreign currency transactions including forward foreign currency contracts, currency swaps or options on currency and currency futures and other derivatives transactions (“Derivative Transactions”), also involve certain risks and special considerations. Derivatives allow an investor to hedge or speculate upon the price movements of a particular security, financial benchmark currency or index at a fraction of the cost of investing in the underlying asset. The value of a derivative depends largely upon price movements in the underlying asset. Therefore, many of the risks applicable to trading the underlying asset are also applicable to derivatives of such asset. However, there are a number of other risks associated with derivatives trading, including the imperfect correlation between the value of such instruments and the underlying assets, the possible default of the other party to the transaction or illiquidity of the derivative instruments. Furthermore, the ability to successfully use Derivative Transactions depends on the Adviser’s ability to predict pertinent market movements, which cannot be assured. Because many derivatives are “leveraged,” and thus provide significantly more market exposure than the money paid or deposited when the transaction is entered into, a relatively small adverse market movement can not only result in the loss of the entire investment, but may also expose the Credit Strategies Fund to the possibility of a loss exceeding the original amount invested. The use of Derivative Transactions may result in losses greater than if they had not been used, may require Credit Strategies Fund to sell or purchase portfolio securities at inopportune times or for prices other than current market values, may limit the amount of appreciation Credit Strategies Fund can realize on an investment or may cause Credit Strategies Fund to hold a security that it might otherwise sell. The use of foreign currency transactions can result in Credit Strategies Fund’s incurring losses as a result of the imposition of exchange controls, suspension of settlements or the inability of Credit Strategies Fund to deliver or receive a specified currency. Additionally, amounts paid by Credit Strategies Fund as premiums and cash or other assets held in margin accounts with respect to Derivative Transactions are not otherwise available to Credit Strategies Fund for investment purposes.

To the extent that Credit Strategies Fund purchases options pursuant to a hedging strategy, Credit Strategies Fund will be subject to the following additional risks. If a put or call option purchased by Credit Strategies Fund is not sold when it has remaining value, and if the market price of the underlying security remains equal to or greater than the exercise price (in the case of a put), or remains less than or equal to the exercise price (in the case of a call), Credit Strategies Fund will lose its entire investment in the option.

 

Also, where a put or call option on a particular security is purchased to hedge against price movements in a related security, the price of the put or call option may move more or less than the price of the related security. If restrictions on exercise were imposed, Credit Strategies Fund might be unable to exercise an option it had purchased. If Credit Strategies Fund were unable to close out an option that it had purchased on a security, it would have to exercise the option in order to realize any profit or the option may expire worthless.

 

The general risks of investing in derivatives do not apply to each Acquired Fund since they generally do not invest in derivatives.

 

Market Risk Generally.  The profitability of a significant portion of Credit Strategies Fund’s investment program depends to a great extent upon correctly assessing the future course of the price movements of securities and other investments and the movements of interest rates. There can be no assurance that the Adviser will be able to predict accurately these price and interest rate movements. With respect to certain investment strategies Credit Strategies Fund utilizes, there is a high degree of market risk.

 

Reinvestment Risk.  Credit Strategies Fund reinvests the cash flows received from a security. The additional income from such reinvestment, sometimes called interest-on-interest, is dependent on the prevailing interest rate levels at the time of reinvestment. There is a risk that the interest rate at which interim cash flows can be reinvested will fall. Reinvestment risk is greater for longer holding periods and for securities with large, early cash flows such as high-coupon bonds. Reinvestment risk also applies generally to the reinvestment of the proceeds Credit Strategies Fund receives upon the maturity or sale of a portfolio security.

 

Timing Risk.  Many agency, corporate and municipal bonds, and most mortgage-backed securities, contain a provision that allows the issuer to “call” all or part of the issue before the bond’s maturity date, often after 5 or 10 years. The issuer usually retains the right to refinance the bond in the future if market interest rates decline below the coupon rate. There are three disadvantages to the call provision. First, the cash flow pattern of a callable bond is not known with certainty. Second, because an issuer is more likely to call the bonds when interest rates have dropped, Credit Strategies Fund is exposed to reinvestment risk, i.e., Credit Strategies Fund may have to reinvest at lower interest rates the proceeds received when the bond is called. Finally, the capital appreciation potential of a bond will be reduced because the price of a callable bond may not rise much above the price at which the issuer may call the bond.

 

Inflation Risk.  Inflation risk results from the variation in the value of cash flows from a security due to inflation, as measured in terms of purchasing power. For example, if Credit Strategies Fund purchases a bond in which it can realize a coupon rate of 5%, but the rate of inflation increases from 2% to 6%, then the purchasing power of the cash flow has declined. For all but adjustable bonds or floating rate bonds, Credit Strategies Fund is exposed to inflation risk because the interest rate the issuer promises to make is fixed for the life of the security. To the extent that interest rates reflect the expected inflation rate, floating rate bonds have a lower level of inflation risk. In addition, during any periods of rising inflation, dividend rates of any variable rate preferred shares issued by the Fund would likely increase, which would tend to further reduce returns to common shareholders.

 

Arbitrage Risks.  Credit Strategies Fund may engage in capital structure arbitrage and other arbitrage strategies. Arbitrage strategies entail various risks including the risk that external events, regulatory approvals and other factors will impact the consummation of announced corporate events and/or the prices of certain positions. In addition, hedging is an important feature of capital structure arbitrage. There is no guarantee that the Adviser will be able to hedge Credit Strategies Fund’s portfolio in the manner necessary to employ successfully Credit Strategies Fund’s strategy.

The general risks of using arbitrage strategies do not apply to each Acquired Fund since they generally do not use arbitrage strategies.

 

Short Sales Risk.  Short sales by Credit Strategies Fund that are not made “against the box” theoretically involve unlimited loss potential since the market price of securities sold short may increase without limit. Short selling involves selling securities which may or may not be owned and borrowing the same securities for delivery to the purchaser, with an obligation to replace the borrowed securities at a later date. Short selling allows Credit Strategies Fund to profit from declines in market prices to the extent such decline exceeds the transaction costs and the costs of borrowing the securities. However, since the borrowed securities must be replaced by purchases at market prices in order to close out the short position, any appreciation in the price of the borrowed securities would result in a loss. There can be no assurance that the securities necessary to cover a short position will be available for purchase. Purchasing securities to close out the short position can itself cause the price of the securities to rise further, thereby exacerbating the loss. Credit Strategies Fund may mitigate such losses by replacing the securities sold short before the market price has increased significantly. Under adverse market conditions, Credit Strategies Fund might have difficulty purchasing securities to meet its short sale delivery obligations, and might have to sell portfolio securities to raise the capital necessary to meet its short sale obligations at a time when fundamental investment considerations would not favor such sales.

 

The general risks of using short sales do not apply to each Acquired Fund since they generally do not use short sales.

 

Risks of Investing in Structured Finance Securities.  A portion of Credit Strategies Fund’s investments may consist of equipment trust certificates, collateralized mortgage obligations, collateralized bond obligations, collateralized loan obligations or similar instruments. Structured finance securities may present risks similar to those of the other types of debt obligations in which Credit Strategies Fund may invest and, in fact, such risks may be of greater significance in the case of structured finance securities. Moreover, investing in structured finance securities may entail a variety of unique risks. Among other risks, structured finance securities may be subject to prepayment risk. In addition, the performance of a structured finance security will be affected by a variety of factors, including its priority in the capital structure of the issuer thereof, the availability of any credit enhancement, the level and timing of payments and recoveries on and the characteristics of the underlying receivables, loans or other assets that are being securitized, remoteness of those assets from the originator or transferor, the adequacy of and ability to realize upon any related collateral and the capability of the servicer of the securitized assets. In addition, the complex structure of the security may not be fully understood at the time of investment and may produce unexpected investment results. Investments in structured finance securities may also be subject to illiquidity risk. Collateralized mortgage obligations may have risks similar to those of mortgage-backed securities. See “Mortgage-Backed Securities Risk” for more information.

 

Risks of Investing in Preferred Securities.  There are special risks associated with investing in preferred securities, including:

 

 

The general risks of investing in preferred securities do not apply to each Acquired Fund since they generally do not invest in preferred securities.

 

Risks of Investing in Synthetic Securities.  In addition to credit risks associated with holding non-investment grade loans and high-yield debt securities, with respect to synthetic securities Credit Strategies Fund will usually have a contractual relationship only with the counterparty of such synthetic securities, and not the Reference Obligor (as defined below) on the Reference Obligation (as defined below). Credit Strategies Fund generally will have no right to directly enforce compliance by the Reference Obligor with the terms of the Reference Obligation or any rights of set-off against the Reference Obligor, nor have any voting rights with respect to the Reference Obligation. Credit Strategies Fund will not benefit directly from any collateral supporting the Reference Obligation or have the benefit of the remedies on default that would normally be available to a holder of such Reference Obligation. In addition, in the event of insolvency of its counterparty, Credit Strategies Fund will be treated as a general creditor of such counterparty and will not have any claim with respect to the credit risk of the counterparty as well as that of the Reference Obligor. As a result, a large amount of synthetic securities with any one counterparty subjects the holders of such synthetic securities to an additional degree of risk with respect to defaults by such counterparty as well as by the Reference Obligor. The Adviser may not perform independent credit analyses of the counterparties, any such counterparty, or an entity guaranteeing such counterparty, individually or in the aggregate. A “Reference Obligation” is the debt security or other obligation upon which the synthetic security is based. A “Reference Obligor” is the obligor on a Reference Obligation. There is no maximum amount of Credit Strategies Fund’s assets that may be invested in these securities.

 

The general risks of investing in synthetic securities do not apply to each Acquired Fund since they generally do not invest in synthetic securities.

 

Valuation Risk.  Fair value is defined as the amount for which assets could be sold in an orderly disposition over a reasonable period of time, taking into account the nature of the asset. Fair value pricing, however, involves judgments that are inherently subjective and inexact, since fair valuation procedures are used only when it is not possible to be sure what value should be attributed to a particular asset or when an event will affect the market price of an asset and to what extent. As a result, there can be no assurance that fair value pricing will reflect actual market value and it is possible that the fair value determined for a security will be materially different from the value that actually could be or is realized upon the sale of that asset.

 

Market Disruption and Geopolitical Risk.  The aftermath of the war in Iraq and the continuing occupation of Iraq, instability in the Middle East and terrorist attacks in the United States and around the world may have resulted in market volatility and may have long-term effects on the U.S. and worldwide financial markets and may cause further economic uncertainties in the United States and worldwide. Terrorism in the U.S. and around the world has had a similar global impact and has increased geopolitical risk. The Adviser does not know how long the securities markets will continue to be affected by these events and cannot predict the effects of the occupation or similar events in the future on the U.S. economy and securities markets. Given the risks described above, an investment in the common shares of Credit Strategies Fund may not be appropriate for all investors. You should carefully consider your ability to assume these risks before making an investment in Credit Strategies Fund.

 

Risks of Investing in a Fund with Anti-Takeover Provisions.  Credit Strategies Fund’s Agreement and Declaration of Trust includes provisions that could limit the ability of other entities or persons to acquire control of Credit Strategies Fund or convert Credit Strategies Fund to open-end status. These provisions could deprive the holders of common shares of opportunities to sell their common shares at a premium over the then current market price of the common shares or at NAV.

 

Key Adviser Personnel Risk.  Credit Strategies Fund’s ability to identify and invest in attractive opportunities is dependent upon Highland, its investment adviser. If one or more key individuals leave Highland, Highland may not be able to hire qualified replacements or may require an extended time to do so. This situation could prevent Credit Strategies Fund from achieving its investment objectives.

 

The Reorganizations seek to combine two smaller funds (High Income Portfolio and Income Shares) into one larger fund (Credit Strategies Fund) to achieve certain economies of scale and other operational efficiencies. Each Acquired Fund is registered as a diversified, closed-end management investment company under the 1940 Act. The Acquiring Fund is registered as a non-diversified, closed-end management investment company under the 1940 Act. Highland is the investment adviser to each Fund.

 

The investment objective of each Acquired Fund is similar to that of Credit Strategies Fund, although each Fund seeks to achieve its objective in different ways. High Income Portfolio seeks to provide high current income, while seeking to preserve shareholders’ capital. Income Shares seeks to provide a high level of current income, with capital appreciation as a secondary objective. Credit Strategies Fund seeks to provide both current income and capital appreciation and therefore has a greater focus on capital appreciation.

 

High Income Portfolio invests at least 65% of its total assets in high-yield, fixed-income securities rated in the lower categories (Ba/BB or lower) by a rating agency or nonrated fixed-income securities deemed by the Adviser to be of comparable quality. High Income Portfolio typically invests a substantially higher percentage of its assets in such securities.

 

Income Shares invests at least 50% of its total assets in debt securities rated in the four highest categories (Baa/BBB or higher) by a rating agency or nonrated debt securities deemed by the Adviser to be of comparable quality.

 

Credit Strategies Fund invests at least 80% of its assets in the following categories of securities and instruments of corporations and other business entities: (i) secured and unsecured floating and fixed rate loans; (ii) bonds and other debt obligations; (iii) debt obligations of stressed, distressed and bankrupt issuers; (iv) structured products, including but not limited to, mortgage-backed and other asset-backed securities and collateralized debt obligations; and (v) equities. A significant portion of Credit Strategies Fund’s assets may be invested in securities rated below investment grade (Ba/BB or lower), which are commonly referred to as “junk securities” or “high-yield securities.”

 

The investment policies of each Fund are different, particularly with respect to investments in senior loans. Credit Strategies Fund invests more heavily in senior loans than either Acquired Fund. Income Shares invests a greater proportion of its assets in investment grade securities than Credit Strategies Fund. Credit Strategies Fund also has the ability to invest in certain types of securities in which the Acquired Funds may not invest. Please see the charts below comparing each Acquired Fund’s investment objectives and policies to that of Credit Strategies Fund for more information.

 

You are being asked to approve an Agreement and Plan of Reorganization to which your Fund is a party, a form of which is attached to this Proxy Statement/Prospectus as Appendix A (each, an “Agreement”). Additional information about each Reorganization and Agreement is set forth below under “Further Information on the Reorganizations.” The Agreements provide for Reorganizations on the following terms:

 

 

 

In addition, prior to a Reorganization, preferred shareholders of an Acquired Fund will receive the liquidation preference associated with their preferred shares plus any accumulated and unpaid dividends. A Reorganization will not be completed unless, before the final shareholder vote thereon, the participating Acquired Fund commences, and irrevocably commits to complete as expeditiously as possible, the process for redeeming its preferred shares.

 

The distribution of Acquiring Fund Common Shares pursuant to the Reorganization of an Acquired Fund will be accomplished by opening new accounts on the books of the Acquiring Fund in the names of that Acquired Fund’s common shareholders of record as of the closing date of the Reorganization and transferring the Acquiring Fund Common Shares to those accounts. Each such account for a former common shareholder of an Acquired Fund will be credited with the pro rata number of Acquiring Fund Common Shares (rounded down, in the case of fractional shares held other than in a Dividend Reinvestment Plan account, to the next largest number of whole shares) due such shareholder. If fractional Acquiring Fund Common Shares otherwise would have been credited to an account, the Acquiring Fund will issue cash for such fractional shares (except for shares held in a Dividend Reinvestment Plan account). See “Further Information on the Reorganizations — Additional Terms of the Agreement and Plan of Reorganization” below for a description of the procedures to be followed by the Acquired Funds’ shareholders to obtain Acquiring Fund Common Shares (and cash in lieu of fractional shares, if any).

 

The Boards of the Funds considered the Reorganizations over several meetings held on September 7, 2007, November 6, 2007, December 14, 2007 and February 20, 2008. At the meeting held on February 20, 2008, the Board of each Fund, including the Trustees/Directors who are not “interested persons” (as defined in the 1940 Act) of each Fund, unanimously approved the Agreement(s) to which its Fund is a participant.

 

The Board of each Acquired Fund has determined that participation in the applicable Reorganization is in the best interests of the Fund and that the interests of its shareholders will not be diluted as a result of that Reorganization. Similarly, the Acquiring Fund’s Board has determined that participation in each Reorganization is in the best interests of its common shareholders and that the interests of such shareholders will not be diluted as a result of each Reorganization. Preferred shareholders of the Acquired Funds will not participate in the Reorganizations. As noted above, the preferred shares will be redeemed prior to each Reorganization. In addition, as a result of the Reorganizations, shareholders of each Fund, particularly the shareholders of the Acquired Funds, will have a smaller percentage of ownership in the larger combined Fund than they did in any of the separate Funds.

 

The Board of each Fund believes that reorganizing each Acquired Fund into the Acquiring Fund, a fund with a similar investment objective, and having a combined portfolio with greater assets, offers you potential benefits. The Board considered the following matters, among others, in approving the proposals:

 

 

 

Each Board also considered that if shareholders approve a Reorganization, Highland would contractually agree to waive a portion of Credit Strategies Fund’s advisory fee and administration fee for two years so that Highland would receive no additional benefit from the Reorganization for two years. The waivers are intended to offset the additional revenue Highland would receive on each Acquired Fund’s assets (calculated as of the date of its Reorganization and including the value of its preferred shares that historically have been outstanding) due to the difference between the advisory fee rates of each Acquired Fund and Credit Strategies Fund and the fact that the Acquired Funds do not pay an administration fee to Highland. However, even with the contractual fee waivers, the annual operating expenses of the combined Fund are expected to be higher than High Income Portfolio’s current

annual operating expenses and, after the waivers expire, the annual operating expenses of the combined Fund are expected to be higher than either Acquired Fund’s current annual operating expenses. As of each Fund’s last fiscal year, the total annual operating expenses, as a percentage of average net assets, of High Income Portfolio, Income Shares and Credit Strategies Fund were 3.34%, 3.99% and 4.06%, respectively. Assuming each Reorganization is approved, the estimated total annual operating expenses of the combined Fund would be 4.03% of average net assets and, with the contractual fee waivers described above, the estimated net annual operating expenses of the combined Fund would be 3.88% of average net assets.

 

The Boards of each Fund also considered that the Adviser would benefit from the Reorganizations. For example, the Adviser may achieve cost savings due to the Acquiring Fund’s lower fixed costs, which may result in reduced costs resulting from a consolidated portfolio management effort. The Boards believe, however, that these savings will not amount to a significant economic benefit to the Adviser.

 

The Acquiring Fund’s pro forma annual operating expenses, which reflect the contractual fee waivers offered by Highland and the proceeds of a rights offering completed by the Acquiring Fund on January 28, 2008, may be lower than the current annual operating expenses of Income Shares, although they are expected to be higher than High Income Portfolio’s annual operating expenses. In addition, a combined Fund offers economies of scale that may lead to a reduction in certain expenses. The Acquiring Fund’s higher expenses are due, in part, to its leveraging by borrowing pursuant to a credit facility rather than by issuing preferred shares. While the use of a credit facility has been more expensive, it provides the Acquiring Fund greater flexibility to change the amount of its leverage depending on market conditions. Over time, this flexibility may enable the Acquiring Fund to achieve greater performance, although there is no guarantee or assurance as to the future performance of Credit Strategies Fund. Credit Strategies Fund’s 1-year performance as of December 31, 2007 on a net asset value basis is better than Income Shares and its overall historical premium/discount profile is better than that of each Acquired Fund. However, more recently, Acquiring Fund Common Shares have traded at a larger discount from NAV than shares of either Acquired Fund. The Acquiring Fund also completed a rights offering on January 28, 2008. There is no guarantee or assurance as to the future performance, liquidity or premium/discount profile of Credit Strategies Fund.

 

A full comparison of advisory fee rates and expense ratios is included below.

 

The Boards also considered details of the relative performance of each Acquired Fund and the Acquiring Fund.

 

For the reasons described herein, the Board of each Acquired Fund, including the Directors who are not “interested persons” (as defined in the 1940 Act) of that Fund, the Acquiring Fund or the Adviser, approved the Reorganization in which that Acquired Fund would participate. In particular, the Directors determined that participation in the Reorganization involving that Fund is in its best interests and that the interests of its shareholders would not be diluted as a result of the Reorganization. Similarly, the Board of the Acquiring Fund, including the Trustees who are not “interested persons” (as defined in the 1940 Act) of any Fund or the Adviser, approved each Reorganization. They also determined that participation in each Reorganization is in the Acquiring Fund’s best interests and that the interests of its shareholders would not be diluted as a result of each Reorganization.

 

With respect to the applicable Acquired Fund, approval of the proposal requires the vote of: (1) the holders of at least a majority of the common and preferred shares entitled to vote, voting as a single class; and (2) the holders of at least a majority of the preferred shares entitled to vote, voting as a separate class.

 

 

 

Shareholders of each Acquired Fund are also being asked to vote on the election of directors as discussed below. Electing directors at this Meeting would avoid the expense of holding two shareholder meetings within a short period of time.

 

PROPOSAL 2(A) — ELECTION OF DIRECTORS: HIGH INCOME PORTFOLIO ONLY

 

At the Meeting, High Income Portfolio’s common shareholders are being asked to elect Scott F. Kavanaugh as a Class II Director of High Income Portfolio, and High Income Portfolio’s preferred shareholders are being asked to elect Timothy K. Hui as a Class II Director of High Income Portfolio, each to serve for a three-year term until the 2011 annual meeting of shareholders and until his successor is duly elected and qualified. Messrs. Kavanaugh and Hui are currently serving as Class II Directors of High Income Portfolio, and each has agreed to continue to serve as a Class II Director, if elected. If either Mr. Kavanaugh or Mr. Hui is not available for election at the time of the Meeting, the persons named as proxies will vote for such substitute nominee as the Nominating Committee may select.

 

High Income Portfolio’s Board is divided into three classes with the term of office of one class expiring each year. Class I is comprised of one Director, and Classes II and III are each comprised of two Directors. R. Joseph Dougherty is currently the Class I Director and was elected to serve a three-year term at High Income Portfolio’s annual meeting of shareholders held on May 25, 2007. Messrs. Hui and Kavanaugh are Class II Directors and will continue to serve as Class II Directors if elected at the Meeting. James F. Leary and Bryan A. Ward are currently Class III Directors and were each elected to serve a three-year term at High Income Portfolio’s annual meeting of shareholders held on May 19, 2006.

 

PROPOSAL 2(B) — ELECTION OF DIRECTORS: INCOME SHARES ONLY

 

At the Meeting, Income Shares’ common shareholders and preferred shareholders are being asked to elect R. Joseph Dougherty as a Class I Director of Income Shares, to serve for a three-year term until the 2011 annual meeting of shareholders and until his successor is duly elected and qualified. Mr. Dougherty is currently serving as a Class I Director of Income Shares and has agreed to continue to serve as a Class I Director, if elected. If Mr. Dougherty is not available for election at the time of the Meeting, the persons named as proxies will vote for such substitute nominee as the Board may select.

 

Income Shares’ Board is divided into three classes with the term of office of one class expiring each year. Class I is comprised of one Director, and Classes II and III are each comprised of two Directors. Mr. Dougherty is currently the Class I Director and will continue to serve as the Class I Director if elected at the Meeting. Messrs. Hui and Kavanaugh are currently serving as Class II Directors and were elected to serve a three-year term at Income Shares’ annual meeting of shareholders held on May 19, 2006. Messrs. Leary and Ward are currently serving as Class III Directors and were elected to serve a three-year term at Income Shares’ annual meeting of shareholders held on May 25, 2007.

 

VOTING FOR DIRECTORS

 

High Income Portfolio and Income Shares

 

The shareholders of any outstanding preferred shares, as a separate class, have the right to elect two Directors; the shareholders of the common shares, as a separate class, have the right to elect two Directors; and the holders of

the preferred shares and the common shares, voting together as a single class, have the right to elect the remaining Director of each of High Income Portfolio or Income Shares. High Income Portfolio’s Nominating Committee has designated Scott F. Kavanaugh as the Class II Director to be elected by the common shareholders and Timothy K. Hui as the Class II Director to be elected by the preferred shareholders. Income Shares’ Board has designated R. Joseph Dougherty as the Class II Director to be elected by the common shareholders and preferred shareholders.

 

In addition, during any period in which High Income Portfolio or Income Shares has not paid dividends on the preferred shares in an amount equal to two full years of dividends (“Voting Period”), the preferred shareholders, voting as a separate class, are entitled to elect (in addition to the two Directors set forth above) the smallest number of additional Directors as is necessary to assure that a majority of the Directors has been elected by the preferred shareholders. If High Income Portfolio or Income Shares has not so paid dividends, the terms of office of all persons who are Directors of High Income Portfolio or Income Shares at the time of the commencement of a Voting Period will continue, notwithstanding the election by the preferred shareholders of the number of Directors that such shareholders are entitled to elect. The additional Directors elected by the preferred shareholders, together with the incumbent Directors, will constitute the duly elected Directors of High Income Portfolio or Income Shares. When all dividends in arrears on the Preferred Shares have been paid or provided for, the terms of office of the additional Directors elected by the preferred shareholders will terminate

 

*          *          *

 

 

Set forth below is the name and certain biographical and other information for each nominee for each Director, as reported to each of High Income Portfolio and Income Shares by each such person:

 

 

 

 

In addition to Mr. Dougherty, the other executive officers of High Income Portfolio and Income Shares are James D. Dondero, Mark K. Okada, M. Jason Blackburn and Michael Colvin. Set forth below are the names and certain biographical and other information for Messrs. Dondero, Okada, Blackburn and Colvin as reported by them to High Income Portfolio and Income Shares. Such officers serve at the pleasure of the Directors or until their successors have been duly elected and qualified. The Directors may fill any vacancy in office or add any additional officers at any time.

 

 

Ownership of Shares

 

Please see Appendix C to the Proxy Statement/Prospectus for information regarding the holdings of each Director in High Income Portfolio and Income Shares and for information regarding the persons who owned of record or beneficially 5% or more of the outstanding common shares or preferred shares of High Income Portfolio and Income Shares.

 

Board Meetings and Committee Meetings

 

During the fiscal year ended October 31, 2007 for High Income Portfolio and December 31, 2007 for Income Shares, the Directors of High Income Portfolio and Income Shares, identified in the table set forth in “Remuneration of Directors and Executive Officers” below, convened 10 and 12 times, respectively. During those specified fiscal years for High Income Portfolio and Income Shares, each Director attended at least 75% of the aggregate of all meetings of the Board and Committees on which he serves. Although High Income Portfolio and Income Shares do

not have a formal policy regarding Directors’ attendance at annual meetings of shareholders, one of the five Directors attended last year’s annual meetings of shareholders.

 

The Board of High Income Portfolio and Income Shares each has four committees; the Audit Committee, the Nominating Committee, the Litigation Committee and the Qualified Legal Compliance Committee, each of which is currently comprised of all of the Board members who are not “interested persons” of High Income Portfolio and Income Shares, as defined in the 1940 Act (the “Non-Interested Directors”), who are also “independent” as defined by the NYSE.

 

The Audit Committee.  Pursuant to each Audit Committee Charter adopted by High Income Portfolio’s and Income Shares’ Board, the function of the Audit Committee of each of High Income Portfolio and Income Shares is to (1) oversee the Fund’s accounting and financial reporting processes and the audits of the Fund’s financial statements and (2) assist in Board oversight of the integrity of the Fund’s financial statements, the Fund’s compliance with legal and regulatory requirements, the independent auditors’ qualifications, independence and performance. In addition, each Audit Committee may address questions arising with respect to the valuation of certain securities in the Fund’s portfolio. The Audit Committees of High Income Portfolio and Income Shares each met three times in fiscal year 2007. The report of the Audit Committee of each of High Income Portfolio and Income Shares is included in Appendix D. A copy of the Audit Committee Charter of each of High Income Portfolio and Income Shares is available at www.highlandfunds.com. The members of each Audit Committee are Messrs. Hui, Kavanaugh, Leary, and Ward, and the Board of High Income Portfolio and Income Shares each has determined that Mr. Leary is an “audit committee financial expert,” for purposes of the federal securities laws.

 

The Nominating Committee.  Each Nominating Committee of High Income Portfolio and Income Shares is responsible for selecting the Non-Interested Director nominees and recommending to the Board candidates for all other Director nominees for election by shareholders or appointment by the Board. A copy of the Nominating Committee Charter of each of High Income Portfolio and Income Shares is available at www.highlandfunds.com. Each Nominating Committee Charter describes the factors considered by the Nominating Committee in selecting nominees. In evaluating potential nominees, including any nominees recommended by shareholders, each Nominating Committee takes into consideration factors listed in the Nominating Committee Charter, including character and integrity, business and professional experience, whether the Nominating Committee believes the person has time availability in light of other commitments and the existence of any other relationships that might give rise to a conflict of interest.

 

Each Nominating Committee will consider recommendations for nominees from shareholders submitted to the Secretary of High Income Portfolio and Income Shares, Two Galleria Tower, Suite 800, 13455 Noel Road, Dallas, Texas 75240. Such shareholder recommendations must include information regarding the recommended nominee as specified in each Nominating Committee Charter. The Nominating Committees of High Income Portfolio and Income Shares each met once during fiscal year 2007. The members of each Nominating Committee are Messrs. Hui, Kavanaugh, Leary, and Ward.

 

High Income Portfolio and Income Shares have not received any recommendation from shareholders requesting consideration of a candidate for inclusion among the Directors’ slate of nominees in this Proxy Statement/Prospectus.

 

The Litigation Committee.  High Income Portfolio and Income Shares each have established a Litigation Committee to seek to address any potential conflicts of interest between it and the Adviser in connection with any potential or existing litigation or other legal proceeding relating to securities held by both it and the Adviser or another client of the Adviser. The Litigation Committee met four times in fiscal year 2007 for High Income Portfolio and did not meet in fiscal year 2007 for Income Shares. The members of the Litigation Committees are Messrs. Hui, Kavanaugh, Leary and Ward.

 

The Qualified Legal Compliance Committee.  The members of each Audit Committee of High Income Portfolio and Income Shares shall serve as the respective Qualified Legal Compliance Committee (the “QLCC”) for High Income Portfolio and Income Shares for the purpose of establishing alternative reporting procedures for Fund counsel and Non-Interested Director Counsel to report evidence of material violations of the federal or state securities laws by High Income Portfolio and Income Shares or their officers, and to address the confidential receipt,

retention and consideration of any reported evidence. The QLCC of each of High Income Portfolio and Income Shares each did not meet in fiscal year 2007.

 

High Income Portfolio and Income Shares do not have Compensation Committees.

 

Remuneration of Directors and Executive Officers

 

The executive officers of High Income Portfolio and Income Shares and the Interested Directors receive no direct remuneration from High Income Portfolio and Income Shares. Currently, Non-Interested Directors of High Income Portfolio and Income Shares receive an annual fee of $150,000 payable in quarterly installments in arrears and allocated among each portfolio in the Highland Fund Complex based on relative net assets. Prior to January 1, 2008, the Non-Interested Directors of High Income Portfolio and Income Shares were compensated at the rate of $15,000 annually and $5,000 annually, respectively, for serving as a Director, and also received compensation from the other portfolios in the Highland Fund Complex. Non-Interested Directors are also reimbursed for actual out-of-pocket expenses relating to attendance at meetings. The Directors do not have any pension or retirement plan.

 

The following tables summarize the compensation paid by High Income Portfolio and Income Shares to its Directors and the aggregate compensation paid by the Highland Fund Complex to the Directors.

 

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the 1934 Act and Section 30(h) of the 1940 Act, and the rules thereunder, require that each Fund’s Directors and officers, the Adviser, certain persons affiliated with the Adviser, and persons who own beneficially, directly or indirectly, more than 10% of each Fund’s common shares, file reports of ownership and changes of ownership with the Securities and Exchange Commission (“SEC”) and the NYSE. Directors, officers, the Adviser, certain affiliates of the Adviser and greater than 10% beneficial owners are required by SEC regulations to furnish to the applicable Fund copies of all Section 16(a) forms they file with respect to shares of the Fund. Based solely upon High Income Portfolio’s and Income Shares’ reviews of the copies of such forms they receive and written representations from such persons, High Income Portfolio and Income Shares believe that during the fiscal years ended October 31, 2007 for High Income Portfolio and December 31, 2007 for Income Shares, these persons complied with all such applicable filing requirements.

 

Selection of Independent Registered Public Accounting Firm

 

Information regarding the selection of Deloitte & Touche LLP (“D&T”) as High Income Portfolio’s and Income Shares’ independent registered public accounting firm for the fiscal year ending October 31, 2008 for High Income Portfolio and December 31, 2008 for Income Shares as well as the fees paid to D&T are found in Appendix D.

 

Approval of Proposal 2(A) (High Income Portfolio).  The election of Mr. Kavanaugh (Class II Director of High Income Portfolio) requires the affirmative vote of a majority of the common shares of High Income Portfolio, represented in person or by proxy at the Meeting and entitled to vote. The election of Mr. Hui (Class II Director of High Income Portfolio) requires the affirmative vote of a majority of the preferred shares of High Income Portfolio, represented in person or by proxy at the Meeting and entitled to vote.

 

Approval of Proposal 2(B) (Income Shares).  The election of Mr. Dougherty (Class I Director of Income Shares) requires the affirmative vote of a majority of the outstanding common shares and preferred shares of Income Shares, voting together as a single class.

 

 

 

ADDITIONAL INFORMATION RELATED TO THE REORGANIZATIONS OF

 

The following tables compare the investment objectives and policies of High Income Portfolio and Income Shares to Credit Strategies Fund and summarize the types of investments that each may engage in. For a more complete description of the types of investments, please refer to Appendix B.

 

 

 

Summary of Expense Comparison

 

As the tables below indicate, with the contractual fee waivers offered by Highland and the proceeds of a rights offering completed by Credit Strategies Fund on January 28, 2008, the pro forma annual operating expenses of Credit Strategies Fund may be lower than the annual operating expenses of Income Shares, although they are expected to be higher than High Income Portfolio’s annual operating expenses. In addition, a combined Fund offers the potential for economies of scale that may lead to a slight reduction in certain expenses.

 

The Funds’ Expenses

 

The tables below illustrate the change in operating expenses expected as a result of the Reorganization. The tables set forth (i) the fees, expenses and distributions to preferred shareholders paid by High Income Portfolio for the period ended October 31, 2007, (ii) the fees, expenses and distributions to preferred shareholders paid by Income Portfolio for the period ended December 31, 2007; (iii) the fees, expenses, and interest payments on borrowed funds paid by Credit Strategies Fund for the period ended December 31, 2007; and (iv) the pro forma fees, expenses and interest payments on borrowed funds for the Acquiring Fund for the period ended December 31, 2007, assuming each of the Reorganizations had been completed at the beginning of such period. The following tables show each Fund’s expenses as a percentage of net assets attributable to common shares and reflect the issuance of preferred shares in an amount equal to 29.33% of High Income Portfolio’s total assets and 33.97% of Income Shares’ total assets and borrowing in an amount equal to 28.54% of Credit Strategies Fund’s total assets and 28.54% of the combined Fund’s total assets after the Reorganizations are completed.

 

As described herein, an unfavorable vote by the shareholders of one Acquired Fund will not affect the consummation of the Reorganization by the other Acquired Fund if approved by such other Acquired Fund’s shareholders. It is anticipated that the most favorable expense ratio will be achieved for each Acquired Fund if both of the Reorganizations are approved and consummated and that a less favorable resulting expense ratio for each Acquired Fund will result if such Acquired Fund is the only Fund that participates in the Reorganization with the Acquiring Fund. As such, the following tables illustrate the anticipated change in operating expenses expected as a

result of (i) both Acquired Funds approving and participating in the Reorganization, (ii) Reorganization of only High Income Portfolio into the Acquiring Fund, and (iii) Reorganization of only Income Shares into the Acquiring Fund.

 

I. Both Acquired Funds Participating in the Reorganization:

 

 

 

 

 

 

II. Reorganization of only High Income Portfolio into the Acquiring Fund:

 

 

 

 

 

III. Reorganization of only Income Shares into the Acquiring Fund:

 

 

 

 

 

The purpose of the tables in this section is to assist you in understanding the various costs and expenses that a shareholder will bear directly or indirectly by investing in a Fund’s common shares and the Acquiring Fund’s costs and expenses that are expected to be incurred in the first year following the Reorganizations.

 

Example

 

The following example is intended to help you compare the costs of investing in the Acquiring Fund pro forma after the Reorganizations with the costs of investing in the Acquired Funds and the Acquiring Fund without the Reorganizations. An investor would pay the following expenses on a $1,000 investment in common shares, assuming (i) the operating expense ratio for each Fund (as a percentage of net assets attributable to common shares) set forth in the table above for years 1 through 10, (ii) dividends on preferred shares as set forth in the table above (iii) average borrowings under Credit Strategies Fund’s credit facility of $253.2 million prior to the Reorganizations, (iv) borrowings under Credit Strategies Fund’s credit facility of $310.4 million after the Reorganizations, (v) a 5% annual return throughout the period (vi) and the contractual fee waivers noted above after the Reorganizations.

 

Assuming Leverage

 

 

 

 

 

The example set forth above assumes the reinvestment of all dividends and other distributions at NAV. The example should not be considered a representation of past or future expenses or annual rates of return. Actual expenses or annual rates of return may be more or less than those assumed for purposes of the example.

 

 

Set forth below is information about each Fund’s common shares as of December 31, 2007.

 

Credit Strategies Fund

 

 

 

 

High Income Portfolio

 

 

Income Shares

 

 

Set forth below is information about High Income Portfolio’s and Income Shares’ preferred shares as of December 31, 2007.

 

High Income Portfolio

 

 

Income Shares

 

 

The following table sets forth the high and low sales prices for common shares of each Fund on the NYSE for each full quarterly period within the two most recent fiscal years or since inception and each full quarter since the beginning of the current fiscal year, along with the NAV and discount or premium to NAV for each quotation.

 

The Funds only make public their net asset values on a weekly basis. Accordingly, the net asset value and the premium and discount from net asset value in the table below are based on the publicly available net asset values for the week in which the high and low sales price occurred. Since the net asset value and the premium and discount

from net asset value is based on the publicly available net asset values for the week, which may not fall on the same date as the high and low sales prices, the range of net asset values and the premium and discount from net asset value for the common shares during the periods shown may be broader or more narrow than what is shown in this table.

 

CREDIT STRATEGIES FUND

 

 

HIGH INCOME PORTFOLIO

 

 

INCOME SHARES

 

 

As of March 31, 2008, (i) the net value per share for common shares of the Acquiring Fund was $14.50 and the market price per share was $13.02, representing a discount to NAV of -10.21%, (ii) the NAV per share for common shares of High Income Portfolio was $2.79 and the market price per share was $2.45, representing a discount to NAV of -12.19%, and (iii) the NAV per share for common shares of Income Shares was $5.50 and the market price per share was $4.78, representing a discount to NAV of -13.07%.

The NAV per share and market price per share of the common shares of each Fund may fluctuate prior to the closing date of its Reorganization. Depending on market conditions immediately prior to the closing date of a Reorganization, Acquiring Fund Common Shares may trade at a larger or smaller discount to NAV than an Acquired Fund’s common shares. This could result in the Acquiring Fund Common Shares having a market value that is greater or less than the market value of an Acquired Fund’s common shares on the closing date of a Reorganization.

 

Common shares of Credit Strategies Fund have traded at a premium to NAV at certain times and at a discount to NAV at certain times. Common shares of both the Acquired Funds have traded at a premium to NAV at certain times and at a discount to NAV at certain times.

 

Each Fund may from time to time take action to attempt to reduce or eliminate a market value discount from NAV by repurchasing their common shares in the open market or by tendering for their common shares at NAV.

 

So long as any preferred shares are outstanding, High Income Portfolio and Income Shares may not purchase, redeem or otherwise acquire any common shares unless (1) all accumulated dividends on the preferred shares or any other preferred shares have been paid or set aside for payment through the date of such purchase, redemption or other acquisition and (2) at the time of such purchase, redemption or acquisition certain asset coverage requirements (determined after deducting the acquisition price of the common shares) are met. Repurchases of common shares may result in High Income Portfolio and Income Shares being required to redeem preferred shares to satisfy asset coverage requirements.

 

Subject to its investment restrictions, a Fund may borrow to finance the repurchase of shares or to make a tender offer. Interest on any borrowings to finance share repurchase transactions or the accumulation of cash by a Fund in anticipation of share repurchases or tenders will reduce the Fund’s net income. The Fund will comply with the Securities Exchange Act of 1934, as amended (the “1934 Act”), the 1940 Act and the rules and regulations thereunder in connection with any share repurchase, tender offer or borrowing that might be approved by the Fund’s Board. Any such borrowings will be subject to the limitations imposed by the 1940 Act and the Rating Agency Guidelines.

 

The repurchase by a Fund of its common shares at prices below NAV will result in an increase in the NAV of those common shares that remain outstanding. However, there can be no assurance that common share repurchases or tender offers at or below NAV will result in the Fund’s common shares trading at a price equal to their NAV. Nevertheless, the fact that a Fund’s common shares may be the subject of repurchase or tender offers from time to time, or that the Fund may be converted to an open-end investment company, may reduce any spread between market price and NAV that might otherwise exist.

 

In addition, a purchase by the Fund of its common shares will decrease the Fund’s total assets which would likely have the effect of increasing the Fund’s expense ratio. Any purchase by the Fund of its common shares at a time when preferred shares are outstanding will increase the leverage applicable to the outstanding common shares then remaining.

 

Before deciding whether to take any action if the common shares trade below NAV, a Fund’s Board would likely consider all relevant factors, including the extent and duration of the discount, the liquidity of the Fund’s portfolio, the impact of any action that might be taken on the Fund or its shareholders and market considerations. Based on these considerations, even if a Fund’s shares should trade at a discount, the Fund’s Board may determine that, in the interest of the Fund and its shareholders, no action should be taken.

 

All Funds.

 

Distributions on each Fund’s common shares are declared based on annual projections of net investment income (defined as dividends and interest income, net of Fund expenses). High Income Portfolio and Credit Strategies Fund pay monthly distributions to common shareholders. Income Shares pays quarterly distributions to common shareholders. As a result of market conditions or investment decisions, the amount of distributions may

exceed net investment income earned at certain times throughout the period. It is anticipated that, on an annual basis, the amount of distributions to common shareholders will not exceed net investment income (as defined above) allocated to common shareholders for income tax purposes. Each Fund intends to pay any capital gain distributions annually.

 

Various factors will affect the level of each Fund’s current income and current gains, such as its asset mix, and each Fund’s use of options. To permit each Fund to maintain more stable monthly dividends and annual distributions, each Fund may from time to time distribute less than the entire amount of income and gains earned in the relevant month or year, respectively. The undistributed income and gains would be available to supplement future distributions. As a result, the distributions paid by each Fund for any particular period may be more or less than the amount of income and gains actually earned by each Fund during the applicable period. Undistributed income and gains will add to each Fund’s NAV and, correspondingly, distributions from undistributed income and gains and from capital, if any, will be deducted from each Fund’s NAV. Shareholders will automatically have all dividends and other distributions reinvested in common shares of each Fund issued by each Fund or purchased in the open market in accordance with each Fund’s Dividend Reinvestment Plan unless an election is made to receive cash. Each participant in each Fund’s Dividend Reinvestment Plan will pay a pro rata portion of brokerage commissions incurred in connection with open market purchases, and participants requesting a sale of securities through the plan agent of the Dividend Reinvestment Plan of the Acquiring Fund are subject to a sales fee and a brokerage commission. See “Dividend Reinvestment Plan.”

 

High Income Portfolio and Income Shares.

 

So long as any preferred shares of High Income Portfolio or Income Shares are outstanding, common shareholders of each Fund will not be entitled to receive any dividends of or other distributions from each Fund, unless at the time of such declaration, (1) all accrued dividends on preferred shares or accrued interest on borrowings have been paid and (2) the value of each Fund’s total assets (determined after deducting the amount of such dividend or other distribution), less all liabilities and indebtedness of each Fund not represented by senior securities, is at least 300% of the aggregate amount of such securities representing indebtedness and at least 200% of the aggregate amount of securities representing indebtedness plus the aggregate liquidation value of the outstanding preferred shares (expected to equal the aggregate original purchase price of the outstanding preferred shares plus redemption premium, if any, together with any accrued and unpaid dividends thereon, whether or not earned or declared and on a cumulative basis). In addition to the requirements of the 1940 Act, each Fund is required to comply with other asset coverage requirements as a condition of each Fund obtaining a rating of the preferred shares from a rating agency. These requirements include an asset coverage test more stringent than under the 1940 Act.

 

Each Fund offers its shareholders a Dividend Reinvestment Plan (the “Plan”), which offers the opportunity to earn compounded yields. The terms of each Plan is set forth below.

 

High Income Portfolio and Income Shares.  If your common shares are registered directly with the Fund or if you hold your common shares with a brokerage firm that participates in the Fund’s Plan, unless you elect by written notice to the Fund to receive cash distributions, all dividends, including any capital gain distributions, on your common shares will be automatically reinvested by PFPC Inc. (the “Plan Agent”), in additional common shares under the Plan. If you elect to receive cash distributions, you will receive all distributions in cash paid by check mailed directly to you by PFPC Inc., as dividend paying agent.

 

If you decide to participate in the Plan, the number of common shares you will receive will be determined as follows:

 

(1) If the common shares are trading at or above NAV at the time of valuation, the Fund will issue new shares of common shares at a price equal to the greater of (i) NAV per share of common shares on that date or (ii) 95% of the market price on that date.

(2) If common shares are trading below NAV at the time of valuation, the Plan Agent will receive the dividend or distribution in cash and will purchase common shares in the open market, on the American Stock Exchange or elsewhere, for the participants’ accounts. It is possible that the market price for the common shares may increase before the Plan Agent has completed its purchases. Therefore, the average purchase price per share of common shares paid by the Plan Agent may exceed the market price at the time of valuation, resulting in the purchase of fewer shares of common shares than if the dividend or distribution had been paid in common shares issued by the Fund. The Plan Agent will use all dividends and other distributions received in cash to purchase common shares in the open market within 30 days of the valuation date except where temporary curtailment or suspension of purchases is necessary to comply with federal securities laws. Interest will not be paid on any uninvested cash payments.

 

You may elect to opt out of or withdraw from the Plan at any time by giving written notice to the Plan Agent, or by telephone at (800) 331-1710, in accordance with such reasonable requirements as the Plan Agent and Fund may agree upon. If you withdraw or the Plan is terminated, you or your broker (on your behalf) will receive (a) your whole shares in non-certificated form and (b) a cash payment for any fraction of a share in your account. If you wish, the Plan Agent will sell your shares and send you the proceeds, minus brokerage commissions.

 

The Plan Agent maintains all common shareholders’ accounts in the Plan and gives written confirmation of all transactions in the accounts, including information you may need for tax records. Common shares in your account will be held by the Plan Agent in non-certificated form. The Plan Agent will forward to each participant any proxy solicitation material and will vote any common shares so held only in accordance with proxies returned to the Fund. Any proxy you receive will include all common shares you have received under the Plan.

 

There is no brokerage charge for reinvestment of your dividends or distributions in common shares. However, all participants will pay a pro rata share of brokerage commissions incurred by the Plan Agent when it makes open market purchases.

 

Automatically reinvesting dividends and other distributions does not mean that you do not have income tax liability thereon. Income from distributions is realized even if you do not receive cash. Consult your financial advisor for more information.

 

If you hold your common shares with a brokerage firm that does not participate in the Plan, you will not be able to participate in the Plan and any dividend reinvestment may be effected on different terms than those described above.

 

The Fund reserves the right to amend or terminate the Plan if in the judgment of the Board of Directors the change is warranted. There is no direct service charge to participants in the Plan; however, the Fund reserves the right to amend the Plan to include a service charge payable by the participants. Additional information about the Plan may be obtained by writing PFPC Inc., 301 Bellevue Parkway, Wilmington, Delaware 19809.

 

Credit Strategies Fund.  Unless the registered owner of common shares elects to receive cash by contacting the Plan Agent, all dividends declared for the common shares of Credit Strategies Fund will be automatically paid in the form of, or reinvested by the Plan Agent (agent for shareholders in administering Credit Strategies Fund’s Plan) in, additional common shares of Credit Strategies Fund. If you are a registered owner of common shares and elect not to participate in the Plan, you will receive all dividends in cash paid by check mailed directly to you (or, if the shares are held in street or other nominee name, then to such nominee) by PFPC Inc., as dividend disbursing agent. You may elect not to participate in the Plan and to receive all dividends in cash by sending written instructions or by contacting PFPC Inc., as dividend disbursing agent, at the address set forth below. Participation in the Plan is completely voluntary and may be terminated or resumed at any time without penalty by contacting the Plan Agent before the dividend record date; otherwise such termination or resumption will be effective with respect to any subsequently declared dividend or other distribution. Some brokers may automatically elect to receive cash on your behalf and may re-invest that cash in additional shares of Credit Strategies Fund for you.

 

The Plan Agent will open an account for each shareholder under the Plan in the same name in which such shareholder’s shares are registered. Whenever Credit Strategies Fund declares a dividend or other distribution (together, a “dividend”) payable in cash, non-participants in the Plan will receive cash and participants in the Plan will receive the equivalent in common shares. The common shares will be acquired by the Plan Agent for the

participants’ accounts, depending upon the circumstances described below, either (i) through receipt of additional unissued but authorized shares from Credit Strategies Fund (“newly issued shares”) or (ii) by purchase of outstanding common shares on the open market (“open-market purchases”) on the NYSE or elsewhere.

 

If, on the payment date for any dividend, the market price per common share plus estimated brokerage commissions is greater than the NAV per common share (such condition being referred to herein as “market premium”), the Fund will issue common shares, including fractions, to the participants in the amount of the dividend. The number of newly issued common shares to be credited to each participant’s account will be determined by dividing the dollar amount of the dividend by the NAV per common share on the payment date; provided that, if the NAV per common share is less than 95% of the market price per common share on the payment date, the dollar amount of the dividend will be divided by 95% of the market price per common share on the payment date.

 

If, on the payment date for any dividend, the NAV per common share is greater than the market value per common share plus estimated brokerage commissions (such condition being referred to herein as “market discount”), the Plan Agent will invest the dividend amount in common shares acquired on behalf of the participants in open-market purchases.

 

In the event of a market discount on the payment date for any dividend, the Plan Agent will have until the last business day before the next date on which the common shares trade on an “ex-dividend” basis or 120 days after the payment date for such dividend, whichever is sooner (the “last purchase date”), to invest the dividend amount in common shares acquired in open-market purchases. It is contemplated that Credit Strategies Fund will pay monthly dividends. Therefore, the period during which open-market purchases can be made will exist only from the payment date of each dividend through the date before the “ex-dividend” date of the third month of the quarter. If, before the Plan Agent has completed its open-market purchases, the market price of a common share exceeds the NAV per common share, the average per common share purchase price paid by the Plan Agent may exceed the NAV of the common shares, resulting in the acquisition of fewer common shares than if the dividend had been paid in newly issued common shares on the dividend payment date. Because of the foregoing difficulty with respect to open market purchases, if the Plan Agent is unable to invest the full dividend amount in open market purchases during the purchase period or if the market discount shifts to a market premium during the purchase period, the Plan Agent may cease making open-market purchases and may invest the uninvested portion of the dividend amount in newly issued common shares at the NAV per common share at the close of business on the last purchase date; provided that, if the NAV per common share is less than 95% of the market price per common share on the payment date, the dollar amount of the dividend will be divided by 95% of the market price per common share on the payment date.

 

The Plan Agent maintains all shareholders’ accounts in the Plan and furnishes written confirmation of all transactions in the accounts, including information needed by shareholders for tax records. Common shares in the account of each Plan participant will be held by the Plan Agent on behalf of the Plan participant, and each shareholder proxy will include those shares purchased or received pursuant to the Plan. The Plan Agent will forward all proxy solicitation materials to participants and vote proxies for shares held under the Plan in accordance with the instructions of the participants.

 

In the case of shareholders such as banks, brokers or nominees which hold shares for others who are the beneficial owners, the Plan Agent will administer the Plan on the basis of the number of common shares certified from time to time by the record shareholder’s name and held for the account of beneficial owners who participate in the Plan.

 

There will be no brokerage charges with respect to common shares issued directly by Credit Strategies Fund. However, each participant will pay a pro rata share of brokerage commissions incurred in connection with open-market purchases. The automatic reinvestment of dividends will not relieve participants of any federal, state or local income tax that may be payable (or required to be withheld) on such dividends. Accordingly, any taxable dividend received by a participant that is reinvested in additional common shares will be subject to federal (and possibly state and local) income tax even though such participant will not receive a corresponding amount of cash with which to pay such taxes. See “Tax Matters.” Participants who request a sale of shares through the Plan Agent are subject to a $2.50 sales fee and pay a brokerage commission of $0.05 per share sold.

 

Credit Strategies Fund reserves the right to amend or terminate the Plan. There is no direct service charge to participants in the Plan; however, Credit Strategies Fund reserves the right to amend the Plan to include a service charge payable by the participants.

All correspondence concerning the Plan should be directed to the Plan Agent at PFPC Inc., 301 Bellevue Parkway, Wilmington, Delaware 19809; telephone (877) 665-1287.

 

Common Shares

 

High Income Portfolio was incorporated in Maryland on May 13, 1988. High Income Portfolio’s Articles of Incorporation, as amended and supplemented (“Charter”) authorize the issuance of up to 100,000,000 common shares, $0.03 par value per share. Income Shares was incorporated in Maryland on March 19, 1973. Income Shares’ Charter authorizes the issuance of up to 15,000,000 common shares, $1.00 par value per share. Each Acquired Fund’s common shares have equal rights as to voting, dividends and liquidation. All common shares issued and outstanding are fully paid and nonassessable. Shares of common shares have no preemptive, conversion or redemption rights and are freely transferable. The voting rights of the common shares are noncumulative, which means that the holders of more than 50% of the common shares voting for the election of Directors can elect all of those Directors that are subject to election by the holders of the common shares if they choose to do so, and, in that event, the holders of the remaining common shares voting for the election of Directors will not be able to elect any Directors. The holders of the common shares vote as a single class with the holders of the preferred shares on all matters except as described below under “Voting Rights.” Each Acquired Fund’s Charter may generally be amended by the affirmative vote of holders of common shares and preferred shares entitled to cast a majority of all votes entitled to be cast on the matter.

 

So long as any preferred shares of an Acquired Fund are outstanding, holders of the Acquired Fund’s common shares will not be entitled to receive any dividends of or other distributions from the Acquired Fund, unless at the time of such declaration (1) all accrued dividends on preferred shares or accrued interest on borrowings have been paid and (2) the value of the Acquired Fund’s total assets (determined after deducting the amount of such dividend or other distribution), less all of its liabilities and indebtedness not represented by senior securities, is at least 300% of the aggregate amount of such securities representing indebtedness and at least 200% of the aggregate amount of securities representing indebtedness plus the aggregate liquidation value of the outstanding preferred shares (expected to equal the aggregate original purchase price of the outstanding preferred shares plus redemption premium, if any, together with any accrued and unpaid dividends thereon, whether or not earned or declared and on a cumulative basis). In addition to the requirements of the 1940 Act, the Acquired Funds are required to comply with other asset coverage requirements as a condition of each Acquired Fund obtaining a rating of the preferred shares from a rating agency. These requirements include an asset coverage test more stringent than that under the 1940 Act.

 

Preferred Shares

 

Under the 1940 Act, each Acquired Fund is permitted to have outstanding more than one series of preferred shares as long as neither a single series has priority over another series nor holders of preferred shares have pre-emptive rights to purchase any other preferred shares that might be issued. Each Acquired Fund’s Charter authorizes the issuance of a class of preferred shares (which class may be divided into more than one series) as the Directors may, without shareholder approval, authorize. The preferred shares has such preferences, voting powers, terms of redemption, if any, and special or relative rights or privileges (including conversion rights, if any) as the Directors may determine and as are set forth in the respective Acquired Fund’s Charter establishing the terms of the preferred shares. Any decision to offer preferred shares is subject to market conditions and to the Board of Directors’ and the Adviser’s continuing belief that leveraging the respective Acquired Fund’s capital structure through the issuance of preferred shares is likely to benefit the holders of common shares. Each Acquired Fund is authorized to issue a maximum of 1,000,000 preferred shares. To date, High Income Portfolio’s Directors have authorized the creation of, and High Income Portfolio has issued, 3,000 Auction Rate Cumulative Preferred Shares, having a par value of $0.001 per share, with a liquidation preference of $25,000 per share, classified as Series W Auction Rate Cumulative Preferred Shares. As of January 31, 2007, High Income Portfolio had redeemed 1,400 preferred shares and had a total of $40 million preferred shares outstanding. To date, Income Shares’ Directors have

authorized the creation of, and Income Shares has issued, 1,200 Auction Rate Cumulative Preferred Shares, having a par value of $0.01 per share, with a liquidation preference of $25,000 per share, classified as Series T Auction Rate Cumulative Preferred Shares, all of which were outstanding as of January 31, 2007.

 

The preferred shares have complete priority over common shares as to distribution of assets. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the affairs of either Acquired Fund, holders of preferred shares will be entitled to receive a preferential liquidating distribution (expected to equal the original purchase price per share plus accumulated and unpaid dividends thereon, whether or not earned or declared) before any distribution of assets is made to holders of common shares. After the payment to the holders of preferred shares of the full preferential amounts, the holders of preferred shares as such will have no right or claim to any of the remaining assets of the relevant Acquired Fund. Neither the consolidation nor merger of either Acquired Fund with or into any other corporation or corporations, nor the sale, lease, exchange or transfer by either Acquired Fund of all or substantially all of its property and assets, will be deemed to be a liquidation, dissolution or winding up of that Acquired Fund.

 

Voting Rights

 

Except as noted below, each Acquired Fund’s common shares and preferred shares have equal voting rights of one vote per share and vote together as a single class. In elections of Directors, the holders of preferred shares, as a separate class, vote to elect two Directors, the holders of the common shares, as a separate class, vote to elect two Directors and the holders of the preferred shares and the common shares, voting together as a single class, elect the remaining Directors. In addition, during any period (“Voting Period”) in which either Acquired Fund has not paid dividends on the preferred shares in an amount equal to two full years’ dividends, the holders of preferred shares, voting as a single class, are entitled to elect (in addition to the two Directors set forth above) the smallest number of additional Directors as is necessary to assure that a majority of the Directors have been elected by the holders of preferred shares.

 

In an instance when an Acquired Fund has not paid dividends as set forth in the immediately preceding paragraph, the terms of office of all persons who are Directors of the Acquired Fund at the time of the commencement of a Voting Period will continue, notwithstanding the election by the holders of the preferred shares of the number of Directors that such holders are entitled to elect. The persons elected by the holders of the preferred shares, together with the incumbent Directors elected by the holders of the common shares, will constitute the duly elected Directors of the Acquired Fund. When all dividends in arrears on the preferred shares have been paid or provided for, the terms of office of the additional Directors elected by the holders of the preferred shares will terminate.

 

The common shares and preferred shares of each Acquired Fund vote as separate classes on amendments to the Charter that would adversely affect their respective interests.

 

In addition, so long as any High Income Portfolio preferred shares are outstanding:

 

(1) High Income Portfolio may not be voluntarily liquidated, dissolved, wound up, merged or consolidated and may not sell all or substantially all of its assets, without the approval of at least a majority of the preferred shares, voting as a separate class;

 

(2) the adoption of any plan of reorganization adversely affecting the preferred shares requires the approval of holders of a majority of the preferred shares, voting as a separate class;

 

(3) High Income Portfolio may not, without the affirmative vote of at least a majority of the preferred shares outstanding, voting as a separate class, file a voluntary application for relief under federal bankruptcy law or any similar application under state law for so long as High Income Portfolio is solvent and does not foresee becoming insolvent;

 

(4) the approval of a majority of the outstanding preferred shares, voting as a separate class, is required to approve any action requiring a vote of security holders under Section 13(a) of the 1940 Act including, among other things, changes in High Income Portfolio’s investment objective, changes in certain investment

restrictions described under “Investment Restrictions” in the SAI and changes in High Income Portfolio’s subclassification as a closed-end investment company; and

 

(5) the approval of a majority of the outstanding preferred shares, voting as a separate class, is required to amend, alter or repeal any of the authorized preferences, rights or powers of the holders of preferred shares.

 

In addition, so long as any Income Shares’ preferred shares are outstanding:

 

(1) Income Shares may not be voluntarily liquidated, dissolved, wound up, merged or consolidated and may not sell all or substantially all of its assets, without the approval of at least a majority of the preferred shares, voting as a separate class;

 

(2) the adoption of any plan of reorganization adversely affecting the preferred shares requires the approval of holders of a majority of the preferred shares, voting as a separate class;

 

(3) Income Shares may not, without the affirmative vote of at least a majority of the preferred shares outstanding, voting as a separate class, file a voluntary application for relief under federal bankruptcy law or any similar application under state law for so long as Income Shares is solvent and does not foresee becoming insolvent; and

 

(4) the approval of a majority of the outstanding preferred shares, voting as a separate class, is required to approve any action requiring a vote of security holders under Section 13(a) of the 1940 Act including, among other things, changes in Income Shares’ investment objectives, changes in certain investment restrictions described under “Investment Restrictions” in the SAI and changes in Income Shares’ subclassification as a closed-end investment company.

 

The required vote for certain of the items listed above for each of the Acquired Funds, such as items 1, 2 and 4, may be subject to the supermajority voting requirements referred to under “Anti-Takeover Provisions” below, if they have not been approved, authorized or adopted by the affirmative vote of at least 80% of the total number of Continuing Directors. “Continuing Directors” are those Directors who have been directors of Income Shares since May 2002 or are those Directors who have been directors of High Income Portfolio since March 2001 or who have subsequently become directors and whose election is approved by a majority of the Continuing Directors then on the Board. The common shares and preferred shares for each Acquired Fund also will vote separately to the extent otherwise required under Maryland law or the 1940 Act, as in effect from time to time. To the extent required under the 1940 Act, certain actions by shareholders of each Acquired Fund require a vote of a majority of that Fund’s outstanding voting securities. If applicable, the class vote of holders of preferred shares described above will in each case be in addition to a separate vote of the requisite percentage of common shares and preferred shares, voting together as a single class, necessary to authorize the action in question.

 

Common Shares

 

Credit Strategies Fund is a statutory trust organized under the laws of Delaware pursuant to an Agreement and Declaration of Trust dated as of March 10, 2006 (“Declaration of Trust”). Credit Strategies Fund is authorized to issue an unlimited number of common shares of beneficial interest, par value $0.001 per share. Each common share has one vote and, when issued and paid for is fully paid and non-assessable, except that the trustees shall have the power to cause shareholders to pay expenses of Credit Strategies Fund by setting off charges due from shareholders from declared but unpaid dividends or distributions owed the shareholders and/or by reducing the number of common shares owned by each respective shareholder. Credit Strategies Fund currently is not aware of any expenses that will be paid pursuant to this provision, except to the extent fees payable under its Dividend Reinvestment Plan are deemed to be paid pursuant to this provision.

 

Credit Strategies Fund intends to hold annual meetings of shareholders so long as the common shares are listed on a national securities exchange and such meetings are required as a condition to such listing. All common shares are equal as to dividends, assets and voting privileges and have no conversion, preemptive or other subscription rights. Credit Strategies Fund will send annual and semi-annual reports, including financial statements, to all holders of its shares.

While Credit Strategies Fund has filed a registration statement to permit it to offer additional shares from time to time, such registration statement has not been declared effective and Credit Strategies Fund has no present intention of offering any additional shares on that registration statement. Any additional offerings of shares will require approval by Credit Strategies Fund’s Board. Any additional offering of common shares will be subject to the requirements of the 1940 Act, which provides that shares may not be issued at a price below the then current NAV, exclusive of sales load, except in connection with an offering to existing holders of common shares or with the consent of a majority of Credit Strategies Fund’s common shareholders. Credit Strategies Fund currently issues additional shares under its Dividend Reinvestment Plan and, if approved, Credit Strategies Fund will issue additional shares pursuant to the Reorganizations.

 

Any additional offerings of common shares would result in current shareholders owning a smaller proportionate interest in Credit Strategies Fund than they owned prior to such offering to the extent that shareholders do not purchase sufficient shares in such offering to maintain their percentage interest. Credit Strategies Fund’s net asset value would be reduced immediately following an offering of the shares due to the costs of such offering, which will be borne entirely by Credit Strategies Fund. The sale of shares by Credit Strategies Fund (or the perception that such sales may occur) may have an adverse effect on prices of shares in the secondary market. An increase in the number of shares available may put downward pressure on the market price for shares. If Credit Strategies Fund were unable to invest the proceeds of an additional offering of shares as intended, Credit Strategies Fund’s per share distribution may decrease and the Trust may not participate in market advances to the same extent as if such proceeds were fully invested as planned.

 

Unlike open-end funds, closed-end funds like Credit Strategies Fund do not continuously offer shares and do not provide daily redemptions. Rather, if a shareholder determines to buy additional common shares or sell shares already held, the shareholder may do so by trading through a broker on the NYSE or otherwise. Shares of closed-end investment companies frequently trade on an exchange at prices lower than NAV. Because the market value of the common shares may be influenced by such factors as dividend levels (which are in turn affected by expenses), dividend stability, NAV, relative demand for and supply of such shares in the market, general market and economic conditions and other factors beyond the control of Credit Strategies Fund, Credit Strategies Fund cannot assure you that common shares will trade at a price equal to or higher than NAV in the future. The common shares are designed primarily for long-term investors and you should not purchase the common shares if you intend to sell them soon after purchase. See the Statement of Additional Information under “Repurchase of Common Shares.”

 

Preferred Shares

 

The Declaration of Trust provides that Credit Strategies Fund’s Board may authorize and issue preferred shares with rights as determined by the Board, by action of the Board without the approval of the holders of the common shares. Holders of common shares have no preemptive right to purchase any preferred shares that might be issued. Whenever preferred shares are outstanding, the holders of common shares will not be entitled to receive any distributions from Credit Strategies Fund unless all accrued dividends on preferred shares have been paid, unless asset coverage (as defined in the 1940 Act) with respect to preferred shares would be at least 200% after giving effect to the distributions and unless certain other requirements imposed by any rating agencies rating the preferred shares have been met.

 

Credit Strategies Fund may issue preferred shares as part of its leverage strategy. We cannot assure you, however, that any preferred shares will be issued. Although the terms of any preferred shares, including dividend rate, liquidation preference and redemption provisions, will be determined by the Board, subject to applicable law and the Declaration of Trust, it is likely that the preferred shares will be structured to carry a relatively short-term dividend rate reflecting interest rates on short-term bonds, by providing for the periodic redetermination of the dividend rate at relatively short intervals through an auction, remarketing or other procedure. Credit Strategies Fund also believes that it is likely that the liquidation preference, voting rights and redemption provisions of the preferred shares will be similar to those stated below.

 

Liquidation Preference.  In the event of any voluntary or involuntary liquidation, dissolution or winding up of Credit Strategies Fund, the holders of preferred shares will be entitled to receive a preferential liquidating distribution, which is expected to equal the original purchase price per preferred share plus accrued and unpaid

dividends, whether or not declared, before any distribution of assets is made to holders of common shares. After payment of the full amount of the liquidating distribution to which they are entitled, the holders of preferred shares will not be entitled to any further participation in any distribution of assets by Credit Strategies Fund.

 

Voting Rights.  The 1940 Act requires that the holders of any preferred shares, voting separately as a single class, have the right to elect at least two trustees at all times. The remaining trustees will be elected by holders of common shares and preferred shares, voting together as a single class. In addition, subject to the prior rights, if any, of the holders of any other class of senior securities outstanding, the holders of any preferred shares have the right to elect a majority of the trustees of Credit Strategies Fund at any time two years’ dividends on any preferred shares are unpaid. The 1940 Act also requires that, in addition to any approval by shareholders that might otherwise be required, the approval of the holders of a majority of any outstanding preferred shares, voting separately as a class, would be required to (i) adopt any plan of reorganization that would adversely affect the preferred shares, and (ii) take any action requiring a vote of security holders under Section 13(a) of the 1940 Act, including, among other things, changes in Credit Strategies Fund’s subclassification as a closed-end investment company or changes in its fundamental investment restrictions. As a result of these voting rights, Credit Strategies Fund’s ability to take any such actions may be impeded to the extent that there are any preferred shares outstanding. The board of trustees presently intends that, except as otherwise indicated in this prospectus and except as otherwise required by applicable law, holders of preferred shares will have equal voting rights with holders of common shares (one vote per share, unless otherwise required by the 1940 Act) and will vote together with holders of common shares as a single class.

 

The affirmative vote of the holders of a majority of the outstanding preferred shares, voting as a separate class, will be required to amend, alter or repeal any of the preferences, rights or powers of holders of preferred shares so as to affect materially and adversely such preferences, rights or powers, or to increase or decrease the authorized number of preferred shares. The class vote of holders of preferred shares described above will in each case be in addition to any other vote required to authorize the action in question.

 

Redemption, Purchase and Sale of Preferred Shares by Credit Strategies Fund.  The terms of the preferred shares are expected to provide that (i) they are redeemable by Credit Strategies Fund in whole or in part at the original purchase price per share plus accrued dividends per share, (ii) Credit Strategies Fund may tender for or purchase preferred shares and (iii) Credit Strategies Fund may subsequently resell any shares so tendered for or purchased. Any redemption or purchase of preferred shares by Credit Strategies Fund will reduce the leverage applicable to the common shares, while any resale of shares by Credit Strategies Fund will increase that leverage.

 

The discussion above describes the possible offering of Preferred Shares by Credit Strategies Fund.  If the Board determines to proceed with such an offering, the terms of the preferred shares may be the same as, or different from, the terms described above, subject to applicable law and the Declaration of Trust. The board of trustees, without the approval of the holders of common shares, may authorize an offering of preferred shares or may determine not to authorize such an offering and may fix the terms of the preferred shares to be offered.

 

While Credit Strategies Fund has filed a registration statement to permit it to offer preferred shares, this registration statement has not been declared effective and Credit Strategies Fund has no present intention of offering any preferred shares in the next twelve months.

 

Other Shares

 

The Board (subject to applicable law and the Declaration of Trust) may authorize an offering, without the approval of the holders of common shares, of other classes of shares, or other classes or series of shares, as they determine to be necessary, desirable or appropriate, having such terms, rights, preferences, privileges, limitations and restrictions as the board of trustees see fit. Credit Strategies Fund currently does not expect to issue any other classes of shares, or series of shares, except for the common shares.

 

Credit Facility

 

Credit Strategies Fund currently leverages through borrowings from a credit facility. Credit Strategies Fund has entered into a revolving credit agreement with The Bank of Nova Scotia (“Scotia”) to borrow up to

$380,000,000 (the “Loan Agreement”). Such borrowings constitute financial leverage. The Loan Agreement contains covenants that limit Credit Strategies Fund’s ability to, without the prior consent of Scotia: (i) pay dividends in certain circumstances, (ii) incur additional debt, or (iii) adopt or carry out any plan of liquidation, reorganization, incorporation, recapitalization, merger or consolidation or sell, transfer or otherwise dispose of all or a substantial part of its assets. For instance, Credit Strategies Fund agreed not to purchase assets not contemplated by the investment policies and restrictions in effect when the Loan Agreement became effective. Furthermore, Credit Strategies Fund may not incur additional debt from any other party, except for in limited circumstances (e.g., in the ordinary course of business). In addition, the Loan Agreement contains a covenant requiring asset coverage ratios that may be more stringent than those required by the 1940 Act. Such restrictions shall apply only so long as the Loan Agreement remains in effect. Any senior security representing indebtedness, as defined in Section 18(g) of the 1940 Act, must have asset coverage of at least 300%. Debt incurred under the Loan Agreement will be considered a senior security for this purpose.

 

The following discussion summarizes certain federal income tax considerations affecting the Funds and their shareholders that are “United States persons” (as defined in the Code). For more information, please see the Statement of Additional Information, under “Federal Income Tax Matters.” Because each shareholder’s tax situation is unique, ask your tax professional about the tax consequences to you of an investment in a Fund.

 

Each Fund intends to qualify annually as a regulated investment company under the Code. Accordingly, each Fund generally will not be subject to federal income tax on income and gains that it distributes to its shareholders.

 

Distributions a Fund makes from its net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss), if any, that it designates as capital gain dividends, are taxable as long-term capital gain, regardless of how long you have held your common shares. All dividends a Fund pays from its investment company taxable income (consisting generally of net investment income, the excess, if any, of net short-term capital gain over net long-term capital loss, and net gains and losses from certain foreign currency transactions, if any, all determined without regard to any deduction for dividends paid) (“ordinary income dividends”) are generally subject to tax as ordinary income.

 

In general, the Funds do not expect that a significant portion of its ordinary income dividends will be treated as “qualified dividend income,” which is eligible for taxation at the rates applicable to net capital gain in the case of individual shareholders (a maximum of 15%), or that a corporate shareholder will be able to claim a dividends-received reduction with respect to any significant portion of Fund distributions.

 

Dividends and other taxable distributions are taxable to you even if they are reinvested in additional common shares of a Fund. Dividends and other distributions generally are treated as received by you at the time the distribution is made. If, however, an Acquired Fund pays you a distribution in January that was declared in the previous October, November or December to shareholders of record on a date in one of those months, then that distribution will be treated for tax purposes as being paid by the Fund and received by you on December 31 of the year in which the distribution was declared.

 

The price of common shares purchased at any time may reflect the amount of a forthcoming distribution. Accordingly, if you purchase common shares just before a distribution, that distribution will be taxable to you even though it represents in part a return of your invested capital.

 

Each Fund sends in shareholders information after the end of each calendar year setting forth the amount and tax status of any distributions it made during that year. Distributions also may be subject to state and local taxes.

 

If you sell or otherwise dispose of common shares, you generally will recognize a gain or loss in an amount equal to the difference between your tax basis in those shares and the amount you receive on the disposition. If you hold your common shares as a capital asset, any such gain or loss generally will be long-term capital gain or loss if you have held the shares for more than one year at the time of sale or exchange thereof.

 

A Fund will be required to withhold, for federal backup withholding tax purposes, 28% of the distributions (and redemption proceeds, if any) payable to a noncorporate shareholder who fails to provide the Fund (or its agent)

with the shareholder’s correct taxpayer identification number (in the case of an individual, generally, the individual’s social security number) or to make required certifications or who has been notified by the Internal Revenue Service (“IRS”) that the shareholder is subject to backup withholding. Certain shareholders are exempt from backup withholding. Backup withholding is not an additional tax, and any amount withheld may be refunded or credited against your federal income tax liability, if any, provided that you furnish the required information to the IRS.

 

The discussions set forth herein and in the Statement of Additional Information do not constitute tax advice, and you are urged to consult your own tax advisor to determine the specific federal, state, local and foreign tax consequences to you of investing in a Fund.

 

Each Acquired Fund’s Charter includes certain “supermajority” voting provisions that could have the effect of limiting the ability of other entities or persons to acquire control of either Acquired Fund or cause either Acquired Fund to engage in certain transactions. These provisions could have the effect of depriving holders of common shares of an opportunity to sell their shares at a premium over prevailing market prices by discouraging a third party from seeking to obtain control of either Acquired Fund. In addition, holders of a minority of the total shares outstanding and entitled to vote may have a veto power over matters which management and/or a majority of the shareholders may believe is desirable and beneficial. However, by discouraging attempts to acquire control of either Acquired Fund, these provisions may enable the relevant Acquired Fund to avoid adverse effects of such attempts such as increasing the expenses of the relevant Acquired Fund and interfering with the normal operation of the relevant Acquired Fund. They also promote continuity and stability, and they enhance each Acquired Fund’s ability to continue to pursue long-term strategies that are consistent with its investment objective.

 

Specifically, each Charter provides for a “supermajority” voting requirement to effect any of the following actions: (1) any amendment to the Charter to make the Fund’s shares “redeemable securities” or to convert the Fund from a “closed-end company” to an “open-end company” (as such terms are defined in the 1940 Act), (2) any shareholder proposal regarding the Fund’s investment objective or specific investment restrictions, policies or decisions made or to be made with respect to the Fund’s assets, (3) any shareholder proposal as to the voluntary liquidation or dissolution of the Fund or any amendment to the Charter to terminate the existence of the Fund, (4) business combinations such as a merger, consolidation, share exchange or the sale of all or substantially all of the Fund’s assets, and, (5) any amendment to Article VI of the Charter of High Income, and any amendment to article Eighth of the Charter of Income Shares.

 

The Charter of each Acquired Fund requires the affirmative vote of the holders of at least 80% of the votes then entitled to be cast by the holders of the common shares and the preferred shares, voting as a single class, and an affirmative vote of the holders of at least 80% of the preferred shares, voting as a separate class, and at least 80% of the entire Board of Directors to authorize any of the foregoing items, unless such action had been approved, adopted or authorized by the affirmative vote of at least 80% of the total number of Continuing Directors (as defined below), in which case (A) for items (1) and (2) above, approval would require the affirmative vote of the lesser of (a) 67% or more of the voting securities present or represented by proxy, if the holders of more than 50% of outstanding voting securities are present or represented by proxy, or (b) more than 50% of the outstanding voting securities, and (B) for items (3) and (4) above, the affirmative vote of at least a majority of the Fund’s securities entitled to vote on the matter, subject, in the case of both (A) and (B), to the preferred shares voting both with the common shares as a single class and separately, as described below.

 

Each Acquired Fund’s Board of Directors has determined that the voting requirements described above, which are greater than the minimum requirements under Maryland law or the 1940 Act and which can only be changed by a favorable vote of the holders of at least 80% of the holders of the common shares and preferred shares, voting as a single class, and a favorable vote of at least 80% of the preferred shares, voting separately, and at least 80% of the entire Board of Directors or a majority of the Continuing Directors, are in the best interests of shareholders generally.

The Fund’s by-laws currently contain other provisions permitted by Maryland law to deter attempts to obtain control of the Fund as follows: (1) the Fund’s Secretary may call a special meeting of shareholders only on the request of the shareholders entitled to cast at least a majority of all the votes entitled to be cast at the meeting and only if the request states the matters proposed to be acted upon at it and the requesting shareholders bear the costs of the Fund’s notification of each shareholder entitled to notice of the meeting, (2) the number of Directors and the positions on the Board to be filled by vote of the holders of particular classes of shares to, if applicable, the exclusion of other classes of shares, shall be fixed from time to time only by resolution of the Board of Directors adopted by a majority of the Directors then in office and (3) the shareholders of the Fund may remove any Director only by the affirmative vote of at least two-thirds (2/3) of all the votes entitled to be cast by the shareholders generally in the election of such Director, and if the Directors have been divided into classes, a Director may not be removed without cause. The Fund has also established a classified or “staggered” Board of Directors. The effect of this structure may make it more difficult for shareholders to change a majority of Directors because it would take two annual meetings to replace the majority of the Directors.

 

The Fund’s Board of Directors may elect to submit to the Fund’s shareholders at any time a proposal to convert the Fund to an open-end investment company and in connection therewith to redeem any outstanding preferred shares, as would be required upon such conversion by the 1940 Act. In determining whether to exercise its discretion to submit this issue to shareholders, the Board of Directors would consider all factors then relevant, including the relationship of the market price of the common shares to NAV, the extent to which the Fund’s capital structure is leveraged and the possibility of re-leveraging, the spread, if any, between yields on high-yield securities in the Fund’s portfolio as compared to interest and dividend charges on senior securities and general market and economic conditions. In addition to any vote required by Maryland law, conversion of the Fund to an open-end investment company would require the affirmative vote of the holders of a majority (as defined in the 1940 Act) of each class of shares entitled to be voted on the matter, including the preferred shares, voting as a separate class. Shareholders of an open-end investment company may require the company to redeem their shares at any time (except in certain circumstances as authorized by or under the 1940 Act) at their NAV, less such redemption charges, if any, as might be in effect at the time of redemption. Conversion of the Fund to an open-end investment company would require the redemption of any outstanding preferred shares. The Board of Directors believes, however, that the closed-end structure is desirable in light of the Fund’s investment objective and policies. Therefore, it is currently not likely that the Board of Directors would vote to convert the Fund to an open-end fund. The Fund’s Charter requires (except under certain circumstances) the affirmative vote of the holders of at least 80% of the votes then entitled to be cast by shareholders and the affirmative vote of at least 80% of the preferred shares, voting as a separate class and at least 80% of the entire Board of Directors to authorize, among other things, any amendment to the Fund’s Charter to make the Fund’s shares “redeemable securities” or to convert the Fund from a closed-end company to an open-end company.

 

Credit Strategies Fund’s Declaration of Trust includes provisions that could have the effect of limiting the ability of other entities or persons to acquire control of the Fund or to change the composition of its board of trustees. This could have the effect of depriving shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging a third party from seeking to obtain control over the Fund. Such attempts could have the effect of increasing the expenses of the Fund and disrupting the normal operation of the Fund. The board of trustees is divided into three classes, with the terms of one class expiring at each annual meeting of shareholders. At each annual meeting, one class of trustees is elected to a three-year term. This provision could delay for up to two years the replacement of a majority of the board of trustees. A trustee may be removed from office (for cause, and not without cause) by the action of a majority of the remaining trustees followed by a vote of the holders of at least 75% of the shares then entitled to vote for the election of the respective trustee.

 

In addition, the Declaration of Trust requires the favorable vote of a majority of the Fund’s board of trustees followed by the favorable vote of the holders of at least 75% of the outstanding shares of each affected class or series of the Fund, voting separately as a class or series, to approve, adopt or authorize certain transactions with 5% or greater holders of a class or series of shares and their associates, unless the transaction has been approved by at least 80% of the trustees, in which case “a majority of the outstanding voting securities” (as defined in the 1940 Act) of

the Fund shall be required. For purposes of these provisions, a 5% or greater holder of a class or series of shares (a “Principal Shareholder”) refers to any person who, whether directly or indirectly and whether alone or together with its affiliates and associates, beneficially owns 5% or more of the outstanding shares of all outstanding classes or series of shares of beneficial interest of the Fund.

 

The 5% holder transactions subject to these special approval requirements are: the merger or consolidation of the Fund or any subsidiary of the Fund with or into any Principal Shareholder; the issuance of any securities of the Fund to any Principal Shareholder for cash, except pursuant to any automatic dividend reinvestment plan; the sale, lease or exchange of all or any substantial part of the assets of the Fund to any Principal Shareholder, except assets having an aggregate fair market value of less than 2% of the total assets of the Fund, aggregating for the purpose of such computation all assets sold, leased or exchanged in any series of similar transactions within a twelve-month period; or the sale, lease or exchange to the Fund or any subsidiary of the Fund, in exchange for securities of the Fund, of any assets of any Principal Shareholder, except assets having an aggregate fair market value of less than 2% of the total assets of the Fund, aggregating for purposes of such computation all assets sold, leased or exchanged in any series of similar transactions within a twelve-month period.

 

To convert the Fund to an open-end investment company, the Declaration of Trust requires the favorable vote of a majority of the board of the trustees followed by the favorable vote of the holders of at least 75% of the outstanding shares of each affected class or series of shares of the Fund, voting separately as a class or series, unless such amendment has been approved by at least 80% of the trustees, in which case “a majority of the outstanding voting securities” (as defined in the 1940 Act) of the Fund shall be required. The foregoing vote would satisfy a separate requirement in the 1940 Act that any conversion of the Fund to an open-end investment company be approved by the shareholders. If approved in the foregoing manner, conversion of the Fund to an open-end investment company could not occur until 90 days after the shareholders’ meeting at which such conversion was approved and would also require at least 30 days’ prior notice to all shareholders. Following any such conversion, it is possible that certain of the Fund’s investment policies and strategies would have to be modified to assure sufficient portfolio liquidity. In the event of conversion, the common shares would cease to be listed on the NYSE or other national securities exchanges or market systems. Shareholders of an open-end investment company may require the company to redeem their shares at any time, except in certain circumstances as authorized by or under the 1940 Act, at their NAV, less such redemption charge, if any, as might be in effect at the time of a redemption. The Fund expects to pay all such redemption requests in cash, but reserves the right to pay redemption requests in a combination of cash or securities. If such partial payment in securities were made, investors may incur brokerage costs in converting such securities to cash. If the Fund were converted to an open-end fund, it is likely that new shares would be sold at NAV plus a sales load. The board of trustees believes, however, that the closed-end structure is desirable in light of the Fund’s investment objectives and policies. Therefore, you should assume that it is not likely that the board of trustees would vote to convert the Fund to an open-end fund.

 

For the purposes of calculating “a majority of the outstanding voting securities” under the Declaration of Trust, each class and series of the Fund shall vote together as a single class, except to the extent required by the 1940 Act or the Declaration of Trust, with respect to any class or series of shares. If a separate class vote is required, the applicable proportion of shares of the class or series, voting as a separate class or series, also will be required.

 

The Declaration of Trust also provides that the Fund may be liquidated upon the approval of 80% of the trustees. The board of trustees has determined that provisions with respect to the board of trustees and the shareholder voting requirements described above, which voting requirements are greater than the minimum requirements under Delaware law or the 1940 Act, are in the best interest of shareholders generally. Reference should be made to the Declaration of Trust, on file with the SEC for the full text of these provisions.

 

As shown in the table below, the performance of Credit Strategies Fund on a net asset value basis has exceeded that of Income Shares for the one-year period ended December 31, 2007. However, there is no guarantee or assurance as to the future performance of Credit Strategies Fund. Each Fund’s performance at market price may differ from its results at NAV. Although market price performance generally reflects investment results, it may also be influenced by several factors, including changes in investor perceptions of each Fund or its investment adviser,

market conditions, fluctuations in supply and demand for each Fund’s shares and changes in each Fund’s distributions.

 

TOTAL RETURNS AS OF DECEMBER 31, 2007