As filed with the Securities and Exchange Commission on October 26, 2017
Securities Act of 1933 Registration No. 333-132400
Investment Company Act of 1940 Registration No. 811-21866
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933 | ||||
Pre-Effective Amendment No. | ||||
Post-Effective Amendment No. 84 | ☒ |
and/or
REGISTRATION STATEMENT
Under
the Investment Company Act Of 1940
Amendment No. 87 | ☒ |
HIGHLAND FUNDS I
(Exact Name of Registrant as Specified in Charter)
c/o Highland Capital Management Fund Advisors, L.P.
200 Crescent Court, Suite 700
Dallas, Texas 75201
(Address of Principal Executive Offices, including Zip Code)
Registrants Telephone Number, Including Area Code: 1-877-665-1287
(Name and Address of Agent for Service) | Copies to: | |
Mr. Dustin Norris | Brian McCabe | |
c/o Highland Capital Management Fund Advisors, L.P. | Ropes & Gray LLP | |
200 Crescent Court, Suite 700 | Prudential Tower | |
Dallas, Texas 75201 | 800 Boylston Street | |
Boston, Massachusetts 02199-3600 |
It is proposed that this filing will become effective: (check appropriate box)
☐ | immediately upon filing pursuant to paragraph (b); or |
☒ | on October 31, 2017 pursuant to paragraph (b); or |
☐ | 60 days after filing pursuant to paragraph (a)(1); or |
☐ | on pursuant to paragraph (a)(1); or |
☐ | 75 days after filing pursuant to paragraph (a)(2); or |
☐ | on pursuant to paragraph (a)(2) of Rule 485. |
If appropriate, check the following box:
☐ | This post-effective amendment designates a new effective date for a previously filed post-effective amendment. |
Class A | Class C | Class Z | |
Highland Long/Short Equity Fund | HEOAX | HEOCX | HEOZX |
Highland Long/Short Healthcare Fund | HHCAX | HHCCX | HHCZX |
Highland Merger Arbitrage Fund | HMEAX | HMECX | HMEZX |
Highland Opportunistic Credit Fund | HNRAX | HNRCX | HNRZX |
Class A | Class C | Class Z | |
Maximum Sales Charge (Load) Imposed On Purchases (as a % of offering price) | 5.50% | None | None |
Maximum Sales Charge (Load) Imposed on Reinvested Dividends and other Distributions (as a % of offering price) | None | None | None |
Maximum Deferred Sales Charge (Load) (as a % of the net asset value at the time of purchase or redemption, whichever is lower) | 1.00% 1 | 1.00% 2 | None |
Exchange Fee | None | None | None |
Redemption Fee | None | None | None |
Class A | Class C | Class Z | |
Management fee | 2.25% | 2.25% | 2.25% |
Distribution and/or Service (12b-1) Fees | 0.35% | 1.00% | None |
Other Expenses | 1.26% | 1.26% | 1.26% |
Interest Payments and Commitment Fees on Borrowed Funds | 0.01% | 0.01% | 0.01% |
Dividend Expense on Short Sales | 0.77% | 0.77% | 0.77% |
Remainder of Other Expenses | 0.48% | 0.48% | 0.48% |
Acquired Fund Fees and Expenses | 0.11% | 0.11% | 0.11% |
Total Annual Fund Operating Expenses 3 | 3.97% | 4.62% | 3.62% |
Management Fee Waiver 4 | -1.25% | -1.25% | -1.25% |
Total Annual Fund Operating Expenses After Management Fee Waiver | 2.72% | 3.37% | 2.37% |
1 | Class A Shares bought without an initial sales charge in accounts aggregating $500,000 or more at the time of purchase are subject to a 1.00% contingent deferred sales charge (“CDSC”) if the shares are sold within 18 months of purchase. |
2 | Class C Shares are subject to a 1% CDSC for redemptions of shares within one year of purchase. This CDSC does not apply to redemptions under a systematic withdrawal plan. |
3 | Total Annual Fund Operating Expenses differ from the ratios of expenses to average net assets shown in the Financial Highlights, which reflect the operating expenses of the Fund and do not include acquired fund fees and expenses. |
4 | Highland Capital Management Fund Advisors, L.P. (“HCMFA” or the “Adviser”) has contractually agreed to waive 1.25% of the Fund’s management fee. This fee waiver will continue through at least October 31, 2018, and may not be terminated prior to this date without the consent of the Fund’s Board of Trustees. |
1 Year | 3 Years | 5 Years | 10 Years | |
Class A | $810 | $1,585 | $2,377 | $4,428 |
Class C | ||||
if you do not sell your shares | $340 | $1,282 | $2,232 | $4,638 |
if you sold all your shares at the end of the period | $440 | $1,282 | $2,232 | $4,638 |
Class Z | $240 | $ 993 | $1,768 | $3,799 |
1 Year | 5 Years | 10 Years | |
Class A (inception 12/5/06) | |||
Return Before Taxes | -5.44% | 3.14% | 3.18% |
Return After Taxes on Distributions | -5.44% | 1.68% | 2.18% |
Return After Taxes on Distributions and Sale of Fund Shares | -3.08% | 1.83% | 2.09% |
Return Before Taxes | |||
Class C (inception 12/5/06) | -1.57% | 3.67% | 3.13% |
Class Z (inception 12/5/06) | 0.44% | 4.66% | 4.10% |
Standard & Poor’s 500 Index (reflects no deduction for fees, expenses or taxes) (inception 12/5/06) | 11.96% | 14.66% | 6.95% |
Portfolio Managers |
Portfolio
Manager
Experience in this Fund |
Title with Adviser |
Jonathan Lamensdorf | 9 years | Portfolio Manager |
Michael McLochlin | 2 years | Portfolio Manager |
Initial Investment | $2,500 |
Subsequent Investments | $ 50 |
• | Through your Financial Intermediary |
• | By writing to Highland Funds I — Highland Long/Short Equity Fund, PO Box 8656, Boston, Massachusetts 02266-8656, or |
• | By calling Boston Financial Data Services, Inc. at 1-877-665-1287 |
Class A | Class C | Class Z | |
Maximum Sales Charge (Load) Imposed On Purchases (as a % of offering price) | 5.50% | None | None |
Maximum Sales Charge (Load) Imposed on Reinvested Dividends and other Distributions (as a % of offering price) | None | None | None |
Maximum Deferred Sales Charge (Load) (as a % of the net asset value at the time of purchase or redemption, whichever is lower) | 1.00% 1 | 1.00% 2 | None |
Exchange Fee | None | None | None |
Redemption Fee | None | None | None |
Class A | Class C | Class Z | |
Management fee | 1.00% | 1.00% | 1.00% |
Distribution and/or Service (12b-1) Fees | 0.35% | 1.00% | None |
Other Expenses | 1.37% | 1.37% | 1.37% |
Interest Payments and Commitment Fees on Borrowed Funds | 0.01% | 0.01% | 0.01% |
Dividend Expense on Short Sales | 0.70% | 0.70% | 0.70% |
Remainder of Other Expenses | 0.66% | 0.66% | 0.66% |
Acquired Fund Fees and Expenses | 0.08% | 0.08% | 0.08% |
Total Annual Fund Operating Expenses 3 | 2.80% | 3.45% | 2.45% |
1 | Class A Shares bought without an initial sales charge in accounts aggregating $500,000 or more at the time of purchase are subject to a 1.00% contingent deferred sales charge (“CDSC”) if the shares are sold within 18 months of purchase. |
2 | Class C Shares are subject to a 1% CDSC for redemptions of shares within one year of purchase. This CDSC does not apply to redemptions under a systematic withdrawal plan. |
3 | Total Annual Fund Operating Expenses differ from the ratios of expenses to average net assets shown in the Financial Highlights, which reflect the operating expenses of the Fund and do not include acquired fund fees and expenses. |
1 Year | 3 Years | 5 Years | 10 Years | |
Class A | $818 | $1,370 | $1,948 | $3,506 |
Class C | ||||
if you do not sell your shares | $348 | $1,059 | $1,793 | $3,730 |
if you sold all your shares at the end of the period | $448 | $1,059 | $1,793 | $3,730 |
Class Z | $248 | $ 764 | $1,306 | $2,786 |
1 Year | 5 Years |
Since
Inception |
|
Class A (inception 5/5/08) | |||
Return Before Taxes | -19.73% | 0.35% | 3.69% |
Return After Taxes on Distributions | -19.73% | -0.39% | 2.61% |
Return After Taxes on Distributions and Sale of Fund Shares | -11.17% | -0.01% | 2.51% |
Return Before Taxes | |||
Class C (inception 5/5/08) | -16.30% | 0.88% | 3.77% |
Class Z (inception 5/5/08) | -14.68% | 1.88% | 4.74% |
Standard & Poor’s 500 Index (reflects no deduction for fees, expenses or taxes) | 11.96% | 14.66% | 7.79% |
Standard & Poor’s Healthcare Index (reflects no deduction for fees, expenses or taxes) | -2.69% | 16.80% | 11.45% |
Portfolio Manager |
Portfolio
Manager
Experience in this Fund |
Title with Adviser |
Michael D. Gregory | 7 years | Portfolio Manager |
Initial Investment | $2,500 |
Subsequent Investments | $ 50 |
• | Through your Financial Intermediary |
• | By writing to Highland Funds I — Highland Long/Short Healthcare Fund, PO Box 8656, Boston, Massachusetts 02266-8656, or |
• | By calling Boston Financial Data Services, Inc. at 1-877-665-1287 |
Class A | Class C | Class Z | |
Maximum Sales Charge (Load) Imposed On Purchases (as a % of offering price) | 5.50% | None | None |
Maximum Sales Charge (Load) Imposed on Reinvested Dividends and other Distributions (as a % of offering price) | None | None | None |
Maximum Deferred Sales Charge (Load) (as a % of the net asset value at the time of purchase or redemption, whichever is lower) | 1.00% 1 | 1.00% 2 | None |
Redemption Fee | None | None | None |
Class A | Class C | Class Z | |
Management fee | 1.20% | 1.20% | 1.20% |
Distribution and/or Service (12b-1) Fees | 0.35% | 1.00% | None |
Other Expenses | 4.85% | 5.08% | 4.91% |
Dividend Expense on Short Sales | 3.19% | 3.47% | 3.22% |
Remainder of Other Expenses | 1.66% | 1.61% | 1.69% |
Total Annual Fund Operating Expenses | 6.40% | 7.28% | 6.11% |
Expense Reimbursement 3 | -1.35% | -1.33% | -1.36% |
Total Annual Fund Operating Expenses After Expense Reimbursement | 5.05% | 5.95% | 4.75% |
1 | Class A Shares bought without an initial sales charge in accounts aggregating $500,000 or more at the time of purchase are subject to a 1.00% contingent deferred sales charge (“CDSC”) if the shares are sold within 18 months of purchase. |
2 | Class C Shares are subject to a 1% CDSC for redemptions of shares within one year of purchase. This CDSC does not apply to redemptions under a systematic withdrawal plan. |
3 | Highland Capital Management Fund Advisors, L.P. (”HCMFA” or the “Adviser”) has contractually agreed to limit the total annual operating expenses (exclusive of fees paid by the Fund pursuant to its distribution plan under Rule 12b-1 under the Investment Company Act of 1940, as amended (the “1940 Act”), taxes, dividend expenses on short sales, interest payments, brokerage commissions and other transaction costs, acquired fund fees and expenses, and extraordinary expenses (collectively, the “Excluded Expenses”)) of the Fund to 1.50% of average daily net assets attributable to any class of the Fund (the “Expense Cap”). The Expense Cap will continue through at least October 31, 2018 and may not be terminated prior to this date without the action or consent of the Fund’s Board of Trustees. Under the expense limitation agreement, the Adviser may recoup waived and/or reimbursed amounts with respect to the Fund within thirty-six months of the date such amounts were waived or reimbursed, provided the Fund’s total annual operating expenses, including such recoupment, do not exceed the Expense Cap in effect at the time of such waiver/reimbursement. |
1 Year | 3 Years | 5 Years | 10 Years | |
Class A | $1,027 | $2,219 | $3,378 | $6,137 |
Class C | ||||
if you do not sell your shares | $ 592 | $2,002 | $3,348 | $6,453 |
if you sold all your shares at the end of the period | $ 692 | $2,002 | $3,348 | $6,453 |
Class Z | $ 476 | $1,687 | $2,872 | $5,721 |
• | Annualized and absolute returns; |
• | Downside risk if a transaction is terminated; |
• | Proposed financing terms; |
• | Transaction size; |
• | Regulatory approvals needed; |
• | Anti-trust concerns; and |
• | Shareholder voting requirements. |
1 Year |
Since
Inception |
|
Class Z | ||
Return Before Taxes | 8.10% | 7.40% |
Return After Taxes on Distributions | 8.10% | 7.40% |
Return After Taxes on Distributions and Sale of Fund Shares | 4.59% | 5.68% |
Return Before Taxes | ||
Class A | 1.77% | 3.96% |
Class C | 6.00% | 6.30% |
Barclays US Aggregate Bond Index (reflects no deduction for fees, expenses or taxes) | 2.65% | 0.94% |
Portfolio Managers |
Portfolio
Manager
Experience in this Fund 1 |
Title with Adviser |
James Dondero | 2 years | Portfolio Manager |
Jonathan Lamensdorf | 2 years | Portfolio Manager |
Initial Investment | $2,500 |
Subsequent Investments | $ 50 |
• | Through your Financial Intermediary |
• | By writing to Highland Funds I — Highland Merger Arbitrage Fund, PO Box 8656, Boston, Massachusetts 02266-8656, or |
• | By calling Boston Financial Data Services, Inc. at 1-877-665-1287 |
Class A | Class C | Class Z | |
Maximum Sales Charge (Load) Imposed On Purchases (as a % of offering price) | 3.50% | None | None |
Maximum Sales Charge (Load) Imposed on Reinvested Dividends and other Distributions (as a % of offering price) | None | None | None |
Maximum Deferred Sales Charge (Load) (as a % of the net asset value at the time of purchase or redemption, whichever is lower) | 1.00% 1 | 1.00% 2 | None |
Exchange Fee | None | None | None |
Redemption Fee | None | None | None |
Class A | Class C | Class Z | |
Management fee | 1.00% | 1.00% | 1.00% |
Distribution and/or Service (12b-1) Fees | 0.35% | 0.85% | None |
Other Expenses | 0.59% | 0.56% | 0.63% |
Dividend Expense on Short Sales | 0.06% | 0.06% | 0.06% |
Remainder of Other Expenses | 0.53% | 0.50% | 0.57% |
Acquired Fund Fees and Expenses | 0.01% | 0.01% | 0.01% |
Total Annual Fund Operating Expenses 3 | 1.95% | 2.42% | 1.64% |
Expense Reimbursement 4 | -0.50% | -0.50% | -0.50% |
Total Annual Fund Operating Expenses After Expense Reimbursement | 1.45% | 1.92% | 1.14% |
1 | Class A Shares bought without an initial sales charge in accounts aggregating $500,000 or more at the time of purchase are subject to a 1.00% contingent deferred sales charge (“CDSC”) if the shares are sold within 18 months of purchase. |
2 | Class C Shares are subject to a 1% CDSC for redemptions of shares within one year of purchase. This CDSC does not apply to redemptions under a systematic withdrawal plan. |
3 | Total Annual Fund Operating Expenses differ from the ratios of expenses to average net assets shown in the Financial Highlights, which reflect the operating expenses of the Fund and do not include acquired fund fees and expenses. |
4 | Highland Capital Management Fund Advisors, L.P. (”HCMFA” or the “Adviser”) has contractually agreed to limit the total annual operating expenses (exclusive of fees paid by the Fund pursuant to its distribution plan under Rule 12b-1 under the Investment Company Act of 1940, as amended (the “1940 Act”), taxes, such as deferred tax expenses, dividend expenses on short sales, interest payments, brokerage commissions and other transaction costs, acquired fund fees and expenses, and extraordinary expenses (collectively, the “Excluded Expenses”)) of the Fund to 0.90% of average daily net assets attributable to any class of the Fund (the “Expense Cap”). The Expense Cap will continue through at least October 31, 2018 and may not be terminated prior to this date without the action or consent of the Fund’s Board of Trustees. Under the expense limitation agreement, the Adviser may recoup waived and/or reimbursed amounts with respect to the Fund within thirty-six months of the date such amounts were waived or reimbursed, provided the Fund’s total annual operating expenses, including such recoupment, do not exceed the Expense Cap in effect at the time of such waiver/reimbursement. |
1 Year | 3 Years | 5 Years | 10 Years | |
Class A | $492 | $894 | $1,321 | $2,506 |
Class C | ||||
if you do not sell your shares | $195 | $707 | $1,245 | $2,718 |
if you sold all your shares at the end of the period | $295 | $707 | $1,245 | $2,718 |
Class Z | $116 | $468 | $ 845 | $1,902 |
1 Year | 5 Years | 10 Years | |
Class Z (inception 5/18/05) | |||
Return Before Taxes | 30.90% | 9.72% | 4.35% |
Return After Taxes on Distributions | 24.06% | 7.48% | -0.30% |
Return After Taxes on Distributions and Sale of Fund Shares | 17.07% | 6.54% | 1.31% |
Return Before Taxes | |||
Class A (inception 5/18/05) | 25.91% | 8.78% | 3.90% |
Class C (inception 5/18/05) | 28.61% | 9.20% | 4.10% |
Credit Suisse Leveraged Loan Index (reflects no deduction for fees, expenses or taxes) | 9.88% | 5.35% | 4.33% |
HFRX Fixed Income - Corporate Index (reflects no deduction for fees, expenses or taxes) | 7.74% | 5.26% | 3.55% |
Portfolio Managers |
Portfolio
Manager
Experience in this Fund |
Title with Adviser |
James D. Dondero | 3 years | Portfolio Manager |
Trey Parker | 2 years | Portfolio Manager |
Initial Investment | $2,500 |
Subsequent Investments | $ 50 |
• | Through your Financial Intermediary |
• | By writing to Highland Funds I — Highland Opportunistic Credit Fund, PO Box 8656, Boston, Massachusetts 02266-8656, or |
• | By calling Boston Financial Data Services, Inc. at 1-877-665-1287 |
• | Investment Grade Securities. Each Fund may invest in a wide variety of bonds that are rated or determined by the Adviser to be of investment grade quality of varying maturities issued by U.S. corporations and other business entities. Bonds are fixed or variable rate debt obligations, including bills, notes, debentures, money market instruments and similar instruments and securities. Bonds generally are used by corporations and other issuers to borrow money from investors for a variety of business purposes. The issuer pays the investor a fixed or variable rate of interest and normally must repay the amount borrowed on or before maturity. |
• | Below Investment Grade Securities. Each Fund may invest in below investment grade securities (also known as “high-yield securities” or “junk securities”). Such securities may be fixed or variable rate obligations and are rated below investment grade (Ba/BB or lower) by a nationally recognized statistical rating organization or are unrated but deemed by the Adviser to be of comparable quality. High-yield debt securities are frequently issued by corporations in the growth stage of their development, but also may be issued by established companies. These bonds are regarded by the rating organizations, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. Such securities also are generally considered to be subject to greater risk than securities with higher ratings with regard to default rates and deterioration of general economic conditions. High-yield securities held by the Funds may include securities received as a result of a corporate reorganization or issued as part of a corporate takeover. |
• | Growth Investing Risk: Growth stocks may be more volatile than other stocks because they are more sensitive to investor perceptions of the issuing company’s growth potential. Growth-oriented funds will typically underperform when value investing is in favor. |
• | Value Investing Risk: Undervalued stocks may not realize their perceived value for extended periods of time or may never realize their perceived value. Value stocks may respond differently to market and other developments than other types of stocks. Value-oriented funds will typically underperform when growth investing is in favor. |
• | Mid-Cap Company Risk: Investments in securities of mid-cap companies entail greater risks than investments in larger, more established companies. Mid-cap companies tend to have more narrow product lines, more limited financial resources and a more limited trading market for their stocks, as compared with larger companies. As a result, their stock prices may decline significantly as market conditions change. |
• | Small-Cap Company Risk: Investing in securities of small-cap companies may involve greater risks than investing in larger, more established companies. Smaller companies may have limited product lines, markets and financial resources. Their securities may trade less frequently and in more limited volume than securities of larger, more established companies. In addition, smaller companies are typically subject to greater changes in earnings and business prospects than are larger companies. Consequently, the prices of small company stocks tend to rise and fall in value more than other stocks. Although investing in small-cap companies may offer potential for above-average returns, the |
companies may not succeed and their stock prices could decline significantly. Investments in small-cap companies may also be subject to valuation risk. |
Fund Name |
Advisory
Fees Paid as a
Percentage of Average Daily Managed Assets for the Fiscal Period Ended June 30, 2017 |
Contractual
Advisory
Fee as a Percentage of Average Daily Managed Assets 1 |
Long/Short Equity Fund 2 | 1.00% | 2.25% |
Long/Short Healthcare Fund | 1.00% | 1.00% |
Merger Arbitrage Fund 3 | -0.08% 4 | 1.20% |
Opportunistic Credit Fund 5 | 0.50% | 1.00% |
1 | In addition to the advisory fees set forth in this table, the Adviser is entitled to receive administration fees of 0.20% of each Fund’s Average Daily Managed Assets, other than the Merger Arbitrage Fund’s and Opportunistic Credit Fund’s, as discussed below. |
2 | The Adviser has contractually agreed to waive 1.25% of Long/Short Equity Fund’s management fee. This fee waiver will continue through at least October 31, 2018, and may not be terminated prior to this date without the consent of the Fund’s Board of Trustees. |
3 | The Adviser had contractually agreed to limit the total annual fund operating expenses of Merger Arbitrage Fund to 1.50% of average daily net assets attributable to any class of the Fund through October 31, 2018. Information on the Fund’s current expense limitation agreement is provided below. |
4 | For the six month period beginning January 1, 2017. |
5 | The Adviser had contractually agreed to limit the total annual fund operating expenses of Opportunistic Credit Fund to 0.90% of average daily net assets attributable to any class of the Fund through October 31, 2018. Information on the Fund’s current expense limitation agreement is provided below. |
Method | Instructions |
Through your Financial Advisor | Your Financial Advisor can help you establish your account and buy shares on your behalf. To receive the current trading day’s price, your Financial Advisor must receive your request in good order prior to the close of regular trading on the NYSE, usually 4:00 p.m., Eastern time. Your Financial Advisor may charge you fees for executing the purchase for you. |
By check (new account) (1) | For new accounts, send to the applicable Fund, at the address noted below, (2) a completed application and check made payable to “Highland Funds I — (Fund Name).” All purchases must be in U.S. Dollars and must be drawn on a U.S. bank. Highland Funds I does not accept cash, U.S. savings bonds, traveler’s checks, money orders, California warrant checks, starter checks, third-party checks, or credit card courtesy checks. Checks dated six months old or older and post-dated checks will not be accepted. |
By check (existing account) (1) | For existing accounts, fill out and return to the applicable Fund, at the address noted below, (2) the additional investment stub included in your account statement, or send a letter of instruction, including the applicable Fund name and account number, with a check made payable to “Highland Funds I — (Fund Name).” All purchases must be in U.S. Dollars and must be drawn on a U.S. bank. Highland Funds I does not accept cash, U.S. savings bonds, traveler’s checks, money orders, California warrant checks, starter checks, third-party checks, or credit card courtesy checks. Checks dated six months old or older and post-dated checks will not be accepted. |
Method | Instructions |
By exchange | You or your Financial Advisor may acquire shares of a Fund for your account by exchanging shares you own in certain other funds advised by HCMFA for shares of the same class of a Fund, subject to the conditions described in “Exchange of Shares” below. In addition, you or your Financial Advisor may exchange shares of a class of a Fund you own for shares of a different class of the same Fund, subject to the conditions described in “Exchange of Shares” below. To exchange, send written instructions to the applicable Fund, at the address noted below (2) or call 1-877-665-1287. |
By wire | You may purchase shares of a Fund by wiring money from your bank account to your Fund account. Prior to sending wire transfers, please contact Shareholder Services at 1-877-665-1287 for specific wiring instructions and to facilitate prompt and accurate credit upon receipt of your wire. You can also find the specific wiring instructions at http://highlandfunds.com/literature/#forms. |
To receive the current trading day’s price, your wire, along with a valid account number, must be received in your Fund account prior to the close of regular trading on the NYSE, usually 4:00 p.m., Eastern time. | |
If your initial purchase of shares is by wire, you must first complete a new account application and promptly mail it to Highland Funds I — (Fund Name), at the address noted below. (2) After completing a new account application, please call 1-877-665-1287 to obtain your account number. Please include your account number on the wire. | |
By electronic funds transfer via an automated clearing house (“ACH”) transaction (1) | You may purchase shares of a Fund by electronically transferring money from your bank account to your Fund account by calling 1-877-665-1287. An electronic funds transfer may take up to two business days to settle and be considered in good order. You must set up this feature prior to your telephone request. Be sure to complete the appropriate section of the application. |
Automatic investment plan | You may make monthly or quarterly investments automatically from your bank account to your Fund account. You may select a pre-authorized amount to be sent via electronic funds transfer. For this feature, please call the applicable Fund at 1-877-665-1287 or visit the Funds’ website, (http://highlandfunds.com/literature/#forms), where you may obtain a copy of the “Account Options Form.” |
(1) | The redemption of shares purchased by check or an automated clearing house (“ACH”) transaction is subject to certain limitations (see “Redemption of Shares”). Any purchase by check or ACH transaction that does not clear may be cancelled, and the investor will be responsible for any associated expenses and losses to the applicable Fund. |
(2) | Regular Mail: Send to “Highland Funds I — (Fund Name),” PO Box 8656, Boston, MA 02266-8656. Overnight Mail: Send to “Highland Funds I — (Fund Name),” 30 Dan Road, Suite #8656, Canton, MA 02021-2809. |
Initial Investment | $2,500 |
Subsequent Investments | $ 50 |
Automatic Investment Plan** | $ 50 |
* | For retirement plans, the investment minimum is $50 for each of the initial investment, subsequent investments and the automatic investment plan. |
** | Your account must already be established and satisfy the initial investment minimum. |
Sales Charge | |||
Amount Invested | As a % of the Public Offering Price | As a % of Your Net Investment | % of Offering Price Paid to Financial Advisor |
Less than $100,000 | 3.50% | 3.63% | 3.25% |
$100,000 to $499,999 | 2.25% | 2.30% | 2.00% |
$500,000 or more* | None | None | ** |
* | Class A Shares bought without an initial sales charge in accounts aggregating $500,000 or more at the time of purchase are subject to a 1.00% CDSC if the shares are sold within 18 months of purchase. Subsequent Class A Share purchases that bring your account value above $500,000 are not subject to a front-end sales charge, but are subject to a CDSC if redeemed within 18 months of purchase. The 18-month period begins on the day the purchase is made. The CDSC does not apply to load waived shares purchased for certain retirement plans or other eligible fee-based programs. |
** | For Class A Share purchases of $500,000 or more, Financial Advisors receive a cumulative commission from the Underwriter as follows: |
Amount Purchased | % Offering Price Paid to Financial Advisor |
Less than $5 million | 1.00% |
$5 million to less than $25 million | 0.40% |
$25 million or more | 0.25% |
Sales Charge | |||
Amount Invested | As a % of the Public Offering Price | As a % of Your Net Investment | % of Offering Price Paid to Financial Advisor |
Less than $50,000 | 5.50% | 5.82% | 4.75% |
$50,000 to $99,999 | 4.25% | 4.44% | 3.75% |
$100,000 to $249,999 | 3.25% | 3.36% | 2.75% |
$250,000 to $499,999 | 2.25% | 2.30% | 1.75% |
$500,000 or more* | None | None | ** |
* | Class A Shares bought without an initial sales charge in accounts aggregating $500,000 or more at the time of purchase are subject to a 1.00% CDSC if the shares are sold within 18 months of purchase. Subsequent Class A Share purchases that bring your account value above $500,000 are not subject to a front-end sales charge, but are subject to a CDSC if redeemed within 18 months of purchase. The 18-month period begins on the day the purchase is made. The CDSC does not apply to load waived shares purchased for certain retirement plans or other eligible fee-based programs. |
** | For Class A Share purchases of $500,000 or more, Financial Advisors receive a cumulative commission from the Underwriter as follows: |
Amount Purchased | % Offering Price Paid to Financial Advisor |
Less than $5 million | 1.00% |
$5 million to less than $25 million | 0.40% |
$25 million or more | 0.25% |
• | Clients of broker-dealers or registered investment advisers that both recommend the purchase of Fund shares and charge clients an asset-based fee; |
• | A retirement plan (or the custodian for such plan) with aggregate plan assets of at least $5 million at the time of purchase and that purchases shares directly from the Fund or through a third party broker-dealer; |
• | Any insurance company, trust company or bank purchasing shares for its own account; |
• | Any endowment, investment company or foundation; and |
• | Any trustee of the Fund, any employee of HCMFA and any family member of any such trustee or employee. |
Highland Opportunistic Credit Fund | Highland Long/Short Equity Fund, Highland Long/Short Healthcare Fund and Highland Merger Arbitrage Fund | ||||
Distribution Fee | Service Fee | Distribution Fee | Service Fee | ||
Class A | 0.10% | 0.25% | Class A | 0.10% | 0.25% |
Class C | 0.60% | 0.25% | Class C | 0.75% | 0.25% |
Class Z | None | None | Class Z | None | None |
Method | Instructions |
By letter | You may mail a letter requesting redemption of shares to: “Highland Funds I – (Fund Name),” P.O. Box 8656, Boston, Massachusetts 02266-8656. Your letter should state the name of the Fund, the share class, the dollar amount or number of shares you are redeeming and your account number. You must sign the letter in exactly the same way the account is registered. If there is more than one owner of shares, all must sign. A Medallion signature guarantee is required for each signature on your redemption letter. You can obtain a Medallion signature guarantee from financial institutions, such as commercial banks, brokers, dealers and savings associations. A notary public cannot provide a Medallion signature guarantee. If the account is registered to a corporation, trust or other entity, additional documentation may be needed. Please call 1-877-665-1287 for further details. |
By telephone or internet | Unless you have requested that telephone redemptions from your account not be permitted, you may redeem your shares in an account (excluding an IRA) directly registered with the Transfer Agent by calling 1-877-665-1287. If the Transfer Agent acts on telephone or Internet instructions after following reasonable procedures to protect against unauthorized transactions, neither the Transfer Agent nor the Fund will be responsible for any losses due to unauthorized telephone transactions and instead you would be responsible. You may request that proceeds from telephone redemptions be mailed to you by check (if your address has not changed in the prior 30 days) or forwarded to you by bank wire. If you would like to request that such proceeds be invested in shares of other Highland funds or other registered, open-end investment companies advised by the Adviser and distributed by the Underwriters, please see “Exchange of Shares” below. Among the procedures the Transfer Agent may use are passwords or verification of personal information. The Funds may impose limitations from time to time on telephone redemptions. |
Proceeds by check | The Funds will make checks payable to the name(s) in which the account is registered and normally will mail the check to the address of record within seven days. |
Proceeds by bank wire | The Funds accept telephone or Internet requests for wire redemption in amounts of at least $1,000. The Funds will send a wire to either a bank designated on your new account application or on a subsequent letter in good order as described above under the instructions for redeeming shares “By letter.” The proceeds are normally wired on the next business day. |
• | Portfolio securities for which market quotations are readily available are valued at their current market value. |
• | Foreign securities listed on foreign exchanges are valued based on quotations from the primary market in which they are traded and are translated from the local currency into U.S. dollars using current exchange rates. Foreign securities may trade on weekends or other days when a Fund does not calculate NAV. As a result, the market value of these investments may change on days when you cannot buy or redeem shares of a Fund. |
• | Investments by a Fund in any other mutual fund are valued at their respective NAVs as determined by those mutual funds each business day. The prospectuses for those mutual funds explain the circumstances under which those funds will use fair value pricing and the effects of using fair value pricing. |
• | All other portfolio securities, including derivatives and cases where market quotations are not readily available, |
or when the market price is determined to be unreliable, are valued at fair value as determined in good faith pursuant to procedures established by the Board subject to approval or ratification by the Board at its next regularly scheduled quarterly meeting. Pursuant to the Funds' pricing procedures, securities for which market quotations are not readily available or for which the market price is determined to be unreliable, may include, but are not limited to, securities that are subject to legal or contractual restrictions on resale, securities for which no or limited trading activity has occurred for a period of time, or securities that are otherwise deemed to be illiquid ( i.e. , securities that cannot be disposed of within seven days at approximately the price at which the security is currently priced by the Fund which holds the security). Market quotations may also be not “readily available” if a significant event occurs after the close of the principal exchange on which a portfolio security trades (but before the time for calculation of a Fund’s NAV) if that event affects or is likely to affect (more than minimally) the NAV per share of a Fund. In determining the fair value price of a security, HCMFA may use a number of other methodologies, including those based on discounted cash flows, multiples, recovery rates, yield to maturity or discounts to public comparables. | |
• | Fair value pricing involves judgments that are inherently subjective and inexact; 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. |
Fund | Distribution Schedule |
Long/Short
Equity Fund
Long/Short Healthcare Fund |
•
Dividends of investment income are typically declared and paid annually.
• Dividends of short-term and long-term capital gains, if any, are typically declared and paid annually. |
Merger Arbitrage Fund |
•
Dividends of investment income are typically declared and paid at least annually.
• Dividends of short-term and long-term capital gains, if any, are typically declared and paid annually. |
Opportunistic Credit Fund |
•
Dividends of investment income are declared daily and paid monthly.
• Dividends of short-term and long-term capital gains, if any, are typically declared and paid annually. |
For the Year Ended June 30, | |||||||||
2017 | 2016 | 2015 | 2014 | 2013 | |||||
Net Asset Value, Beginning of Year | $ 10.95 | $ 11.98 | $ 12.18 | $ 11.37 | $ 11.30 | ||||
Income from Investment Operations: (a) | |||||||||
Net investment loss | (0.18) | (0.18) | (0.20) | (0.21) | (0.16) | ||||
Redemption fees added to paid-in capital | — | — | — | — (b) | — (b) | ||||
Net realized and unrealized gain/(loss) | 1.03 | (0.40) | 0.48 | 1.97 | 0.53 | ||||
Total from investment operations | 0.85 | (0.58) | 0.28 | 1.76 | 0.37 | ||||
Less Distributions Declared to Shareholders: | |||||||||
From net realized gains | — | (0.45) | (0.48) | (0.95) | (0.30) | ||||
Total distributions declared to shareholders | — | (0.45) | (0.48) | (0.95) | (0.30) | ||||
Net Asset Value, End of Year (c) | $ 11.80 | $ 10.95 | $ 11.98 | $ 12.18 | $ 11.37 | ||||
Total Return (c)(d) | 7.76% | (4.99)% | 2.45% | 15.60% | 3.38% | ||||
Ratios to Average Net Assets (e) /Supplemental Data: | |||||||||
Net assets, end of period (in 000’s) | $32,163 | $40,219 | $76,813 | $195,612 | $141,351 | ||||
Gross operating expenses (e)(f) | 3.89% | 3.62% | 3.58% | 3.75% | 3.79% | ||||
Net investment income/(loss) | (1.64)% | (1.56)% | (1.63)% | (1.69)% | (1.40)% | ||||
Portfolio turnover rate | 404% | 457% | 414% | 349% | 706% |
(a) | Per share data was calculated using average shares outstanding during the period. |
(b) | Represents less than $0.005 per share. |
(c) |
The Net Asset Value per share
and total return have been calculated based on net assets which include adjustments
made in accordance with U.S. Generally Accepted Accounting Principles required at period end for financial reporting purposes. These figures may not necessarily reflect the Net Asset Value per share or total return experienced by the shareholder at period end. |
(d) | Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For |
(e) | Includes dividends and fees on securities sold short. |
(f) | Supplemental expense ratios are shown below: |
For the Years Ended June 30, | ||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | ||||||
Net
operating expenses (net of
waiver/reimbursement, if applicable, but gross of all other operating expenses) |
2.64% | 2.37% | 2.33% | 2.50% | 2.54% | |||||
Interest expense and commitment fees | 0.01% | 0.02% | 0.07% | — | — | |||||
Dividends and fees on securities sold short | 0.80% | 0.57% | 0.49% | 0.56% | 0.66% |
For the Year Ended June 30, | |||||||||
2017 | 2016 | 2015 | 2014 | 2013 | |||||
Net Asset Value, Beginning of Period | $ 10.25 | $ 11.32 | $ 11.62 | $ 10.95 | $ 10.96 | ||||
Income from Investment Operations: (a) | |||||||||
Net investment loss | (0.24) | (0.23) | (0.26) | (0.27) | (0.22) | ||||
Net realized and unrealized gain/(loss) | 0.97 | (0.39) | 0.44 | 1.89 | 0.51 | ||||
Total from investment operations | 0.73 | (0.62) | 0.18 | 1.62 | 0.29 | ||||
Less Distributions Declared to Shareholders: | |||||||||
From net realized gains | — | (0.45) | (0.48) | (0.95) | (0.30) | ||||
Total distributions declared to shareholders | — | (0.45) | (0.48) | (0.95) | (0.30) | ||||
Net Asset Value, End of Period (b) | $ 10.98 | $ 10.25 | $ 11.32 | $ 11.62 | $ 10.95 | ||||
Total Return (b)(c ) | 7.12% | (5.65)% | 1.69% | 14.89% | 2.75% | ||||
Ratios to Average Net Assets (d) /Supplemental Data: | |||||||||
Net assets, end of period (in 000’s) | $26,263 | $50,006 | $55,639 | $55,795 | $45,925 | ||||
Gross operating expenses (d)(e) | 4.51% | 4.27% | 4.28% | 4.39% | 4.48% | ||||
Net investment income/(loss) | (2.31)% | (2.20)% | (2.27)% | (2.35)% | (2.02)% | ||||
Portfolio turnover rate | 404% | 457% | 414% | 349% | 706% |
(a) | Per share data was calculated using average shares outstanding during the period. |
(b) |
The Net Asset Value per share
and total return have been calculated based on net assets which include adjustments
made in accordance with U.S. Generally Accepted Accounting Principles required at period end for financial reporting purposes. These figures may not necessarily reflect the Net Asset Value per share or total return experienced by the shareholder at period end. |
(c) | Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For |
(d) | Includes dividends and fees on securities sold short. |
(e) | Supplemental expense ratios are shown below: |
For the Years Ended June 30, | ||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | ||||||
Net
operating expenses (net of waiver/reimbursement, if
applicable, but gross of all other operating expenses) |
3.26% | 3.02% | 3.03% | 3.14% | 3.22% | |||||
Interest expense and commitment fees | 0.01% | 0.01% | 0.07% | — | — | |||||
Dividends and fees on securities sold short | 0.77% | 0.57% | 0.54% | 0.56% | 0.67% |
For the Year Ended June 30, | |||||||||
2017 | 2016 | 2015 | 2014 | 2013 | |||||
Net Asset Value, Beginning of Year | $ 11.34 | $ 12.35 | $ 12.51 | $ 11.61 | $ 11.50 | ||||
Income from Investment Operations: (a) | |||||||||
Net investment (loss) | (0.15) | (0.14) | (0.16) | (0.17) | (0.11) | ||||
Redemption fees added to paid-in capital | — | — | — | — (b) | — (b) | ||||
Net realized and unrealized gain/(loss) | 1.08 | (0.42) | 0.48 | 2.02 | 0.52 | ||||
Total from investment operations | 0.93 | (0.56) | 0.32 | 1.85 | 0.41 | ||||
Less Distributions Declared to Shareholders: | |||||||||
From net realized gains | — | (0.45) | (0.48) | (0.95) | (0.30) | ||||
Total distributions declared to shareholders | — | (0.45) | (0.48) | (0.95) | (0.30) | ||||
Net Asset Value, End of Year (c) | $ 12.27 | $ 11.34 | $ 12.35 | $ 12.51 | $ 11.61 | ||||
Total return (c)(d) | 8.20% | (4.67)% | 2.71% | 16.07% | 3.68% | ||||
Ratios to Average Net Assets (e) /Supplemental Data: | |||||||||
Net assets, end of period (in 000’s) | $335,493 | $570,998 | $724,250 | $766,646 | $692,705 | ||||
Gross operating expenses (d)(f) | 3.51% | 3.27% | 3.28% | 3.39% | 3.54% | ||||
Net investment (loss) | (1.31)% | (1.20)% | (1.27)% | (1.34)% | (0.96)% | ||||
Portfolio turnover rate | 404% | 457% | 414% | 349% | 706% |
(a) | Per share data was calculated using average shares outstanding during the period. |
(b) | Represents less than $0.005 per share. |
(c) | The Net Asset Value per share and total return have been calculated based on net assets which include adjustments made in accordance with U.S. Generally Accepted Accounting Principles required at period end for financial reporting purposes. These figures may not necessarily reflect the Net Asset Value per share or total return experienced by the shareholder at period end. |
(d) |
Total return is at net asset
value assuming all distributions are reinvested and no initial sales charge or CDSC. For periods with waivers/
reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. |
(e) | Includes dividends and fees on securities sold short. |
(f) | Supplemental expense ratios are shown below: |
For the Years Ended June 30, | ||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | ||||||
Net
operating expenses (net of waiver/reimbursement, if
applicable, but gross of all other operating expenses) |
2.26% | 2.02% | 2.03% | 2.14% | 2.28% | |||||
Interest expense and commitment fees | 0.01% | 0.01% | 0.07% | — | — | |||||
Dividends and fees on securities sold short | 0.77% | 0.57% | 0.54% | 0.56% | 0.71% |
For the Year Ended June 30, | |||||||||
2017 | 2016 | 2015 | 2014 | 2013 | |||||
Net Asset Value, Beginning of Year | $ 11.50 | $ 16.22 | $ 15.07 | $ 11.03 | $ 10.87 | ||||
Income from Investment Operations: | |||||||||
Net investment loss (a) | (0.21) | (0.28) | (0.32) | (0.27) | (0.26) | ||||
Redemption fees added to paid-in capital | — | — | — | — (a)(e) | — (a)(e) | ||||
Capital contributions | — | — | — | — | (0.03) (a) | ||||
Net realized and unrealized gain/(loss) (a) | 0.32 | (3.86) | 2.15 | 4.31 | 0.45 | ||||
Total from investment operations | 0.11 | (4.14) | 1.83 | 4.04 | 0.16 | ||||
Less Distributions Declared to Shareholders: | |||||||||
From net realized gains | — | (0.58) | (0.68) | — | — | ||||
Total distributions declared to shareholders | — | (0.58) | (0.68) | — | — | ||||
Net Asset Value, End of Year (b) | $ 11.61 | $ 11.50 | $ 16.22 | $ 15.07 | $ 11.03 | ||||
Total Return (b)(c) | 0.96% | (26.03)% | 12.71% | 36.63% | 1.47% | ||||
Ratios to Average Net Assets (d) /Supplemental Data: | |||||||||
Net assets, end of period (in 000’s) | $30,967 | $83,952 | $179,486 | $153,358 | $11,652 | ||||
Gross operating expenses (d)(f) | 2.72% | 2.70% | 2.55% | 2.55% | 3.52% | ||||
Net investment income/(loss) | (1.82)% | (2.01)% | (2.09)% | (1.82)% | (2.48)% | ||||
Portfolio turnover rate | 964% | 901% | 409% | 538% | 1,035% |
(a) | Per share data was calculated using average shares outstanding during the period. |
(b) | The Net Asset Value per share and total return have been calculated based on net assets which include adjustments made in accordance with U.S. Generally Accepted Accounting Principles required at period end for financial reporting purposes. These figures may not necessarily reflect the Net Asset Value per share or total return experienced by the shareholder at period end. |
(c) | Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. |
(d) | Includes dividends and fees on securities sold short. |
(e) | Represents less than $0.005 per share. |
(f) | Supplemental expense ratios are shown below: |
For the Years Ended June 30, | ||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | ||||||
Net
operating expenses (net of waiver/reimbursement, if
applicable, but gross of all other operating expenses) |
2.72% | 2.70% | 2.55% | 2.55% | 3.52% | |||||
Interest expense and commitment fees | 0.01% | — | — | — | — | |||||
Dividends and fees on securities sold short | 0.70% | 0.85% | 0.77% | 0.77% | 1.03% |
For the Year Ended June 30, | |||||||||
2017 | 2016 | 2015 | 2014 | 2013 | |||||
Net Asset Value, Beginning of Period | $ 10.90 | $ 15.48 | $ 14.50 | $ 10.68 | $10.59 | ||||
Income from Investment Operations: | |||||||||
Net investment loss (a) | (0.27) | (0.34) | (0.42) | (0.35) | (0.31) | ||||
Redemption fees added to paid-in capital | — | — | — | — (a)(f) | — (a)(f) | ||||
Capital contributions | — | — | — | — | (0.03) (a) | ||||
Net realized and unrealized gain/(loss) (a) | 0.31 | (3.66) | 2.08 | 4.17 | 0.43 | ||||
Total from investment operations | 0.04 | (4.00) | 1.66 | 3.82 | 0.09 | ||||
Less Distributions Declared to Shareholders: | |||||||||
From net realized gains | — | (0.58) | (0.68) | — | — | ||||
Total distributions declared to shareholders | — | (0.58) | (0.68) | — | — | ||||
Net Asset Value, End of Period (b) | $ 10.94 | $ 10.90 | $ 15.48 | $ 14.50 | $10.68 | ||||
Total Return (b)(c) | 0.37% | (26.37)% | 12.02% | 35.77% | 0.85% | ||||
Ratios to Average Net Assets (d) /Supplemental Data: | |||||||||
Net assets, end of period (in 000’s) | $22,805 | $55,381 | $83,971 | $47,964 | $ 5,460 | ||||
Gross operating expenses (e)(g) | 3.37% | 3.38% | 3.29% | 3.25% | 4.20% | ||||
Net investment income/(loss) | (2.47)% | (2.66)% | (2.81)% | (2.51)% | (3.05)% | ||||
Portfolio turnover rate | 964% | 901% | 409% | 538% | 1,035% |
(a) | Per share data was calculated using average shares outstanding during the period. |
(b) | The Net Asset Value per share and total return have been calculated based on net assets which include adjustments made in accordance with U.S. Generally Accepted Accounting Principles required at period end for financial reporting purposes. These figures may not necessarily reflect the Net Asset Value per share or total return experienced by the shareholder at period end. |
(c) | Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. |
(d) | All ratios for the period have been annualized, unless otherwise indicated. |
(e) | Includes dividends and fees on securities sold short. |
(f) | Represents less than $0.005 per share. |
(g) | Supplemental expense ratios are shown below: |
For the Years Ended June 30, | ||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | ||||||
Net
operating expenses (net of waiver/reimbursement, if
applicable, but gross of all other operating expenses) |
3.37% | 3.38% | 3.29% | 3.25% | 4.20% | |||||
Interest expense and commitment fees | 0.01% | — | 0.01% | — | — | |||||
Dividends and fees on securities sold short | 0.70% | 0.87% | 0.84% | 0.79% | 1.07% |
For the Year Ended June 30, | |||||||||
2017 | 2016 | 2015 | 2014 | 2013 | |||||
Net Asset Value, Beginning of Year | $ 11.87 | $ 16.66 | $ 15.40 | $ 11.23 | $ 11.03 | ||||
Income from Investment Operations: | |||||||||
Net investment (loss) (a) | (0.18) | (0.23) | (0.30) | (0.22) | (0.21) | ||||
Redemption fees added to paid-in capital | — | — | — | — (a)(e) | — (a)(e) | ||||
Capital contributions | — | — | — | — | (0.03) (a) | ||||
Net realized and unrealized gain/(loss) (a) | 0.35 | (3.98) | 2.24 | 4.39 | 0.44 | ||||
Total from investment operations | 0.17 | (4.21) | 1.94 | 4.17 | 0.20 | ||||
Less Distributions Declared to Shareholders: | |||||||||
From net realized gains | — | (0.58) | (0.68) | — | — | ||||
Total distributions declared to shareholders | — | (0.58) | (0.68) | — | — | ||||
Net Asset Value, End of Year (b) | $ 12.04 | $ 11.87 | $ 16.66 | $ 15.40 | $ 11.23 | ||||
Total return (b)(c) | 1.43% | (25.75)% | 13.16% | 37.13% | 1.81% | ||||
Ratios to Average Net Assets (d) /Supplemental Data: | |||||||||
Net assets, end of period (in 000’s) | $53,839 | $158,854 | $454,021 | $112,879 | $13,801 | ||||
Gross operating expenses (d)(f) | 2.38% | 2.32% | 2.41% | 2.26% | 3.24% | ||||
Net investment (loss) | (1.49)% | (1.62)% | (1.90)% | (1.51)% | (1.95)% | ||||
Portfolio turnover rate | 964% | 901% | 409% | 538% | 1,035% |
(a) | Per share data was calculated using average shares outstanding during the period. |
(b) | The Net Asset Value per share and total return have been calculated based on net assets which include adjustments made in accordance with U.S. Generally Accepted Accounting Principles required at period end for financial reporting purposes. These figures may not necessarily reflect the Net Asset Value per share or total return experienced by the shareholder at period end. |
(c) | Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. |
(d) | Includes dividends and fees on securities sold short. |
(e) | Represents less than $0.005 per share. |
(f) | Supplemental expense ratios are shown below: |
For the Years Ended June 30, | ||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | ||||||
Net
operating expenses (net of waiver/reimbursement, if
applicable, but gross of all other operating expenses) |
2.38% | 2.32% | 2.41% | 2.26% | 3.24% | |||||
Interest expense and commitment fees | 0.01% | — | 0.01% | — | — | |||||
Dividends and fees on securities sold short | 0.70% | 0.82% | 0.96% | 0.80% | 1.13% |
For
the
Six Months Ended June 30, 2017 |
For
the
Period Ended December 31, 2016 (a) |
||
Net Asset Value, Beginning of Period | $20.53 | $20.00 | |
Income from Investment Operations: | |||
Net investment income (b) | 0.24 | (0.22) | |
Net realized and unrealized gain | 0.88 | 0.75 | |
Total from investment operations | 1.12 | 0.53 | |
Less Distributions Declared to Shareholders: | |||
From net realized gains | — | — (c) | |
Total distributions declared to common shareholders | — | — (c) | |
Net Asset Value, End of Period (d) | $21.65 | $20.53 | |
Total Return (d)(e)(f) | 5.46% | 2.66% | |
Ratios to Average Net Assets (g) /Supplemental Data: | |||
Net assets, end of period (in 000’s) | $ 1,661 | $ 121 | |
Gross operating expenses (h) | 6.40% | 7.16% | |
Net investment income/(loss) | 2.30% | (3.00)% | |
Portfolio turnover rate (f) | 233% | 718% |
(a) | Class commenced operations on August 19, 2016. |
(b) | Net investment income per share is based on average shares outstanding during the period. |
(c) | Represents less than $0.005 per share. |
(d) | The Net Asset Value per share and total return have been calculated based on net assets which include adjustments made in accordance with U.S. Generally Accepted Accounting Principles required at period end for financial reporting purposes. These figures may not necessarily reflect the Net Asset Value per share or total return experienced by the shareholder at period end. |
(e) | Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. |
(f) | Not annualized. |
(g) | All ratios for the period have been annualized, unless otherwise indicated. |
(h) | Supplemental expense ratios are shown below: |
For
the
Six Months Ended June 30, 2017 |
For
the
Period Ended December 31, 2016 |
|||
Net
operating expenses (net of waiver/reimbursement, if
applicable, but gross of all other operating expenses) |
5.05% | 4.62% | ||
Interest expense | — | 1.60% | ||
Dividends and fees on securities sold short | 3.19% | 1.14% |
For
the
Six Months Ended June 30, 2017 |
For
the
Period Ended December 31, 2016 (a) |
||
Net Asset Value, Beginning of Period | $20.48 | $20.00 | |
Income from Investment Operations: | |||
Net investment income (b) | 0.05 | (0.28) | |
Net realized and unrealized gain | 0.99 | 0.76 | |
Total from investment operations | 1.04 | 0.48 | |
Less Distributions Declared to Shareholders: | |||
From net realized gains | — | — (c) | |
Total distributions declared to common shareholders | — | — (c) | |
Net Asset Value, End of Period (d) | $21.52 | $20.48 | |
Total Return (d)(e)(f) | 5.08% | 2.41% | |
Ratios to Average Net Assets (g) /Supplemental Data: | |||
Net assets, end of period (in 000’s) | $ 1,094 | $ 96 | |
Gross operating expenses (h) | 7.28% | 8.15% | |
Net investment income/(loss) | 0.47% | (3.93)% | |
Portfolio turnover rate (f) | 233% | 718% |
(a) | Class commenced operations on August 19, 2016. |
(b) | Net investment income per share is based on average shares outstanding during the period. |
(c) | Represents less than $0.005 per share. |
(d) | The Net Asset Value per share and total return have been calculated based on net assets which include adjustments made in accordance with U.S. Generally Accepted Accounting Principles required at period end for financial reporting purposes. These figures may not necessarily reflect the Net Asset Value per share or total return experienced by the shareholder at period end. |
(e) | Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. |
(f) | Not annualized. |
(g) | All ratios for the period have been annualized, unless otherwise indicated. |
(h) | Supplemental expense ratios are shown below: |
For
the
Six Months Ended June 30, 2017 |
For
the
Period Ended December 31, 2016 |
|||
Net
operating expenses (net of waiver/reimbursement, if
applicable, but gross of all other operating expenses) |
5.95% | 5.62% | ||
Interest expense | — | 1.39% | ||
Dividends and fees on securities sold short | 3.47% | 1.69% |
For
the
Six Months Ended June 30, 2017 |
For
the
Period Ended December 31, 2016 (a) |
||
Net Asset Value, Beginning of Period | $ 20.60 | $ 20.05 | |
Income from Investment Operations: | |||
Net investment income (b) | 0.19 | (0.12) | |
Net realized and unrealized gain | 0.97 | 0.67 | |
Total from investment operations | 1.16 | 0.55 | |
Less Distributions Declared to Shareholders: | |||
From net realized gains | — | — (c) | |
Total distributions declared to common shareholders | — | — (c) | |
Net Asset Value, End of Period (d) | $ 21.76 | $ 20.60 | |
Total Return (d)(e)(f) | 5.63% | 2.76% | |
Ratios to Average Net Assets (g) /Supplemental Data: | |||
Net assets, end of period (in 000’s) | $27,291 | $22,393 | |
Gross operating expenses (h) | 6.11% | 6.04% | |
Net investment income/(loss) | 1.84% | (1.68)% | |
Portfolio turnover rate (f) | 233% | 718% |
(a) | Class commenced operations on August 19, 2016. |
(b) | Net investment income per share is based on average shares outstanding during the period. |
(c) | Represents less than $0.005 per share. |
(d) | The Net Asset Value per share and total return have been calculated based on net assets which include adjustments made in accordance with U.S. Generally Accepted Accounting Principles required at period end for financial reporting purposes. These figures may not necessarily reflect the Net Asset Value per share or total return experienced by the shareholder at period end. |
(e) | Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. |
(f) | Not annualized. |
(g) | All ratios for the period have been annualized, unless otherwise indicated. |
(h) | Supplemental expense ratios are shown below: |
For
the
Six Months Ended June 30, 2017 |
For
the
Period Ended December 31, 2016 (a) |
|||
Net
operating expenses (net of waiver/reimbursement, if applicable,
but gross of all other operating expenses) |
4.75% | 3.50% | ||
Interest expense | — | 0.84% | ||
Dividends and fees on securities sold short | 3.22% | 1.14% |
For the Year Ended June 30, | |||||
2017 | 2016 | 2015* | |||
Net Asset Value, Beginning of Year | $ 3.73 | $ 5.30 | $ 6.22 | ||
Income from Investment Operations: | |||||
Net investment income (a) | 0.38 | 0.53 | 0.24 | ||
Net realized and unrealized gain/(loss) | 0.48 | (1.59) | (0.93) | ||
Total from investment operations | 0.86 | (1.06) | (0.69) | ||
Less Distributions Declared to Shareholders: | |||||
From net investment income | (0.37) | (0.51) | (0.23) | ||
Total distributions declared to shareholders | (0.37) | (0.51) | (0.23) | ||
Net Asset Value, End of Year (b) | $ 4.22 | $ 3.73 | $ 5.30 | ||
Total Return (b)(c) | 23.79% | (19.68)% | (11.14)% (d) | ||
Ratios to Average Net Assets (e) /Supplemental Data: | |||||
Net assets, end of period (in 000’s) | $ 8,527 | $ 5,149 | $ 7,730 | ||
Gross operating expenses (f) | 1.94% | 2.14% | 2.30% | ||
Net investment income/(loss) | 9.15% | 13.06% | 4.43% | ||
Portfolio turnover rate | 113% | 83% | 41% (d) |
* | Effective July 1, 2014, the Highland Opportunistic Credit Fund changed its fiscal year end from December 31 to June 30. Class A shares commenced operations on July 1, 2014. |
(a) | Per share data was calculated using average shares outstanding during the period. |
(b) | The Net Asset Value per share and total return have been calculated based on net assets which include adjustments made in accordance with U.S. Generally Accepted Accounting Principles required at period end for financial reporting purposes. These figures may not necessarily reflect the Net Asset Value per share or total return experienced by the shareholder at period end. |
(c) | Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. |
(d) | Not annualized. |
(e) | All ratios for the period have been annualized, unless otherwise indicated. |
(f) | Supplemental expense ratios are shown below: |
For the Years Ended June 30, | ||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | ||||||
Net
operating expenses (net of waiver/reimbursement, if
applicable, but gross of all other operating expenses) |
1.44% | 1.53% | 1.27% | 0.99% | 1.04% | |||||
Interest expense and commitment fees | — (g) | 0.23% | — | 0.08% | 0.10% | |||||
Dividends and fees on securities sold short | 0.06% | — | — | 0.04% | — |
(g) | Represents less than 0.005%. |
For the Year Ended June 30, | |||||
2017 | 2016 | 2015* | |||
Net Asset Value, Beginning of Period | $ 3.75 | $ 5.30 | $ 6.22 | ||
Income from Investment Operations: (a) | |||||
Net investment income | 0.30 | 0.50 | 0.21 | ||
Net realized and unrealized gain/(loss) | 0.54 | (1.58) | (0.93) | ||
Total from investment operations | 0.84 | (1.08) | (0.72) | ||
Less Distributions Declared to Shareholders: | |||||
From net investment income | (0.35) | (0.47) | (0.20) | ||
Total distributions declared to shareholders | (0.35) | (0.47) | (0.20) | ||
Net Asset Value, End of Period (b) | $ 4.24 | $ 3.75 | $ 5.30 | ||
Total Return (b)(c) | 23.14% | (20.16)% | (11.61)% (d) | ||
Ratios to Average Net Assets (e) /Supplemental Data: | |||||
Net assets, end of period (in 000’s) | $ 3,695 | $ 344 | $ 160 | ||
Gross operating expenses (f) | 2.41% | 2.64% | 2.80% | ||
Net investment income/(loss) | 6.99% | 12.85% | 3.88% | ||
Portfolio turnover rate | 113% | 83% | 41% (d) |
* | Effective July 1, 2014, the Highland Opportunistic Credit Fund changed its fiscal year end from December 31 to June 30. Class C shares commenced operations on July 1, 2014. |
(a) | Per share data was calculated using average shares outstanding during the period. |
(b) | The Net Asset Value per share and total return have been calculated based on net assets which include adjustments made in accordance with U.S. Generally Accepted Accounting Principles required at period end for financial reporting purposes. These figures may not necessarily reflect the Net Asset Value per share or total return experienced by the shareholder at period end. |
(c) | Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. |
(d) | Not Annualized. |
(e) | All ratios for the period have been annualized, unless otherwise indicated. |
(f) | Supplemental expense ratios are shown below: |
For the Years Ended June 30, | ||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | ||||||
Net
operating expenses (net of waiver/reimbursement, if
applicable, but gross of all other operating expenses) |
1.91% | 2.03% | 1.77% | 0.99% | 1.04% | |||||
Interest expense and commitment fees | — (g) | 0.23% | — | 0.08% | 0.10% | |||||
Dividends and fees on securities sold short | 0.06% | — | — | 0.04% | — |
(g) | Represents less than 0.005%. |
For the Year Ended June 30, |
For
the
Six Months Ended June 30, 2014 |
For
the
Year Ended December 31 |
|||||||||
2017 | 2016 | 2015 | 2013 | 2012 | |||||||
Net Asset Value, Beginning of Year | $ 3.71 | $ 5.30 | $ 6.21 | $ 6.04 | $ 4.49 | $ 3.36 | |||||
Income from Investment Operations: | |||||||||||
Net investment income/(loss) | 0.38 | 0.54 (a) | 0.26 (a) | (0.05) | 0.05 | (0.04) (a) | |||||
Net realized and unrealized gain/(loss) | 0.49 | (1.59) | (0.92) | 0.22 | 1.50 | 1.17 | |||||
Total from investment operations | 0.87 | (1.05) | (0.66) | 0.17 | 1.55 | 1.13 | |||||
Less Distributions Declared to Shareholders: | |||||||||||
From net investment income | (0.38) | (0.54) | (0.25) | — | — | — | |||||
Total distributions declared to shareholders | (0.38) | (0.54) | (0.25) | — | — | — | |||||
Net Asset Value, End of Year (b) | $ 4.20 | $ 3.71 | $ 5.30 | $ 6.21 | $ 6.04 | $ 4.49 | |||||
Total return (b)(c) | 24.31% | (19.43)% | (10.63)% | 2.81% (d) | 34.52% | 33.23% | |||||
Ratios to Average Net Assets (d) /Supplemental Data: | |||||||||||
Ratios and Supplemental Data: | |||||||||||
Net assets, end of period (in 000’s) | $71,706 | $53,977 | $78,893 | $2,721 | $ 816 | $ 605 | |||||
Gross operating expenses (e) | 1.63% | 1.79% | 1.95% | 4.23% (f) | 8.52% (f) | 6.86% | |||||
Net investment income/(loss) | 9.28% | 13.35% | 4.80% | (1.53)% | 0.93% | (1.55)% | |||||
Portfolio turnover rate | 113% | 83% | 41% | —% | —% | —% |
* | Effective July 1, 2014, the Highland Opportunistic Credit Fund changed its fiscal year end from December 31 to June 30. |
** | Historical data shown is that of the Highland Special Situations Fund, which reorganized into the Highland Opportunistic Credit Fund on July 1, 2014. |
(a) | Per share data was calculated using average shares outstanding during the period. |
(b) | The Net Asset Value per share and total return have been calculated based on net assets which include adjustments made in accordance with U.S. Generally Accepted Accounting Principles required at period end for financial reporting purposes. These figures may not necessarily reflect the Net Asset Value per share or total return experienced by the shareholder at period end. |
(c) | Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced. |
(d) | Not annualized. |
(e) | All ratios for the period have been annualized, unless otherwise indicated. |
(f) | Supplemental expense ratios are shown below: |
For the Years Ended June 30, |
For
the
Six Months Ended June 30, 2014** |
For
the
Years Ended December 31, |
||||||||||
2017 | 2016 | 2015* | 2013** | 2012** | ||||||||
Net
operating expenses (net of waiver/reimbursement, if
applicable, but gross of all other operating expenses) |
1.13% | 1.18% | 0.91% | 4.23% | 8.52% | 6.86% | ||||||
Interest expense and commitment fees | — (g) | 0.23% | — | — | — | — | ||||||
Dividends and fees on securities sold short | 0.06% | — | — | — | — | — |
(g) | Represents less than 0.005%. |
Appendix
Intermediary Sales Charge Discounts and Waivers
As described in the Prospectus, Class A and Class T Shares of the Funds are subject to an initial sales charge and Class C Shares are subject to a contingent deferred sales charge (CDSC). Class A and Class T shares purchased through certain financial intermediaries may be subject to different initial sales charges or the initial sales charge or CDSC may be waived in certain circumstances. This Appendix details the variations in sales charge waivers for Class A and Class T shares purchased through certain specified financial intermediaries.
You should consult your financial representative for assistance in determining whether you may qualify for a particular sales charge waiver or discount.
The information in this Appendix is part of, and incorporated in, the Funds Prospectus.
Front-End Sales Charge Schedule for Class T Shares
(Morgan Stanley, Wells Fargo and RBC)
Front-End Sales Charge |
Maximum Dealers
Reallowance |
|||||||||||
Your Investment |
(As a % of Purchase
Price) |
(As a % of Your Net
Investment) |
(As a % of Purchase
Price) |
|||||||||
Less than $250,000 |
2.50 | % | 2.56 | % | 2.50 | % | ||||||
$250,000 but less than $500,000 |
2.00 | % | 2.04 | % | 2.00 | % | ||||||
$500,000 but less than $1,000,000 |
1.50 | % | 1.52 | % | 1.50 | % | ||||||
$1,000,000 or more |
1.00 | % | 1.01 | % | 1.00 | % |
1
Merrill Lynch, Pierce, Fenner & Smith Incorporated (Merrill Lynch):
Effective April 10, 2017, if you purchase Fund shares through a Merrill Lynch platform or account held at Merrill Lynch, you will be eligible only for the following sales charge waivers (front-end sales charge waivers and CDSC waivers) and discounts, which may differ from those disclosed elsewhere in these Funds Prospectus or SAI. It is your responsibility to notify your financial representative at the time of purchase of any relationship or other facts qualifying you for sales charge waivers or discounts.
Front-End Sales Charge Waivers on Class A Shares available at Merrill Lynch
| Employer-sponsored retirement, deferred compensation and employee benefit plans (including health savings accounts) and trusts used to fund those plans, provided that the shares are not held in a commission-based brokerage account and shares are held for the benefit of the plan |
| Shares purchased by or through a 529 Plan |
| Shares purchased through a Merrill Lynch affiliated investment advisory program |
| Shares purchased by third party investment advisors on behalf of their advisory clients through Merrill Lynchs platform |
| Shares of funds purchased through the Merrill Edge Self-Directed platform (if applicable) |
| Shares purchased through reinvestment of capital gains distributions and dividend reinvestment when purchasing shares of the same fund (but not any other fund within the fund family) |
| Shares exchanged from Class C ( i.e. level-load) shares of the same fund in the month of or following the 10-year anniversary of the purchase date |
| Employees and registered representatives of Merrill Lynch or its affiliates and their family members |
| Directors or Trustees of the Funds, and employees of the Funds investment adviser or any of its affiliates, as described in the this Prospectus |
| Shares purchased from the proceeds of redemptions within the same fund family, provided (1) the repurchase occurs within 90 days following the redemption, (2) the redemption and purchase occur in the same account, and (3) redeemed shares were subject to a front-end or deferred sales charge (known as Rights of Reinstatement) |
CDSC Waivers on Class A and C Shares available at Merrill Lynch
| Death or disability of the shareholder |
| Shares sold as part of a systematic withdrawal plan as described in the Funds Prospectus |
| Return of excess contributions from an IRA Account |
| Shares sold as part of a required minimum distribution for IRA and retirement accounts due to the shareholder reaching age 70 1 ⁄ 2 |
| Shares sold to pay Merrill Lynch fees but only if the transaction is initiated by Merrill Lynch |
2
| Shares acquired through a right of reinstatement |
| Shares held in retirement brokerage accounts, that are exchanged for a lower cost share class due to transfer to certain fee based account or platform (applicable to A and C shares only) |
Front-End Sales Charge Discounts Available at Merrill Lynch: Breakpoints, Rights of Accumulation & Letters of Intent (All share classes other than Class T Shares)
| Breakpoints as described in this Prospectus. |
| Rights of Accumulation (ROA) which entitle shareholders to sales charge discounts will be automatically calculated based on the aggregated holding of fund family assets held by accounts within the purchasers household at Merrill Lynch. Eligible fund family assets not held at Merrill Lynch may be included in the ROA calculation only if the shareholder notifies his or her financial advisor about such assets |
| Letters of Intent (LOI) which allow for sales charge discounts based on anticipated purchases within a fund family, through Merrill Lynch, over a 13-month period of time (if applicable) |
Morgan Stanley Wealth Management
Class T Sales Charge Waivers
Class T shares are available for purchase by Morgan Stanley Wealth Management clients with the front-end sales charge waived as follows:
| Employer-sponsored retirement plans (e.g., 401(k) plans, 457 plans, employer-sponsored 403(b) plans, profit sharing and money purchase pension plans and defined benefit plans). For purposes of this provision, employer-sponsored retirement plans do not include SEP IRAs, Simple IRAs, SAR-SEPs or Keogh plans; however these plans are eligible to purchase Class T shares through a transactional brokerage account. |
| Morgan Stanley Wealth Management employee and employee-related accounts according to Morgan Stanleys account linking rules. |
| Shares purchased through reinvestment of dividends and capital gains distributions when purchasing shares of the same fund. |
| Mutual fund shares exchanged from an existing position in the same fund as part of a share class conversion instituted by Morgan Stanley Wealth Management. |
Unless specifically described above, no other front-end sales charge waivers are available to mutual fund purchases by Morgan Stanley Wealth Management clients in transactional brokerage accounts.
3
Highland/iBoxx Senior Loan ETF
Ticker: SNLN NASDAQ, Inc.
Prospectus
October 31, 2017
Although these securities have been registered with the Securities and Exchange Commission (SEC), the SEC has not approved or disapproved any shares offered in this Prospectus or determined whether this Prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
Not FDIC Insured
May Lose Value
No Bank Guarantee
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
Highland/iBoxx Senior Loan ETF
Ticker: SNLNNASDAQ, Inc.
Investment Objective
The investment objective of Highland/iBoxx Senior Loan ETF (the Fund) is to provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the Markit iBoxx USD Liquid Leveraged Loan Index (the Underlying Index).
Fees and Expenses
The following tables describe the fees and expenses that you may pay if you buy and hold shares of the Fund. Annual Fund Operating Expenses (expenses that you pay each year as % of the value of your investment).
Management Fee | 0.45% | |||||
Other Expenses | 0.29% | |||||
Total Annual Fund Operating Expenses | 0.74% | |||||
Expense Reimbursement 1 |
-0.19% | |||||
Total Annual Fund Operating Expenses After Expense Reimbursement | 0.55% |
1 | Highland Capital Management Fund Advisors, L.P. (HCMFA or the Adviser) has contractually agreed to limit the total annual operating expenses (exclusive of taxes, brokerage commissions and other transaction costs, acquired fund fees and expenses and extraordinary expenses (collectively, the Excluded Expenses)) of the Fund to 0.55% of average daily net assets of the Fund (the Expense Cap). The Expense Cap will continue through at least October 31, 2018, and may not be terminated prior to this date without the action or consent of the Funds Board of Trustees (the Board). Under the Expense Cap, the Adviser may recoup waived and/or reimbursed amounts with respect to the Fund within thirty-six months of the date such amounts were waived or reimbursed, provided the Funds total annual operating expenses, including such recoupment, do not exceed the Expense Cap in effect at the time of such waiver/reimbursement. |
Expense Example
This Example helps you compare the cost of investing in the Fund to the cost of investing in other funds. The Example assumes that you invest $10,000 in the Fund for the time periods indicated and then sell or redeem all your shares at the end of those periods. The Example also assumes that your investment has a 5% return each year and that the Funds operating expenses remain the same. Only the first year of each period in the example takes into account the expense reimbursement described above. Your actual costs may be higher or lower. Investors in the Fund may pay brokerage commissions on their purchases and sales of Fund shares, which are not included in the examples below.
1 Year | 3 Years | 5 Years | 10 Years | |||
$56 | $217 | $393 | $901 |
Portfolio Turnover
The Fund pays transaction costs, such as commissions, when it buys and sells securities (or turns over its portfolio). A higher portfolio turnover rate may indicate higher transaction costs and may result in higher taxes when Fund shares are held in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the Example, affect the Funds performance. During the most recent fiscal year, the Funds portfolio turnover rate was 115% of the average value of its portfolio.
Principal Investment Strategies
The Fund will, under normal circumstances, invest at least 80% of its assets (the 80% basket) in component securities of the Underlying Index (Component Securities). The Fund may invest the remaining 20% of its assets (the 20% basket) in securities not included in the Underlying Index, but which the Adviser believes will help the Fund track the Underlying Index. For example, the Fund may invest in securities that are not components of the Underlying Index to reflect various corporate actions (such as mergers) and other changes in the Underlying Index (such as reconstitutions, additions and deletions). The Fund may invest in securities of any type and of companies of any market capitalization, market sector or industry. The Fund may use the 20% basket to invest in securities issued by other investment companies, including other exchange-traded funds. The Fund also may invest in warrants and may also use derivatives, primarily swaps (including equity, variance and volatility swaps), options and futures contracts on securities, interest rates, non-physical commodities and/or currencies, with the 20% basket to track the Underlying Index and as substitutes for direct investments the Fund can make. The Fund may also use derivatives such as swaps, options (including options on futures), futures, and foreign currency transactions (e.g., foreign currency swaps, futures and forwards) to hedge various investments for risk management and speculative purposes. In addition, the Funds 20% basket may be invested in cash and cash equivalents, including shares of money market funds advised by the Adviser or its affiliates.
Unlike many investment companies, the Fund does not try to beat the index it tracks. The Fund uses a passive management strategy designed to track the total return performance of the Underlying Index as a proxy for the senior secured loan universe. The Underlying Index is a subset of the Markit iBoxx USD Leveraged Loan Index. Leveraged Loans are loans to companies that typically already have a high amount of debt and are often characterized by lower credit ratings or higher interest rates. The Underlying Index is a rules-based index consisting of some of the largest, most liquid Leveraged Loans, as measured by the number of active market participants trading the security and the dollar face amount of outstanding senior loans issued. Currently, loans eligible for inclusion in the Underlying Index are measured by type, size, liquidity, spread, credit rating and minimum time to maturity.
The Underlying Index is sponsored by Markit Indices Limited (the Index Provider), an organization that is independent of the Fund and the Adviser. The Index Provider determines the composition and relative weightings of the securities in the Underlying Index and publishes information regarding the market value of the Underlying Index.
1
The Adviser uses a representative sampling indexing strategy to manage the Fund. Representative sampling is an indexing strategy that involves investing in a representative sample of securities that collectively has an investment profile similar to the Underlying Index. The securities selected are expected to have, in the aggregate, investment characteristics (based on factors such as market capitalization and industry weightings), fundamental characteristics (such as return variability, duration, maturity or credit ratings and yield) and liquidity measures similar to those of the Underlying Index. The Fund may or may not hold all of the securities in the Underlying Index. Tracking error is the difference between the performance (return) of the Funds portfolio and that of the Underlying Index. The Adviser expects that, over time, the Funds tracking error will not exceed 5%. Funds that employ a representative sampling strategy may incur tracking error risk to a greater extent than funds that seek to replicate an index.
The Component Securities primarily consist of senior loans (Senior Loans) to domestic or foreign corporations, partnerships and other entities that operate in a variety of industries and geographic regions, which may include emerging markets (Borrowers). The Fund will, under normal circumstances, invest at least 80% of its assets (i.e., net assets plus borrowings for investment purposes) in Senior Loans. Senior Loans, at the time of the Funds purchase, have the most senior position in a Borrowers capital structure or share the senior position with other senior debt securities of the Borrower. Senior Loans generally are arranged through private negotiations between a Borrower and several financial institutions (the Lenders) represented in each case by one or more such Lenders acting as agent (the Agent) of the several Lenders. On behalf of the Lenders, the Agent is primarily responsible for negotiating the loan agreement (Loan Agreement) that establishes the relative terms and conditions of the Senior Loan and rights of the Borrower and the Lenders. The Component Securities in which the Fund will invest are expected to be below investment grade securities (also known as high yield securities or junk securities). Such securities are rated below investment grade by a nationally recognized statistical rating organization (NRSRO) or are unrated but deemed by the Adviser to be of comparable quality. The Underlying Index may include, and the Fund may acquire and retain in its portfolio, below investment grade or unrated securities, including loans of Borrowers that are insolvent or in default, provided that all criteria of the Underlying Index, including liquidity requirements, are met.
The Fund may invest in participations (Participations) in Senior Loans and may purchase assignments (Assignments) of portions of Senior Loans from third parties. Senior Loans often are secured by specific assets of the Borrower, although the Fund may invest without limitation in Senior Loans that are not secured by any collateral.
The Fund is a non-diversified fund as defined in the Investment Company Act of 1940, as amended (the 1940 Act), but intends to adhere to the diversification requirements applicable to regulated investment companies (RICs) under Subchapter M of the Internal Revenue Code of 1986, as amended (the Code). The Fund is not intended to be a complete investment program. Except for investment restrictions designated as fundamental in this Prospectus or in the Funds Statement of Additional Information (SAI), the investment policies described in this Prospectus or the Funds SAI are not fundamental and may be changed without shareholder approval.
Principal Risks
When you sell Fund shares, they may be worth less than what you paid for them. Consequently, you can lose money by investing in the Fund. No assurance can be given that the Fund will achieve its objective, and investment results may vary substantially over time and from period to period. An investment in the Fund is not appropriate for all investors.
Asset Class Risk. Securities in the Underlying Index or in the Funds portfolio may underperform in comparison to the general securities markets or other asset classes.
Cash Transaction Risk. Unlike most exchange-traded funds (ETFs), the Fund currently intends to effect creations and redemptions principally for cash, rather than principally for in-kind securities, because of the nature of the Funds investments. As a result, investments in Fund shares may be less tax-efficient than investments in conventional ETFs. Paying redemption proceeds in cash rather than through in-kind delivery of portfolio securities may require the Fund to dispose of or sell portfolio investments to obtain the cash needed to distribute redemption proceeds at an inopportune time. This may cause the Fund to recognize gains or losses that it might not have incurred if it had made a redemption in-kind.
Commodities Risk. Commodities markets historically have been extremely volatile, and the performance of securities and other instruments that provide exposure to those markets therefore also may be highly volatile. The commodities markets may fluctuate widely based on a variety of factors. These include changes in overall market movements, domestic and foreign political and economic events and policies, war, acts of terrorism, changes in domestic or foreign interest rates and/or investor expectations concerning interest rates, domestic and foreign inflation rates and/or investor expectations concerning inflation rates and investment and trading activities of mutual funds, hedge funds and commodities funds. Commodity-linked derivative instruments have a high degree of price variability and are subject to rapid and substantial price changes. Commodity-linked derivative instruments may employ leverage, which creates the possibility for losses greater than the amount invested.
Counterparty Risk. A counterparty (the other party to a transaction or an agreement or the party with whom the Fund executes transactions) to a transaction with the Fund may be unable or unwilling to make timely principal, interest or settlement payments, or otherwise honor its obligations.
Credit Risk. The issuers of certain securities or the counterparties of a derivatives contract or repurchase contract might be unable or unwilling (or perceived as being unable or unwilling) to make interest and/or principal payments when due, or to otherwise honor its obligations. Debt securities are subject to the risk of non-payment of
2
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
scheduled interest and/or principal. Non-payment would result in a reduction of income to the Fund, a reduction in the value of the obligation experiencing non-payment and a potential decrease in the Funds net asset value (NAV) and the market price of the Funds shares.
Debt Securities and Leveraged Loans Risk. The value of debt securities typically changes in response to various factors, including, by way of example, market-related factors (such as changes in interest rates or changes in the risk appetite of investors generally) and changes in the actual or perceived ability of the issuer (or of issuers generally) to meet its (or their) obligations. During periods of rising interest rates, debt securities generally decline in value. Conversely, during periods of falling interest rates, debt securities generally rise in value. This kind of market risk is generally greater for funds investing in debt securities with longer maturities. In addition, the interest rates of floating rate loans typically only adjust to changes in short-term interest rates; long-term interest rates can vary dramatically from short-term interest rates. Leveraged Loans are subject to the same risks typically associated with debt securities. In addition, Leveraged Loans, which typically hold a senior position in the capital structure of a borrower, are subject to the risk that a court could subordinate such loans to presently existing or future indebtedness or take other action detrimental to the holders of Leveraged Loans. Leveraged Loans are also especially subject to the risk that the value of the collateral, if any, securing a loan may decline, be insufficient to meet the obligations of the borrower or be difficult to liquidate.
Because loans are not ordinarily registered with the SEC or any state securities commission or listed on any securities exchange, there is usually less publicly available information about such instruments. In addition, loans may not be considered securities for purposes of the anti-fraud protections of the federal securities laws and, as a result, as a purchaser of these instruments, we may not be entitled to the anti-fraud protections of the federal securities laws. In the course of investing in such instruments, we may come into possession of material nonpublic information and, because of prohibitions on trading in securities of issuers while in possession of such information, we may be unable to enter into a transaction in a publicly-traded security of that issuer when it would otherwise be advantageous for us to do so. Alternatively, we may choose not to receive material nonpublic information about an issuer of such loans, with the result that we may have less information about such issuers than other investors who transact in such assets.
Derivatives Risk. Derivatives Risk is a combination of several risks, including the risks that: (1) an investment in a derivative instrument may not correlate well with the performance of the securities or asset class to which the Fund seeks exposure, (2) derivative contracts, including options, may expire worthless and the use of derivatives may result in losses to the Fund, (3) a derivative instrument entailing leverage may result in a loss greater than the principal amount invested, (4) derivatives not traded on an exchange may be subject to credit risk, for example, if the counterparty does not meet its obligations (see also Counterparty Risk), and (5) derivatives not traded on an exchange may be subject to liquidity risk and the related risk that the instrument is difficult or impossible to value accurately. As a general matter, when the Fund establishes certain derivative instrument positions, such as certain futures and options contract positions, it will segregate liquid assets (such as cash, U.S. Treasury bonds or commercial paper) equivalent to the Funds outstanding obligations under the contract or in connection with the position. In addition, recent legislation has called for a new regulatory framework for the derivatives market. The impact of the new regulations are still unknown, but has the potential to increase the costs of using derivatives, may limit the availability of some forms of derivatives or the Funds ability to use derivatives, and may adversely affect the performance of some derivative instruments used by the Fund as well as the Funds ability to pursue its investment objective through the use of such instruments.
Exchange-Traded Funds Risk. The price movement of an exchange-traded fund may not exactly track the underlying index and may result in a loss. In addition, shareholders bear both their proportionate share of the Funds expenses and similar expenses of the underlying investment company when the Fund invests in shares of another investment company.
Fixed Income Market Risk. Fixed income markets may, in response to governmental intervention, economic or market developments (including potentially a reduction in the number of broker-dealers willing to engage in market-making activity), or other factors, experience periods of increased volatility and reduced liquidity. During those periods, the Fund may experience increased levels of shareholder redemptions, and may have to sell securities at times when it would otherwise not do so, and at unfavorable prices. Fixed income securities may be difficult to value during such periods. As of the date of this Prospectus, market interest rates in the United States are at or near historic lows, which may increase the Funds exposure to risks associated with rising market interest rates. Rising market interest rates could have unpredictable effects on the markets and may expose fixed-income and related markets to heightened volatility, which could reduce liquidity for certain investments, adversely affect values, and increase costs. Increased redemptions may cause the Fund to liquidate portfolio positions when it may not be advantageous to do so and may lower returns. If dealer capacity in fixed-income and related markets is insufficient for market conditions, it may further inhibit liquidity and increase volatility in the fixed-income and related markets. Further, recent and potential future changes in government policy may affect interest rates.
Focused Investment Risk. The Funds investments in Senior Loans arranged through private negotiations between a Borrower and several financial institutions may expose the Fund to risks associated with the financial services industry. The financial services industry is subject to extensive government regulation, which can limit both the amounts and types of loans and other financial commitments financial services companies can make and the interest rates and fees they can charge. Profitability is largely dependent on the availability and cost of capital funds, and can fluctuate significantly when interest rates change. Because financial services companies are highly dependent on short-term interest rates, they can be adversely affected by downturns in
3
the U.S. and foreign economies or changes in banking regulations. Losses resulting from financial difficulties of Borrowers can negatively affect financial services companies.
High-Yield Debt Securities Risk. Below investment grade securities or unrated securities of similar credit quality (commonly known as high-yield securities or junk securities) are more likely to default than higher rated securities. The Funds ability to invest in high-yield debt securities generally subjects the Fund to greater risk than securities with higher ratings. Such securities are regarded by the rating organizations as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. The market value of these securities is more sensitive to corporate developments and economic conditions and can be volatile. Market conditions can diminish liquidity and make accurate valuations difficult to obtain.
Illiquid Securities Risk. The Adviser may not be able to sell illiquid securities at the price it would like or may have to sell them at a loss. Securities of non-U.S. issuers and emerging markets securities in particular, are subject to greater liquidity risk.
Industry Concentration Risk. Because the Fund may invest 25% or more of the value of its assets in an industry or group of industries to the extent that the Underlying Index concentrates in an industry or group of industries, the Funds performance largely depends on the overall condition of such industry or group of industries and the Fund is susceptible to economic, political and regulatory risks or other occurrences associated with that industry or group of industries.
Intellectual Property Risk. The Adviser relies on a license, which may be terminated by the Index Provider, that permits the Fund to use the Underlying Index and associated trade names, trademarks and service marks (the Intellectual Property) in connection with the name and investment strategies of the Fund.
Interest Rate Risk. When interest rates decline, the value of fixed rate securities already held by the Fund can be expected to rise. Conversely, when interest rates rise, the value of existing fixed rate portfolio securities can be expected to decline. A fund with a longer average portfolio duration will be more sensitive to changes in interest rates than a fund with a shorter average portfolio duration. In addition, the interest rates of floating rate loans typically only adjust to changes in short-term interest rates; long-term interest rates can vary dramatically from short-term interest rates.
Lender Liability Risk. A number of judicial decisions have upheld the right of Borrowers to sue lending institutions on the basis of various evolving legal theories founded upon the premise that an institutional Lender has violated a duty of good faith and fair dealing owed to the Borrower or has assumed a degree of control over the Borrower resulting in a creation of a fiduciary duty owed to the Borrower or its other creditors or shareholders. Because of the nature of certain of the Funds investments, the Fund or the Adviser could be subject to such liability.
Limited Information Risk. The types of Senior Loans in which the Fund will invest historically may not have been rated by a NRSRO, have not been registered with the SEC or any state securities commission, and have not been listed on any national securities exchange. Although the Fund will generally have access to financial and other information made available to the Lenders in connection with Senior Loans, the amount of public information available with respect to Senior Loans will generally be less extensive than that available for rated, registered or exchange-listed securities.
Liquidity Risk. Liquidity risk is the risk that low trading volume, lack of a market maker, large position size, or legal restrictions (including daily price fluctuation limits or circuit breakers) limits or prevents the Fund from selling particular securities or unwinding derivative positions at desirable prices. At times, a major portion of any portfolio security may be held by relatively few institutional purchasers. Even if the Fund considers such securities liquid because of the availability of an institutional market, such securities may become difficult to value or sell in adverse market or economic conditions. Because loan transactions often take longer to settle than transactions in other securities, the Fund may not receive the proceeds from the sale of a loan for a significant period of time. As a result, the Fund may maintain higher levels of cash and short-term investments than mutual funds that invest in securities with shorter settlement cycles and/or may enter into a line of credit to permit the Fund to finance redemptions pending settlement of the sale of portfolio securities, each of which may adversely affect the Funds performance. No assurance can be given that these measures will provide the Fund with sufficient liquidity in the event of abnormally large redemptions.
Loan Participation Risk. In addition to the risks typically associated with debt securities, Participations involve the risk that there may not be a readily available market for Participation interests and, in some cases, the Fund may have to dispose of such securities at a substantial discount from face value. Participations also involve the credit risk associated with the underlying corporate borrower.
Management Risk. Management risk is the risk associated with the fact that the Fund relies on the Advisers ability to achieve its investment objective. The Adviser may be incorrect in its assessment of the intrinsic value of companies whose securities the Fund holds, which may result in a decline in the value of Fund shares and failure to achieve its investment objective. The Funds portfolio manager uses qualitative analyses and/or models. Any imperfections or limitations in such analyses and models could affect the ability of the portfolio manager to implement strategies.
Market Price Variance Risk. Fund shares will be listed for trading on NASDAQ, Inc. (the Exchange) and can be bought and sold in the secondary market at market prices. The market prices of shares will fluctuate in response to changes in the NAV and supply and demand for shares. As a result, the trading prices of Shares may deviate significantly from NAV during periods of market volatility. The Adviser cannot predict whether shares will trade above, below or at their NAV. Given the fact that shares can be created and redeemed in Creation Units, the Adviser believes that large discounts or premiums to the NAV of shares should not be sustained in the long-term. In addition, the securities held by the Fund may be traded in
4
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
markets that close at a different time than NASDAQ. Liquidity in those securities may be reduced after the applicable closing times. Accordingly, during the time when NASDAQ is open but after the applicable market closing, fixing or settlement times, bid-ask spreads and the resulting premium or discount to the Shares NAV may widen. Further, secondary markets may be subject to irregular trading activity, wide bid/ask spreads and extended trade settlement periods, which could cause a material decline in the Funds NAV. The bid/ask spread of the Fund may be wider in comparison to the bid/ask spread of other ETFs, given the liquidity of the Funds assets. The Funds investment results are measured based upon the daily NAV of the Fund. Investors purchasing and selling shares in the secondary market may not experience investment results consistent with those experienced by those purchasing and redeeming directly with the Fund.
Non-Diversification Risk. As a non-diversified fund for purposes of the 1940 Act, the Fund may invest a larger portion of its assets in the securities of fewer issuers than a diversified fund. The Funds investment in fewer issuers may result in the Funds shares being more sensitive to the economic results of those issuers. An investment in the Fund could fluctuate in value more than an investment in a diversified fund.
Non-Payment Risk. Debt securities are subject to the risk of non-payment of scheduled interest and/or principal. Non-payment would result in a reduction of income to the Fund, a reduction in the value of the obligation experiencing non-payment and a potential decrease in the Funds NAV and the market price of the Funds shares.
Ongoing Monitoring Risk. Ongoing monitoring risk is the risk associated with ongoing monitoring of the Agent. On behalf of the several Lenders, the Agent generally will be required to administer and manage the Senior Loans and, with respect to collateralized Senior Loans, to service or monitor the collateral. Financial difficulties of Agents can pose a risk to the Fund. Unless, under the terms of the loan, the Fund has direct recourse against the Borrower, the Fund may have to rely on the Agent or other financial intermediary to apply appropriate credit remedies against a Borrower.
Operational and Technology Risk. Cyber-attacks, disruptions, or failures that affect the Funds service providers, counterparties, market participants, or issuers of securities held by the Fund may adversely affect the Fund and its shareholders, including by causing losses for the Fund or impairing Fund operations.
Options Risk. Options, such as covered calls and covered puts, are subject to the risk that significant differences between the securities and options markets that could result in an imperfect correlation between these markets.
Passive Investment Risk. The Fund is not actively managed and HCMFA does not attempt to take defensive positions under any market conditions, including during declining markets.
Prepayment Risk. During periods of falling interest rates, issuers of debt securities may repay higher rate securities before their maturity dates. This may cause the Fund to lose potential price appreciation and to be forced to reinvest the unanticipated proceeds at lower interest rates. This may result in a decrease in the Funds income.
Regulatory Risk. To the extent that legislation or state or federal regulators impose additional requirements or restrictions with respect to the ability of financial institutions to make loans in connection with highly leveraged transactions, the availability of Senior Loan interests for investment by the Fund may be adversely affected.
Securities Market Risk. The value of securities owned by the Fund may go up or down, sometimes rapidly or unpredictably, due to factors affecting particular companies or the securities markets generally. A general downturn in the securities market may cause multiple asset classes to decline in value simultaneously. Many factors can affect this value and you may lose money by investing in the Fund.
To the extent that legislation or state or federal regulators impose additional requirements or restrictions with respect to the ability of financial institutions to make loans in connection with highly leveraged transactions, the availability of Senior Loan interests for investment by the Fund may be adversely affected. In addition, such requirements or restrictions may reduce or eliminate sources of financing for affected Borrowers. Further, to the extent that legislation or federal or state regulators require such institutions to dispose of Senior Loan interests relating to highly leveraged transactions or subject such Senior Loan interests to increased regulatory scrutiny, such financial institutions may determine to sell Senior Loan interests in a manner that results in a price that, in the opinion of the Adviser, is not indicative of fair value. Were the Fund to attempt to sell a Senior Loan interest at a time when a financial institution was engaging in such a sale with respect to the Senior Loan interest, the price at which the Fund could consummate such a sale might be adversely affected. See Industry Concentration Risk above.
Senior Loans Risk. The Funds investments in Senior Loans are typically below investment grade and are considered speculative because of the credit risk of their issuers. As with any debt instrument, Senior Loans are generally subject to the risk of price declines and to increases in interest rates, particularly long-term rates. Senior loans are also subject to the risk that, as interest rates rise, the cost of borrowing increases, which may increase the risk of default. In addition, the interest rates of floating rate loans typically only adjust to changes in short-term interest rates; long-term interest rates can vary dramatically from short-term interest rates. Therefore, Senior Loans may not mitigate price declines in a rising long-term interest rate environment. The secondary market for loans is generally less liquid than the market for higher grade debt. Less liquidity in the secondary trading market could adversely affect the price at which the Fund could sell a loan, and could adversely affect the Funds income. The volume and frequency of secondary market trading in such loans varies significantly over time and among loans. Although Senior Loans in which the Fund will invest will often be secured by collateral, there can be no assurance that liquidation of such collateral would satisfy the Borrowers obligation in the event of a default or that such collateral could be readily liquidated.
5
Swaps Risk. Investments in swaps involve both the risks associated with an investment in the underlying investments or instruments (including equity investments) and counterparty risk. In a standard over-the-counter (OTC) swap transaction, two parties agree to exchange the returns, differentials in rates of return or some other amount calculated based on the notional amount of predetermined investments or instruments, which may be adjusted for an interest factor. Swaps can involve greater risks than direct investments in securities, because swaps may be leveraged and OTC swaps are subject to counterparty risk (e.g., the risk of a counterpartys defaulting on the obligation or bankruptcy), credit risk and pricing risk (i.e., swaps may be difficult to value). Swaps may also be considered illiquid. Certain swap transactions, including interest rate swaps and index credit default swaps, may be subject to mandatory clearing and exchange trading, although the swaps in which the Fund will invest are not currently subject to mandatory clearing and exchange trading. The use of swaps is a highly specialized activity which involves investment techniques, risk analyses and tax planning different from those associated with ordinary portfolio securities transactions. The value of swaps, like many other derivatives, may move in unexpected ways and may result in losses for the Fund.
Tracking Error Risk. The performance of the Fund may diverge from that of the Underlying Index. Because the Fund employs a representative sampling strategy, the Fund may experience tracking error to a greater extent than a fund that seeks to replicate an index. The Adviser may not be able to cause the Funds performance to correlate to that of the Funds benchmark, either on a daily or aggregate basis. Because the Underlying Index rebalances monthly but the Fund is not obligated to do the same, the risk of tracking error may increase following the rebalancing of the Underlying Index.
An investment in the Fund is not a bank deposit and is not insured or guaranteed by the FDIC or any other government agency. As with any investment company, there is no guarantee that the Fund will achieve its goal.
Performance
The bar chart and the Average Annual Total Returns table below provide some indication of the risks of investing in the Fund by showing the Funds investment results from November 6, 2012 (commencement of operations) through December 31, 2016 and how the Funds average annual returns for various periods compare with a broad measure of market performance. As with all mutual funds, the Funds past performance (before and after taxes) does not predict how the Fund will perform in the future. Both the chart and the table assume the reinvestment of dividends and distributions. For a portion of the periods, the Fund had expense limitations, without which returns would have been lower. Updated information on the Funds performance can be obtained by visiting http://highlandfunds.com/highland-funds-2/ or by calling 1-855-799-4757.
Annual Total Returns
The bar chart shows the performance of the Fund as of December 31.
The highest calendar quarter total return of the Fund was 2.51% for the quarter ended September 30, 2016 and the lowest calendar quarter total return was -2.36% for the quarter ended September 30, 2015. The Funds year-to-date total return through September 30, 2017 was 1.13%.
Average Annual Total Returns
Annualized Total Returns for the period ended December 31, 2016.
1 Year |
Since
Inception (11/6/12) |
|||||||
Return Before Taxes | 8.48% | 3.01% | ||||||
Return After Taxes on Distributions | 6.42% | 1.02% | ||||||
Return After Taxes on Distributions and Redemptions | 4.76% | 1.39% | ||||||
Markit iBoxx USD Liquid Leveraged Loan Index (reflects no deduction for fees, expenses or taxes) | 9.20% | 3.16% |
After-tax returns in the table above are shown on a before- and after-tax returns basis for the Fund. After-tax returns are calculated using the historical highest individual federal marginal income tax rates and do not reflect the impact of state and local taxes. Actual after-tax returns depend on an investors tax situation and may differ from those shown. For example, after-tax returns shown are not relevant to investors who hold Fund shares through tax-deferred arrangements, such as 401(k) plans or individual retirement accounts.
In some cases, average annual return after taxes on distributions and sale of fund shares is higher than the average annual return after taxes on distributions because of realized losses that would have been sustained upon the sale of fund shares immediately after the relevant periods. The calculations assume that an investor holds the shares in a taxable account, is in the actual historical highest individual federal marginal income tax bracket for each year and would have been able to immediately utilize the full realized loss to reduce his or her federal tax liability. However, actual individual tax results may vary and investors should consult their tax advisers regarding their personal tax situations.
6
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
Portfolio Management
Highland Capital Management Fund Advisors, L.P. serves as the investment adviser to the Fund.
The portfolio managers for the Fund are Mark Okada and Allan Smallwood, who have managed the Fund since June 2017:
Portfolio Manager |
Portfolio Manager
Experience in this Fund |
Title with
Adviser |
||
Mark Okada | Less than 1 year | Portfolio Manager | ||
Allan Smallwood | Less than 1 year | Portfolio Manager |
Purchase and Sale of Fund Shares
The Fund is an exchange-traded fund. The Fund will issue and redeem shares only to authorized participants who have entered into agreements with the Funds distributor (Authorized Participants) in exchange for the deposit or delivery of a basket of assets (securities and/or cash) in large blocks, known as Creation Units, each of which comprises 100,000 shares. Retail investors may only purchase and sell shares on a national securities exchange through a broker-dealer. The price of Fund shares is based on market price, and because ETF shares trade at market prices rather than NAV, shares may trade at a price greater than NAV (a premium) or less than NAV (a discount).
Important Additional Information
Tax Information
The Fund intends to make distributions that generally will be taxable to you as ordinary income or capital gains, unless you are a tax-exempt investor or otherwise investing in the Fund through a tax-advantaged arrangement, such as a 401(k) plan or an individual retirement account. If you are investing in the Fund through a tax-advantaged arrangement, you may be taxed later upon withdrawals from that account.
Payments to Broker-Dealers and Other Financial Intermediaries
If you purchase shares of the Fund through a broker-dealer or other financial intermediary (such as a bank), the Fund and its related companies may pay the intermediary for the sale of Fund shares and related services. These payments may create a conflict of interest by influencing the broker-dealer or other intermediary and your salesperson to recommend the Fund over another investment. Ask your salesperson or visit your financial intermediarys website for more information.
7
Description of Underlying Index
Additional information about the Funds Underlying Index construction is set forth below.
Highland/iBoxx Senior Loan Index
The Underlying Index of the Fund is a subset of the benchmark Markit iBoxx USD Leveraged Loan Index (USD LLI), and is designed to track the broader market with a smaller subset of index constituents. Constituents are calculated at the end of each business day and re-balanced at the end of each month.
The selection process will involve the identification of the eligible universe using the following eligibility criteria: loan type, minimum size, liquidity/depth of market, spread, credit rating, and minimum time to maturity. If the size of the eligible universe is greater than the target number of loans, the liquidity ranking procedure will be used to determine the final index constituents. Only USD-denominated loans are eligible for the index. A minimum facility size of USD $500mm nominal is required to be eligible for the index. The liquidity check is based on the 3-month period prior to the rebalancing cut-off date (liquidity test period). Only loans with a minimum liquidity/depth of 2 for at least 50% of trading days of the liquidity test period are eligible for the indices. Loans issued less than 3 months prior to the rebalancing cut-off date require a minimum liquidity/depth of 3 for at least 50% of trading days in the period from the issue date to the rebalancing cut-off date. Only sub-investment grade loans are eligible for the index (including defaulted loans). Rated loans must have a minimum current spread of 125 basis points over LIBOR to be eligible for the index. A minimum initial time to maturity of 1 year is required for potential constituents.
The target number of loans is 100. Loans will be removed from the index if they are no longer present in the current eligible universe or are not ranked within the first 125 places in terms of 3 month average liquidity score. On every subsequent rebalancing, the number of new loans to be selected will be equal to the number of loans which will be removed from the index.
As of June 30, 2017, the Underlying Index included 100 securities with a weighted average facility size of $2.4 billion. These amounts are subject to change.
8
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
Description of Principal Investments
The following is a description of principal investment practices in which the Fund may engage. Any references to investments made by the Fund include those that may be made both directly by the Fund and indirectly by the Fund (e.g., through its investments in derivatives or other pooled investment vehicles). Please see Principal Risks below for the risks associated with each of the principal investment practices.
Assignments. The Fund may purchase Assignments from Lenders. The purchaser of an Assignment typically succeeds to all the rights and obligations under the Loan Agreement of the assigning Lender and becomes a Lender under the Loan Agreement with the same rights and obligations as the assigning Lender.
Borrower Credit Ratings. The Fund may invest in debt securities and/or Senior Loans rated below investment grade by a NRSRO and unrated debt securities of comparable quality. Debt securities rated below investment grade (or unrated debt securities of comparable quality) commonly are referred to as junk securities. The Fund seeks to invest in debt securities and/or Senior Loans which, in the judgment of the Adviser, demonstrate one or more of the following characteristics: sufficient cash flow to service debt; adequate liquidity; successful operating history; strong competitive position; experienced management; and, with respect to collateralized Senior Loans, collateral coverage that equals or exceeds the outstanding principal amount of the Senior Loan. The Fund may, however, invest without limitation in loans and/or debt securities that do not exhibit all or any of these characteristics. In addition, the Adviser will consider, and may rely in part on, with respect to Senior Loans, the analyses performed by the Agent and other Lenders, including such persons determinations with respect to collateral securing a Senior Loan.
Bridge Financing. The Fund may acquire interests in Senior Loans that are designed to provide temporary or bridge financing to a Borrower pending the sale of identified assets or the arrangement of longer-term loans or the issuance and sale of debt obligations. A Borrowers use of a bridge loan involves a risk that the Borrower may be unable to locate permanent financing to replace the bridge loan, which may impair the Borrowers perceived creditworthiness and increase the likelihood that an event of default would be declared.
Commitments to Make Additional Payments. A Lender may have obligations pursuant to a Loan Agreement to make additional loans in certain circumstances. Such circumstances may include, without limitation, obligations under revolving credit facilities and facilities that provide for further loans to Borrowers based upon compliance with specified financial requirements. The Fund currently intends to reserve against any such contingent obligation by segregating a sufficient amount of cash and/or liquid securities (including liquid Senior Loans). The Fund will not purchase interests in Senior Loans that would require the Fund to make any such additional loans if the aggregate of such additional loan commitments would exceed 20% of the Funds total assets or would cause the Fund to fail to meet the diversification requirements set forth under the heading Investment Restrictions in the Funds SAI.
Debt Restructuring. The Fund may purchase and retain in its portfolio an interest in a Senior Loan to a Borrower that has filed for protection under the federal bankruptcy laws or has had an involuntary bankruptcy petition filed against it by its creditors. The Advisers decision to purchase or retain such an interest will depend on its assessment of the suitability of such investment for the Fund, the Borrowers ability to meet debt service on Senior Loan interests, the likely duration, if any, of a lapse in the scheduled repayment of principal, and prevailing interest rates. At times, in connection with the restructuring of a Senior Loan either outside of bankruptcy court or in the context of bankruptcy court proceedings, the Fund may determine or be required to accept equity securities or junior debt securities in exchange for all or a portion of a Senior Loan interest. Depending upon, among other things, the Advisers evaluation of the potential value of such securities in relation to the price that could be obtained by the Fund at any given time upon sale thereof, the Fund may determine to hold such securities in its portfolio.
Debt Securities. The Fund may invest in debt securities, including investment grade securities, below investment grade securities and other debt obligations.
|
Investment Grade Securities. The Fund may invest in a wide variety of bonds that are rated or determined by the Adviser to be of investment grade quality of varying maturities issued by U.S. corporations and other business entities. Bonds are fixed or variable rate debt obligations, including bills, notes, debentures, money market instruments and similar instruments and securities. Bonds generally are used by corporations and other issuers to borrow money from investors for a variety of business purposes. The issuer pays the investor a fixed or variable rate of interest and normally must repay the amount borrowed on or before maturity. |
Below Investment Grade Securities. The Fund may invest in below investment grade securities (also known as high-yield securities or junk securities). See High-Yield Debt Securities Risk below for more information.
Derivatives. The Fund may invest in various derivatives instruments that are commonly known as derivatives. Generally, a derivative is a financial arrangement, the value of which is based on, or derived from, a security, asset or market index. Futures, forwards, swaps and options are commonly used for traditional hedging purposes, among other purposes, to attempt to protect the Fund from exposure to changing interest rates, securities prices, or currency exchange rates and as a low-cost method of gaining exposure to a particular securities market without investing directly in those securities. The Fund may enter into credit derivatives, such as credit default swaps and credit default index investments, including loan credit default swaps and loan credit default index swaps. The Fund may use these investments (i) as alternatives to direct long or short investments in a particular security, (ii) to adjust the Funds asset allocation or risk exposure, or (iii) for hedging purposes. The Fund may invest in warrants and may also use derivatives, primarily swaps (including equity, variance and volatility
9
Description of Principal Investments
swaps), options and futures contracts on securities, interest rates, non-physical commodities and/or currencies, with the 20% basket to track the Underlying Index and as substitutes for direct investments the Fund can make. The Fund may also use derivatives such as swaps, options (including options on futures), futures, and foreign currency transactions (e.g., foreign currency swaps, futures and forwards) to hedge various investments for risk management and speculative purposes.
The Funds use of credit default swaps may have the effect of creating a short position in a security. These investments can create investment leverage, which tends to magnify the effects of an instruments price changes as market conditions change. Special tax considerations apply to the Funds use of derivatives. See the Taxation section below.
Exchange-Traded Funds. The Fund may invest in other ETFs. ETFs are listed on various exchanges and typically seek to provide investment results that correspond generally to the performance of specified market indices.
Fees. The Fund may be required to pay or may receive various fees and commissions in connection with purchasing, selling and holding interests in Senior Loans. The fees normally paid by Borrowers may include commitment fees and prepayment penalties. Commitment fees are paid to Lenders on an ongoing basis based upon the undrawn portion committed by the Lenders of the underlying Senior Loan. Lenders may receive prepayment penalties when a Borrower prepays all or part of a Senior Loan. The Fund will receive commitment fees and prepayment penalties directly from the Borrower, if the Fund acquires an interest in a Senior Loan by way of Assignment. Whether or not the Fund receives any fees depends upon negotiations between the Fund and the Lender selling the Senior Loan interests. When the Fund is an assignee, it may be required to pay a fee to, or forgo a portion of interest and any fees payable to it from, the Lender selling the Assignment. Occasionally, the assignor will pay a fee to the Fund based on the portion of the principal amount of the Senior Loan that is being assigned. A Lender selling a Participation to the Fund may deduct a portion of the interest and any fees payable to the Fund as an administrative fee prior to payment thereof to the Fund. The Fund may be required to pay over or pass along to a purchaser of an interest in a Senior Loan from the Fund a portion of any fees that the Fund would otherwise be entitled to.
Illiquid and Restricted Securities. The Fund may invest in illiquid and restricted securities. Restricted securities generally may not be resold without registration under the Securities Act of 1933, as amended (the Securities Act), except in transactions exempt from the registration requirements of the Securities Act. A security that may be restricted as to resale under federal securities laws (or otherwise) will not be subject to the applicable percentage limitation if the Adviser determines that the security is, at the time of acquisition, readily marketable. Illiquid securities are those that cannot be disposed of within seven days in the ordinary course of business at approximately the amount at which the Fund has valued the securities. Illiquid and restricted securities may offer higher returns and yields than comparable publicly-traded securities. However, the Fund may not be able to sell these securities when the Adviser considers it desirable to do so or, to the extent they are sold privately, may have to sell them at less than the price of otherwise comparable securities. Restricted securities may be illiquid; however, some restricted securities, such as those eligible for resale under Rule 144A under the Securities Act, may be treated as liquid.
Options. The Fund may utilize options on securities, indices and currencies as part of their principal investment strategies. An option on a security is a contract that gives the holder of the option, in return for a premium, the right to buy from (in the case of a call) or sell to (in the case of a put) the writer of the option the security underlying the option at a specified exercise or strike price. The writer of an option on a security has the obligation upon exercise of the option to deliver the underlying security upon payment of the exercise price or to pay the exercise price upon delivery of the underlying security. If an option written by the Fund expires unexercised, the Fund realizes on the expiration date a gain equal to the premium received by the Fund at the time the option was written. If an option purchased by the Fund expires unexercised, the Fund realizes a loss equal to the premium paid. Prior to the earlier of exercise or expiration, an exchange-traded option may be closed out by an offsetting purchase or sale of an option of the same series (type, underlying security, exercise price and expiration). There can be no assurance, however, that a closing purchase or sale transaction can be effected when the Fund desires. The Fund realizes an economic loss from a closing sale transaction if the premium received from the sale of the option is less than the premium it initially paid to purchase the option (plus transaction costs). The Fund realizes an economic loss from a closing purchase transaction if the cost of the closing purchase transaction (premium plus transaction costs) is greater than the premium initially received from writing the option.
Participations. The Fund may invest without limit in Participations. The selling Lenders and other persons interpositioned between such Lenders and the Fund with respect to Participations will likely conduct their principal business activities in the financial services industry. The Fund may be more susceptible than an investment company that does not invest in Participations in Senior Loans to any single economic, political or regulatory occurrence affecting this industry. Persons engaged in this industry may be more susceptible than are persons engaged in some other industries to, among other things, fluctuations in interest rates, changes in the Federal Open Market Committees monetary policy, governmental regulations concerning such industries and concerning capital raising activities generally and fluctuations in the financial markets generally.
Participation by the Fund in a Lenders portion of a Senior Loan typically will result in the Fund having a contractual relationship only with such Lender, not with the Borrower. As a result, the Fund may have the right to receive payments of principal, interest and any fees to which it is entitled only from the Lender selling the Participation and only upon receipt by
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Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
the Lender of payments from the Borrower. In connection with purchasing Participations, the Fund generally will have no right to enforce compliance by the Borrower with the terms of the Loan Agreement, nor any rights with respect to any funds acquired by other Lenders through set-off against the Borrower, and the Fund may not directly benefit from the collateral supporting the Senior Loan in which it has purchased the Participation. As a result, the Fund may assume the credit risk of both the Borrower and the Lender selling the Participation. In the event of the insolvency of the Lender selling a Participation, the Fund may be treated as a general creditor of the Lender, and may not benefit from any set-off between the Lender and the Borrower. The Fund will only acquire Participations from counterparties that are judged by the Adviser to present acceptable credit risk to the Fund.
Portfolio Maturity. Although the initial time to maturity for Component Securities in the Underlying Index will generally be at least one year, the Fund is not subject to any restrictions with respect to the maturity of Senior Loans held in its portfolio. Senior Loans usually will have rates of interest that are redetermined periodically. Investment in Senior Loans with longer interest rate redetermination periods may increase fluctuations in the Funds NAV and the market price of the Funds shares as a result of changes in interest rates. Because many Senior Loans in the investment portfolio will be subject to mandatory and/or optional prepayment and there may be significant economic incentives for a Borrower to prepay its loans, prepayments of Senior Loans in the Funds investment portfolio may occur. Accordingly, the actual remaining maturity of the Funds investment portfolio invested in Senior Loans may vary substantially from the average stated maturity of the Senior Loans held in the Funds investment portfolio.
Prepayments. Pursuant to the relevant Loan Agreement, a Borrower may be required, and may have the option at any time, to prepay the principal amount of a Senior Loan, often without incurring a prepayment penalty. In the event that like-yielding loans are not available in the marketplace, the prepayment of and subsequent reinvestment by the Fund in Senior Loans could have a materially adverse effect on the yield of the Funds investment portfolio. Prepayments may have a beneficial impact on income due to receipt of prepayment penalties, if any, and any facility fees earned in connection with reinvestment.
Senior Loans. The Fund may invest in Senior Loans. Senior Loans generally are arranged through private negotiations between a Borrower and Lenders represented in each case by one or more Agents of the several Lenders. On behalf of the several Lenders, the Agent, which is frequently a commercial bank or other entity that originates the Senior Loan and the person that invites other parties to join the lending syndicate, will be primarily responsible for negotiating the Loan Agreement that establishes the relative terms, conditions and rights of the Borrower and the several Lenders. In larger transactions it is common to have several Agents; however, generally only one such Agent has primary responsibility for documentation and administration of a Senior Loan.
In a typical Senior Loan, the Agent administers the terms of the Loan Agreement and is responsible for the collection of principal and interest and fee payments from the Borrower and the apportionment of those payments to the credit of all Lenders that are parties to the Loan Agreement. The Fund generally will rely on the Agent to collect its portion of the payments on a Senior Loan. Furthermore, the Fund will rely on the Agent to use appropriate creditor remedies against the Borrower. Typically, under a Loan Agreement, the Agent is given broad discretion in monitoring the Borrowers performance under the Loan Agreement and is obligated to use only the same care it would use in the management of its own property. Upon an event of default, the Agent typically will act to enforce the Loan Agreement after instruction from Lenders holding a majority of the Senior Loan. The Borrower compensates the Agent for the Agents services. This compensation may include special fees paid on structuring and funding the Senior Loan and other fees paid on a continuing basis. The practice of an Agent relying exclusively or primarily on reports from the Borrower may involve a risk of fraud by the Borrower.
Loan Agreements typically provide for the termination of the Agents agency status in the event that it fails to act as required under the relevant Loan Agreement, becomes insolvent, enters receivership of the Federal Deposit Insurance Corporation (FDIC), or, if not FDIC insured, enters into bankruptcy. Should an Agent, Lender or any other institution interpositioned between the Fund and the Borrower become insolvent or enter FDIC receivership or bankruptcy, any interest in the Senior Loan of any such interpositioned institution and any loan payment held by any such interpositioned institution for the benefit of the Fund should not be included in the estate of such interpositioned institution. If, however, any such amount were included in such interpositioned institutions estate, the Fund would incur costs and delays in realizing payment or could suffer a loss of principal or interest. In such event, the Fund could experience a decrease in NAV.
It is anticipated that the proceeds of the Senior Loans in which the Fund will acquire interests primarily will be used to finance leveraged buyouts, recapitalizations, mergers, acquisitions, stock repurchases, and, to a lesser extent, to finance internal growth and for other corporate purposes of Borrowers. Senior Loans have the most senior position in a Borrowers capital structure, although some Senior Loans may hold an equal ranking with other senior securities and certain other obligations of the Borrower. The capital structure of a Borrower may include Senior Loans, senior and junior subordinated debt securities (which may include junk securities) and preferred and common stock issued by the Borrower, typically in descending order of seniority with respect to claims on the Borrowers assets. Senior and junior subordinated debt is collectively referred to in this Prospectus as junior debt securities.
Senior Loans generally are secured by specific collateral. The Fund may invest without limitation in Senior Loans that are not secured by any collateral and, to the extent that the Fund
11
Description of Principal Investments
invests a portion of its assets in Senior Loans that are not secured by specific collateral, the Fund will not enjoy the benefits associated with collateralization with respect to such Senior Loans, and such Senior Loans may pose a greater risk of nonpayment of interest or loss of principal than do collateralized Senior Loans. As discussed below, the Fund may also acquire warrants, equity securities and junior debt securities issued by the Borrower or its affiliates as part of a package of investments in the Borrower or its affiliates. The Fund may acquire interests in warrants, other equity securities or junior debt securities through a negotiated restructuring of a Senior Loan or in a bankruptcy proceeding of the Borrower.
In order to borrow money pursuant to a collateralized Senior Loan, a Borrower will typically, for the term of the Senior Loan, pledge assets as collateral. In addition, in the case of some Senior Loans, there may be additional collateral pledged in the form of guarantees by and/or securities of affiliates of the Borrowers. In some instances, a collateralized Senior Loan may be secured only by stock in the Borrower or its subsidiaries. Collateral may consist of assets that are not readily liquidated, and there is no assurance that the liquidation of such assets would fully satisfy a Borrowers obligations under a Senior Loan. Similarly, in the event of bankruptcy proceedings involving the Borrower, the Lenders may be delayed or prevented from liquidating collateral or may choose not to do so as part of their participation in a plan of reorganization of the Borrower. Senior Loans higher standing in an issuers capital structure has historically resulted in generally higher recoveries than other below investment grade securities in the event of a corporate reorganization or other restructuring, but there can be no assurance that this will be the case with respect to any particular Senior Loan.
Loan Agreements may also include various restrictive covenants designed to limit the activities of the Borrower in an effort to protect the right of the Lenders to receive timely payments of interest on and repayment of principal of the Senior Loans. Breach of such a covenant, if not waived by the Lenders, is generally an event of default under the applicable Loan Agreement and may give the Lenders the right to accelerate principal and interest payments. The Adviser will consider the terms of restrictive covenants in deciding whether to invest in Senior Loans for the Funds investment portfolio. When the Fund holds a Participation in a Senior Loan, it may not have the right to vote to waive enforcement of a restrictive covenant breached by a Borrower. Lenders voting in connection with a potential waiver of a restrictive covenant may have interests different from those of the Fund, and such Lenders will not consider the interests of the Fund in connection with their votes.
Senior Loans in which the Fund will invest generally pay interest at rates that are periodically redetermined by reference to a base lending rate plus a premium. These base lending rates generally are the London Interbank Offered Rate (LIBOR), the prime rate offered by one or more major United States banks (Prime Rate) or the certificate of deposit (CD) rate or other base lending rates used by commercial Lenders. LIBOR generally is an average of the interest rates quoted by several designated banks as the rates at which such banks would offer to pay interest to major financial institution depositors in the London interbank market on U.S. dollar denominated deposits for a specified period of time. The CD rate generally is the average rate paid on large certificates of deposit traded in the secondary market. Senior Loans traditionally have been structured so that Borrowers pay higher premiums when they elect LIBOR, in order to permit Lenders to obtain generally consistent yields on Senior Loans, regardless of whether Borrowers select the LIBOR option or the Prime Rate option. Because their interest rates are adjusted for changes in short-term interest rates, Senior Loans generally have less interest rate risk than other high yield investments, which typically pay fixed rates of interest.
The Fund may invest in Participations in Senior Loans and may purchase Assignments of portions of Senior Loans from third parties.
Senior Loan Ratings. The Fund may invest all or substantially all of its assets in Senior Loans that are rated below investment grade, including Senior Loans rated CCC or below by S&P or Caa or below by Moodys, and unrated Senior Loans of comparable quality.
Additional Information. The foregoing percentage limitations in the Funds investment strategies apply at the time of purchase of securities. The Board may change any of the foregoing investment policies, including its investment objective, the Underlying Index and its 80% investment policy, without shareholder approval. The Fund will provide shareholders with written notice at least 60 days prior to committing less than 80% of its assets, under normal circumstances, in component securities of the Funds Underlying Index. For example, if the Funds Underlying Index is discontinued by its Index Provider, the license agreement for the Underlying Index is terminated by the Index Provider or the Board determines that it would not be beneficial to shareholders for the Fund to continue operations using the Underlying Index, the Board may change the Underlying Index as described in the Investment Restrictions section of the Funds SAI.
In addition to its 80% investment policy described above, the Fund is subject to the SECs names rule (Rule 35d-1 under the 1940 Act), and therefore commits to invest at least 80% of its assets (i.e., net assets plus borrowings for investment purposes), under normal circumstances, in Senior Loans. Senior Loans, at the time of the Funds purchase, have the most senior position in a Borrowers capital structure or share the senior position with other senior debt securities of the Borrower. The Fund will provide shareholders with written notice at least 60 days prior to committing less than 80% of its assets, under normal circumstances, in Senior Loans.
If the Funds shares are delisted, the Board may seek to list its shares on another exchange, merge with another ETF or traditional mutual fund or redeem its shares at NAV.
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Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
Description of Risks
Factors that may affect the Funds portfolio as a whole are called principal risks and are summarized in this section. This summary describes the nature of these principal risks and certain related risks, but is not intended to include every potential risk. The Fund could be subject to additional risks because the types of investments it makes may change over time. The SAI includes more information about the Fund and its investments. The Fund is not intended to be a complete investment program.
Asset Class Risk. The securities in the Underlying Index or in the Funds portfolio may underperform the returns of other securities or indices that track other countries, regions, industries, groups of industries, markets, asset classes or sectors. Various types of securities or indices tend to experience cycles of outperformance and underperformance in comparison to general securities markets.
Cash Transaction Risk. Unlike most ETFs, the Fund effects creations and redemptions principally for cash, rather than for in-kind securities, because of the nature of the Funds investments. ETFs generally are able to make in-kind redemptions and avoid being taxed on gain on the distributed portfolio securities at the fund level. Because the Fund currently intends to effect redemptions principally for cash, rather than principally for in-kind securities, it may be required to sell portfolio securities in order to obtain the cash needed to distribute redemption proceeds. The Fund may recognize a capital gain on these sales that might not have been incurred if the Fund had made a redemption in-kind, and this may decrease the tax efficiency of the Fund compared to ETFs that utilize an in-kind redemption process.
Commodities Risk. Commodities markets historically have been extremely volatile, and the performance of securities and other instruments that provide exposure to those markets therefore also may be highly volatile. The commodities markets may fluctuate widely based on a variety of factors. These include changes in overall market movements, domestic and foreign political and economic events and policies, war, acts of terrorism, changes in domestic or foreign interest rates and/or investor expectations concerning interest rates, domestic and foreign inflation rates and/or investor expectations concerning inflation rates and investment and trading activities of mutual funds, hedge funds and commodities funds. Commodity-linked derivative instruments have a high degree of price variability and are subject to rapid and substantial price changes. Commodity-linked derivative instruments may employ leverage, which creates the possibility for losses greater than the amount invested.
Counterparty Risk. The Fund may engage in transactions in securities and financial instruments that involve counterparties. Counterparty risk is the risk that a counterparty (the other party to a transaction or an agreement or the party with whom the Fund executes transactions) to a transaction with the Fund may be unable or unwilling to make timely principal, interest, settlement or margin payments, or otherwise honor its obligations. If a counterparty becomes bankrupt or otherwise fails to perform its obligations due to financial difficulties, the Funds income or the value of its assets may decrease. The Fund may experience significant delays in obtaining any recovery in a bankruptcy or other reorganization proceeding and the Fund may obtain only limited recovery or may obtain no recovery in such circumstances. In an attempt to limit the counterparty risk associated with such transactions, the Fund conducts business only with financial institutions judged by the Adviser to present acceptable credit risk.
Credit Risk. The value of debt securities owned by the Fund may be affected by the ability of issuers to make principal and interest payments and by the issuers or counterpartys credit quality. If an issuer cannot meet its payment obligations or if its credit rating is lowered, the value of its debt securities may decline. Lower quality bonds are generally more sensitive to these changes than higher quality bonds. Even within securities considered investment grade, differences exist in credit quality and some investment-grade debt securities may have speculative characteristics. A securitys price may be adversely affected by the markets perception of the securitys credit quality level even if the issuer or counterparty has suffered no degradation in its ability to honor the obligation.
Credit risk varies depending upon whether the issuers of the securities are corporations or domestic or foreign governments or their sub-divisions or instrumentalities and whether the particular note or other instrument held by the Fund has a priority in payment of principal and interest. U.S. government securities are subject to varying degrees of credit risk depending upon whether the securities are supported by the full faith and credit of the United States, supported by the ability to borrow from the U.S. Treasury, supported only by the credit of the issuing U.S. government agency, instrumentality, or corporation, or otherwise supported by the United States. Obligations issued by U.S. government agencies, authorities, instrumentalities or sponsored enterprises, such as Government National Mortgage Association, are backed by the full faith and credit of the U.S. Treasury, while obligations issued by others, such as Federal National Mortgage Association (FNMA), Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal Home Loan Banks (FHLBs), are backed solely by the ability of the entity to borrow from the U.S. Treasury or by the entitys own resources. No assurance can be given that the U.S. government would provide financial support to U.S. government agencies, authorities, instrumentalities or sponsored enterprises if it is not obligated to do so by law.
Debt Securities and Leveraged Loan Risk. The value of a debt security (and other income-producing securities, such as preferred stocks, convertible preferred stocks, equity-linked notes, and interests in income-producing trusts) changes in response to interest rate changes. In general, the value of a debt security is likely to fall as interest rates rise. This risk is generally greater for obligations with longer maturities or for debt securities that do not pay current interest (such as zero-coupon securities). Debt securities with floating interest rates can be less sensitive to interest rate changes, although, to the extent the Funds income is based on short-term interest
13
Description of Risks
rates that fluctuate over short periods of time, income received by the Fund may decrease as a result of a decline in interest rates. In addition, the interest rates of floating rate loans typically only adjust to changes in short-term interest rates; long-term interest rates can vary dramatically from short-term interest rates. In response to an interest rate decline, debt securities that provide the issuer with the right to call or redeem the security prior to maturity may be called or redeemed.
If a debt security is repaid more quickly than expected, the Fund may not be able to reinvest the proceeds at the same interest rate, reducing the potential for gain. When interest rates increase or for other reasons, debt securities may be repaid more slowly than expected. As a result, the maturity of the debt instrument is extended, increasing the potential for loss.
The value of a debt security also depends on the issuers credit quality or ability to pay principal and interest when due. The value of a debt security is likely to fall if an issuer or the guarantor of a security is unable or unwilling (or perceived to be unable or unwilling) to make timely principal and/or interest payments or otherwise to honor its obligations, or if the debt securitys rating is downgraded by a credit rating agency. The obligations of issuers (and obligors of asset-backed securities) are subject to bankruptcy, insolvency, and other laws affecting the rights and remedies of creditors. The value of a debt security can also decline in response to other changes in market, economic, industry, political, and regulatory conditions that affect a particular type of debt security or issuer or debt securities generally. The values of many debt securities may fall in response to a general increase in investor risk aversion or a decline in the confidence of investors generally in the ability of issuers to meet their obligations.
Leveraged Loans are subject to the same risks typically associated with debt securities. In addition, Leveraged Loans, which typically hold a senior position in the capital structure of a borrower, are subject to the risk that a court could subordinate such loans to presently existing or future indebtedness or take other action detrimental to the holders of Leveraged Loans. Leveraged Loans are also especially subject to the risk that the value of the collateral, if any, securing a loan may decline, be insufficient to meet the obligations of the borrower, or be difficult to liquidate.
Because loans are not ordinarily registered with the SEC or any state securities commission or listed on any securities exchange, there is usually less publicly available information about such instruments. In addition, loans may not be considered securities for purposes of the federal securities laws and, as a result, as a purchaser of these instruments, we may not be entitled to the anti-fraud protections of the federal securities laws. In the course of investing in such instruments, we may come into possession of material nonpublic information and, because of prohibitions on trading in securities of issuers while in possession of such information, we may be unable to enter into a transaction in a publicly-traded security of that issuer when it would otherwise be advantageous for us to do so. Alternatively, we may choose not to receive material nonpublic information about an issuer of such loans, with the result that we may have less information about such issuers than other investors who transact in such assets.
Derivatives Risk. The Fund may invest in derivatives, which are financial contracts whose value depends on, or is derived from, the value of underlying assets, reference rates or indices. Derivatives involve the risk that changes in their value may not move as expected relative to the value of the assets, rates or indices they are designed to track. Derivatives include futures, non-U.S. currency contracts, swap contracts, warrants and options contracts, among other types of contracts. Derivatives may relate to or reference securities, interest rates, currencies or currency exchange rates, inflation rates, commodities and indices.
There are many risks associated with derivatives transactions. The use of derivatives involves risks that are in addition to, and potentially greater than, the risks of investing directly in securities and other more traditional assets. A decision as to whether, when and how to use derivatives 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. The use of derivative transactions may result in losses greater than if they had not been used, may require the Fund to sell or purchase portfolio securities at inopportune times or for prices other than current market values, may limit the amount of appreciation the Fund can realize on an investment or may cause the Fund to hold a security that it might otherwise sell. The Fund may enter into credit derivatives, such as credit default swaps and credit default index investments, including loan credit default swaps and loan credit default index swaps. The Funds use of credit default swaps may have the effect of creating a short position in a security. These investments can create investment leverage and may create additional investment risks that may subject the Fund to greater volatility than investments in more traditional securities. Derivative contracts may expire worthless.
The Fund may invest in derivatives with a limited number of counterparties, and events affecting the creditworthiness of any of those counterparties may have a pronounced effect on the Fund. Derivatives risk is particularly acute in environments (like those of 2008) in which financial services firms are exposed to systemic risks of the type evidenced by the insolvency of Lehman Brothers and subsequent market disruptions. In addition, during those periods, the Fund may have a greater need for cash to provide collateral for large swings in its mark-to-market obligations under the derivatives in which it has invested.
The Funds use of derivatives may not be effective or have the desired results. Moreover, suitable derivatives will not be available in all circumstances. For example, the economic costs of taking some derivative positions may be prohibitive, and if a counterparty or its affiliate is deemed to be an affiliate of the Fund, the Fund will not be permitted to trade with that
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Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
counterparty. In addition, the Adviser may decide not to use derivatives to hedge or otherwise reduce the Funds risk exposures, potentially resulting in losses for the Fund.
Swap contracts and other OTC derivatives are highly susceptible to liquidity risk (see Liquidity Risk) and counterparty risk (see Counterparty Risk), and are subject to documentation risks. Because many derivatives have a leverage component (i.e., a notional value in excess of the assets needed to establish and/or maintain the derivative position), adverse changes in the value or level of the underlying asset, rate or index may result in a loss substantially greater than the amount invested in the derivative itself. See Leverage Risk below.
Derivatives also present other risks described in this section, including market risk, liquidity risk, currency risk, credit risk and counterparty risk. Special tax considerations apply to the Funds use of derivatives. See the Taxation section below.
Under recently adopted rules and regulations, transactions in some types of swaps (including interest rate swaps and credit default swaps on North American and European indices) are required to be centrally cleared. In a transaction involving those swaps (cleared derivatives), the Funds counterparty is a clearing house, rather than a bank or broker. Since the Fund is not a member of any clearing houses and only members of a clearing house (clearing members) can participate directly in the clearing house, the Fund will hold cleared derivatives through accounts at clearing members. In cleared derivatives transactions, the Fund will make payments (including margin payments) to and receive payments from a clearing house through their accounts at clearing members. Clearing members guarantee performance of their clients obligations to the clearing house.
In many ways, cleared derivative arrangements are less favorable to mutual funds than bilateral arrangements. For example, the Fund may be required to provide more margin for cleared derivatives transactions than for bilateral derivatives transactions. Also, in contrast to a bilateral derivatives transaction, following a period of notice to the Fund, a clearing member generally can require termination of an existing cleared derivatives transaction at any time or an increase in margin requirements above the margin that the clearing member required at the beginning of a transaction. Clearing houses also have broad rights to increase margin requirements for existing transactions or to terminate those transactions at any time. Any increase in margin requirements or termination of existing cleared derivatives transactions by the clearing member or the clearing house could interfere with the ability of the Fund to pursue its investment strategy. Further, any increase in margin requirements by a clearing member could expose the Fund to greater credit risk to its clearing member, because (as described under Counterparty Risk) margin for cleared derivatives transactions in excess of a clearing houses margin requirements typically is held by the clearing member. Also, the Fund is subject to risk if it enters into a derivatives transaction that is required to be cleared (or that the Adviser expects to be cleared), and no clearing member is willing or able to clear the transaction on the Funds behalf. In those cases, the transaction might have to be terminated, and the Fund could lose some or all of the benefit of the transaction, including loss of an increase in the value of the transaction and/or loss of hedging protection. In addition, the documentation governing the relationship between the Fund and clearing members is drafted by the clearing members and generally is less favorable to the Fund than typical bilateral derivatives documentation. For example, documentation relating to cleared derivatives generally includes a one-way indemnity by the Fund in favor of the clearing member for losses the clearing member incurs as the Funds clearing member and typically does not provide the Fund any remedies if the clearing member defaults or becomes insolvent.
These and other new rules and regulations could, among other things, further restrict the Funds ability to engage in, or increase the cost to the Fund of derivatives transactions, for example, by making some types of derivatives no longer available to the Fund, increasing margin or capital requirements, or otherwise limiting liquidity or increasing transaction costs. These regulations are new and evolving, so their potential impact on the Fund and the financial system are not yet known. While the new regulations and central clearing of some derivatives transactions are designed to reduce systemic risk (i.e., the risk that the interdependence of large derivatives dealers could cause them to suffer liquidity, solvency or other challenges simultaneously), there is no assurance that the new clearing mechanisms will achieve that result, and in the meantime, as noted above, central clearing exposes the Fund to new kinds of risks and costs.
In addition, the SEC recently proposed a rule under the 1940 Act regulating the use by registered investment companies of derivatives and many related instruments. That rule, if adopted as proposed, would, among other things, restrict a Funds ability to engage in derivatives transactions or so increase the cost of derivatives transactions that a Fund would be unable to implement its investment strategy.
Distressed and Defaulted Securities Risk. Distressed and defaulted securities risk is the risk that securities of financially distressed and bankrupt issuers, including debt obligations that are in covenant or payment default, will 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.
Exchange-Traded Funds Risk. The value of ETFs can be expected to increase and decrease in value in proportion to increases and decreases in the indices that they are designed to track. The volatility of different index tracking stocks can be
15
Description of Risks
expected to vary in proportion to the volatility of the particular index they track. ETFs are traded similarly to stocks of individual companies. Although an ETF is designed to provide investment performance corresponding to its index, it may not be able to exactly replicate the performance of its index because of its operating expenses and other factors.
An investment in an ETF generally presents the same primary risks as an investment in a conventional fund (i.e., one that is not exchange-traded) that has the same investment objective, strategies, and policies. The price of an ETF can fluctuate within a wide range, and the Fund could lose money investing in an ETF if the prices of the securities owned by the ETF go down. In addition, ETFs are subject to the following risks that do not apply to conventional funds: (1) the market price of the ETFs shares may trade at a discount or a premium to their net asset value; (2) an active trading market for an ETFs shares may not develop or be maintained; and (3) trading of an ETFs shares may be halted by the activation of individual or market wide circuit breakers (which halt trading for a specific period of time when the price of a particular security or overall market prices decline by a specified percentage), if the shares are delisted from the Exchange 1 without first being listed on another exchange, or if the listing exchanges officials deem such action appropriate in the interest of a fair and orderly market or to protect investors. In addition, shareholders bear both their proportionate share of the Funds expenses and similar expenses of the underlying investment company when the Fund invests in shares of another investment company.
Most ETFs are investment companies. Therefore, the Funds purchases of ETF shares generally are subject to the limitations on, and the risks of, the Funds investments in other investment companies.
Fixed Income Market Risk. Fixed income securities markets may, in response to governmental intervention, economic or market developments (including potentially a reduction in the number of broker-dealers willing to engage in market-making activity), or other factors, experience periods of increased volatility and reduced liquidity. During those periods, the Fund may experience increased levels of shareholder redemptions, and may have to sell securities at times when it would otherwise not do so, and at unfavorable prices. Fixed income securities may be difficult to value during such periods. In recent periods, governmental financial regulators, including the U.S. Federal Reserve, have taken steps to maintain historically low interest rates by purchasing bonds. Steps by those regulators to curtail or taper such activities could result in the effects described above, and could have a material adverse effect on prices for fixed income securities and on the management of the Fund.
As of the date of this Prospectus, market interest rates in the United States are at or near historic lows, which may increase the Funds exposure to risks associated with rising market interest rates. Rising market interest rates could have unpredictable effects on the markets and may expose fixed-income and related markets to heightened volatility, which could reduce liquidity for certain investments, adversely affect values, and increase costs. Increased redemptions may cause the Fund to liquidate portfolio positions when it may not be advantageous to do so and may lower returns. If dealer capacity in fixed-income and related markets is insufficient for market conditions, it may further inhibit liquidity and increase volatility in the fixed-income and related markets. Further, recent and potential future changes in government policy may affect interest rates.
Focused Investment Risk . The Funds investments in Senior Loans arranged through private negotiations between a Borrower and several financial institutions may expose the Fund to risks associated with the financial services industry. Financial services companies are subject to extensive government regulation, which can limit both the amounts and types of loans and other financial commitments they can make and the interest rates and fees they can charge. Profitability is largely dependent on the availability and cost of capital funds and can fluctuate significantly when interest rates change. Because financial services companies are highly dependent on short-term interest rates, they can be adversely affected by downturns in the U.S. and foreign economies or changes in banking regulations. Credit losses resulting from financial difficulties of Borrowers can negatively affect financial services companies. Insurance companies can be subject to severe price competition. The financial services industry is currently undergoing relatively rapid change as existing distinctions between financial service segments become less clear. For instance, recent business combinations have included insurance, finance, and securities brokerage under single ownership. Some primarily retail corporations have expanded into the securities and insurance industries. Moreover, the federal laws generally separating commercial and investment banking have been repealed. These changes may make it more difficult for the Adviser to analyze loans in this industry. Additionally, the recently increased volatility in the financial markets and implementation of the recent financial reform legislation may affect the financial services industry as a whole in ways that may be difficult to predict.
Foreign Securities Risk. Investments in securities of non-U.S. issuers involve certain risks not involved in domestic investments (for example, fluctuations in foreign exchange rates (for non-U.S. securities not denominated in U.S. dollars); future foreign economic, financial, political and social developments; nationalization; exploration or confiscatory taxation; smaller markets; different trading and settlement practices; less governmental supervision; and different accounting, auditing and financial recordkeeping standards and requirements) that may result in the Fund experiencing more rapid and extreme changes in value than a fund that invests exclusively in securities of U.S. companies. These risks are magnified for investments in issuers tied economically to emerging markets, the economies of which tend to be more volatile than the economies of developed markets. In addition, investments by the Fund in non-U.S. securities may be subject to withholding and other taxes imposed by foreign countries on dividends, interest, capital gains, or other income or proceeds. Those taxes will reduce the Funds yield on any such securities.
16
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
High-Yield Debt Securities Risk. The Fund may invest in below investment grade securities (also known as high-yield securities or junk bonds). Below investment grade securities may be fixed or variable rate obligations and are rated below investment grade (Ba/BB or lower) by a nationally recognized statistical rating organization or are unrated but deemed by the Adviser to be of comparable quality. Such securities should be considered speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. High-yield debt securities are frequently issued by corporations in the growth stage of their development, but also may be issued by established companies. High-yield securities held by the Fund may include securities received as a result of a corporate reorganization or issued as part of a corporate takeover. Below investment grade securities have greater credit and liquidity risk than more highly rated obligations and are generally unsecured and may be subordinate to other obligations of the obligor. The lower rating of such 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 market and other markets may adversely affect such issuers by inhibiting their ability to refinance their obligations at maturity. Investments in obligations of issuers that are generally trading at significantly higher yields than had been historically typical of the applicable issuers obligations 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 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 may not be protected by financial covenants or limitations upon additional indebtedness and are unlikely to be secured by collateral. See Taxation below and Income Tax Considerations in the SAI for a discussion of special tax consequences associated with certain below investment grade securities.
Illiquid Securities Risk. Illiquid investments may be difficult to resell at approximately the price they are valued in the ordinary course of business within seven days. When investments cannot be sold readily at the desired time or price, the Fund may have to accept a much lower price, may not be able to sell the investment at all or may be forced to forego other investment opportunities, all of which may adversely impact the Funds returns. Illiquid investments also may be subject to valuation risk.
Industry Concentration Risk. Because the Fund may invest 25% or more of the value of its assets in an industry or group of industries to the extent that the Underlying Index concentrates in an industry or group of industries, the Funds performance largely depends on the overall condition of such industry or group of industries and the Fund is susceptible to economic, political and regulatory risks or other occurrences associated with that industry or group of industries. The performance of the Fund if it invests a significant portion of its assets in a particular sector or industry may be closely tied to the performance of companies in a limited number of sectors or industries. Companies in a single sector often share common characteristics, are faced with the same obstacles, issues and regulatory burdens and their securities may react similarly to adverse market conditions. The price movements of investments in a particular sector or industry may be more volatile than the price movements of more broadly diversified investments.
Intellectual Property Risk. The Fund relies on a license that permits the Adviser to use the Intellectual Property in connection with the name and investment strategies of the Fund. Such license may be terminated by the Index Provider, and, as a result, the Fund may lose its ability to use the Intellectual Property. There is also no guarantee that the Index Provider has all rights to license the Intellectual Property. Accordingly, in the event the license is terminated or the Index Provider does not have rights to license the Intellectual Property, it may have a significant effect on the operation of the Fund.
Interest Rate Risk. When interest rates decline, the value of fixed rate securities already held by the Fund can be expected to rise. Conversely, when interest rates rise, the value of existing fixed-rate portfolio securities can be expected to decline. To the extent the Fund invests in fixed-rate debt securities with longer maturities, the Fund is subject to greater interest rate risk than funds investing solely in shorter-term fixed-rate debt securities. In addition, in a period of rising interest rates, the higher cost of any leverage employed by the Fund and/or increasing defaults by issuers of high-yield securities (or junk securities) would likely exacerbate any decline in the Funds NAV and the market price of the Funds shares. If an issuer of a debt security containing a redemption or call provision exercises either provision in a declining interest rate market, the Fund would likely replace the security with a security having a lower interest rate, which could result in a decreased return for shareholders.
To the extent that changes in market rates of interest are reflected not in a change to a base rate (such as LIBOR) but in a change in the spread over the base rate, which is payable on loans of the type and quality in which the Fund invests, the Funds income could be adversely affected. This is because the
17
Description of Risks
value of a Senior Loan is partially a function of whether the Senior Loan is paying what the market perceives to be a market rate of interest, given its individual credit and other characteristics. However, unlike changes in market rates of interest for which there is generally only a temporary lag before the portfolio reflects those changes, changes in a Senior Loans value based on changes in the market spread on Senior Loans in the Funds portfolio may be of longer duration.
Duration is a measure used to determine the sensitivity of a securitys price to changes in interest rates that incorporates a securitys yield, coupon, final maturity and call features, among other characteristics. Duration is useful primarily as a measure of the sensitivity of a fixed income securitys market price to interest rate (i.e. yield) movements. All other things remaining equal, for each one percentage point increase in interest rates, the value of a portfolio of fixed income investments would generally be expected to decline by one percent for every year of the portfolios average duration above zero. For example, the value of a portfolio of fixed income securities with an average duration of three years would generally be expected to decline by approximately 3% if interest rates rose by one percentage point.
Lender Liability Risk . A number of judicial decisions in the United States and elsewhere have upheld the right of Borrowers to sue lending institutions on the basis of various evolving legal theories (collectively termed lender liability). Generally, lender liability is founded upon the premise that an institutional Lender has violated a duty (whether implied or contractual) of good faith and fair dealing owed to the Borrower or has assumed a degree of control over the Borrower resulting in a creation of a fiduciary duty owed to the Borrower or its other creditors or shareholders. Because of the nature of certain of the Funds investments, the Fund or the Adviser could be subject to allegations of lender liability.
In addition, under common law principles that in some cases form the basis for lender liability claims, if a lending institution (i) intentionally takes an action that results in the under capitalization of a Borrower to the detriment of other creditors of such Borrower, (ii) engages in other inequitable conduct to the detriment of such other creditors, (iii) engages in fraud with respect to, or makes misrepresentations to, such other creditors or (iv) uses its influence as a stockholder to dominate or control a Borrower to the detriment of other creditors of such Borrower, a court may elect to subordinate the claim of the offending lending institution to the claims of the disadvantaged creditor or creditors, a remedy termed equitable subordination. As an owner of bank debt in reorganizing companies, the Fund could be subject to claims from creditors of a company that the Funds claim should be equitably subordinated, including as a result of actions or omissions by the Funds predecessors in interest.
Limited Information Risk . The types of Senior Loans in which the Fund will invest may not have been rated by a NRSRO, have not been registered with the SEC or any state securities commission, and have not been listed on any national securities exchange. Although the Fund will generally have access to financial and other information made available to the Lenders in connection with Senior Loans, the amount of public information available with respect to Senior Loans will generally be less extensive than that available for rated, registered or exchange-listed securities.
Liquidity Risk. Liquidity risk is the risk that low trading volume, lack of a market maker, large position size, or legal restrictions (including daily price fluctuation limits or circuit breakers) limits or prevents the Fund from selling particular securities or unwinding derivative positions at desirable prices. The Fund is also exposed to liquidity risk when it has an obligation to purchase particular securities (e.g., as a result of entering into reverse repurchase agreements, writing a put, or closing a short position). When there is no willing buyer or investments cannot be readily sold or closed out, the Fund may have to sell at a lower price than the price at which the Fund is carrying the investments or may not be able to sell the investments at all, each of which would have a negative effect on the Funds performance. Although most of the Funds investments must be liquid at the time of investment, investments may become illiquid after purchase by the Fund, particularly during periods of market turmoil.
Because loan transactions often take longer to settle than transactions in other securities, the Fund may not receive the proceeds from the sale of a loan for a significant period of time. As a result, the Fund may maintain higher levels of cash and short-term investments than mutual funds that invest in securities with shorter settlement cycles, may enter into a line of credit to permit the Fund to finance redemptions pending settlement of the sale of portfolio securities, or may be required to sell portfolio securities when it would not otherwise chose to do so, each of which may adversely affect the Funds performance. No assurance can be given that these measures will provide the Fund with sufficient liquidity to pay redemption proceeds in a timely manner in the event of abnormally large redemptions.
Loan Participation Risk. In addition to the risks typically associated with debt securities, Participations involve the risk that there may not be a readily available market for Participation interests and, in some cases, the Fund may have to dispose of such securities at a substantial discount from face value. Participations also involve the credit risk associated with the underlying corporate borrower. Participations also carry the risk of insolvency of the lending bank or other intermediary.
Management Risk. The Fund does not fully replicate its Underlying Index and may hold securities not included in its Underlying Index. As a result, the Fund is subject to management risk because it relies on the Advisers ability to achieve its investment objective. The Fund runs the risk that the Advisers investment techniques will fail to produce desired results and cause the Fund to incur significant losses. The Adviser also may fail to use derivatives effectively, choosing to hedge or not to hedge positions at disadvantageous times. In addition, if one or more key individuals leave, the Adviser may not be able to hire qualified replacements or may require an
18
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
extended time to do so. This situation could prevent the Fund from achieving its investment objectives. The Funds portfolio manager uses quantitative analyses and/or models. Any imperfections or limitations in such analyses and models could affect the ability of the portfolio manager to implement strategies. By necessity, these analyses and models make simplifying assumptions that limit their efficacy. Models that appear to explain prior market data can fail to predict future market events. Further, the data used in models may be inaccurate and/or it may not include the most recent information about a company or a security.
Market Price Variance Risk. The Funds Shares are listed for trading on NASDAQ and are bought and sold in the secondary market at market prices. The market prices of Shares will fluctuate in response to changes in the NAV and supply and demand for Shares. As a result, the trading prices of Shares may deviate significantly from NAV during periods of market volatility. Differences between secondary market prices and the net asset value (NAV of the Fund may be due largely to supply and demand forces in the secondary market, which may not be the same forces as those influencing prices for securities held by the Fund at a particular time. The Adviser cannot predict whether shares will trade above, below or at their NAV. Given the fact that shares can be created and redeemed in Creation Units, the Adviser believes that large discounts or premiums to the NAV of shares should not be sustained in the long-term. In addition, there may be times when the market price of the Fund and the Funds NAV vary significantly and you may pay more than the Funds NAV when buying Shares on the secondary market, and you may receive less than the Funds NAV when you sell those Shares. While the creation/redemption feature is designed to make it likely that Shares normally will trade close to the Funds NAV, disruptions to creations and redemptions may result in trading prices that differ significantly from the Funds NAV. The market price of Shares, like the price of any exchange-traded security, includes a bid-ask spread charged by the exchange specialist, market makers or other participants that trade the particular security. In times of severe market disruption, the bid-ask spread often increases significantly. This means that Shares may trade at a discount to the Funds NAV, and the discount is likely to be greatest when the price of Shares is falling fastest, which may be the time that you most want to sell your Shares.
Non-Diversification Risk. Due to the nature of the Funds investment strategy and its non-diversified status (for purposes of the 1940 Act), the Fund may invest a greater percentage of its assets in the securities of fewer issuers than a diversified fund, and accordingly may be more vulnerable to changes in the value of those issuers securities. Since the Fund invests in the securities of a limited number of issuers, it is particularly exposed to adverse developments affecting those issuers, and a decline in the market value of a particular security held by the Fund is likely to affect the Funds performance more than if the Fund invested in the securities of a larger number of issuers.
Non-Payment Risk. Debt securities are subject to the risk of non-payment of scheduled interest and/or principal. Non-payment would result in a reduction of income to the Fund, a reduction in the value of the security experiencing non-payment and a potential decrease in the NAV of the Fund. There can be no assurance that the liquidation of any collateral would satisfy the borrowers obligation in the event of non-payment of scheduled interest or principal payments, or that such collateral could be readily liquidated. Moreover, as a practical matter, most borrowers cannot satisfy their debts by selling their assets. Borrowers pay their debts from the cash flow they generate. This is particularly the case for borrowers that are highly leveraged. If the borrowers cash flow is insufficient to pay its debts as they come due, the borrower is far more likely to seek to restructure its debts than it is to sell off assets to pay its senior loans. Borrowers may try to restructure their debts either by seeking protection from creditors under Chapter 11 of the U.S. Bankruptcy Code (the Bankruptcy Code) or negotiating a work-out. In the event of bankruptcy of a borrower, the Fund could experience delays or limitations with respect to its ability to realize the benefits of the collateral securing a debt security. The agent generally is responsible for determining that the lenders have obtained a perfected security interest in the collateral securing the debt security. If a borrower files for protection from creditors under Chapter 11 of the Bankruptcy Code, the Bankruptcy Code will impose an automatic stay that prohibits the agent from liquidating collateral. The agent may ask the bankruptcy court to lift the stay. As a practical matter, the court is unlikely to lift the stay if it concludes that the borrower has a chance to emerge from the reorganization proceedings and the collateral is likely to hold most of its value. If the Lenders have a perfected security interest, the debt security will be treated as a separate class in the reorganization proceedings and will retain a priority interest in the collateral. Chapter 11 reorganization plans typically are the product of negotiation among the borrower and the various creditor classes. Successful negotiations may require the lenders to extend the time for repayment, change the interest rate or accept some consideration in the form of junior debt or equity securities. A work-out outside of bankruptcy may produce similar concessions by senior lenders.
Ongoing Monitoring Risk. On behalf of the several Lenders, the Agent generally will be required to administer and manage the Senior Loans and, with respect to collateralized Senior Loans, to service or monitor the collateral. In this connection, the valuation of assets pledged as collateral will reflect market value and the Agent may rely on independent appraisals as to the value of specific collateral. The Agent, however, may not obtain an independent appraisal as to the value of assets pledged as collateral in all cases. The Fund normally will rely primarily on the Agent (where the Fund or owns an Assignment) or the selling Lender (where the Fund owns a Participation) to collect principal of and interest on a Senior Loan. Furthermore, the Fund usually will rely on the Agent (where the Fund or owns an Assignment) or the selling Lender (where the Fund owns a Participation) to monitor compliance by the Borrower with the restrictive covenants in the Loan
19
Description of Risks
Agreement and notify the Fund of any adverse change in the Borrowers financial condition or any declaration of insolvency. Collateralized Senior Loans will frequently be secured by all assets of the Borrower that qualify as collateral, which may include common stock of the Borrower or its subsidiaries. Additionally, the terms of the Loan Agreement may require the Borrower to pledge additional collateral to secure the Senior Loan, and enable the Agent, upon proper authorization of the Lenders, to take possession of and liquidate the collateral and to distribute the liquidation proceeds pro rata among the Lenders. If the terms of a Senior Loan do not require the Borrower to pledge additional collateral in the event of a decline in the value of the original collateral, the Fund will be exposed to the risk that the value of the collateral will not at all times equal or exceed the amount of the Borrowers obligations under the Senior Loan. Lenders that have sold Participation interests in such Senior Loan will distribute liquidation proceeds received by the Lenders pro rata among the holders of such Participations. Unless, under the terms of the loan, the Fund has direct recourse against the Borrower, the Fund may have to rely on the Agent or other financial intermediary to apply appropriate credit remedies against a Borrower. The Adviser will also monitor these aspects of the Funds investments.
Operational and Technology Risk. The Fund, its service providers, and other market participants increasingly depend on complex information technology and communications systems to conduct business functions. These systems are subject to a number of different threats or risks that could adversely affect the Fund and its shareholders, despite the efforts of the Adviser, the Fund and its service providers to adopt technologies, processes, and practices intended to mitigate these risks.
For example, unauthorized third parties may attempt to improperly access, modify, disrupt the operations of, or prevent access to these systems of the Fund, the Funds service providers, counterparties, or other market participants or data within them (a cyber-attack). Power or communications outages, acts of god, information technology equipment malfunctions, operational errors, and inaccuracies within software or data processing systems may also disrupt business operations or impact critical data. Market events also may trigger a volume of transactions that overloads current information technology and communication systems and processes, impacting the ability to conduct the Funds operations.
Cyber-attacks, disruptions, or failures that affect the Funds service providers or counterparties may adversely affect the Fund and its shareholders, including by causing losses for the Fund or impairing the Funds operations. For example, the Fund or its service providers assets or sensitive or confidential information may be misappropriated, data may be corrupted, and operations may be disrupted (e.g., cyber-attacks or operational failures may cause the release of private shareholder information or confidential Fund information, interfere with the processing of shareholder transactions, impact the ability to calculate the Funds NAV, and impede trading). In addition, cyber-attacks, disruptions, or failures may cause reputational damage and subject the Fund or its service providers to regulatory fines, litigation costs, penalties or financial losses, reimbursement or other compensation costs, and/or additional compliance costs. While the Fund and its service providers may establish business continuity and other plans and processes to address the possibility of cyber-attacks, disruptions, or failures, there are inherent limitations in such plans and systems, including that they do not apply to third parties, such as other market participants, as well as the possibility that certain risks have not been identified or that unknown threats may emerge in the future.
Similar types of operational and technology risks are also present for issuers of the Funds investments, which could have material adverse consequences for such issuers, and may cause the Funds investments to lose value. In addition, cyber-attacks involving the Fund counterparty could affect such counterpartys ability to meet its obligations to the Fund, which may result in losses to the Fund and its shareholders. Furthermore, as a result of cyber-attacks, disruptions, or failures, an exchange or market may close or issue trading halts on specific securities or the entire market, which may result in the Fund being, among other things, unable to buy or sell certain securities or financial instruments or unable to accurately price its investments. The Fund cannot directly control any cybersecurity plans and systems put in place by its service providers, counterparties, issuers in which the Fund invests, or securities markets and exchanges.
Options Risk. The use of options is a highly specialized activity which involves investment techniques and risks different from those associated with ordinary portfolio securities transactions. 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 transaction in options or securities may be unsuccessful to some degree because of market behavior or unexpected events. When the Fund writes a covered call option, the Fund forgoes, during the options life, the opportunity to profit from increases in the market value of the security covering the call option above the sum of the premium and the strike price of the call, but retains the risk of loss should the price of the underlying security decline. The writer of an option has no control over the time when it may be required to fulfill its obligation and once an option writer has received an exercise notice, it must deliver the underlying security at the exercise price. When the Fund writes a covered put option, the Fund bears the risk of loss if the value of the underlying stock declines below the exercise price minus the put premium. If the option is exercised, the 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 the Fund received when it wrote the option. While the Funds potential gain in writing a covered put option is limited to distributions earned on the liquid assets securing the put option plus the premium received from the purchaser of the put option, the Fund risks a loss equal to the entire exercise price of the option minus the put premium.
20
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
Passive Investment Risk. The Fund is not actively managed and may be affected by a general decline in loan market segments included in the applicable Underlying Index. The Fund invests in securities included in, or representative of, the Underlying Index regardless of their investment merits. The Adviser does not attempt to take defensive positions under any market conditions, including during declining markets.
Portfolio Turnover Risk. A high rate of portfolio turnover (i.e., 100% or more) will result in increased transaction costs for the Fund in the form of increased dealer spreads and brokerage commissions. Greater transaction costs may reduce Fund performance. High portfolio turnover also may result in increased realization of net short-term capital gains (which are taxable to shareholders as ordinary income when distributed to them), higher taxable distributions and lower the Funds after-tax performance.
Prepayment Risk. Borrowers may pay back principal before the scheduled due date. Such prepayments may require the Fund to replace a debt security with a lower-yielding security. During periods of falling interest rates, issuers of debt securities may repay higher rate securities before their maturity dates. This may cause the Fund to lose potential price appreciation and to be forced to reinvest the unanticipated proceeds at lower interest rates. This may adversely affect the NAV of the Funds shares.
Regulatory Risk. Legal, tax and regulatory changes could occur and may adversely affect the Fund and its ability to pursue its investment strategies and/or increase the costs of implementing such strategies. New (or revised) laws or regulations may be imposed by the Commodity Futures Trading Commission (CFTC), the Securities and Exchange Commission (SEC), the Internal Revenue Service (IRS), the U.S. Federal Reserve or other banking regulators, other governmental regulatory authorities or self-regulatory organizations that supervise the financial markets that could adversely affect the Fund. In particular, these agencies are empowered to promulgate a variety of new rules pursuant to financial reform legislation in the United States. The Fund also may be adversely affected by changes in the enforcement or interpretation of existing statutes and rules by these governmental regulatory authorities or self-regulatory organizations.
Securities Market Risk. Securities market risk is the risk that the value of securities owned by the Fund may go up or down, sometimes rapidly or unpredictably, due to factors affecting particular companies or the securities markets generally. The profitability of the Fund substantially depends upon the Adviser correctly assessing the future price movements of stocks, bonds, loans, options on stocks, and other securities and the movements of interest rates. The Adviser cannot guarantee that it will be successful in accurately predicting price movements.
The market prices of equities may decline for reasons that directly relate to the issuing company (such as poor management performance or reduced demand for its goods or services), factors that affect a particular industry (such as a decline in demand, labor or raw material shortages, or increased production costs) or general market conditions not specifically related to a company or industry (such as real or perceived adverse economic conditions, changes in the general outlook for corporate earnings, changes in interest or currency rates, or adverse investor sentiment generally). See also Debt Securities Risk above.
As a result of the nature of the Funds investment activities, it is possible that the Funds financial performance may fluctuate substantially from period to period. Additionally, at any point in time an investment in the Fund may be worth less than the original investment, even after taking into account the reinvestment of dividends and distributions.
Senior Loans Risk . Senior loans may not be rated by a rating agency, registered with the SEC or any state securities commission or listed on any national securities exchange. Therefore, there may be less publicly available information about them than for registered or exchange-listed securities. The risks associated with Senior Loans are similar to the risks of below investment grade securities in that they are considered speculative. The Funds investments in Senior Loans are typically below investment grade and are considered speculative because of the credit risk of their issuers. Also, because portfolio management relies mainly on its own evaluation of the creditworthiness of borrowers, the Fund may be particularly dependent on portfolio managements analytical abilities. Moreover, any specific collateral used to secure a loan may decline in value or lose all its value or become illiquid, which would adversely affect the loans value. Economic and other events, whether real or perceived, can reduce the demand for certain Senior Loans or Senior Loans generally, which may reduce market prices and cause the Funds NAV per share to fall. The frequency and magnitude of such changes cannot be predicted. The secondary market in which these investments are traded is generally less liquid than the market for higher-grade debt. Less liquidity in the secondary trading market could adversely affect the price at which the Fund could sell a high yield Senior Loan, and could adversely affect the market price and NAV of the Funds shares. At times of less liquidity, it may be more difficult to value high yield Senior Loans because this valuation may require more research, and elements of judgment may play a greater role in the valuation since there is less reliable, objective data available. Investments in Senior Loans and other securities may result in greater NAV and market price fluctuation of the Funds shares than if the Fund did not make such investments. See Taxation below and Income Tax Considerations in the SAI for a discussion of special tax consequences associated with any investment by the Fund in below investment grade securities.
As with any debt security, Senior Loans are generally subject to the risk of price declines due to increases in interest rates, particularly long-term rates. Senior loans are also subject to the risk that, as interest rates rise, the cost of borrowing increases, which may increase the risk of default. In addition, the interest rates of floating rate loans typically only adjust to changes in short-term interest rates; long-term interest rates
21
Description of Risks
can vary dramatically from short-term interest rates. Therefore, Senior Loans may not mitigate price declines in a rising long-term interest rate environment. Declines in interest rates may increase prepayments of debt obligations and require the Fund to invest assets at lower yields. No active trading market may exist for certain Senior Loans, which may impair the ability of the Fund to realize full value in the event of the need to liquidate such assets. Adverse market conditions may impair the liquidity of some actively traded Senior Loans. Although Senior Loans in which the Fund may invest will often be secured by collateral, there can be no assurance that liquidation of such collateral would satisfy the Borrowers obligation in the event of a default or that such collateral could be readily liquidated. In the event of bankruptcy of a Borrower, the Fund could experience delays or limitations in its ability to realize the benefits of any collateral securing a Senior Loan. The Fund may also invest in Senior Loans that are not secured. In addition to the risks typically associated with debt securities and loans generally, Senior Loans are also subject to the risk that a court could subordinate a Senior Loan, which typically holds a senior position in the capital structure of a borrower, to presently existing or future indebtedness or take other action detrimental to the holders of Senior Loans.
Stop Order Risk. During periods of high market volatility, a Fund share may trade at a significant discount to its NAV, and in these circumstances certain types of brokerage orders may expose an investor to an increased risk of loss. A stop order, sometimes called a stop-loss order, may cause a Fund share to be sold at the next prevailing market price once the stop level is reached, which during a period of high volatility can be at a price that is substantially below NAV. By including a limit criteria with a brokerage order, a shareholder may be able to limit the size of the loss resulting from the execution of an ill-timed stop order, although no assurance can be given that inclusion of limit criteria will benefit the shareholder.
Swaps Risk. The use of swaps is a highly specialized activity which involves investment techniques, risk analyses and tax planning different from those associated with ordinary portfolio securities transactions. These transactions can result in sizeable realized and unrealized capital gains and losses relative to the gains and losses from the Funds direct investments in securities.
Transactions in swaps can involve greater risks than if the Fund had invested in the reference assets directly since, in addition to general market risks, swaps may be leveraged and are also subject to illiquidity risk, counterparty risk, credit risk and pricing risk. However, certain risks may be reduced (but not eliminated) if the Fund invests in cleared swaps. Regulators also may impose limits on an entitys or group of entities positions in certain swaps. Because bilateral swap agreements are two- party contracts and because they may have terms of greater than seven days, these swaps may be considered to be illiquid. Moreover, the Fund bears the risk of loss of the amount expected to be received under a swap in the event of the default or bankruptcy of a swap counterparty. Many swaps are complex and valued subjectively. Swaps and other derivatives may also be subject to pricing or basis risk, which exists when the price of a particular derivative diverges from the price of corresponding cash market instruments. Under certain market conditions it may not be economically feasible to initiate a transaction or liquidate a position in time to avoid a loss or take advantage of an opportunity. If a swap transaction is particularly large or if the relevant market is illiquid, it may not be possible to initiate a transaction or liquidate a position at an advantageous time or price, which may result in significant losses.
The value of swaps can be very volatile, and a variance in the degree of volatility or in the direction of securities prices from the Advisers expectations may produce significant losses in the Funds investments in swaps. In addition, a perfect correlation between a swap and a reference asset may be impossible to achieve. As a result, the Advisers use of swaps may not be effective in fulfilling the investment advisers investment strategies and may contribute to losses that would not have been incurred otherwise.
Certain separately managed accounts (SMAs) that are designed to track the performance of an index may serve as the underlying reference asset for total return swaps used by the Fund (SMA Total Return Swaps). This investment technique provides the Fund with synthetic long investment exposure to the performance of the index the SMAs seek to track, and thus, any underlying SMAs, through payments made by a swap counterparty to the Fund that reflect the positive total return, net of fees of the SMA, which may be netted against the payment of transaction fees . In exchange, the Fund makes periodic payments to the counterparty under the swap based on certain upfront and/or monthly transaction fees as well as payments reflecting any negative total return on the SMA. The swap generally provides the Fund with the economic equivalent of ownership of the portfolio of the SMA through an entitlement to receive any gains realized by the SMA and an obligation to pay any losses realized by the SMA, which may be netted against the financing expenses of the swap. This investment technique is intended to provide the Fund with exposure to the performance of the SMA and, indirectly, the performance of the index the SMA is designed to track.
The performance of an SMA Total Return Swap is subject to the performance and the risks of the index the SMA seeks to track, and ultimately, of the underlying SMA and its investment portfolio. If the performance of the SMA underlying the SMA Total Return Swap is negative or is not sufficiently positive to offset the periodic payment due to the counterparty, then the performance of the Fund will be negatively impacted. Additionally, the performance of the underlying SMA may deviate from the performance of the index it is designed to track. To the extent that the SMAs performance deviates from that of the relevant index, the performance of the SMA Total Return Swap, and in, turn, the performance of the Fund, will deviate from the performance of the relevant index as well. The expenses paid by the underlying SMA holder (including fees paid on the basis of the performance of the underlying account manager) reduce the performance returns of the SMAs investments and those expenses are embedded in the
22
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
performance returns of the SMA Total Return Swap, as the returns of the SMA Total Return Swap are based on the net returns of the SMA. The Funds use of SMA Total Return Swaps may also subject the Fund to the risks of leverage, to the extent utilized by the SMAs.
Tracking Error Risk. Imperfect correlation between the Funds portfolio securities and those in the applicable Underlying Index, rounding of prices, changes to the Underlying Index and regulatory requirements may cause tracking error, which is the divergence of the Funds performance from that of the Underlying Index. This risk may be heightened during times of increased market volatility or other unusual market conditions. Tracking error also may result because the Fund incurs fees and expenses, while the Underlying Index does not. For example, the Fund incurs a number of operating expenses not applicable to the Underlying Index and incurs costs associated with buying and selling securities, especially when rebalancing the Funds securities holdings to reflect changes in the composition of the Underlying Index and raising cash to meet redemptions or deploying cash in connection with newly created Creation Units. Because the Fund bears the costs and risks associated with buying and selling securities while such costs are not factored into the return of the Underlying Index, the Funds return may deviate significantly from the return of the Underlying Index. Because the Fund employs a representative sampling strategy, the Fund may experience tracking error to a greater extent than a fund that seeks to replicate an index. The Adviser may not be able to cause the Funds performance to correlate to that of the Funds benchmark, either on a daily or aggregate basis. Because the Underlying Index rebalances monthly but the Fund is not obligated to do the same, the risk of tracking error may increase following the rebalancing of the Underlying Index.
23
Board of Trustees and Investment Adviser
The Board of Trustees (the Board or Trustees) has overall management responsibility for the Fund. See Management in the SAI for the names of and other information about the Trustees and officers of the Fund.
Highland Capital Management Fund Advisors, L.P. (HCMFA or the Adviser) serves as the investment adviser to the Fund. The address of the Adviser is 200 Crescent Court, Suite 700, Dallas, Texas 75201. HCMFA provides the day-to-day management of the Funds portfolio of securities, which includes buying and selling securities for the Fund and conducting investment research. Additionally, HCMFA furnishes offices, necessary facilities, equipment and personnel. Organized in February 2009, HCMFA is registered as an investment adviser under the Investment Advisers Act of 1940, as amended. As of June 30, 2017, HCMFA has approximately $3.2 billion in assets under management.
The Fund has entered into an investment advisory agreement with HCMFA (the Investment Advisory Agreement), pursuant to which HCMFA either provides the day-to-day management of the Funds portfolio of securities, which includes buying and selling securities for the Fund and conducting investment research, or hires a sub-adviser to do so, subject to HCMFAs general oversight.
In return for its advisory services, the Fund pays the Adviser an advisory fee of 0.45% of the Funds Average Daily Managed Assets for the most recent fiscal year. The Adviser has contractually agreed to limit the total annual operating expenses (exclusive of taxes, brokerage commissions and other transaction costs, acquired fund fees and expenses and extraordinary expenses (collectively, the Excluded Expenses)) of the Fund to 0.55% of average daily net assets of the Fund (the Expense Cap). The Expense Cap will continue through at least October 31, 2018, and may not be terminated prior to this date without the action or consent of the Board. Under the Expense Cap, the Adviser may recoup waived and/or reimbursed amounts with respect to the Fund within thirty-six months of the date such amounts were waived or reimbursed, provided the Funds total annual operating expenses, including such recoupment, do not exceed the Expense Cap in effect at the time of such waiver/reimbursement.
Average Daily Managed Assets of the Fund shall mean the average daily value of the total assets of the Fund, less all accrued liabilities of the Fund (other than the aggregate amount of any outstanding borrowings constituting financial leverage). The Fund pays its own ordinary operating and activity expenses, such as legal and auditing fees, investment advisory fees, administrative fees, custodial fees, transfer agency fees, the cost of communicating with shareholders and registration fees, as well as other operating expenses such as interest, taxes, brokerage, insurance, bonding, compensation of Independent Trustees of the Fund and extraordinary expenses. A discussion regarding the Boards approval of the Investment Advisory Agreement for the Fund is available in the Trusts semiannual report to shareholders for the period ended December 31, 2016. The Investment Advisory Agreement may be terminated by the Fund or by vote of a majority of the outstanding voting securities of the Fund, without the payment of any penalty, on not more than 60 days nor less than 30 days written notice. In addition, the Investment Advisory Agreement automatically terminates in the event of its assignment (as defined in the 1940 Act).
The Fund is a party to contractual arrangements with various parties, including, among others, the Funds investment adviser, administrator, distributor, and shareholder servicing agent, who provide services to the Fund. Shareholders are not parties to, or intended (third-party) beneficiaries of, any such contractual arrangements, and such contractual arrangements are not intended to create in any individual shareholder or group of shareholders any right to enforce them against the service providers or to seek any remedy under them against the service providers, either directly or on behalf of the Fund.
Neither this prospectus, nor the related SAI, is intended, or should be read, to be or to give rise to an agreement or contract between the Trust or the Fund and any investor, or to give rise to any rights in any shareholder or other person other than any rights under federal or state law that may not be waived.
Multi-Manager Structure
On October 26, 2010, the SEC issued a multi-managers exemptive order (the Order) from certain provisions of the 1940 Act, pursuant to which the Adviser will, subject to the oversight of the Funds Board, be permitted to enter into and materially amend sub-advisory agreements on behalf of the Fund with sub-advisers unaffiliated with the Adviser without such agreements being approved by the shareholders of the Fund. The Funds Board and the Adviser will therefore have the right to hire, terminate or replace sub-advisers without first obtaining shareholder approval, including in the event that a sub-advisory agreement has automatically terminated as a result of an assignment. The Adviser will continue to have the ultimate responsibility to oversee each sub-adviser and recommend its hiring, termination and replacement. The Fund has obtained approval of its reliance on the Order from the Board and from the initial shareholder of the Fund. The Trust and the Adviser will be subject to certain conditions imposed by the Order, including the condition that within 90 days of hiring of a new non-affiliated sub-adviser, the Fund will provide shareholders with an information statement containing information about the sub-adviser. Shareholders of the Fund retain the right to terminate a sub-advisory agreement for the Fund at any time by a vote of the majority of the outstanding securities of the Fund. Operation of the Fund under the Multi-Manager Structure will not: (1) permit management fees paid by the Fund to HCMFA to be increased without shareholder approval; or (2) diminish HCMFAs responsibilities to the Fund, including HCMFAs overall responsibility for overseeing the portfolio management services furnished by its sub-advisers. Shareholders will be notified of any changes made to sub-advisers or sub-advisory agreements within 90 days of the change.
24
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
Portfolio Manager
The portfolio of the Fund is managed by Mark Okada and Allan Smallwood. Mr. Okada and Mr. Smallwood have managed the Fund since June 2017.
Mr. Okada is a Portfolio Manager at HCMFA. He has managed the Funds portfolio since June 2017. Mr. Okada co-founded Highland Capital Management, L.P. (Highland) and has served as Chief Investment Officer of Highland since 1993. He is a pioneer in the development of the bank loan market and has over 25 years of credit experience. Mr. Okada is responsible for structuring one of the industrys first arbitrage CLOs. He received a BA in Economics and a BA in Psychology, cum laude, from the University of California, Los Angeles. He has earned the right to use the Chartered Financial Analyst designation.
Mr. Smallwood is a Credit Product Strategist at Highland and has managed the Funds portfolio since June 2017. Prior to joining Highland, he was a Senior Strategist with LPL Financial where he was involved in all aspects of market and investment strategy for the firms centrally managed investment platforms. Prior to LPL Financial, Mr. Smallwood held positions with PIMCO as a Client Portfolio Manager and at Bank of America Merrill Lynch as a Portfolio Manager for the banks actively managed corporate loan portfolio. He received a BS in Business Administration from Miami University and an MBA from the Fuqua School of Business at Duke University. He has earned the right to use the Chartered Financial Analyst designation.
The SAI provides additional information about each portfolio managers compensation, other accounts managed by each portfolio manager and each portfolio managers ownership of securities issued by the Fund.
Distributor of the Fund
The Funds shares are offered for sale through SEI Investments Distribution Co. (the Distributor), One Freedom Valley Drive, Oaks, PA 19456. The Distributor does not maintain a secondary market in shares of the Fund. The Distributor has no role in determining the policies of the Fund or the securities that are purchased or sold by the Fund.
Distribution (12b-1) Plan
Under a Rule 12b-1 Distribution Plan (the Plan) adopted by the Board, the Fund may pay the Distributor and financial intermediaries, such as broker-dealers and investment advisors, up to 0.25% on an annualized basis of the average daily net assets of the Fund as reimbursement or compensation for distribution related activities and other services with respect to the Fund. Because these fees are paid out of the Funds assets on an on-going basis, over time these fees will increase the cost of your investment and may cost you more than paying other types of sales charges. As of the date of this Prospectus, no payments have been made by the Fund under the Plan.
25
Disclosure of Portfolio Holdings
A description of the Funds policies and procedures with respect to the disclosure of the Funds portfolio securities is available (i) in the SAI and (ii) on the Funds website at http://www.highlandfunds.com.
26
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
The Trust issues and redeems shares of the Fund only in aggregations of Creation Units. A Creation Unit is comprised of 100,000 shares. The value of such Creation Unit was $2,000,000 at the Funds inception.
See the section of this Prospectus entitled Creation and Redemption of Shares for more information.
Shares of the Fund will be listed on the Exchange for trading on any day that the Exchange is open for business. Shares can be bought and sold throughout the trading day like shares of other publicly-traded companies. The Trust does not impose any minimum investment for shares of the Fund purchased on an exchange. Buying or selling Fund shares on an exchange involves two types of costs that may apply to all securities transactions. When buying or selling shares of the Fund through a broker, you will likely incur a brokerage commission or other charges determined by your broker. In addition, you may incur the cost of the spread that is, any difference between the bid price and the ask price. The commission is frequently a fixed amount and may be a significant proportional cost for investors seeking to buy or sell small amounts of shares. The spread varies over time for shares of the Fund based on its trading volume and market liquidity, and is generally lower if the Fund has a lot of trading volume and market liquidity and higher if the Fund has little trading volume and market liquidity. Shares of the Fund will trade on NASDAQ under the trading symbol SNLN.
The Board has adopted a policy of not monitoring for frequent purchases and redemptions of Fund shares (frequent trading) that appear to attempt to take advantage of a potential arbitrage opportunity presented by a lag between a change in the value of the Funds portfolio securities after the close of the primary markets for the Funds portfolio securities and the reflection of that change in the Funds NAV (market timing), because the Funds shares are listed for trading on a national securities exchange. Because secondary market trades do not involve the Fund directly, it is unlikely those trades would cause many of the harmful effects of market timing, including dilution, disruption of portfolio management, increases in the Funds trading costs and the realization of capital gains.
Section 12(d)(1) of the 1940 Act restricts investments by investment companies in the securities of other investment companies. Registered investment companies are permitted to invest in the Fund beyond the limits set forth in Section 12(d)(1), subject to certain terms and conditions set forth in SEC rules or in an SEC exemptive order issued to the Trust. In order for a registered investment company to invest in shares of the Fund pursuant to the exemptive relief obtained by the Trust from the limitations of Section 12(d)(1), the company must enter into an agreement with the Trust.
27
Shares of the Fund are held in book-entry form, which means that no stock certificates are issued. The Depository Trust Company (DTC) or its nominee is the record owner of all outstanding shares of the Fund and is recognized as the owner of all shares for all purposes.
Investors owning shares of the Fund are beneficial owners as shown on the records of DTC or its participants. DTC serves as the securities depository for shares of the Fund. DTC participants include securities brokers and dealers, banks, trust companies, clearing corporations and other institutions that directly or indirectly maintain a custodial relationship with DTC. Beneficial owners of shares are not entitled to receive physical delivery of stock certificates or to have shares registered in their names, and they are not considered a registered owner of shares. Therefore, to exercise any right as an owner of shares, a beneficial owner must rely upon the procedures of DTC and its participants. These procedures are the same as those that apply to any other securities that a beneficial owner holds in book-entry or street name form.
28
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
Creation and Redemption of Shares
The Trust issues and sells Creation Units on a continuous basis through the Distributor, without a sales load, at their NAV next determined after receipt of a purchase order, on any day that the Exchange is open for business. Creation Units of shares may be purchased only by or through a DTC Participant that has entered into an Authorized Participant Agreement with the Distributor. Investors who are not Authorized Participants must make appropriate arrangements with an Authorized Participant. The Fund may direct portfolio transactions to certain Authorized Participants or their affiliates in certain circumstances, such as to achieve best execution, but does not direct transactions based on the purchase/sale of fund shares. Due to the nature of the Funds investments, Authorized Participants generally will deposit cash in exchange for a specified number of Creation Units, although the Fund may permit Authorized Participants to deposit a portfolio of securities approximating the holdings of the Fund or a combination of cash and a portfolio of securities approximating the holdings of the Fund in exchange for a specified amount of Creation Units. To the extent practicable, the composition of such portfolio generally corresponds pro rata to the holdings of the Fund.
Investors should be aware that their particular broker may not be a DTC Participant or may not have executed an Authorized Participant Agreement, in which case orders to purchase Creation Units of shares may have to be placed by the investors broker through an Authorized Participant. As a result, purchase orders placed through an Authorized Participant may result in additional charges to such investor. The Trust expects to enter into Authorized Participant Agreements with only a small number of DTC Participants.
29
Purchases through and outside the Clearing Process
An Authorized Participant may place an order to purchase (or redeem) Creation Units (i) through the Continuous Net Settlement clearing processes of the National Securities Clearing Corporation (NSCC) as such processes have been enhanced to effect purchases (and redemptions) of Creation Units, such processes being referred to herein as the Clearing Process, or (ii) outside the Clearing Process. To purchase or redeem through the Clearing Process, an Authorized Participant must be a member of NSCC that is eligible to use the Continuous Net Settlement system. For purchase orders placed through the Clearing Process, the Authorized Participant Agreement authorizes the Distributor to transmit through the Funds transfer agent (the Transfer Agent) to NSCC, on behalf of an Authorized Participant, such trade instructions as are necessary to effect the Authorized Participants purchase order. Pursuant to such trade instructions to NSCC, the Authorized Participant agrees to deliver the requisite deposit securities and the balancing amount to the Trust, together with the Transaction Fee and such additional information as may be required by the Distributor. A purchase order must be received by the Distributor by 4:00 p.m. Eastern Time if transmitted by mail or by 3:00 p.m. Eastern Time if transmitted by telephone, facsimile or other electronic means permitted under the Participant Agreement in order to receive that days Closing NAV per Share.
An Authorized Participant that wishes to place an order to purchase Creation Units outside the Clearing Process must state that it is not using the Clearing Process and that the purchase instead will be effected through a transfer of securities and cash directly through DTC. Purchases (and redemptions) of Creation Units settled outside the Clearing Process will be subject to a higher Transaction Fee than those settled through the Clearing Process.
Purchase orders effected outside the Clearing Process are likely to require transmittal by the Authorized Participant earlier on the Transmittal Date than orders effected using the Clearing Process. Those persons placing orders outside the Clearing Process should ascertain the deadlines applicable to DTC and the Federal Reserve Bank wire system by contacting the operations department of the broker or depository institution effectuating such transfer.
30
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
The Trust reserves the absolute right to reject a purchase order transmitted to it by the Distributor in respect of the Fund if (a) the purchaser or group of purchasers, upon obtaining the shares ordered, would own 80% or more of the currently outstanding shares of the Fund; (b) the deposit securities delivered are not as specified by the Adviser and the Adviser has not consented to acceptance of an in-kind deposit that varies from the designated deposit securities; (c) acceptance of the purchase transaction order would have certain adverse tax consequences to the Fund; (d) the acceptance of the purchase transaction order would, in the opinion of counsel, be unlawful; (e) the acceptance of the purchase order transaction would otherwise, in the discretion of the Trust or the Adviser, have an adverse effect on the Trust or the rights of beneficial owners; (f) the value of a cash purchase amount, or the value of the balancing amount to accompany an in-kind deposit, exceeds a purchase authorization limit extended to an Authorized Participant by the custodian and the Authorized Participant has not deposited an amount in excess of such purchase authorization with the custodian prior to the relevant cut-off time for the Fund on the Transmittal Date; or (g) in the event that circumstances outside the control of the Trust, the Distributor and the Adviser make it impractical to process purchase orders. The Trust shall notify a prospective purchaser of its rejection of the order of such person. The Trust and the Distributor are under no duty, however, to give notification of any defects or irregularities in the delivery of purchase transaction orders nor shall either of them incur any liability for the failure to give any such notification.
31
Similarly, shares may be redeemed only in Creation Units at their NAV next determined after receipt of a redemption request in good order by the Distributor on any day on that the Exchange is open for business. The Fund reserves the right to reject any redemption request that is not in good order. The specific requirements for good order depend on the type of account and the method of redemption. Contact HCMFA if you have any questions about your particular circumstances. Generally, good order means that the redemption request meets all applicable requirements described in this Prospectus.
The Trust will not redeem shares in amounts less than Creation Units.
Beneficial owners also may sell shares in the secondary market, but must accumulate enough shares to constitute a Creation Unit in order to have such shares redeemed by the Trust. There can be no assurance, however, that there will be sufficient liquidity in the public trading market at any time to permit assembly of a Creation Unit of shares. Investors should expect to incur brokerage and other costs in connection with assembling a sufficient number of shares to constitute a redeemable Creation Unit.
The Fund, however, may suspend the right of redemption and postpone payment for more than seven days: (i) during periods when trading on the Exchange is closed on days other than weekdays or holidays; (ii) during periods when trading on the Exchange is restricted; (iii) during any emergency which makes it impractical for the Fund to dispose of its securities or fairly determine the NAV of the Fund; and (iv) during any other period permitted by the SEC for your protection.
Because new shares may be created and issued on an ongoing basis, at any point during the life of the Fund, a distribution, as such term is used in the Securities Act, may be occurring. Broker-dealers and other persons are cautioned that some activities on their part may, depending on the circumstances, result in their being deemed participants in a distribution in a manner that could render them statutory underwriters and subject to the prospectus delivery and liability provisions of the Securities Act. Any determination of whether one is an underwriter must take into account all the relevant facts and circumstances of each particular case.
Broker-dealers should also note that dealers who are not underwriters but are participating in a distribution (as contrasted to ordinary secondary transactions), and thus dealing with shares that are part of an unsold allotment within the meaning of Section 4(3)(C) of the Securities Act, would be unable to take advantage of the prospectus delivery exemption provided by Section 4(3) of the Securities Act. For delivery of prospectuses to exchange members, the prospectus delivery mechanism of Rule 153 under the Securities Act is available only with respect to transactions on a national securities exchange.
32
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
A redemption request received by the Fund will be effected at the NAV per share next determined after the Fund receives the request in good order. While the Fund will generally pay redemptions proceeds in cash, the Fund may pay your redemption proceeds wholly or partially in portfolio securities. In this event, the portfolio of securities the Fund will deliver upon redemption of Fund shares may differ from the portfolio of securities required for purchase of a Creation Unit. You will be exposed to market risk until you convert these portfolio securities into cash, you will likely pay commissions upon any such conversion, and you may recognize taxable gain or loss resulting from fluctuations in value of the portfolio securities between the conversion date and the redemption date. If you receive illiquid securities, you could find it more difficult to sell such securities and may not be able to sell such securities at prices that reflect the Advisers or your assessment of their fair value or the amount paid for them by the Fund. Illiquidity may result from the absence of an established market for such securities as well as legal, contractual or other restrictions on their resale and other factors.
33
Authorized Participants are charged standard creation and redemption transaction fees (Transaction Fees) to offset transfer and other transaction costs associated with the issuance and redemption of Creation Units. Purchasers and redeemers of Creation Units for cash are required to pay an additional variable charge (up to the maximum amount shown below) to compensate for brokerage and market impact expenses. The standard creation and redemption transaction fees are set forth below. The standard creation transaction fee is charged to each purchaser on the day such purchaser creates a Creation Unit. The standard creation transaction fee is the same regardless of the number of Creation Units purchased by an investor on the applicable business day. Similarly, the standard redemption transaction fee is the same regardless of the number of Creation Units redeemed on the same day. Creations and redemptions through DTC for cash (when cash creations and redemptions are available or specified) are also subject to an additional variable charge up to the maximum amounts shown in the table below. In addition, purchasers of shares in Creation Units are responsible for payment of the costs of transferring securities to the Fund and redeemers of shares in Creation Units are responsible for the costs of transferring securities from the Fund. Investors who use the services of a broker or other financial intermediary may pay fees for such services.
The following table shows, as of the date of commencement of operations, the approximate value of one Creation Unit, standard fees and maximum additional charges for creations and redemptions for the Fund:
Approximate
Value of a Creation Unit |
Creation Unit Size |
Standard
Creation/Redemption Transaction Fee** |
Maximum
Additional Charge for Creations* |
Maximum
Additional Charge for Redemptions* |
||||
$2,000,000 | 100,000 shares | $500 | 1.0% | 1.0% |
* | As a percentage of the net asset value per Creation Unit, inclusive of the standard transaction fee. |
** | Transaction fees may not be waived. |
34
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
Net Asset Value
The NAV per share of the Fund is calculated as of 4:00 p.m., Eastern Time, on each day that the Exchange is open for business, except on days on which regular trading on the Exchange is scheduled to close before 4:00, when the Fund calculates NAV as of the scheduled close of regular trading. The Exchange is open Monday through Friday, but currently is scheduled to be closed on New Years Day, Dr. Martin Luther King, Jr. Day, Presidents Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day or on the preceding Friday or subsequent Monday when a holiday falls on a Saturday or Sunday, respectively.
The NAV per share is computed by dividing the value of the Funds net assets (i.e., the value of its securities and other assets less its liabilities, including expenses payable or accrued but excluding capital stock and surplus) attributable to the Fund by the total number of shares of the Fund outstanding at the time the determination is made.
The Funds portfolio securities are valued in accordance with the Funds valuation policies approved by the Board. The value of the Funds investments is generally determined as follows:
|
Portfolio securities for which market quotations are readily available are valued at their current market value. |
|
Foreign securities listed on foreign exchanges are valued based on quotations from the primary market in which they are traded and are translated from the local currency into U.S. dollars using current exchange rates. Foreign securities may trade on weekends or other days when the Fund does not calculate NAV. As a result, the market value of these investments may change on days when you cannot buy or redeem shares of the Fund. |
|
Investments by the Fund in any mutual fund are valued at their respective NAVs as determined by those mutual funds each business day. The prospectuses for those mutual funds explain the circumstances under which those funds will use fair value pricing and the effects of using fair value pricing. |
|
All other portfolio securities, including derivatives and cases where market quotations are not readily available or when the market price is determined to be unreliable, are valued at fair value as determined in good faith pursuant to procedures established by the Board subject to approval or ratification by the Board at its next regularly scheduled quarterly meeting. Pursuant to the Funds pricing procedures, securities for which market quotations are not readily available or for which the market price is determined to be unreliable, may include but are not limited to securities that are subject to legal or contractual restrictions on resale, securities for which no or limited trading activity has occurred for a period of time, or securities that are otherwise deemed to be illiquid (i.e., securities that cannot be disposed of within seven days at approximately the price at which the security is currently priced by the Fund which holds the security). Market quotations may also be not readily available if a significant event occurs after the close of the principal exchange on which a portfolio security trades (but before the time for calculation of the Funds NAV) if that event affects or is likely to affect (more than minimally) the NAV per share of the Fund. In determining the fair value price of a security, HCMFA may use a number of other methodologies, including those based on discounted cash flows, multiples, recovery rates, yield to maturity or discounts to public comparables. Fair value pricing involves judgments that are inherently subjective and inexact; 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. |
Valuing the Funds investments using fair value pricing will result in using prices for those investments that may differ from current market valuations. Use of fair value prices and certain current market valuations could result in a difference between the prices used to calculate the Funds NAV and the prices used by the Underlying Index, which, in turn, could result in a difference between the Funds performance and the performance of the Underlying Index.
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The trading prices of the Funds shares in the secondary market generally differ from the Funds daily NAV and are affected by market forces such as supply and demand, economic conditions and other factors. Information regarding the intraday value of shares of the Fund, also known as the indicative optimized portfolio value (IOPV), is disseminated every 15 seconds throughout the trading day by the national securities exchange on which the Funds shares are listed or by market data vendors or other information providers. The IOPV is based on the current market value of the securities and/or cash required to be deposited in exchange for a Creation Unit. The IOPV does not necessarily reflect the precise composition of the current portfolio of securities held by the Fund at a particular point in time or the best possible valuation of the current portfolio. Therefore, the IOPV should not be viewed as a real-time update of the Funds NAV, which is computed only once a day. The IOPV is generally determined by using both current market quotations and/or price quotations obtained from broker-dealers that may trade in the portfolio securities held by the Fund. The quotations of certain Fund holdings may not be updated during U.S. trading hours if such holdings do not trade in the U.S. The Fund is not involved in, or responsible for, the calculation or dissemination of the IOPV and makes no representation or warranty as to its accuracy.
36
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
The table that follows presents information about the differences between the daily market price on secondary markets for shares of the Fund and the Funds NAV for the period from January 1, 2016 through September 30, 2017. NAV is the price per share at which the Fund issues and redeems shares. It is calculated in accordance with the standard formula for valuing mutual fund shares. The price used to calculate market returns (Market Price) of the Fund generally is determined using the midpoint between the bid and the ask on the primary securities exchange on which shares of the Fund are listed for trading, as of the time that the Funds NAV is calculated. The Funds Market Price may be at, above or below its NAV.
Fund Name |
# of Days Market Price Greater than NAV |
|||||||||||||||
1/1/16-
12/31/16 |
1/1/17-
3/31/17 |
4/1/17-
6/30/17 |
7/1/17-
9/30/17 |
|||||||||||||
Highland/iBoxx Senior Loan ETF | 125 | 41 | 41 | 45 |
Fund Name |
# of Days NAV
Greater than Market Price |
|||||||||||||||
1/1/16-
12/31/16 |
1/1/17-
3/31/17 |
4/1/17-
6/30/17 |
7/1/17-
9/30/17 |
|||||||||||||
Highland/iBoxx Senior Loan ETF | 86 | 6 | 4 | 6 |
The NAV of the Fund will fluctuate with changes in the market value of its portfolio holdings. The Market Price of the Fund will fluctuate in accordance with changes in its NAV, as well as market supply and demand. Shareholders may pay more than NAV when they buy Fund shares and receive less than NAV when they sell those shares, because shares are bought and sold at current Market Prices.
Premiums or discounts are the differences (expressed as a percentage) between the NAV and Market Price of the Fund on a given day, generally at the time the NAV is calculated. A premium is the amount that the Fund is trading above the reported NAV, expressed as a percentage of the NAV. A discount is the amount that the Fund is trading below the reported NAV, expressed as a percentage of the NAV. Further information about the frequency of distributions of premium and discounts for the Fund is available at http://highlandfunds.com.
37
Dividends and Other Distributions
The Fund intends to declare and pay dividends of net investment income monthly and to pay any capital gain distributions on an annual basis. There is no fixed dividend rate, and there can be no assurance that the Fund will pay any dividends or make any capital gain distributions.
No dividend reinvestment service is provided by the Trust. Broker-dealers may make available the DTC book-entry Dividend Reinvestment Service for use by beneficial owners of the Fund for reinvestment of their dividend distributions. Beneficial owners should contact their broker to determine the availability and costs of the service and the details of participation therein. Brokers may require beneficial owners to adhere to specific procedures and timetables. If this service is available and used, dividend distributions of both income and realized gains will be automatically reinvested in additional whole shares of the Fund purchased in the secondary market. Dividends and other taxable distributions are taxable to you, whether received in cash or reinvested in additional shares of the Fund pursuant to DTCs Dividend Reinvestment Service. Shareholders using the Dividend Reinvestment Service should consult their broker-dealer for more information about the specific terms of the service, including potential tax consequences to such shareholders in light of their particular circumstances.
38
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
Index Providers
The Fund is based on the Markit iBoxx USD Liquid Leveraged Loan Index, provided by Markit, Inc., a leading provider of independent data, portfolio valuations and OTC derivatives trade processing to the financial markets. The Underlying Index is sponsored by Markit Indices Limited (the Index Provider), an organization that is independent of the Fund and the Adviser. The Index Provider determines the composition and relative weightings of the securities in the Underlying Index and publishes information regarding the market value of the Underlying Index. The Index Provider is not affiliated with the Trust, the Adviser, the Distributor, or any of their respective affiliates. Markit also serves as the primary pricing source for the Fund. Markits dual roles as index provider and pricing source may give rise to a conflict of interest in the sense that Markit has a financial interest in maintaining consistent values for the instruments held in both the Fund and the index. Further information about the Index Provider and the Underlying Index is available at http://www.markit.com.
The Underlying Index referenced herein is the property of Markit Indices Limited and has been licensed for use in connection with the Fund. Each party acknowledges and agrees that the Fund is not sponsored, endorsed or promoted by the Index Provider. The Index Provider makes no representation whatsoever, whether express or implied, and hereby expressly disclaim all warranties (including, without limitation, those of merchantability or fitness for a particular purpose or use), with respect to the Underlying Index or any data included therein or relating thereto, and in particular disclaim any warranty either as to the quality, accuracy and/or completeness of the Underlying Index or any data included therein, the results obtained from the use of the Underlying Index and/or the composition of the Underlying Index at any particular time on any particular date or otherwise and/or the creditworthiness of any entity, or the likelihood of the occurrence of a credit event or similar event (however defined) with respect to an obligation, in the Underlying Index at any particular time on any particular date or otherwise.
The Index Provider shall not be liable (whether in negligence or otherwise) to the parties or any other person for any error in the Underlying Index, and the Index Provider is under no obligation to advise the parties or any person of any error therein. The Index Provider makes no representation whatsoever, whether express or implied, as to the advisability of purchasing or selling the Fund, the ability of the Underlying Index to track relevant markets performances, or otherwise relating to the Underlying Index or any transaction or product with respect thereto, or of assuming any risks in connection therewith. The Index Provider has no obligation to take the needs of any party into consideration in determining, composing or calculating the Underlying Index. No party purchasing or selling the Fund, nor the Index Provider, shall have any liability to any party for any act or failure to act by the Index Provider in connection with the determination, adjustment, calculation or maintenance of the Underlying Index. The Index Provider and its affiliates may deal in any obligations that compose the Underlying Index, and may, where permitted, accept deposits from, make loans or otherwise extend credit to, and generally engage in any kind of commercial or investment banking or other business with the issuers of such obligations or their affiliates, and may act with respect to such business as if the Underlying Index did not exist, regardless of whether such action might adversely affect the Underlying Index or the Fund.
39
The following discussion is a summary of some of the important U.S. federal income tax considerations generally applicable to an investment in the Fund. Your investment may have other tax implications. The discussion reflects provisions of the Code, existing Treasury regulations, rulings published by the Internal Revenue Service (IRS), and other applicable authorities, as of the date of this Prospectus. These authorities may be changed, possibly with retroactive effect, or subject to new legislative, administrative or judicial interpretations. No attempt is made to present a detailed explanation of all U.S. federal, state, local and foreign tax law concerns affecting the Fund and its shareholders (including shareholders owning large positions in the Fund) or to address all aspects of taxation that may apply to individual shareholders or to specific types of shareholders, such as foreign persons, that may qualify for special treatment under U.S. federal income tax laws. The discussion set forth herein does not constitute tax advice. Please consult your tax advisor about foreign, federal, state, local or other tax laws applicable to you. For more information, please see Income Tax Considerations in the SAI.
The Fund has elected to be treated and intends to qualify annually as a regulated investment company (RIC) under Subchapter M of the Code including by complying with the applicable qualifying income and diversification requirements. If the Fund so qualifies and satisfies certain distribution requirements, the Fund generally will not be subject to U.S. federal income tax on income and gains that the Fund distributes to its shareholders in a timely manner in the form of dividends or capital gain dividends (as defined below). As described in Dividends and Other Distributions above, the Fund intends to distribute at least annually all or substantially all of its net investment income and net realized capital gains. The Fund will be subject to a Fund-level income tax at regular corporate income tax rates on any taxable income or gains that it does not distribute to its shareholders.
Amounts not distributed on a timely basis in accordance with a calendar year distribution requirement will be subject to a nondeductible 4% U.S. federal excise tax at the Fund level. To avoid the tax, the Fund must distribute during each calendar year an amount at least equal to the sum of (i) 98% of its ordinary income (taking into account certain deferrals and elections) for the calendar year, (ii) 98.2% of its capital gains in excess of its capital losses (adjusted for certain ordinary losses) for a one-year period ending on October 31 of the calendar year, and (iii) any undistributed amounts described in (i) and (ii) above from the prior year on which the Fund paid no U.S. federal income tax. While the Fund intends to distribute any income and capital gain in the manner necessary to minimize imposition of the 4% U.S. federal excise tax, there can be no assurance that sufficient amounts of the Funds taxable income and capital gain will be distributed to avoid entirely the imposition of the tax. In that event, the Fund will be liable for the excise tax only on the amount by which it does not meet the foregoing distribution requirement.
Additionally, if for any taxable year the Fund were not to qualify as a RIC and were ineligible to or otherwise did not cure such failure, all of its taxable income and gain would be subject to a Fund-level tax at regular corporate income tax rates without any deduction for distributions to shareholders. This treatment would reduce the Funds net income available for investment or distribution to its shareholders. In addition, all distributions from earnings and profits, including any net long-term capital gains, would be taxable to shareholders as ordinary income. Some portions of such distributions may be eligible for the dividends-received deduction in the case of corporate shareholders or to be treated as qualified dividend income in the case of individual shareholders. The Fund also could be required to recognize unrealized gains, pay substantial taxes and interest and make substantial distributions before requalifying as a RIC that is accorded special tax treatment.
The tax rules applicable to certain derivative instruments in which a Fund may invest are uncertain under current law, including the provisions applicable to RICs under Subchapter M of the Code. For instance, the timing and character of income or gains arising from certain derivatives can be uncertain, including for Subchapter M purposes. Accordingly, while each Fund intends to account for such transactions in a manner it deems to be appropriate, an adverse determination or future guidance by the IRS with respect to one or more of these rules (which determination or guidance could be retroactive) may adversely affect a Funds ability to meet one or more of the relevant requirements to maintain its qualification as a RIC, as well as to avoid Fund-level taxes.
Certain of the Funds investment practices, including derivative transactions and hedging activities, generally, as well as the Funds investments in certain types of securities, including Component Securities, may be subject to special and complex U.S. federal income tax provisions that may, among other things: (i) disallow, suspend or otherwise limit the allowance of certain losses or deductions; (ii) convert lower taxed long-term capital gain into higher taxed short-term capital gain or ordinary income; (iii) accelerate the recognition of income; (iv) convert short-term losses into long-term losses; (v) cause the Fund to recognize income or gain without a corresponding receipt of cash; (vi) adversely affect the time as to when a purchase or sale of securities is deemed to occur; (vii) cause adjustments in the holding periods of the Funds securities; or (viii) otherwise adversely alter the characterization of certain complex financial transactions. These U.S. federal income tax provisions could therefore affect the amount, timing and/or character of distributions to Fund shareholders. In particular, a portion of the Funds investments in Component Securities or other debt instruments may be treated as having market discount and/or original issue discount for U.S. federal income tax purposes, which, in some cases, could be significant, and could cause the Fund to recognize income in respect of these investments before, or without receiving, cash representing such income. The Fund intends to monitor its transactions, may make certain tax elections, and may be required to, among other things, dispose of securities
40
Highland/iBoxx Senior Loan ETF Prospectus
October 31, 2017
(including at a time when it is not advantageous to do so) to mitigate the effect of these provisions, prevent the Funds disqualification as a RIC, or avoid incurring Fund-level U.S. federal income and/or excise tax.
Investments in below investment grade Component Securities and other debt instruments that are at risk of or in default present special tax issues for the Fund. Tax rules are not entirely clear about issues such as whether and to what extent the Fund should recognize market discount on a distressed debt obligation, when the Fund may cease to accrue interest, original issue discount or market discount, when and to what extent the Fund may take deductions for bad debts or worthless securities and how the Fund should allocate payments received on obligations in default between principal and income. These and other related issues will be addressed by the Fund as necessary, in order to seek to ensure that it distributes sufficient income to preserve its status as a RIC and that it does not become subject to Fund-level U.S. federal income and/or excise taxes.
The Funds income from or its gross proceeds received on the disposition of its investments in foreign countries may be subject to withholding and other taxes imposed by foreign countries on interest, capital gains or other income or proceeds. Tax treaties between the U.S. and other countries may reduce or eliminate such taxes. Foreign taxes paid by the Fund will reduce the return from the Funds investments. The Fund does not expect that it will be eligible to elect to treat any foreign taxes it paid as paid by its shareholders, who therefore will not be entitled to credits or deductions for such taxes on their own returns.
Distributions paid to you by the Fund from net capital gain (that is, the excess of any net long-term capital gain over net short-term capital loss, in each case with reference to any loss carryforwards) that the Fund reports as capital gain dividends (capital gain dividends) generally are taxable to you as long-term capital gain includible in net capital gain and taxed to individuals at reduced rates, regardless of how long you have held your shares. All other dividends paid to you by the Fund (including dividends from short-term capital gain (that is, the excess of any net short-term capital gain over any net long-term capital loss)) from its current or accumulated earnings and profits generally are taxable to you as ordinary income. Distributions of investment income reported by the Fund as derived from qualified dividend income will be taxed in the hands of individuals at the rates applicable to long-term capital gains, provided holding periods and other requirements are met at both the shareholder and Fund level. The Fund generally does not expect that a significant portion of Fund distributions will qualify for favorable tax treatment as qualified dividend income for individual shareholders.
A Medicare contribution tax of 3.8% is imposed on the net investment income of certain individuals, estates and trusts to the extent their income exceeds certain threshold amounts. Net investment income generally includes for this purpose dividends paid by the Fund, including any capital gain dividends, and capital gains recognized on the taxable sale, redemption or exchange of shares of the Fund. Shareholders are advised to consult their tax advisors regarding the possible implications of this additional tax on their investment in the Fund.
If, for any taxable year, the Funds total distributions exceed both current earnings and profits and accumulated earnings and profits, the excess will generally be treated as a tax-free return of capital up to the amount of your tax basis in the shares. The amount treated as a tax-free return of capital will reduce your tax basis in the shares, thereby increasing your potential gain or reducing your potential loss on the subsequent sale of the shares. Any amounts distributed to you in excess of your tax basis in the shares will be taxable to you as capital gain (assuming the shares are held as a capital asset).
Dividends and other taxable distributions are taxable to you, whether received in cash or reinvested in additional shares of the Fund pursuant to DTCs Dividend Reinvestment Service (see Dividends and Other Distributions). Dividends and other distributions paid by the Fund generally are treated as received by you at the time the dividend or distribution is made. If, however, the Fund pays you a dividend in January that was declared in the previous October, November or December and you were a shareholder of record on a specified record date in one of those months, then such dividend 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 dividend was declared.
The price of shares purchased at any time may reflect the amount of a forthcoming distribution. If you purchase shares just prior to the ex-dividend date for a distribution, you generally will receive a distribution that will be taxable to you even though it represents in part a return of your invested capital.
The Fund (or your broker or other financial intermediary through which you own your shares) will send information after the end of each calendar year setting forth the amount and tax status of any dividends or other distributions paid to you by the Fund. Dividends and other distributions may also be subject to state, local and other taxes.
If you sell or otherwise dispose of any of your shares of the Fund (including through a redemption), you will generally recognize a gain or loss in an amount equal to the difference between your tax basis in such shares of the Fund and the amount you receive upon disposition of such shares. If you hold your shares as capital assets, any such gain or loss will be long-term capital gain or loss if you have held (or are treated as having held) such shares for more than one year at the time of sale. All or a portion of any loss you realize on a taxable sale or exchange of your shares of the Fund will be disallowed if you acquire other shares of the Fund (whether through the reinvestment of dividends or otherwise) within a 61-day period beginning 30 days before and ending 30 days after your sale or exchange of the shares. In such case, the basis of the shares acquired will be adjusted to reflect the
41
Taxation
disallowed loss. In addition, any loss realized upon a taxable sale or exchange of Fund shares held (or deemed held) by you for six months or less will be treated as long-term, rather than short-term, to the extent of any capital gain dividends received (or deemed received) by you with respect to those shares. Present law taxes both long-term and short-term capital gains of corporations at the rates applicable to ordinary income.
The Fund (or your broker or other financial intermediary through which you own your shares) may be required to withhold, for U.S. federal backup withholding tax purposes, a portion of the dividends, distributions and redemption proceeds payable to you if: (i) you fail to provide the Fund (or the intermediary) with your correct taxpayer identification number (in the case of an individual, generally, such individuals social security number) or to make the required certification; or (ii) the Fund (or the intermediary) has been notified by the IRS that you are subject to backup withholding. Certain shareholders are exempt from backup withholding. Backup withholding is not an additional tax and any amount withheld may be refunded or credited against your U.S. federal income tax liability, if any, provided that you furnish the required information to the IRS.
Special Considerations for Purchase and Redemption of Creation Units
An Authorized Participant that purchases Creation Units in exchange for cash, portfolio securities or a combination thereof generally will recognize a gain or a loss on the exchange. The gain or loss generally will be equal to the difference between the market value of the Creation Units at the time and the sum of the cash paid by the Authorized Participant and the Authorized Participants aggregate basis in any securities surrendered by the Authorized Participant. An Authorized Participant that redeems Creation Units for cash and/or portfolio securities generally will recognize a gain or loss equal to the difference between the Authorized Participants basis in the Creation Units surrendered and the sum of the cash received by the Authorized Participant and the aggregate market value of any securities received by the Authorized Participant. In certain cases, however, the IRS may assert that a loss realized upon an exchange of securities for Creation Units cannot be deducted currently under the rules governing wash sales, or on the basis that there has been no significant change in economic position. Authorized Participants exchanging securities should consult their own tax advisor with respect to whether or when a loss might be deductible.
Gain or loss recognized by an Authorized Participant upon a purchase of Creation Units in exchange for Component Securities or other debt instruments may be capital or ordinary gain or loss depending on the circumstances. Any capital gain or loss realized upon a purchase of Creation Units in exchange for Component Securities or other debt instruments generally will be treated as long-term capital gain or loss if the securities have been held for more than one year. Any capital gain or loss realized upon a redemption of Creation Units generally will be treated as long-term capital gain or loss if the Creation Units have been held for more than one year. Otherwise, such capital gain or loss generally will be treated as short-term capital gain or loss. Authorized Participants should consult their own tax advisor with respect to the tax treatment to them of any creation or redemption transaction.
THE FOREGOING IS A GENERAL AND ABBREVIATED SUMMARY OF THE PROVISIONS OF THE CODE AND THE TREASURY REGULATIONS IN EFFECT AS THEY DIRECTLY GOVERN THE TAXATION OF THE FUND AND ITS SHAREHOLDERS. THESE PROVISIONS ARE SUBJECT TO CHANGE BY LEGISLATIVE OR ADMINISTRATIVE ACTION, AND ANY SUCH CHANGE MAY BE RETROACTIVE. A MORE COMPLETE DISCUSSION OF THE TAX RULES APPLICABLE TO THE FUND AND ITS SHAREHOLDERS, INCLUDING FOREIGN SHAREHOLDERS, CAN BE FOUND IN THE STATEMENT OF ADDITIONAL INFORMATION, WHICH IS INCORPORATED BY REFERENCE INTO THIS PROSPECTUS. SHAREHOLDERS ARE URGED TO CONSULT THEIR TAX ADVISERS REGARDING SPECIFIC QUESTIONS AS TO U.S. FEDERAL, STATE, LOCAL AND FOREIGN INCOME OR OTHER TAXES.
42
Highland/iBoxx Senior Loan ETF |
The financial highlights table is intended to help you understand the Funds financial performance since inception. Certain information reflects financial results for a single Fund share. The total returns in the table represent the rate that an investor would have earned (or lost) on an investment in the Fund (assuming reinvestment of all dividends and distributions). This information for the years ended June 30, 2017 and June 30, 2016 has been audited by KPMG LLP, whose report, along with the Funds financial statements, are included in the Funds annual report, which is available upon request. The information for the prior periods was audited by another Independent Registered Public Accounting Firm. To request the Funds 2017 Annual Report, please call the Fund at (855) 799-4757.
For the Year
Ended |
For the Year
Ended |
For the Year
Ended |
For the Year
Ended |
For the Period
Ended |
||||||||||||||||
06/30/17 | 06/30/16 | 06/30/15 | 06/30/14 | 06/30/13 (a) | ||||||||||||||||
Net Asset Value, Beginning of Year/Period |
$ | 18.37 | $ | 19.19 | $ | 19.94 | $ | 19.93 | $ | 20.00 | ||||||||||
Income from Investment Operations: | ||||||||||||||||||||
Net investment income (b) |
0.86 | 0.81 | 0.76 | 0.93 | 0.73 | |||||||||||||||
Net realized and unrealized gain (loss) |
0.01 | (0.82 | ) | (0.75 | ) | 0.08 | (0.13 | ) | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total from investment operations |
0.87 | (0.01 | ) | 0.01 | 1.01 | 0.60 | ||||||||||||||
Less Distributions Declared to Shareholders: | ||||||||||||||||||||
From net investment income |
(0.86 | ) | (0.81 | ) | (0.76 | ) | (0.93 | ) | (0.67 | ) | ||||||||||
From net realized gains |
| | | (0.06 | ) | | ||||||||||||||
From return of capital |
(0.00 | ) (h) | | (0.00 | ) (h) | (0.01 | ) | | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total distributions declared to shareholders |
(0.86 | ) | (0.81 | ) | (0.76 | ) | (1.00 | ) | (0.67 | ) | ||||||||||
Net Asset Value, End of Year/Period | $ | 18.38 | $ | 18.37 | $ | 19.19 | $ | 19.94 | $ | 19.93 | ||||||||||
Market Price, End of Year/Period |
$ | 18.39 | $ | 18.38 | (i) | $ | 19.23 | (i) | $ | 19.93 | (i) | $ | 19.96 | (i) | ||||||
Total return (c) |
4.78 | % | 0.02 | % | 0.09 | % | 5.19 | % | 3.04 | % (g) | ||||||||||
Ratios to Average Net Assets/Supplemental Data: | ||||||||||||||||||||
Net assets, end of year/period (000s) |
$ | 562,510 | $ | 391,293 | $ | 324,371 | $ | 199,367 | $ | 89,672 | ||||||||||
Gross operating expenses (f) |
0.74 | % | 0.77 | % | 0.73 | % | 0.92 | % | 1.62 | % (d) | ||||||||||
Net investment income |
4.62 | % | 4.39 | % | 3.90 | % | 4.68 | % | 5.60 | % (d) | ||||||||||
Portfolio turnover rate |
115 | % | 51 | % | 9 | % | 35 | % | 38 | % (e) |
(a) | The Highland/iBoxx Senior Loan ETF commenced operations on November 6, 2012. |
(b) | Per share data was calculated using average shares outstanding for the period. |
(c) | Total return is at net asset value assuming all distributions are reinvested. For periods with waivers/reimbursements, had the Funds Investment Adviser not waived or reimbursed a portion of expenses, total return would have been reduced. |
(d) | Annualized. |
(e) | Not annualized. |
(f) | Supplemental expense ratios are shown below: |
For the Year
Ended |
For the Year
Ended |
For the Year
Ended |
For the Year
Ended |
For the Period
Ended |
||||||||||||||||
06/30/17 | 06/30/16 | 06/30/15 | 06/30/14 | 06/30/13 (a) | ||||||||||||||||
Net operating expenses (net of waiver/reimbursement, if applicable, but gross of all other operating expenses) |
0 .55 | % | 0.55 | % | 0.55 | % | 0.55 | % | 0.55 | % (d) |
(g) | Total return is for the period indicated and is not annualized. |
(h) | Amount represents less than $0.01 per share. |
(i) | The Market Price has not been previously audited. |
Amounts designated as are $0.
43 |
http://www.highlandfunds.com
More information about the Fund and the investment portfolios of Highland Funds I is available without charge upon request through the following:
Statement of Additional Information (SAI): The SAI, as it may be amended or supplemented from time to time, includes more detailed information about the Fund and is available, free of charge, on the Funds website at http://www.highlandfunds.com. The SAI is on file with the SEC and is incorporated by reference into this Prospectus. This means that the SAI, for legal purposes, is a part of this Prospectus.
Annual and Semi-Annual Reports: Additional information about the Funds investments is available in the Funds annual and semi-annual reports to shareholders, which are also available, free of charge, on the Funds website at http://www.highlandfunds.com.
To Obtain More Information:
By Internet:
http://www.highlandfunds.com
By Telephone:
Call (855) 799-4757
By Mail:
Highland Funds I
200 Clarendon Street, 16th Floor
Boston, MA 02116
From the SEC:
You can also obtain the SAI or the annual and semi-annual reports, as well as other information about the Fund, from the EDGAR Database on the SECs website (http://www.sec.gov). You may review and copy documents at the SEC Public Reference Room in Washington, DC. For information on the operation of the Public Reference Room, call 1-202-551-8090. You may request documents from the SEC, upon payment of a duplicating fee, by e-mailing the SEC at publicinfo@sec.gov or by writing to:
Securities and Exchange Commission
Public Reference Section
Washington, DC 20549-1520
The Trusts Investment Company Act Registration Number: 811-21866 |
HFI-ETF-PROS-1017 |
HIGHLAND FUNDS I
STATEMENT OF ADDITIONAL INFORMATION
October 31, 2017
200 Crescent Court, Suite 700,
Dallas, Texas 75201
For information, call 1-877-665-1287
HIGHLAND LONG/SHORT EQUITY FUND
Class/Ticker: A/HEOAX, C/HEOCX, Z/HEOZX
HIGHLAND LONG/SHORT HEALTHCARE FUND
Class/Ticker: A/HHCAX, C/HHCCX, Z/HHCZX
HIGHLAND MERGER ARBITRAGE FUND
Class/Ticker: A/HMEAX, C/HMECX, Z/HMEZX
HIGHLAND OPPORTUNISTIC CREDIT FUND
Class/Ticker: A/HNRAX, C/HNRCX, Z/HNRZX
This Statement of Additional Information (SAI) supplements the information contained in the Statutory Prospectus of Highland Funds I (the Trust) dated October 31, 2017, as amended (the Prospectus), and should be read in conjunction with the Prospectus. The Trust is an open-end management investment company issuing shares in six separate publicly offered series, five of which are described herein. This SAI, although not a Prospectus, is incorporated in its entirety by reference into the Prospectus. Copies of the Prospectus describing each series of the Trust described above (each a Fund and collectively the Funds or Highland Funds) may be obtained without charge by calling the Trust at the telephone number listed above.
On May 12, 2016, Highland Merger Arbitrage Fund acquired the assets of Highland Merger Arbitrage Fund, L.P., a Delaware limited partnership (the Merger Arbitrage Predecessor Fund). Highland Merger Arbitrage Fund is the successor to the performance information of the Merger Arbitrage Predecessor Fund. The Highland Merger Arbitrage Fund changed its fiscal year end from December 30 to June 30 on April 13, 2017.
On July 1, 2014, Highland Opportunistic Credit Fund acquired the assets of Highland Special Situations Fund, a Delaware statutory trust and closed-end fund (the HSSF Predecessor Fund). Highland Opportunistic Credit Fund is the successor to the accounting and performance information of the HSSF Predecessor Fund.
The Highland Long/Short Equity Funds, Highland Long/Short Healthcare Funds, Highland Merger Arbitrage Funds and Highland Opportunistic Credit Funds financial statements and notes thereto and financial highlights for the fiscal year ended June 30, 2017, including the independent registered public accounting firms report thereon, are incorporated by reference from the Funds Annual Report and have been so incorporated in reliance upon the report of the independent registered public accounting firm, given on its authority as an expert in auditing and accounting. No other parts of the Funds Annual Report or Semi-Annual Report are incorporated by reference.
1
For a free copy of the Funds Annual or Semi-Annual Reports, please call 1-877-665-1287. Information regarding the status of shareholder accounts may be obtained by calling the Trust at the telephone number listed above or by writing the Trust at Boston Financial Data Services Inc., P.O. Box 8656, Boston, Massachusetts, 02266-8656. Terms that are defined in the Prospectus shall have the same meanings in this SAI.
2
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APPENDIX B HIGHLAND CAPITAL MANAGEMENT FUND ADVISORS, L.P. PROXY VOTING POLICY |
B-1 |
3
Highland Long/Short Equity Fund (Long/Short Equity Fund), Highland Long/Short Healthcare Fund (Long/Short Healthcare Fund), Highland Opportunistic Credit Fund (Opportunistic Credit Fund) and Highland Merger Arbitrage Fund (Merger Arbitrage Fund) are each non-diversified series of Highland Funds I (the Trust), an open-end management investment company organized as a Delaware statutory trust on February 28, 2006. Long/Short Equity Fund, Long/Short Healthcare Fund, Opportunistic Credit Fund and Merger Arbitrage Fund commenced investment operations on January 1, 2000 (commencement of operations of Predecessor Fund), December 5, 2006, May 5, 2008, April 12, 2005 (commencement of operations of HSSF Predecessor Fund) and January 20, 2015 (commencement of operations of Merger Arbitrage Predecessor Fund, as defined herein) respectively. Each Fund offers three classes of shares: Class A, Class C and Class Z.
The name of the Trust was changed from Highland Funds I to Pyxis Funds I effective January 9, 2012. The name of the Trust was changed from Pyxis Funds I to Highland Funds I effective February 8, 2013.
On July 1, 2014, Opportunistic Credit Fund acquired the assets of Highland Special Situations Fund, a Delaware statutory trust and closed-end fund (the HSSF Predecessor Fund). Opportunistic Credit Fund is the successor to the accounting and performance information of the HSSF Predecessor Fund.
Merger Arbitrage Fund acquired the assets and liabilities of Highland Merger Arbitrage Fund, L.P. a Delaware limited partnership (the Merger Arbitrage Predecessor Fund), on May 12, 2016 (the Merger Arbitrage Reorganization). Following the Merger Arbitrage Reorganization, the Merger Arbitrage Predecessor Fund was the performance survivor and therefore certain information for periods prior to the date of this SAI relate to the Merger Arbitrage Predecessor Fund. In the Reorganization, shareholders of the Merger Arbitrage Predecessor Fund received Class Z Shares of the Merger Arbitrage Fund.
Highland Capital Management Advisors L.P. (formerly Pyxis Capital, L.P) (HCMFA or the Adviser) is the investment adviser to the Funds.
DESCRIPTION OF NON-PRINCIPAL INVESTMENTS AND RISK FACTORS
The principal investment objective or objectives of each Fund are not fundamental and can be changed without the approval of a majority of the outstanding voting shares of beneficial interest of that Fund. Certain investment restrictions are fundamental and cannot be changed without shareholder approval. In contrast, certain other investment restrictions, as well as the investment policies, of each Fund are not fundamental and may be changed by the Trusts Board of Trustees (the Board) without shareholder approval.
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There can be no assurance that any of the Funds will achieve their investment objective or objectives. Investors should not consider any one Fund alone to be a complete investment program. All of the Funds are subject to the risk of changing economic conditions, as well as the risk inherent in the ability of the portfolio manager to make changes in the composition of the Fund in anticipation of changes in economic, business and financial conditions. As with any security, a risk of loss is inherent in an investment in the shares of any of the Funds. The securities, investments, and investment practices used by each Fund all have attendant risks of varying degrees. For example, with respect to equity securities, there can be no assurance of capital appreciation and there is a substantial risk of decline. With respect to debt securities, there exists the risk that the issuer of a security may not be able to meet its obligations on interest or principal payments at the time required by the instrument. In addition, the value of debt instruments generally rise and fall inversely with prevailing current interest rates. As described below, an investment in certain of the Funds entails special additional risks as a result of their ability to invest a substantial portion of their assets in foreign securities.
In addition to the investment strategies implemented by the portfolio managers of the Funds described in the Prospectus and herein, the portfolio managers of certain Funds may also give trading desk personnel of the Adviser general authorization to enter into a limited amount of short-term trades (purchases expected to be sold within 15 business days) in debt instruments on behalf of such Funds. Over time, it is expected that these trades will not exceed 2% of each such Funds assets.
Supplemental information concerning certain of the securities and other instruments in which the Funds may invest, the investment policies and strategies that the Funds may utilize and certain risks attendant to those investments, policies and strategies is provided below. The following is a combined description of investment strategies and risks for the Funds, and certain strategies and risks described below may not apply to each Fund. Unless otherwise indicated, all Funds are permitted to engage in the following investment strategies and techniques. The Funds are not obligated to pursue the following strategies or techniques and do not represent that these strategies or techniques are available now or will be available at any time in the future. A Fund will not purchase all of the following types of securities or employ all of the following strategies unless doing so is consistent with its investment objective.
In addition to the principal investments described in the Prospectus, the Adviser may also invest some of the Funds assets in short-term U.S. government obligations, certificates of deposit, commercial paper and other money market instruments, including repurchase agreements with respect to such obligations, to enable the Funds to make investments quickly and to serve as collateral with respect to certain of their investments. However, if the Adviser believes that a defensive position is appropriate because of expected economic or business conditions or the outlook for security prices, a greater percentage of a Funds assets may be invested in such obligations. A Fund may purchase securities on a when-issued or forward commitment basis, engage in securities lending activities, and invest up to 33 1/3% of its total assets in reverse repurchase agreements when aggregated with all other borrowings (other than temporary borrowings). Each Fund may also invest its assets (up to 20% of Long/Short Equity Funds assets and up to 100% of Long/Short Healthcare Funds and Opportunistic Credit Funds assets) in high yield bonds (also known as junk bonds) which are bonds typically rated below investment grade by one or more nationally recognized statistical ratings organizations (NRSROs). NRSROs generally regard high-yield debt securities as predominately speculative with respect to ability to pay interest and repay principal and riskier than higher-rated debt securities. Appendix A contains additional information concerning the characteristics of the ratings used by certain NRSROs. From time to time, in the sole discretion of the Adviser, cash balances of the Funds may be placed in a money market fund or investments may be made in shares of other investment companies, subject to the applicable limits under the Investment Company Act of 1940, as amended (the 1940 Act).
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Limited Role in Affairs of Portfolio Companies. Although the Adviser does not take an active role in the affairs of the companies in which the Funds have positions other than voting proxies with respect to the Funds portfolio holdings, it will be the policy of each Fund to take such steps as are necessary to protect its economic interests. If the opportunity presents itself, the Adviser reserves the option for any of its investment personnel to accept a role on the board of directors of any company, regardless of whether a Fund holds any of the companys securities.
Financial Futures. The Funds are sponsored by the Adviser, which is registered as a commodity pool operator and commodity trading adviser under the Commodity Exchange Act (CEA). However, pursuant to Commodity Futures Trading Commission (the CFTC) Rule 4.5, the Adviser has claimed an exclusion from the definition of the term commodity pool operator under the CEA; therefore, the Adviser, with respect to the Funds, is not subject to registration or regulation as a commodity pool operator under the CEA. To remain eligible for the exclusion under CFTC Rule 4.5, the Funds will be limited in their ability to use certain derivative instruments regulated under the CEA (commodity interests), including futures, swaps and options on futures. In the event that a Funds investments in commodity interests exceed a certain threshold, the Adviser may be required to register as a commodity pool operator and/or commodity trading advisor with the CFTC with respect to that Fund. The Advisers eligibility to claim the exclusion with respect to a Fund will be based upon the level and scope of such Funds investment in commodity interests, the purposes of such investments and the manner in which that Fund holds out its use of commodity interests. For example, CFTC Rule 4.5 requires a fund with respect to which the sponsor is claiming the exclusion to, among other things, satisfy one of the two following trading thresholds: (i) the aggregate initial margin and premiums required to establish positions in commodity interests cannot exceed 5% of the liquidation value of the funds portfolio, after taking into account unrealized profits and unrealized losses; or (ii) the aggregate net notional value of commodity interests not used solely for bona fide hedging purposes, determined at the time the most recent position was established, cannot generally exceed 100% of the liquidation value of the funds portfolio, after taking into account unrealized profits and unrealized losses on any such positions it has entered into. In the event a Fund becomes unable to rely on the exclusion in Rule 4.5 and the Adviser is required to register with the CFTC as a commodity pool operator with respect to that Fund, the Funds expenses may increase.
The CFTC and certain futures exchanges have established limits, referred to as position limits, on the maximum net long or net short positions which any person may hold or control in particular options and futures contracts; those position limits may in the future also apply to certain other derivatives positions a Fund may wish to take. All positions owned or controlled by the same person or entity, even if in different accounts, may in the future be aggregated for purposes of determining whether the applicable position limits have been exceeded. Thus, even if a Fund does not intend to exceed applicable position limits, it is possible that different clients managed by the Adviser and its affiliates may be aggregated for this purpose. Therefore, it is possible that in the future the trading decisions of the Adviser may have to be modified and that positions held by a Fund may have to be liquidated in order to avoid exceeding such limits. The modification of investment decisions or the elimination of open positions, if it occurs, may adversely affect the performance of a Fund.
Fixed-Income and Other Debt Securities
Fixed-income and other debt instrument securities include all bonds, high yield or junk bonds, municipal bonds, debentures, U.S. Government securities, mortgage-related securities, zero coupon securities and custodial receipts. The market value of fixed-income obligations of a Fund will be affected by general changes in interest rates, which will result in increases or decreases in the
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value of the obligations held by a Fund. The market value of the fixed-income obligations held by a Fund can be expected to vary inversely to changes in prevailing interest rates. As a result, shareholders should anticipate that the market value of the fixed-income obligations held by a Fund generally will increase when prevailing interest rates are declining and generally will decrease when prevailing interest rates are rising. Shareholders also should recognize that, in periods of declining interest rates, a Funds yield will tend to be somewhat higher than prevailing market rates and, in periods of rising interest rates, a Funds yield will tend to be somewhat lower. Also, when interest rates are falling, the inflow of net new money to a Fund from the continuous sale of its shares will tend to be invested in instruments producing lower yields than the balance of its portfolio, thereby reducing a Funds current yield. In periods of rising interest rates, the opposite can be expected to occur. In addition, securities in which a Fund may invest may not yield as high a level of current income as might be achieved by investing in securities with less liquidity, less creditworthiness or longer maturities.
Ratings made available by NRSROs are relative and subjective and are not absolute standards of quality. Although these ratings are initial criteria for selection of portfolio investments, the Adviser also will make its own evaluation of these securities. Among the factors that will be considered are the long-term ability of the issuers to pay principal and interest and general economic trends.
Fixed-income securities may be purchased on a when-issued or delayed-delivery basis. See When-Issued Securities and Forward Commitments below.
Commercial Paper. Commercial paper consists of short-term (usually from 1 to 270 days) unsecured promissory notes issued by corporations in order to finance their current operations. A variable amount master demand note (which is a type of commercial paper) represents a direct borrowing arrangement involving periodically fluctuating rates of interest under a letter agreement between a commercial paper issuer and an institutional lender pursuant to which the lender may determine to invest varying amounts.
Medium-, Lower-Rated and Unrated Securities . Securities rated in the fourth highest category by a NRSRO, although considered investment grade, may possess speculative characteristics, and changes in economic or other conditions are more likely to impair the ability of issuers of these securities to make interest and principal payments than is the case with respect to issuers of higher grade bonds.
Generally, medium- or lower-rated securities and unrated securities of comparable quality, sometimes referred to as junk bonds, offer a higher current yield than is offered by higher rated securities, but also (i) will likely have some quality and protective characteristics that, in the judgment of the rating organizations, are outweighed by large uncertainties or major risk exposures to adverse conditions and (ii) are predominantly speculative with respect to the issuers capacity to pay interest and repay principal in accordance with the terms of the obligation. The yield of junk bonds will fluctuate over time.
The market values of certain of these securities also tend to be more sensitive to individual corporate developments and changes in economic conditions than higher quality bonds. In addition, medium- and lower-rated securities and comparable unrated securities generally present a higher degree of credit risk. The risk of loss due to default by these issuers is significantly greater because medium- and lower-rated securities, and unrated securities of comparable quality, generally are unsecured and frequently are subordinated to the prior payment of senior indebtedness. Since the risk of default is higher for lower-rated debt securities, the Advisers research and credit analysis are an especially important part of managing securities of this type held by a Fund.
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In addition, the market for securities in lower-rated categories is more volatile than that for higher-rated securities, and the markets in which medium- and lower-rated or unrated securities are traded are more limited than those in which higher-rated securities are traded. The existence of limited markets may make it more difficult for the Fund to obtain accurate market quotations for purposes of valuing its portfolio and calculating its net asset value. Moreover, the lack of a liquid trading market may restrict the availability of securities for a Fund to purchase and may also have the effect of limiting the ability of a Fund to sell securities at their fair value either to meet redemption requests or to respond to changes in the economy or the financial markets.
Lower-rated debt obligations also present risks based on payment expectations. If an issuer calls the obligation for redemption, a Fund may have to replace the security with a lower yielding security, resulting in a decreased return for shareholders. Also, as the principal value of bonds moves inversely with movements in interest rates, in the event of rising interest rates the value of the securities held by a Fund may decline relatively proportionately more than a portfolio consisting of higher rated securities. If a Fund experiences unexpected net redemptions, it may be forced to sell its higher rated bonds, resulting in a decline in the overall credit quality of the securities held by a Fund and increasing the exposure of a Fund to the risks of lower rated securities. Investments in zero coupon bonds may be more speculative and subject to greater fluctuations in value due to changes in interest rates than bonds that pay interest currently.
Subsequent to its purchase by a Fund, an issue of securities may cease to be rated or its rating may be reduced. Neither event will require sale of these securities by the Fund, but the Adviser will consider this event in its determination of whether a Fund should continue to hold the securities.
The market for lower-rated debt securities may be thinner and less active than that for higher rated debt securities, which can adversely affect the prices at which the former are sold. If market quotations are not available, lower-rated debt securities will be valued in accordance with procedures established by the Board, including the use of outside pricing services. Judgment plays a greater role in valuing high yield corporate debt securities than is the case for securities for which more external sources for quotations and last sale information is available. Adverse publicity and changing investor perception may affect the ability of outside pricing services to value lower-rated debt securities and the ability to dispose of these securities.
In considering investments for a Fund, the Adviser will attempt to identify those issuers of high yielding debt securities whose financial condition is adequate to meet future obligations or has improved or is expected to improve in the future. The analysis of the Adviser focuses on relative values based on such factors as interest or dividend coverage, asset coverage, earnings prospects and the experience and managerial strength of the issuer.
A Fund may choose, at its expense or in conjunction with others, to pursue litigation or otherwise exercise its rights as a security holder to seek to protect the interest of security holders if it determines this to be in the best interest of the Fund.
Investments in high-yield debt obligations or other debt obligations that are at risk of, or are in, default present special tax issues for a Fund investing in or holding such securities. See Income Tax Considerations below.
Certificates of Deposit, Bankers Acceptances and Time Deposits. Certificates of deposit are receipts issued by a depository institution in exchange for the deposit of funds. The issuer agrees to pay the amount deposited plus interest to the bearer of the receipt on the date specified on the certificate. The certificate usually can be traded in the secondary market prior to maturity. Bankers
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acceptances typically arise from short-term credit arrangements designed to enable businesses to obtain funds to finance commercial transactions. Generally, an acceptance is a time draft drawn on a bank by an exporter or an importer to obtain a stated amount of funds to pay for specific merchandise. The draft is then accepted by a bank that, in effect, unconditionally guarantees to pay the face value of the instrument on its maturity date. The acceptance may then be held by the accepting bank as an earning asset or it may be sold in the secondary market at the going rate of discount for a specific maturity. Although maturities for acceptances can be as long as 270 days, most acceptances have maturities of six months or less.
Time deposits are non-negotiable deposits maintained in a banking institution for a specified period of time at a stated interest rate. Investments in time deposits maturing in more than seven days will be subject to the U.S. Securities and Exchange Commissions (SEC) restrictions that limit investments in illiquid securities to no more than 15% of the value of a Funds net assets.
U.S. Government Securities. U.S. Government securities are obligations issued or guaranteed by the U.S. Government, its agencies, authorities or instrumentalities. Some U.S. Government securities, such as U.S. Treasury bills, Treasury notes and Treasury bonds, which differ only in their interest rates, maturities and times of issuance, are supported by the full faith and credit of the United States. Others are supported by: (i) the right of the issuer to borrow from the U.S. Treasury, such as securities of the Federal Home Loan Banks; (ii) the discretionary authority of the U.S. Government to purchase the agencys obligations, such as securities of the Federal National Mortgage Association or (iii) only the credit of the issuer, such as securities of the Student Loan Marketing Association. No assurance can be given that the U.S. Government will provide financial support in the future to U.S. Government agencies, authorities or instrumentalities that are not supported by the full faith and credit of the United States. To the extent a Fund invests in U.S. Government securities that are not backed by the full faith and credit of the U.S. Treasury, such investments may involve a greater risk of loss of principal and interest since a Fund must look principally or solely to the issuing or guaranteeing agency or instrumentality for repayment.
Securities guaranteed as to principal and interest by the U.S. Government, its agencies, authorities or instrumentalities include: (i) securities for which the payment of principal and interest is backed by an irrevocable letter of credit issued by the U.S. Government or any of its agencies, authorities or instrumentalities; and (ii) participation interests in loans made to foreign governments or other entities that are so guaranteed. The secondary market for certain of these participation interests is limited and, therefore, may be regarded as illiquid.
U.S. Treasury Bills . U.S. Treasury Bills are issued with maturities of up to one year. Three month bills are currently offered by the Treasury on a 13-week cycle and are auctioned each week by the Treasury. Bills are issued in bearer form only and are sold only on a discount basis, and the difference between the purchase price and the maturity value (or the resale price if they are sold before maturity) constitutes the interest income for the investor.
Mortgage-Related Securities. There are several risks associated with mortgage-related securities. One is that the monthly cash inflow from the underlying loans may not be sufficient to meet the monthly payment requirements of the mortgage-related security. Prepayment of principal by mortgagors or mortgage foreclosures will shorten the term of the underlying mortgage pool for a mortgage-related security. Early returns of principal will affect the average life of the mortgage-related securities remaining in a Fund. The occurrence of mortgage prepayments is affected by factors including the level of interest rates, general economic conditions, the location and age of the mortgage and other social and demographic conditions. In periods of rising interest rates, the rate of prepayment tends to decrease, thereby lengthening the average life of a pool of mortgage-related securities. Conversely, in periods of falling interest rates, the rate of prepayment tends to increase,
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thereby shortening the average life of a pool. Reinvestment of prepayments may occur at higher or lower interest rates than the original investment, thus affecting the yield of a Fund. Because prepayments of principal generally occur when interest rates are declining, it is likely that a Fund will have to reinvest the proceeds of prepayments at lower interest rates than those at which the assets were previously invested. If this occurs, a Funds yield will correspondingly decline. Thus, mortgage-related securities may have less potential for capital appreciation in periods of falling interest rates than other fixed-income securities of comparable maturity, although these securities may have a comparable risk of decline in market value in periods of rising interest rates. To the extent that the Fund purchases mortgage-related securities at a premium, unscheduled prepayments, which are made at par, will result in a loss equal to any unamortized premium.
Collateralized Mortgage Obligations (CMOs) are obligations fully collateralized by a portfolio of mortgages or mortgage-related securities. Payments of principal and interest on the mortgages are passed through to the holders of the CMOs on the same schedule as they are received, although certain classes of CMOs have priority over others with respect to the receipt of prepayments on the mortgages. Therefore, depending on the type of CMOs in which a Fund invests, the investment may be subject to a greater or lesser risk of prepayment than other types of mortgage-related securities.
Mortgage-related securities may not be readily marketable. To the extent any of these securities are not readily marketable in the judgment of the Adviser, a Funds restrictions on investments in illiquid instruments will apply.
Zero Coupon Securities. Zero coupon U.S. Government securities are debt obligations that are issued or purchased at a significant discount from face value. The discount approximates the total amount of interest the security will accrue and compound over the period until maturity or the particular interest payment date at a rate of interest reflecting the market rate of the security at the time of issuance. Zero coupon securities do not require the periodic payment of interest. These investments benefit the issuer by mitigating its need for cash to meet debt service, but also require a higher rate of return to attract investors who are willing to defer receipt of cash. These investments may experience greater volatility in market value than U.S. Government securities that make regular payments of interest. A Fund accrues income on these investments for tax and accounting purposes, which must be distributed to shareholders in order to avoid taxation. Because no cash is received at the time of accrual, a Fund may be required to liquidate other portfolio securities (including when it is not advantageous to do so) to satisfy a Funds distribution obligations (see Income Tax Considerations below), in which case a Fund will forego the purchase of additional income producing assets. Zero coupon securities include Separately Traded Registered Interest and Principal Securities (STRIPS). STRIPS are securities underwritten by securities dealers or banks that evidence ownership of future interest payments, principal payments or both on certain notes or bonds issued by the U.S. Government, its agencies, authorities or instrumentalities. They also include Coupons Under Book Entry Safekeeping (CUBES), which are component parts of U.S. Treasury bonds and represent scheduled interest and principal payments on the bonds.
Custodial Receipts . Custodial receipts or certificates include Certificates of Accrual on Treasury Securities (CATS), Treasury Investment Growth Receipts (TIGRs) and Financial Corporation certificates (FICO Strips). CATS, TIGRs and FICO Strips are securities underwritten by securities dealers or banks that evidence ownership of future interest payments, principal payments or both on certain notes or bonds issued by the U.S. Government, its agencies, authorities or instrumentalities. The underwriters of these certificates or receipts purchase a U.S. Government security and deposit the security in an irrevocable trust or custodial account with a custodian bank, which then issues receipts or certificates that evidence ownership of the periodic unmatured coupon payments and the final principal payment on the U.S. Government security. Custodial receipts evidencing specific coupon or principal payments have the same general attributes as zero coupon
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U.S. Government securities, described above. Although typically under the terms of a custodial receipt a Fund is authorized to assert its rights directly against the issuer of the underlying obligation, a Fund may be required to assert through the custodian bank such rights as may exist against the underlying issuer. Thus, if the underlying issuer fails to pay principal and/or interest when due, a Fund may be subject to delays, expenses and risks that are greater than those that would have been involved if a Fund had purchased a direct obligation of the issuer. In addition, if the trust or custodial account in which the underlying security has been deposited were determined to be an association taxable as a corporation, instead of a non-taxable entity, the yield on the underlying security would be reduced in respect of any taxes paid.
Loans and Other Direct Debt Instruments. These are instruments in amounts owed by a corporate, governmental or other borrower to another party. They may represent amounts owed to lenders or lending syndicates (loans and loan participations), to suppliers of goods or services (trade claims or other receivables) or to other parties. Direct debt instruments purchased by a Fund may have a maturity of any number of days or years, may be secured or unsecured, and may be of any credit quality. Direct debt instruments involve the risk of loss in the case of default or insolvency of the borrower. Direct debt instruments may offer less legal protection to a Fund in the event of fraud or misrepresentation. In addition, loan participations involve a risk of insolvency of the lending bank or other financial intermediary. Direct debt instruments also may include standby financing commitments that obligate a Fund to supply additional cash to the borrower on demand at a time when a Fund would not have otherwise done so, even if the borrowers condition makes it unlikely that the amount will ever be repaid.
These instruments will be considered illiquid securities and so will be limited in accordance with a Funds restrictions on illiquid securities.
Because loans are not ordinarily registered with the SEC or any state securities commission or listed on any securities exchange, there is usually less publicly available information about such instruments. In addition, loans may not be considered securities for purposes of the anti-fraud provisions under the federal securities laws and, as a result, as a purchaser of these instruments, a Fund may not be entitled to the anti-fraud protections of the federal securities laws. In the course of investing in such instruments, a Fund may come into possession of material nonpublic information and, because of prohibitions on trading in securities of issuers while in possession of such information, the Fund may be unable to enter into a transaction in a publicly-traded security of that issuer when it would otherwise be advantageous for the Fund to do so. Alternatively, a Fund may choose not to receive material nonpublic information about an issuer of such loans, with the result that the Fund may have less information about such issuers than other investors who transact in such assets.
Illiquid Securities
Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act of 1933, as amended (the 1933 Act), securities that are otherwise not readily marketable and repurchase agreements having a maturity of longer than seven days. Securities that have not been registered under the 1933 Act are referred to as private placements or restricted securities and are purchased directly from the issuer or in the secondary market. Investment companies do not typically hold a significant amount of these restricted securities or other illiquid securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have an adverse effect on the marketability of portfolio securities and an investment company might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions within seven days. An investment company might also have to
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register such restricted securities in order to dispose of them, which would result in additional expense and delay. Adverse market conditions could impede such a public offering of securities. A Fund may not acquire any illiquid securities if, as a result thereof, more than 15% of the market value of such Funds net assets would be in investments that are illiquid or otherwise not readily marketable.
In recent years, however, a large institutional market has developed for certain securities that are not registered under the 1933 Act, including repurchase agreements, commercial paper, foreign securities, municipal securities and corporate bonds and notes. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuers ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale of such investments to the general public or to certain institutions may not be indicative of their liquidity.
| Rule 144A Securities. The SEC has adopted Rule 144A, which allows a broader institutional trading market for securities otherwise subject to restriction on their resale to the general public. Rule 144A establishes a safe harbor from the registration requirements of the 1933 Act on resales of certain securities to qualified institutional buyers. The Adviser will monitor the liquidity of Rule 144A securities in a Funds portfolio under the oversight of the Board. In reaching liquidity decisions, the Adviser will consider, among other things, the following factors: (1) the frequency of trades and quotes for the security; (2) the number of dealers and other potential purchasers wishing to purchase or sell the security; (3) dealer undertakings to make a market in the security; and (4) the nature of the security and of the marketplace trades ( e.g. , the time needed to dispose of the security, the method of soliciting offers and the mechanics of the transfer). |
A Fund may purchase securities in the United States that are not registered for sale under federal securities laws but which can be resold to institutions under Rule 144A or under an exemption from such laws. Provided that a dealer or institutional trading market in such securities exists, these restricted securities or Rule 144A securities are treated as exempt from the Funds limit on illiquid securities. The Board, with advice and information from the Adviser will determine the liquidity of restricted securities or Rule 144A securities by looking at factors such as trading activity and the availability of reliable price information and, through reports from the Adviser, the Board will monitor trading activity in restricted securities. If institutional trading in restricted securities or Rule 144A securities were to decline, a Funds illiquidity could increase and the Fund could be adversely affected.
| Section 4(a)(2) Commercial Paper. A Fund may invest in commercial paper issued in reliance on the exemption from registration afforded by Section 4(a)(2) of the 1933 Act. Section 4(a)(2) commercial paper is restricted as to disposition under federal securities laws and is generally sold to institutional investors who agree that they are purchasing the paper for investment purposes and not with a view to public distribution. Any resale by the purchaser must be in an exempt transaction. Section 4(a)(2) commercial paper is normally resold to other institutional investors through or with the assistance of the issuer or investment dealers who make a market in Section 4(a)(2) commercial paper, thus providing liquidity. The Adviser believes that Section 4(a)(2) commercial paper and possibly certain other restricted securities that meet the criteria for liquidity established by the Board are quite liquid. The Funds intend therefore, to treat the restricted securities which meet the criteria for liquidity established by the Board, including Section 4(a)(2) commercial paper, as determined by the Adviser as liquid and not subject to the investment limitation applicable to illiquid securities. In addition, because Section 4(a)(2) commercial paper is liquid, the Funds do not intend to subject such paper to the limitation applicable to restricted securities. Each Fund will not invest more than 10% of its total assets in restricted securities (excluding Rule 144A securities). |
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Borrowing and Lending
Borrowing. Each Fund may borrow money from banks (including their custodian bank) or from other lenders to the extent permitted under applicable law. The 1940 Act requires a Fund maintain asset coverage of at least 300% for all such borrowings, and should such asset coverage at any time fall below 300%, the Fund would be required to reduce its borrowings within three days to the extent necessary to meet the requirements of the 1940 Act. No Fund will make any borrowing that would cause its outstanding borrowings to exceed one-third of the value of its total assets. To reduce its borrowings, a Fund might be required to sell securities at a time when it would be disadvantageous to do so. In addition, because interest on money borrowed is a Fund expense that it would not otherwise incur, the Fund may have less net investment income during periods when its borrowings are substantial. The interest paid by the Fund on borrowings may be more or less than the yield on the securities purchased with borrowed funds, depending on prevailing market conditions.
Securities Loans . Each Fund may seek additional income by making secured loans of its portfolio securities through its custodian, State Street Bank and Trust Company (State Street). Such loans will be in an amount not greater than one-third of the value of the Funds total assets. State Street will charge a Fund fees based on a percentage of the securities lending income. The Funds will receive collateral consisting of cash (U.S. and foreign currency), securities issued or guaranteed by the U.S. government or its agencies or instrumentalities, sovereign debt, convertible bonds, irrevocable bank letters of credit or such other collateral as may be agreed on by the parties to a securities lending arrangement, initially with a value of 102% or 105% of the market value of the loaned securities and thereafter maintained at a value of 100% of the market value of the loaned securities.. If the collateral consists of non-cash collateral, the borrower will pay the Fund a loan premium fee. If the collateral consists of cash, State Street will reinvest the cash. Although voting rights, or rights to consent, with respect to the loaned securities pass to the borrower, the Fund will recall the loaned securities upon reasonable notice in order that the securities may be voted by the Fund if the holders of such securities are asked to vote upon or consent to matters materially affecting the investment. The Fund also may call such loans in order to sell the securities involved.
The risks in lending portfolio securities, as with other extensions of credit, consist of possible delays in recovery of the securities or possible loss of rights in the collateral should the borrower fail financially. A Fund also bears the risk that the value of investments made with collateral may decline. Although a Fund has the right to call loans at any time on reasonable notice and will do so if holders of a loaned security are asked to vote upon or consent to material matters, the Fund bears the risk of delay in the return of the security, impairing the Funds ability to vote on such matters.
Securities lending also exposes a Fund to counterparty risk, as the borrower of the Funds securities may be unable or unwilling to make timely principal, interest, or settlement payments or otherwise honor its obligations. There can be no assurance that a counterparty will meet its obligations, especially during unusually adverse market conditions. If the counterparty defaults, the Fund will have contractual remedies, but the Fund may be unable to enforce its contractual rights.
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Derivatives
Each Fund may invest in various instruments that are commonly known as derivatives to any extent deemed by the Adviser to be in the best interest of the Funds, and to the extent permitted by the 1940 Act. Generally, a derivative is a financial arrangement, the value of which is based on, or derived from, a traditional security, asset or market index. There are, in fact, many different types of derivatives and many different ways to use them. There is a range of risks associated with those uses. Futures and options are commonly used for traditional hedging purposes to attempt to protect a Fund from exposure to changing interest rates, securities prices or currency exchange rates and as a low cost method of gaining exposure to a particular securities market without investing directly in those securities. However, some derivatives are used for leverage, which tends to magnify the effects of an instruments price changes as market conditions change. Leverage involves the use of a small amount of money to control a large amount of financial assets, and can in some circumstances lead to significant losses.
In addition, the SEC recently proposed a rule under the 1940 Act regulating the use by registered investment companies of derivatives and many related instruments. That rule, if adopted as proposed, would, among other things, restrict a Funds ability to engage in derivatives transactions or so increase the cost of derivatives transactions that a Fund would be unable to implement its investment strategy.
Options. An option on a security is a contract that gives the holder of the option, in return for a premium, the right to buy from (in the case of a call) or sell to (in the case of a put) the writer of the option the security underlying the option at a specified exercise or strike price.
The Funds may write (sell) covered call and put options (covered options) on stocks, securities, futures contracts, non-physical commodities, indices and foreign currencies in an attempt to increase income. When a Fund writes a covered call option, it gives the purchaser of the option the right to buy, and obligates the writer to sell, the underlying security at the price specified in the option (the exercise price) by exercising the option at any time during the option period. If the option expires unexercised, the Fund will realize income in an amount equal to the premium received for writing the option. If the option is exercised, a decision over which the Fund has no control, the Fund must sell the underlying security to the option holder at the exercise price. By writing a covered call option, a Fund foregoes, in exchange for the premium less the commission (net premium), the opportunity to profit during the option period from an increase in the market value of the underlying security above the exercise price.
When a Fund writes a covered put option, it gives the purchaser of the option the right to sell, and obligates the writer to buy, the underlying security to the Fund at the specified exercise price at any time during the option period. If the option expires unexercised, the Fund will realize income in the amount of the premium received for writing the option. If the put option is exercised, a decision over which the Fund has no control, the Fund must purchase the underlying security from the option holder at the exercise price. By writing a covered put option, the Fund, in exchange for the net premium received, accepts the risk of a decline in the market value of the underlying security below the exercise price.
A Fund may terminate its obligation as the writer of a call or put option by purchasing an option with the same exercise price and expiration date as the option previously written. This transaction is called a closing purchase transaction. With respect to writing covered options, the Fund will realize a profit or loss for a closing purchase transaction if the amount paid to purchase an option is less or more, as the case may be, than the amount received from the sale thereof. To close out a position as a purchaser of an option, the Fund may make a closing sale transaction which involves liquidating
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the Funds position by selling the option previously purchased. Where the Fund cannot effect a closing purchase transaction, it may be forced to incur brokerage commissions or dealer spreads in selling securities it receives or it may be forced to hold underlying securities until an option is exercised or expires.
When a Fund writes a call option, it will cover its obligation by owning and earmarking the underlying security or other assets on the books of the Funds custodian. When a Fund writes a put option, it will cover its obligation by earmarking assets at the Funds custodian.
A Fund may purchase call and put options on any securities in which it may invest. A Fund would normally purchase a call option in anticipation of an increase in the market value of such securities. The purchase of a call option would entitle the Fund, in exchange for the premium paid, to purchase a security at a specified price during the option period. The Fund would ordinarily have an economic gain if the value of the securities increased above the exercise price sufficiently to cover the premium and would have an economic loss if the value of the securities remained at or below the exercise price during the option period.
A Fund would normally purchase put options in anticipation of a decline in the market value of securities in its portfolio (protective puts) or securities of the type in which it is permitted to invest. The purchase of a put option would entitle the Fund, in exchange for the premium paid, to sell a security, which may or may not be held in the Funds portfolio, at a specified price during the option period. The purchase of protective puts is designed merely to offset or hedge against a decline in the market value of a Funds portfolio securities. Put options also may be purchased by the Fund for the purpose of affirmatively benefiting from a decline in the price of securities which the Fund does not own. Upon exercise, the Fund would ordinarily realize a gain if the value of the securities decreased below the exercise price sufficiently to cover the premium and would realize a loss if the value of the securities remained at or above the exercise price. Gains and losses on the purchase of protective put options would tend to be offset by countervailing changes in the value of underlying portfolio securities.
Options on Securities Indices . A Fund may purchase and write put and call options on securities indices listed on domestic and on foreign exchanges. Such options give the holder the right to receive a cash settlement during the term of the option based upon the difference between the exercise price and the value of the index. Options on securities indices entail risks in addition to the risks of options on securities. The absence of a liquid secondary market to close out options positions on securities indices is more likely to occur. Use of options on securities indices also entails the risk that trading in such options may be interrupted if trading in certain securities included in the index is interrupted.
Because options on securities indices require settlement in cash, the Adviser may be forced to liquidate portfolio securities to meet settlement obligations. When a Fund writes a put or call option on a securities index, it will cover the position by earmarking assets with the Funds custodian.
Options on Foreign Currencies . A Fund may write covered put and call options and purchase put and call options on foreign currencies for the purpose of protecting against declines in the dollar value of portfolio securities and against increases in the dollar cost of securities to be acquired. For example, a decline in the dollar value of a foreign currency in which portfolio securities are denominated will reduce the dollar value of such securities, even if their value in the foreign currency remains constant. In order to protect against such diminutions in the value of portfolio securities, a Fund may purchase put options on the foreign currency. If the value of the currency does decline, a Fund will have the right to sell such currency for a fixed amount in dollars and will thereby offset, in whole or in part, the adverse effect on its portfolio which otherwise would have resulted.
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Conversely, where a rise in the dollar value of a currency in which securities to be acquired are denominated is projected, thereby increasing the cost of such securities, a Fund may purchase call options thereon. The purchase of such options could offset, at least partially, the effects of the adverse movements in exchange rates. As in the case of other types of options, however, the benefit to a Fund derived from purchases of foreign currency options will be reduced by the amount of the premium and related transaction costs. In addition, where currency exchange rates do not move in the direction or to the extent anticipated, the Fund could sustain losses on transactions in foreign currency options that would require it to forego a portion or all of the benefits of advantageous changes in such rates.
As in the case of forward contracts, certain options on foreign currencies are traded over-the-counter and involve liquidity and credit risks that may not be present in the case of exchange-traded currency options. A Funds ability to terminate over-the-counter options (OTC Options) will be more limited than the exchange-traded options. It is also possible that broker-dealers participating in OTC Options transactions will not fulfill their obligations. Until such time as the staff of the SEC changes its position, the Funds will treat purchased OTC Options and assets used to cover written OTC Options as illiquid securities. With respect to options written with primary dealers in U.S. Government securities pursuant to an agreement requiring a closing purchase transaction at a formula price, the amount of illiquid securities may be calculated with reference to the repurchase formula.
Forward Currency Contracts. Because, when investing in foreign securities, a Fund buys and sells securities denominated in currencies other than the U.S. dollar and receives interest, dividends and sale proceeds in currencies other than the U.S. dollar, the Fund from time to time may enter into forward currency transactions to convert to and from different foreign currencies and to convert foreign currencies to and from the U.S. dollar. The Fund either enters into these transactions on a spot (i.e., cash) basis at the spot rate prevailing in the foreign currency exchange market or uses forward currency contracts to purchase or sell foreign currencies.
A forward currency contract is an obligation by a Fund to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract. Forward currency contracts establish an exchange rate at a future date. These contracts are transferable in the interbank market conducted directly between currency traders (usually large commercial banks) and their customers. A forward currency contract generally has no deposit requirement and is traded at a net price without commission. The Fund earmarks liquid securities at its custodian in an amount at least equal to its obligations under each forward currency contract. Neither spot transactions nor forward currency contracts eliminate fluctuations in the prices of the Funds securities or in foreign exchange rates, or prevent loss if the prices of these securities should decline.
A Fund may enter into foreign currency hedging transactions in an attempt to protect against changes in foreign currency exchange rates between the trade and settlement dates of specific securities transactions or changes in foreign currency exchange rates that would adversely affect a portfolio position or an anticipated investment position. Although these transactions tend to minimize the risk of loss due to a decline in the value of the hedged currency, at the same time they tend to limit any potential gain that might be realized should the value of the hedged currency increase. The precise matching of the forward currency contract amounts and the value of the securities involved will not generally be possible because the future value of such securities in foreign currencies will change as a consequence of market movements in the value of such securities between the date the forward currency contract is entered into and the date it matures. The projection of currency market movements is extremely difficult, and the successful execution of a hedging strategy is highly uncertain.
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While these contracts are not presently regulated by the CFTC, the CFTC may in the future assert authority to regulate forward currency contracts. In such event a Funds ability to utilize forward currency contracts may be restricted. Forward currency contracts may reduce the potential gain from a positive change in the relationship between the U.S. dollar and foreign currencies. Unanticipated changes in currency prices may result in poorer overall performance for the Fund than if it had not entered into such contracts. The use of forward currency contracts may not eliminate fluctuations in the underlying U.S. dollar equivalent value of the prices of or rates of return on the Funds foreign currency denominated portfolio securities and the use of such techniques will subject the Fund to certain risks.
The matching of the increase in value of a forward currency contract and the decline in the U.S. dollar equivalent value of the foreign currency denominated asset that is the subject of the hedge generally will not be precise. In addition, a Fund may not always be able to enter into forward currency contracts at attractive prices and this will limit the Funds ability to use such contract to hedge or cross-hedge its assets. Also, with regard to the Funds use of cross-hedges, there can be no assurance that historical correlations between the movements of certain foreign currencies relative to the U.S. dollar will continue. Thus, at any time poor correlation may exist between movements in the exchange rates of the foreign currencies underlying the Funds cross-hedges and the movements in the exchange rates of the foreign currencies in which the Funds assets that are the subject of such cross-hedges are denominated.
Futures Contracts and Related Options. To the extent consistent with applicable law, each Fund may invest in futures contracts on, among other things, individual equity securities, securities indices, interest rates, currencies, non-physical commodities and inflation indices. The sale of a futures contract creates an obligation by a Fund, as seller, to deliver the specific type of financial instrument called for in the contract at a specified future time for a specified price. At the time a futures contract is purchased or sold, a Fund must allocate cash or securities as a deposit payment (initial margin). It is expected that the initial margin that the Fund will pay may range from approximately 1% to approximately 5% of the value of the securities or commodities underlying the contract. In certain circumstances, however, such as periods of high volatility, a Fund may be required by an exchange to increase the level of its initial margin payment. Certain futures contracts are physically settled (i.e., involve the making and taking of delivery of a specified amount of an underlying security or other asset). Some futures contracts, however, are cash settled, which means that the purchase price is subtracted from the current market value of the instrument and the net amount, if positive, is paid to the purchaser by the seller of the futures contract and, if negative, is paid by the purchaser to the seller of the futures contract.
Options on futures contracts are similar to options on securities except that an option on a futures contract gives the purchaser the right in return for the premium paid to assume a position in a futures contract (a long position if the option is a call and a short position if the option is a put).
Futures contracts and related options involve costs and may result in losses in excess of the amount invested in the futures contract or related option. If a futures contract is used for hedging, an imperfect correlation between movements in the price of the futures contract and the price of the security, currency, or other investment being hedged creates risk. Correlation is higher when the investment being hedged underlies the futures contract. Correlation is lower when the investment being hedged is different than the instrument underlying the futures contract, such as when a futures contract on one security or commodity is used to hedge a different security or commodity or when a futures contract in one currency is used to hedge a security denominated in another currency. In the event of an imperfect correlation between a futures position and the portfolio position (or anticipated position) intended to be protected, the Fund may realize a loss on the futures contract and/or on the portfolio position intended to be protected. The risk of imperfect correlation generally tends to
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diminish as the maturity date of the futures contract approaches. To compensate for imperfect correlations, a Fund may purchase or sell futures contracts in a greater amount than the hedged investments if the volatility of the price of the hedged investments is historically greater than the volatility of the futures contracts. Conversely, a Fund may purchase or sell fewer futures contracts if the volatility of the price of the hedged investments is historically less than that of the futures contract.
The Funds ability to engage in the futures and options on futures strategies depends on the liquidity of the markets in those instruments. Trading interest in various types of futures and options on futures cannot be predicted. Therefore, no assurance can be given that a Fund will be able to utilize these instruments effectively. In addition, there can be no assurance that a liquid market will exist at a time when a Fund seeks to close out a futures or option on a futures contract position, and that Fund would remain obligated to meet margin requirements until the position is closed. The liquidity of a secondary market in a futures contract may be adversely affected by daily price fluctuation limits established by commodity exchanges to limit the amount of fluctuation in a futures contract price during a single trading day.
A Fund that purchases or sells a futures contract is only required to deposit initial and variation margin as required by relevant regulations and the rules of the contract market. Because the purchase of a futures contract obligates the Fund to purchase the underlying security or other instrument at a set price on a future date, the Funds net asset value will fluctuate with the value of the security or other instrument as if it were already in the Funds portfolio. Futures transactions have the effect of investment leverage to the extent the Fund does not maintain liquid assets equal to the face amount of the contract. If a Fund combines short and long positions, in addition to possible declines in the values of its investment securities, the Fund will incur losses if the index underlying the long futures position underperforms the index underlying the short futures position.
Merger Arbitrage
Although a variety of strategies may be employed depending upon the nature of the reorganizations selected for investment, the simplest form of merger-arbitrage activity involves purchasing the shares of an announced acquisition target at a discount to their expected value upon completion of the acquisition. The size of this discount, known as the arbitrage spread, may represent the Merger Arbitrage Funds potential profit on such an investment. The size of this spread is dependent on a large number of factors, including the status of the negotiations between the two companies (for example, spreads typically narrow as the parties advance from an agreement in principle to a definitive agreement), the complexity of the transaction, the number of regulatory approvals required, the likelihood of government intervention on antitrust or other grounds, the type of consideration to be received and the possibility of competing offers for the target company. The expected gain on an individual arbitrage investment is normally considerably smaller than the possible loss should the transaction be unexpectedly terminated. The expected timing of each transaction is also important since the length of time that the Merger Arbitrage Funds capital must be committed to any given reorganization will affect the rate of return realized by the Merger Arbitrage Fund, and delays can substantially reduce such returns.
Mark-to-market losses on merger-arbitrage positions can occur intra-month even if a particular deal is not breaking-up and such losses may or may not be recouped upon successful consummation of such deal. Further, the consummation of mergers, tender offers and exchange offers can be prevented or delayed by a variety of factors, including: (i) regulatory and antitrust restrictions; (ii) political motivations; (iii) industry weakness; (iv) stock specific events; (v) failed financings; and (vi) general market declines. If the Merger Arbitrage Fund does not hedge against market fluctuations, the Fund may incur losses even if the proposed transaction is consummated. The success of merger-arbitrage strategies also depends on the overall volume of merger activity, which has historically been
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cyclical in nature. During periods when merger activity is low, it may be difficult or impossible to identify opportunities for profit or to identify a sufficient number of such opportunities to provide diversification among potential merger transactions. This may be due to, among other things, a number of merger-arbitrage advisers and other investors investing in a limited number of potential deals. Also, when market interest rates are relatively low, the spreads on merger-arbitrage positions may be relatively small (i.e., narrow).
Other Investment Policies
Swap Agreements. To help enhance the value of their portfolio or manage their exposure to different types of investments, the Funds may enter into credit default swap agreements, interest rate, currency and mortgage swap agreements and may purchase and sell interest rate caps, floors and collars.
In a standard swap transaction, two parties agree to exchange the returns (or differentials in rates of return) on different currencies, securities, baskets of currencies or securities, indices or other instruments, which returns are calculated with respect to a notional value, ( i.e. , the designated reference amount of exposure to the underlying instruments). The Funds intend to enter into swaps primarily on a net basis, i.e. , the two payment streams are netted out, with a Fund receiving or paying, as the case may be, only the net amount of the two payments. If the other party to a swap contract entered into on net basis defaults, the Funds risk of loss will consist of the net amount of payments that the Fund is contractually entitled to receive. The net amount of the excess, if any, of the Funds obligations over its entitlements will be maintained in a segregated account by the Funds custodian. The Funds will not enter into swap agreements unless the claims-paying ability of the other party thereto is considered to be an acceptable credit risk to such Fund by the Adviser. If there is a default by the other party to such a transaction, the Fund will have contractual remedies pursuant to the agreements related to the transaction. Swap instruments are not exchange-listed securities and may be traded only in the over-the-counter market.
In a typical interest rate swap agreement, one party agrees to make regular payments equal to a floating interest rate on a specified amount (the notional principal amount) in return for payments equal to a fixed interest rate on the same amount for a specified period. If a swap agreement provides for payment in different currencies, the parties may also agree to exchange the notional principal amount. Mortgage swap agreements are similar to interest rate swap agreements, except that notional principal amount is tied to a reference pool of mortgages. In a cap or floor, one party agrees, usually in return for a fee, to make payments under particular circumstances. For example, the purchaser of an interest rate cap has the right to receive payments to the extent a specified interest rate exceeds an agreed level; the purchaser of an interest rate floor has the right to receive payments to the extent a specified interest rate falls below an agreed level. A collar entitles the purchaser to receive payments to the extent a specified interest rate falls outside an agreed range.
Investments in swaps involve the exchange by a Fund with another party of their respective commitments. Use of swaps subjects a Fund to risk of default by the counterparty. If there is a default by the counterparty to such a transaction, there may be contractual remedies pursuant to the agreements related to the transaction although contractual remedies may not be sufficient in the event the counterparty is insolvent. However, the swap market has grown substantially in recent years with a large number of banks and investment banking firms acting both as principals and agents utilizing standardized swap documentation. As a result, the swap market has become relatively liquid in comparison with the markets for other similar instruments which are traded in the interbank market. Swap agreements are sophisticated financial instruments that typically involve a small investment of cash relative to the magnitude of risks assumed. Swaps may involve leverage and can be highly volatile and may have a considerable impact on a Funds performance, as the potential gain or loss
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on any swap transaction is not necessarily subject to any fixed limit. All swap agreements are considered as illiquid securities and, therefore, will be limited, along with all of the Funds other illiquid securities, to 15% of the Funds net assets.
The Funds may enter into credit default swap agreements. The buyer in a credit default contract is obligated to pay the seller a periodic stream of payments over the term of the contract provided that no event of default on an underlying reference obligation has occurred. If an event of default occurs, the seller must pay the buyer the par value (full notional value) of the reference obligation in exchange for the reference obligation. A Fund may be either the buyer or seller in the transaction. If a Fund is a buyer and no event of default occurs, the Fund loses its investment and recovers nothing. However, if an event of default occurs, the buyer receives full notional value for a reference obligation that may have little or no value. As a seller, the Fund receives income throughout the term of the contract, which typically is between six months and three years, provided that there is no default event.
Credit default swap agreements are subject to greater risk than direct investment in the reference obligation. Like all swap agreements, credit default swaps are subject to liquidity, credit and counterparty risks. A buyer in a credit default swap contract will lose its investment and recover nothing should no event of default occur. If an event of default were to occur, the value of the reference obligation received by the seller, coupled with the periodic payments previously received, may be less than the full notional value it pays to the buyer, resulting in a loss of value to the seller. In addition, collateral posting requirements are individually negotiated and there is no regulatory requirement that a counterparty post collateral to secure its obligations under a credit default swap. Furthermore, there is no requirement that a party be informed in advance when a credit default swap agreement is sold. Accordingly, a Fund may have difficulty identifying the party responsible for payment of its claims. The notional value of credit default swaps with respect to a particular investment is often larger than the total par value of such investment outstanding and, in event of a default, there may be difficulties in making the required deliveries of the reference investments, possibly delaying payments.
The market for credit default swaps has become more volatile recently as the creditworthiness of certain counterparties has been questioned and/or downgraded. If a counterpartys credit becomes significantly impaired, multiple requests for collateral posting in a short period of time could increase the risk that a Fund may not receive adequate collateral. A Fund generally may exit its obligations under a credit default swap only by terminating the contract and paying applicable breakage fees, or by entering into an offsetting credit default swap position, which may cause the Fund to incur more losses. If a Fund uses credit default swaps to leverage its portfolio, it will be exposed to additional risks, including the risk that the Funds use of leverage will magnify the effect of any losses the Fund incurs since if an event of default occurs the seller must pay the buyer the full notional value of the reference obligation.
When-Issued Securities and Forward Commitments . Each Fund may enter into forward commitments for the purchase or sale of interests in Senior Loans and other portfolio securities, including on a when-issued or delayed delivery basis in excess of customary settlement periods for the type of security involved. In some cases, a forward commitment may be conditioned upon the occurrence of a subsequent event, such as approval and consummation of a merger, corporate reorganization or debt restructuring ( i.e. , a when, as and if issued security). When such transactions are negotiated, the price is fixed at the time of the commitment, with payment and delivery taking place in the future, generally a month or more after the date of the commitment. While a Fund will only enter into a forward commitment with the intention of actually acquiring the security, the Fund may sell the security before the settlement date if it is deemed advisable. Securities purchased by a Fund under a forward commitment are subject to market fluctuation, and no interest (or dividends)
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accrues to the Fund prior to the settlement date. For forward commitments that are cash settled, a Fund will designate or segregate liquid assets in an amount equal to the Funds daily marked-to-market value of such commitments.
Purchases of securities on a forward commitment basis may involve more risk than other types of purchases. Securities purchased on a forward commitment basis and the securities held in a Funds portfolio are subject to changes in value based upon the publics perception of the creditworthiness of the issuer and changes, real or anticipated, in the level of interest rates. Purchasing securities on a forward commitment basis can involve the risk that the yields available in the market when the delivery takes place may actually be higher or lower than those obtained in the transaction itself. On the settlement date of the forward commitment transaction, the Fund will meet its obligations from then available cash flow, sale of securities reserved for payment of the commitment, sale of other securities or, although it would not normally expect to do so, from sale of the forward commitment securities themselves (which may have a value greater or lesser than the Funds payment obligations). The sale of securities to meet such obligations may result in the realization of capital gains or losses. Purchasing securities on a forward commitment basis can also involve the risk of default by the other party on its obligation, delaying or preventing the Fund from recovering the collateral or completing the transaction.
Repurchase Agreements. Merger Arbitrage Fund may enter into repurchase agreements without limitation as part of its investment strategies. Long/Short Healthcare Fund and Opportunistic Credit Fund may each enter into repurchase agreements with respect to up to 33 1/3% of the value of such Funds total assets and Long/Short Equity Fund may enter into repurchase agreements with respect to up to 20% of the value of the Funds total assets. A repurchase agreement is a purchase of, and a simultaneous commitment to resell, a financial instrument at an agreed-upon price on an agreed-upon date. When participating in repurchase agreements, a Fund buys securities from a seller ( e.g. , a bank or brokerage firm) with the agreement that the seller will repurchase the securities at the agreed-upon price at a later date. Repurchase agreements may also be viewed as loans made by a Fund that are collateralized by the securities subject to repurchase. Such transactions afford an opportunity for a Fund to earn a return on available liquid assets at minimal market risk, although a Fund may be subject to various delays and risks of loss if the counterparty is unable to meet its obligation to repurchase. If the counterparty to a repurchase agreement defaults on its repurchase obligation pursuant to the repurchase agreement, a Fund may lose money to the extent proceeds from the sale of collateral are less than the repurchase price. If the member bank or member firm that is the party to the repurchase agreement petitions for bankruptcy or otherwise becomes subject to the Bankruptcy Code, the law regarding the rights of a Fund is unsettled and a Funds realization upon the collateral may be delayed or limited. The Adviser will evaluate the creditworthiness of the repurchase agreement counterparties with whom the Funds do business and will monitor their creditworthiness during the period of any repurchase agreement.
Reverse Repurchase Agreements . Each Fund may enter into reverse repurchase agreements with respect to securities held by the Fund that could otherwise be sold by the Fund. In a reverse repurchase agreement a Fund sells a security held by the Fund and simultaneously obtains the commitment of the purchaser (typically, a commercial bank or a broker or dealer) to sell the security back to the Fund at an agreed-upon price on an agreed-upon date. A Fund will maintain cash or liquid securities in an amount sufficient to cover its obligations with respect to reverse repurchase agreements. A Fund receives payment for such securities only upon physical delivery or evidence of book entry transfer by its custodian. Regulations of the SEC require that, if securities are sold by a Fund under a reverse repurchase agreement, the Fund designate or segregate liquid assets in an amount equal to the Funds daily marked-to-market value of such agreement. Reverse repurchase agreements are considered borrowings of money by the Funds and as such would be subject to the restrictions on issuing senior securities described below under Investment Restrictions.
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Reverse repurchase agreements could involve certain risks in the event of default or insolvency of the counterparty, including possible delays or restrictions upon a Funds ability to dispose of the proceeds of the sale received from the counterparty. An additional risk is that the market value of securities sold by a Fund under a reverse repurchase agreement could decline below the price at which the Fund is obligated to repurchase them.
Euro-Relate d Risk. The global economic crisis brought several small economies in Europe to the brink of bankruptcy and many other economies into recession and weakened the banking and financial sectors of many European countries. For example, the governments of Greece, Spain, Portugal, and the Republic of Ireland have all experienced large public budget deficits, the effects of which are still yet unknown and may slow the overall recovery of the European economies from the global economic crisis. In addition, due to large public deficits, some European countries may be dependent on assistance from other European governments and institutions or other central banks or supranational agencies such as the International Monetary Fund. Assistance may be dependent on a countrys implementation of reforms or reaching a certain level of performance. Failure to reach those objectives or an insufficient level of assistance could result in a deep economic downturn which could significantly affect the value of a Funds European investments.
The Economic and Monetary Union of the European Union (EMU) is comprised of the European Union members that have adopted the euro currency. By adopting the euro as its currency, a member state relinquishes control of its own monetary policies. As a result, European countries are significantly affected by fiscal and monetary policies implemented by the EMU and European Central Bank. The euro currency may not fully reflect the strengths and weaknesses of the various economies that comprise the EMU and Europe generally.
It is possible that one or more EMU member countries could abandon the euro and return to a national currency and/or that the euro will cease to exist as a single currency in its current form. The effects of such an abandonment or a countrys forced expulsion from the euro on that country, the rest of the EMU, and global markets are impossible to predict, but are likely to be negative. The exit of any country out of the euro may have an extremely destabilizing effect on other eurozone countries and their economies and a negative effect on the global economy as a whole. Such an exit by one country may also increase the possibility that additional countries may exit the euro should they face similar financial difficulties. In addition, in the event of one or more countries exit from the euro, it may be difficult to value investments denominated in euros or in a replacement currency. On June 23, 2016, the United Kingdom approved a referendum to leave the European Union. On March 29, 2017 the United Kingdom invoked Article 50 of the Lisbon Treaty which gives the United Kingdom and the European Union two years to agree to the terms of the United Kingdoms exit. The United Kingdom is currently scheduled to leave the European Union on Friday March 29, 2019. While the United Kingdom is not a part of the euro currency system, significant uncertainty remains in the market regarding the ramifications of that development, and the range and potential implications of possible political, regulatory, economic and market outcomes are difficult to predict.
Emerging and Developing Markets . Merger Arbitrage Fund may invest without limitation in emerging market countries. Each of Long/Short Equity Fund and Long/Short Healthcare Fund may invest up to 50% of the value of their total assets in emerging market countries. The Opportunistic Credit Fund may invest without limit in securities of non-U.S. issuers, including investments in the securities of so-called emerging or developing market issuers. Such investment may be denominated in U.S. dollars, non-U.S. currencies or multinational currency units.
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Investing in emerging or developing market countries involves certain risks not typically associated with investing in the United States and imposes risks greater than, or in addition to, risks of investing in more developed foreign countries. These risks include, but are not limited to, the following: greater risks of nationalization or expropriation of assets or confiscatory taxation; currency devaluations and other currency exchange rate fluctuations; greater social, economic, and political uncertainty and instability (including amplified risk of war and terrorism); more substantial government involvement in the economy; less government supervision and regulation of the securities markets and participants in those markets; controls on foreign investment and limitations on repatriation of invested capital and on a Funds ability to exchange local currencies for U.S. dollars; unavailability of currency hedging techniques in certain emerging and developing market countries; the fact that companies in emerging and developing market countries may be smaller, less seasoned, and newly organized companies; the difference in, or lack of, auditing and financial reporting standards, which may result in unavailability of material information about issuers; the risk that it may be more difficult to obtain and/or enforce a judgment in a court outside the United States; and greater price volatility, substantially less liquidity, and significantly smaller market capitalization of securities markets. Also, any change in the leadership or politics of emerging or developing market countries, or the countries that exercise a significant influence over those countries, may halt the expansion of or reverse the liberalization of foreign investment policies now occurring and adversely affect existing investment opportunities. Furthermore, high rates of inflation and rapid fluctuations in inflation rates have had, and may continue to have, negative effects on the economies and securities markets of certain emerging and developing market countries.
Money Market Instruments. Each Fund may invest in money market instruments. Money market securities are high-quality, dollar-denominated, short-term instruments. They consist of (i) bankers acceptances, certificates of deposit, notes and time deposits of highly-rated U.S. banks and U.S. branches of foreign banks; (ii) U.S. Treasury obligations and obligations issued or guaranteed by agencies and instrumentalities of the U.S. Government; (iii) high-quality commercial paper issued by U.S. foreign corporations; (iv) debt obligations with a maturity of one year or less issued by corporations with outstanding high-quality commercial paper ratings; and (v) repurchase agreements involving any of the foregoing obligations entered into with highly-rated banks and broker-dealers.
Convertible Securities. Convertible securities may offer higher income than the common stocks into which they are convertible and include fixed-income or zero coupon debt securities, which may be converted or exchanged at a stated or determinable exchange ratio into underlying shares of common stock. Prior to their conversion, convertible securities may have characteristics similar to both non-convertible debt securities and equity securities. While convertible securities generally offer lower yields than non-convertible debt securities of similar quality, their prices may reflect changes in the value of the underlying common stock. Convertible securities entail less credit risk than the issuers common stock.
Asset Coverage. To assure that a Funds use of futures and related options, as well as when issued and delayed-delivery transactions, forward currency contracts and swap transactions, are not used to achieve investment leverage, the Fund will cover such transactions, as required under applicable SEC interpretations, either by owning the underlying securities or by earmarking liquid securities with its custodian in an amount at all times equal to or exceeding the Funds commitment with respect to these instruments or contracts.
Warrants and Rights. Warrants are options to purchase equity securities at a specified price and are valid for a specific time period. Rights are similar to warrants, but normally have a short duration and are distributed by the issuer to its shareholders. Each of Long/Short Equity Fund and Long/Short Healthcare Fund may purchase warrants and rights, provided that the Funds presently do not intend to invest more than 10% of their respective net assets at the time of purchase in warrants and rights other than those that have been acquired in units or attached to other securities.
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Short-Term Trading. Short-term trading involves the selling of securities held for a short time, ranging from several months to less than a day. The object of such short-term trading is to increase the potential for capital appreciation and/or income of a Fund in order to take advantage of what the Adviser believes are changes in market, industry or individual company conditions or outlook. Any such trading would increase the turnover rate of the Fund and its transaction costs, and could result in higher taxes for shareholders if Fund shares are held in a taxable account.
Short Selling. Short selling (also known as shorting or going short) is a strategy in which a Fund sells a security it does not own in anticipation that the market price of that security will decline. When the Fund makes a short sale, it must borrow the security sold short from a broker-dealer and deliver it to the buyer upon conclusion of the sale. The Fund will ordinarily have to pay a fee to borrow a security and is often obligated to repay the lender of the security any dividend or interest that accrues on the security during the period of the loan. If the price of the security sold short increases between the time of the short sale and the time the Fund replaces the borrowed security, the Fund will incur a loss.
The Fund may sell a security short if it owns at least an equal amount of the security sold short or another security convertible or exchangeable for an equal amount of the security sold short without payment of further compensation (a short sale against-the-box). The Fund also may engage in short sales that are not against-the-box, and will be subject to additional risks to the extent that it engages in short sales that are not against-the-box. The Funds loss on a short sale could be unlimited in cases where the Fund is unable, for whatever reason, to close out its short position.
Short sales by the Fund that are not made against-the-box (that is when the Fund has an offsetting long position in the asset that is selling short) involve unlimited loss potential since the market price of securities sold short may continuously increase. When the Fund engages in a short sale on a security, it must borrow the security sold short and deliver it to the counterparty. The Fund will ordinarily have to pay a fee or premium to borrow particular securities and be obligated to repay the lender of the security any dividends or interest that accrue on the security during the period of the loan. The amount of any gain from a short sale will be decreased, and the amount of any loss increased, by the amount of the premium, dividends, interest or expenses the Fund pays in connection with the short sale. Short selling allows the 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. Purchasing securities to close out the short position can itself cause the price of the securities to rise further, thereby exacerbating the loss. The Fund may mitigate such losses by replacing the securities sold short before the market price has increased significantly. Under adverse market conditions, the 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. See Income Tax Considerations below for special tax considerations associated with engaging in short sales.
Micro Cap Securities. Each Fund may invest in companies whose total market capitalization at the time of investment is generally between $30 million and $500 million, referred to as micro cap
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companies. Micro cap companies may not be well-known to the investing public, may not have significant institutional ownership and may have cyclical, static or only moderate growth prospects. Micro cap companies may have greater risk and volatility than large companies and may lack the management depth of larger, mature issuers. Micro cap companies may have relatively small revenues and limited product lines, markets, or financial resources, and their securities may trade less frequently and in more limited volume than those of larger, more mature companies. In addition, micro cap companies may be developing or marketing new products or services for which markets are not yet established and may never become established. As a result, the prices of their securities may fluctuate more than those of larger issuers.
Securities of Other Investment Companies. Such investments are subject to limitations prescribed by the 1940 Act unless an SEC exemption is applicable or as may be permitted by rules under the 1940 Act or SEC staff interpretations thereof. The 1940 Act limitations currently provide, in part, that the Funds may not purchase shares of an investment company if (a) such a purchase would cause a Fund to own in the aggregate more than 3% of the total outstanding voting stock of the investment company; (b) such a purchase would cause a Fund to have more than 5% of its total assets invested in the investment company; or (c) more than 10% of a Funds total assets would be invested in the aggregate in all investment companies. A Fund may invest in excess of the foregoing limitations in an exchange traded fund (ETF) that is not part of the same group of investment companies ( e.g. , an unaffiliated ETF) if the ETF has obtained exemptive relief from the SEC and both the ETF and the Fund adhere to the conditions in the exemptive relief.
The Funds may invest in investment companies that are advised by the Adviser or its affiliates, including ETFs, to the extent permitted by applicable law and/or pursuant to exemptive relief from the SEC. These investment companies typically incur fees that are separate from those fees incurred directly by the Fund. The Funds purchase of such investment company securities results in the layering of expenses, such that shareholders would indirectly bear a proportionate share of the operating expenses of such investment companies, including advisory fees, in addition to paying Fund expenses.
Privately-Placed Securities. Each Fund may invest in securities that are neither listed on a stock exchange nor traded over-the-counter, including privately placed securities. Investing in such unlisted securities, including investments in new and early stage companies, may involve a high degree of business and financial risk that can result in substantial losses. As a result of the absence of a public trading market for these securities, they may be less liquid than publicly traded securities. Although these securities may be resold in privately negotiated transactions, the prices realized from these sales could be less than those originally paid by the Fund, or less than what may be considered the fair value of such securities. Further, companies whose securities are not publicly traded may not be subject to the disclosure and other investor protection requirements that might be applicable if their securities were publicly traded. If such securities are required to be registered under the securities laws of one or more jurisdictions before being resold, the Fund may be required to bear the expenses of registration.
Initial Public Offerings (IPOs). Each Fund may invest in IPOs. An IPO presents the risk that the market value of IPO shares will fluctuate considerably due to factors such as the absence of a prior public market, unseasoned trading, the small number of shares available for trading and limited information about the issuer. The purchase of IPO shares may involve high transactions costs. IPO shares are subject to market risk and liquidity risk. When a Funds asset base is small, a significant portion of the Funds performance could be attributable to investments in IPOs, because such investments would have a magnified impact on the Fund. As the Funds assets grow, the effect of the Funds investments in IPOs on the Funds performance probably will decline, which could reduce the Funds performance. Because of the price volatility of IPO shares, the Fund may choose to hold IPO
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shares for a very short period of time. This may increase the turnover of the Fund and may lead to increased expenses to the Fund, such as commissions and transaction costs. By selling IPO shares, the Fund may realize taxable gains it will subsequently distribute to shareholders. In addition, the market for IPO shares can be speculative and/or inactive for extended periods of time. There is no assurance that a Fund will be able to obtain allocable portions of IPO shares. The limited number of shares available for trading in some IPOs may make it more difficult for the Fund to buy or sell significant amounts of shares without an unfavorable impact on prevailing prices. Investors in IPO shares can be affected by substantial dilution in the value of their shares, by sales of additional shares and by concentration of control in existing management and principal shareholders.
The Funds investments in IPO shares may include the securities of unseasoned companies (companies with less than three years of continuous operations), which present risks considerably greater than common stocks of more established companies. These companies may have limited operating histories and their prospects for profitability may be uncertain. These companies may be involved in new and evolving businesses and may be vulnerable to competition and changes in technology, markets and economic conditions. They may be more dependent on key managers and third parties and may have limited products.
Operating Deficits. The expenses of operating a Fund (including the fees payable to the Adviser) may exceed its income, thereby requiring that the difference be paid out of the Funds capital, reducing the Funds investments and potential for profitability.
Accuracy of Public Information. The Adviser selects investments for each Fund, in part, on the basis of information and data filed by issuers with various government regulators or made directly available to the Adviser by the issuers or through sources other than the issuers. Although the Adviser evaluates all such information and data and ordinarily seeks independent corroboration when the Adviser considers it appropriate and when such corroboration is reasonably available, the Adviser is not in a position to confirm the completeness, genuineness or accuracy of such information and data.
Trading Limitations. For all securities listed on a securities exchange, including options listed on a public exchange, the exchange generally has the right to suspend or limit trading under certain circumstances. Such suspensions or limits could render certain strategies difficult to complete or continue and subject the Funds to loss. Also, such a suspension could render it impossible for the Adviser to liquidate positions and thereby expose the Funds to potential losses. Finally, to the extent that advisory personnel of the Adviser acquire material non-public information in the course of service on the board of directors or creditors committee of a company, the Funds may be prevented from buying or selling securities of that company.
Risks of Interest Only Mortgage-Backed Securities. Interest only mortgage-backed securities present a heightened risk of total loss of investment.
Risks of Inverse Floaters. As interest rates rise, inverse floaters produce less current income. A change in prevailing interest rates will often result in a greater change in the interest rate paid by an inverse floater. As a result, inverse floaters may have a greater degree of volatility than other types of interest-bearing securities of similar credit quality.
The frequency and amount of portfolio purchases and sales (known as the turnover rate) will vary from year to year. The portfolio turnover rate may vary greatly from year to year and will not be a limiting factor when the Adviser deems portfolio changes appropriate. Although the Funds generally
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do not intend to trade for short-term profits, the securities held by a Fund will be sold whenever the Adviser believes it is appropriate to do so, without regard to the length of time a particular security may have been held. Higher portfolio turnover involves correspondingly greater transaction costs, including any brokerage commissions that a Fund will bear directly, and can cause the Fund to recognize more short-term capital gains (which are taxable to shareholders at higher rates than long-term capital gains). Each Fund may engage in active trading to achieve its investment goals and, as a result, may have substantial portfolio turnover. A 100% turnover rate would occur if all of a Funds portfolio securities were replaced once within a one-year period.
For the past two fiscal years, the portfolio turnover rate for each of the Funds was as follows:
Fiscal Year
Ended June 30, 2017 |
Fiscal Year
Ended June 30, 2016 |
|||||||
Long/Short Equity Fund |
404 | % | 457 | % | ||||
Long/Short Healthcare Fund |
964 | % | 901 | % | ||||
Merger Arbitrage Fund |
233 | % 1 | 718 | % 2 | ||||
Opportunistic Credit Fund |
113 | % | 83 | % |
1 | The Merger Arbitrage Fund had a fiscal year end change from December 31 to June 30 in 2017. The period shown represents the six months ended June 30, 2017. |
2 | For the period from commencement of operations as a registered investment company on August 19, 2016 to December 31, 2016. |
The fundamental investment restrictions below may be changed only with the approval of a vote of a majority of the outstanding voting securities of the Fund. A vote of a majority of the outstanding voting securities of a Fund means the lesser of (i) 67% or more of the shares at a meeting if the holders of more than 50% of the outstanding shares are present or represented by proxy or (ii) more than 50% of the outstanding shares. Except for investment restrictions designated as fundamental in a Funds Prospectus or in this SAI, the investment policies described in this Prospectus or the Funds SAI are not fundamental and may be changed without shareholder approval. If a percentage policy set forth in the Prospectus or one of the following percentage investment restrictions is adhered to at the time a security is purchased, later changes in a percentage will not be considered a violation of the policy or restriction unless any excess or deficiency exists immediately after and as a result of such purchase or pertains to the Fund limitations on borrowing and investment in illiquid securities.
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Fundamental Investment Restrictions. The following investment restrictions are fundamental policies and, as such, may not be changed without the approval of a vote of a majority of the outstanding voting securities. A Fund may not:
1. | Purchase any security that would cause such Fund, other than Merger Arbitrage Fund, to concentrate (invest 25% or more of its total assets) in securities of issuers primarily engaged in any particular industry (other than securities issued or guaranteed by the U.S. government or any of its agencies or instrumentalities), except that Long/Short Healthcare Fund will invest more than 25% and may invest up to 100% of its assets in securities of issuers in the industry group consisting of healthcare companies (as defined in the Prospectus). With respect to Merger Arbitrage Fund, the Fund will not concentrate its investments within the meaning of the 1940 Act; |
2. | In the case of Long/Short Healthcare Fund and Opportunistic Credit Fund, issue senior securities or borrow in excess of the amounts permitted by the 1940 Act; * |
3. | In the case of Long/Short Equity Fund and Merger Arbitrage Fund, issue senior securities (including borrowing money, including on margin if margin securities are owned, and through entering into reverse repurchase agreements) in excess of 33 1/3% of such Funds total assets (including the amount of senior securities issued, but excluding any liabilities and indebtedness not constituting senior securities), except that Long/Short Equity Fund and Merger Arbitrage Fund may borrow up to an additional 5% of its total assets for temporary purposes; or pledge its assets other than to secure such issuances or in connection with hedging transactions, short sales, securities lending, when-issued and forward commitment transactions and similar investment strategies. Long/Short Equity Funds and Merger Arbitrage Funds obligations under the foregoing types of transactions and investment strategies are not treated as senior securities; |
4. | Underwrite securities of other issuers, except to the extent that such Fund, in disposing of Fund securities, may be deemed an underwriter within the meaning of the 1933 Act; |
5. | Purchase or sell real estate, except that a Fund may (a) invest in securities or other instruments directly or indirectly secured by real estate, (b) invest in securities or other instruments issued by issuers that invest in real estate, and (c) hold for prompt sale, real estate or interests in real estate to which it may gain an ownership interest through the forfeiture of collateral securing loans or debt securities held by it; |
6. | Purchase or sell commodities or commodity contracts, but this shall not prevent a Fund from purchasing, selling and entering into financial futures contracts (including futures contracts on indices of securities, interest rates and currencies), options on financial futures contracts (including futures contracts on indices of securities, interest rates and currencies), warrants, swaps, forward contracts, foreign currency spot and forward contracts or other derivative instruments that are not related to physical commodities; and |
* | Under the 1940 Act, a Fund may not issue senior securities or borrow in excess of 33 1/3% of the Funds total assets (after giving effect to any such borrowing), which amount excludes borrowing for temporary purposes and in an amount not more than 5% of the Funds total assets at the time borrowing is made. |
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7. | In the case of Long/Short Equity Fund, Long/Short Healthcare Fund, Merger Arbitrage Fund and Opportunistic Credit Fund, lend any property or make any loan if, as a result, more than 33 1/3% of its total assets would be loaned to other parties, but this limitation does not apply to the purchase of debt securities or to repurchase agreements. |
For purposes of fundamental investment restriction number 6 above, at the time of the establishment of the restriction, swap contracts on financial instruments or rates were not within the understanding of the terms commodities or commodity contracts, and notwithstanding any federal legislation or regulatory action by the CFTC that subject such swaps to regulation by the CFTC, the Funds will not consider such instruments to be commodities or commodity contracts for purposes of this restriction.
Non-Fundamental Investment Restrictions. Each Fund is also subject to the following non-fundamental investment restrictions and policies that may be changed by the Board without shareholder approval. A Fund may not:
1. | In the case of Long/Short Healthcare Fund, Merger Arbitrage Fund and Opportunistic Credit Fund, enter into repurchase agreements if, as a result thereof, more than 33 1/3% of such Funds total assets would be invested in repurchase agreements and in the case of Long/Short Equity Fund, as an operating policy and notwithstanding fundamental investment restriction number 7, Long/Short Equity Fund may not acquire debt securities or enter into repurchase agreements if, as a result thereof, more than 20% of Long/Short Equity Funds total assets would be invested in debt securities or repurchase agreements; |
2. | Acquire any illiquid securities, such as repurchase agreements with more than seven calendar days to maturity or fixed time deposits with a duration of over seven calendar days, if, as a result thereof, more than 15% of the market value of such Funds net assets would be in investments that are illiquid; |
3. | Acquire securities of investment companies that are not part of the same group of investment companies (other investment companies), except as permitted by applicable law (currently under the 1940 Act, in addition to any investments permitted by exemptive relief, a Fund may invest up to 10% of its total assets in the aggregate in shares of other investment companies and up to 5% of its total assets in any one other investment company, provided that any investment does not result in a Fund owning more than 3% of the voting stock of the acquired investment company at the time such shares are purchased); |
4. | Borrow on margin, notwithstanding, in the case of Long/Short Healthcare Fund, and Opportunistic Credit Fund, fundamental investment restriction number 2, and in the case of Merger Arbitrage Fund and Long/Short Equity Fund, fundamental investment restriction number 3, unless such activity is permitted by applicable law; and |
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5. | In the case of Long/Short Healthcare Fund, engage in any activities described under fundamental investment restriction number 2 pursuant to which the lenders would be able to foreclose on more than 33 1/3% of Long/Short Healthcare Funds total assets. |
6. | In the case of each Fund that is invested in by another series of the Trust or by a series of Highland Funds II, acquire securities of registered open-end investment companies or registered unit investment trusts in reliance on Sections 12(d)(1)(F) or 12(d)(1)(G) of the 1940 Act. |
Other Information. The following commentary is intended to help investors better understand the meaning of the Funds fundamental policies by briefly describing limitations, if any, imposed by the 1940 Act. References to the 1940 Act below may encompass rules, regulations or orders issued by the SEC and, to the extent deemed appropriate by the Fund, interpretations and guidance provided by the SEC staff. These descriptions are intended as brief summaries of such limitations as of the date of this SAI; they are not comprehensive and they are qualified in all cases by reference to the 1940 Act (including any rules, regulations or orders issued by the SEC and any relevant interpretations and guidance provided by the SEC staff). These descriptions are subject to change based on evolving guidance by the appropriate regulatory authority and are not part of the Funds fundamental policies.
The 1940 Act currently permits an open-end investment company to borrow money from a bank so long as immediately after any such borrowing the ratio that the value of the total assets of the investment company (including the amount of any such borrowing), less the amount of all liabilities and indebtedness (other than such borrowing) of the investment company, bears to the amount of such borrowing is at least 300%. A lender to a Fund may require that the Fund pledge its assets as collateral. If a Fund were to default on a loan secured by pledged assets, the lender would be entitled to foreclose on and dispose of the pledged assets, but the lender could retain only the amount of assets (or the disposition proceeds of such assets) necessary to pay off the defaulted loan.
Under the 1940 Act, a fund may not issue senior securities or borrow in excess of 33 1/3% of the Funds total assets (after giving effect to any such borrowing), which amount excludes borrowing for temporary purposes and in an amount not more than 5% of the Funds total assets at the time the borrowing for temporary purposes is made.
The percentage limitations in the restriction listed above apply at the time of purchases of securities and a later increase or decrease in percentage resulting from a change in value of net assets, or in any ratings, will not be deemed to result in a violation of the restriction. For purposes of investment restriction number 1 above, the Adviser will, on behalf of each Fund, make reasonable determinations as to the appropriate industry classification to assign to each issuer of securities in which the Fund invests. As a general matter, the Adviser relies on the industry classifications provided by the Morgan Stanley Capital International/Standard & Poors Global Industry Classification Standard. An industry is considered to be a group of companies whose principal activities, products or services offered give them a similar economic risk profile vis à vis issuers active in other sectors of the economy. The definition of what constitutes a particular industry is therefore an evolving one. Some issuers could reasonably fall within more than one industry category. To the extent that the Global Industry Classification Standard classifications are so broad that the primary economic characteristics in a single class are materially different, each Fund may further classify issuers in accordance with industry classifications as published by the SEC or relevant SEC staff interpretations. Each Fund may change any source used for determining industry classifications without prior shareholder notice or approval.
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For purposes of non-fundamental investment restriction number 2 above, the purchase of Senior Loans, corporate debt securities, and other investment assets with the proceeds of a permitted borrowing, as well as margin payments or other arrangements in connection with transactions in short sales, futures contracts, options, and other financial instruments are not considered to constitute the purchase of securities on margin.
The Board provides broad oversight of the operations and affairs of the Funds and protects the interests of shareholders. The Board has overall responsibility to manage and control the business affairs of the Funds, including the complete and exclusive authority to establish policies regarding the management, conduct and operation of the Funds business. The names and birthdates of the Trustees and officers of the Funds, the year each was first elected or appointed to office, their principal business occupations during the last five years, the number of funds overseen by each Trustee and other directorships or trusteeships they hold are shown below. The business address for each Trustee and officer of the Funds is c/o Highland Capital Management Fund Advisors, L.P., 200 Crescent Court, Suite 700, Dallas, Texas 75201.
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Name and Date of Birth |
Position(s) with the Trust |
Term of Office 1 and Length of Time Served |
Principal Occupation(s) During the Past Five Years |
Number of
Portfolios in Highland Fund Complex Overseen by the Trustees 2 |
Other Directorships/ Trusteeships Held During the Past Five Years |
Experience, Qualifications, Attributes, Skills for Board Membership |
||||||
INDEPENDENT TRUSTEES | ||||||||||||
Timothy K. Hui (6/13/1948) | Trustee | Indefinite Term; Trustee since inception in 2006. | Dean of Educational Resources since July 2012 at Cairn University. | 25 | None | Significant experience on this board of directors/trustees; administrative and managerial experience; legal training and practice. | ||||||
Bryan A. Ward (2/4/1955) | Trustee | Indefinite Term; Trustee since inception in 2006. | Private Investor, BW Consulting, LLC since 2014; Senior Manager, Accenture, LLP (a consulting firm) from 2002 until retirement in 2014. | 25 | Director of Equity Metrix, LLC. | Significant experience on this and/or other boards of directors/trustees; significant managerial and executive experience; significant experience as a management consultant. | ||||||
Dr. Bob Froehlich (4/28/1953) | Trustee | Indefinite Term; Trustee since December 2013. | Executive Vice President and Chief Investment Strategist, The Hartford Mutual Funds from 2009 until retirement in 2012. | 25 |
Trustee of ARC Realty Finance Trust, Inc. (from January 2013 to May 2016); Director of KC Concessions, Inc.; Trustee of Realty Capital Income Funds Trust; Director of American Realty Capital Healthcare Trust II (from January 2013 to June 2016); Director, American Realty Capital Daily Net Asset Value Trust, Inc. (from November 2012 to July 2016); Director of American Sports Enterprise, Inc.; Director of Davidson |
Significant experience in the financial industry; significant managerial and executive experience; significant experience on other boards of directors, including as a member of several audit committees. |
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33
Name and Date of Birth |
Position(s) with the Trust |
Term of Office 1 and Length of Time Served |
Principal Occupation(s) During the Past Five Years |
Number of
Portfolios in Highland Fund Complex Overseen by the Trustees 2 |
Other Directorships/ Trusteeships Held During the Past Five Years |
Experience, Qualifications, Attributes, Skills for Board Membership |
||||||
since December 2015; Trustee/Director of the Highland Fund Complex from June 2012 until July 2013 and since December 2013; Chief Product Strategist of Highland Capital Management Fund Advisors, L.P. (HCMFA) from 2012 until December 2015; Senior Retail Fund Analyst of HCM from 2007 until December 2015 and HCMFA from its inception until December 2015; Secretary of NexPoint Credit Strategies Fund (NHF) from November 2010 until June 2012; President and Principal Executive Officer of NHF from June 2012 until May 2015; Secretary of NHF from May 2015 until December 2015; Executive Vice President and Principal Executive Officer of Highland Funds I (HFI) and Highland Funds II (HFII) from June 2012 until December 2015; and Secretary of HFI and HFII from November 2010 to May 2015. |
OFFICERS
Name and Date of Birth |
Position(s) with the Fund |
Term of Office and Length of Time Served |
Principal Occupation(s) During Past Five Years |
|||
J. Bradley Ross (5/13/59) | President and Principal Executive Officer | Indefinite Term; President and Principal Executive Officer since December 2015 | Principal Executive Officer of Highland Floating Rate Opportunities Fund (FRO) and Highland Global Allocation Fund II (GAFII) since August 2017; Principal Executive Officer of HFI and HFII since December 2015; President of Highland Capital Funds Distributor, Inc. (HCFD) since February 2014; President of HCMFA since |
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Name and Date of Birth |
Position(s) with the Fund |
Term of Office and Length of Time Served |
Principal Occupation(s) During Past Five Years |
|||
June 2012; Member of the Sales Force Marketing Committee of the Investment Company Institute since 2003; Executive Vice President and National Sales Director of Ivy Funds from 2003 until June 2012. | ||||||
Trey Parker (1/27/1976) |
Executive Vice President | Indefinite Term; Executive Vice President since September 2017. | Executive Vice President of HCMFA, NexPoint Advisors, L.P., HFI, HFII, FRO, and GAFII since September 2017, Executive Vice President; Assistant Secretary of Highland Restoration Capital Partners GP, LLC since September 2017; Assistant Secretary of Highland SunBridge GP, LLC since December 2015; Assistant Secretary of HCM since August 2015; Director of JHT Holdings, Inc. since August 2013; Director of TerreStar Corporation since March 2013; Director of OmniMax International, Inc. since March 2012; and Secretary of Granite Bay Advisors, L.P. since February 2012. | |||
Frank Waterhouse (4/14/1971) |
Treasurer; Principal Financial Officer and Principal Accounting Officer |
Indefinite Term; Treasurer since May 2015. Principal Financial Officer and Principal Accounting Officer since October 2017. | Principal Financial Officer and Principal Accounting Officer of FRO, GAFII, NexPoint Capital, Inc., NHF, HFI, HFII, and NexPoint Real Estate Advisors, L.P. since October 2017; Treasurer of FRO and GAFII since August 2017; Assistant Treasurer of Acis Capital Management, L.P. from December 2011 until February 2012; Treasurer of Acis Capital Management, L.P. since February 2012; Assistant Treasurer of HCM from November 2011 until April 2012; Treasurer of HCM since April 2012; Assistant Treasurer of HCMFA from December 2011 until October 2012; Treasurer of HCMFA since October 2012; Treasurer of NexPoint Advisors, L.P. since March 2012 and Treasurer of NexPoint Capital, Inc., NHF, HFI, HFII, and NexPoint Real Estate Advisors, L.P. since May 2015 and Treasurer of NexPoint Real Estate Strategies Fund since March 2016. | |||
Clifford Stoops (11/17/1970) | Assistant Treasurer | Indefinite Term; Assistant Treasurer since March 2017. | Assistant Treasurer of FRO and GAFII since August 2017; Assistant Treasurer of HFI, HFII, NHF, NexPoint Capital, Inc. and NexPoint Real Estate Strategies Fund since March 2017; Chief Accounting Officer at HCM since December 2011. |
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Name and Date of Birth |
Position(s) with the Fund |
Term of Office and Length of Time Served |
Principal Occupation(s) During Past Five Years |
|||
Jason Post (1/9/1979) |
Chief Compliance Officer | Indefinite Term; Chief Compliance Officer since September 2015. | Chief Compliance Officer and Anti-Money Laundering Officer of FRO and GAFII since August 2017; Chief Compliance Officer and Anti-Money Laundering Officer of HFI, HFII, NexPoint Credit Strategies, NexPoint Capital, Inc. and NexPoint Real Estate Strategies Fund since September 2015; and Chief Compliance Officer for HCMFA and NexPoint Advisors, L.P since September 2015. Prior to this role served as Deputy Chief Compliance Officer and Director of Compliance for HCM. | |||
Dustin Norris (1/6/1984) |
Secretary | Indefinite Term; Secretary since October 2017. | Secretary of FRO, GAFII, HFI and HFII since October 2017; Assistant Secretary of FRO and GAFII from August 2017 to October 2017; Chief Product Strategist at HCMFA since September 2015, Director of Product Strategy at HCMFA from May 2014 to September 2015; Secretary of NHF since December 2015; Assistant Secretary of HFI and HFII from March 2017 to October 2017; Assistant Treasurer of Highland Funds I and Highland Funds II from November 2012 to March 2017; Assistant Treasurer of NHF from November 2012 to December 2015; Secretary of NexPoint Capital, Inc. since 2014; Secretary of NexPoint Real Estate Strategies Fund since March 2016; and Senior Accounting Manager at HCMFA from August 2012 to May 2014. |
1 | On an annual basis, as a matter of Board policy, the Governance Committee reviews each Trustees performance and determines whether to extend each such Trustees service for another year. Effective June 2013, the Board adopted a retirement policy wherein the Governance Committee shall not recommend the continued service as a Trustee of a Board member who is older than 80 years of age at the time the Governance Committee reports its findings to the Board. |
2 | The Highland Fund Complex consists of NHF, each series of HFI, each series of HFII, FRO, GAFII, NexPoint Merger Arbitrage Fund, NexPoint Latin American Opportunities Fund, NexPoint Real Estate Strategies Fund, NexPoint Opportunistic Credit Fund, NexPoint Energy and Materials Opportunities Fund, NexPoint Discount Yield Fund, NexPoint Healthcare Opportunities Fund, and NexPoint Capital, Inc., a closed-end management investment company that has elected to be treated as a business development company under the 1940 Act. |
3 | Since May 1, 2015, Mr. Honis has been treated as an Independent Trustee of the Trust. Prior to that date, Mr. Honis was treated as an Interested Trustee because he was a partner of an investment adviser affiliated with the Adviser until his resignation in November 2014. As of September 30, 2017, Mr. Honis was entitled to receive aggregate severance and/or deferred compensation payments of approximately $880,000 from another affiliate of the Adviser. Mr. Honis also serves as a director of a portfolio company affiliated with the Adviser. During the Trusts last two fiscal years, Mr. Honis aggregate compensation from this portfolio company for his services as a director was approximately $50,000. |
In addition, Mr. Honis serves as a trustee of a trust that owns substantially all of the economic interest in an investment adviser affiliated with the Adviser. Mr. Honis indirectly receives an asset-based fee in respect of such interest, which is projected to range from $100,000-$150,000 annually. In light of these relationships between Mr. Honis and affiliates of the Adviser, it is possible that the SEC might in the future determine Mr. Honis to be an interested person of the Trust.
4 |
Effective December 4, 2015, Mr. Powell resigned from his position with the Adviser. Although the Trust believes that Mr. Powell is technically no longer an interested |
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person of the Trust, in light of his previous employment and the possibility that he may provide consulting services to the Adviser and affiliates of the Adviser, it is possible that the SEC might in the future determine Mr. Powell to be an interested person of the Trust. Therefore, the Trust treats Mr. Powell as an Interested Trustee of the Trust for all purposes other than compensation and the Funds code of ethics (Mr. Powell will be compensated at the same rate as the Independent Trustees) from December 16, 2015 until at least December 4, 2017 (the second anniversary of his resignation). |
Qualifications of Trustees
The following provides an overview of the considerations that led the Board to conclude that each individual serving as a Trustee of the Trust should so serve. Among the factors the Board considered when concluding that an individual should serve on the Board were the following: (i) the individuals business and professional experience and accomplishments; (ii) the individuals ability to work effectively with the other members of the Board; (iii) the individuals prior experience, if any, serving on company boards (including public companies and, where relevant, other investment companies) and the boards of other complex enterprises and organizations; and (iv) how the individuals skills, experiences and attributes would contribute to an appropriate mix of relevant skills and experience on the Board.
In respect of each current Trustee, the individuals professional accomplishments and prior experience, including, in some cases, in fields related to the operations of the Trust, were a significant factor in the determination that the individual should serve as a Trustee of the Trust. Each Trustees professional experience and additional considerations that contributed to the Boards conclusion that an individual should serve on the Board are summarized in the table above.
Trustees Compensation
The officers of the Trust and those of its Trustees who are interested persons (as defined in the 1940 Act) of the Funds receive no direct remuneration from the Trust. The following table sets forth the aggregate compensation paid to each of the Trustees who is not an interested person (as defined in the 1940 Act) of the Trust (the Independent Trustees) by the Trust and the total compensation paid to each of the Trustees by the Highland Fund Complex for the fiscal year ended June 30, 2017.
Name of Trustee |
Aggregate
Compensation From the Trust |
Pension or
Retirement Benefits Accrued as Part of the Funds Expense |
Estimated
Annual Benefits Upon Retirement |
Total
Compensation From the Highland Fund Complex 1 |
||||||||||||
Interested Trustee |
||||||||||||||||
Ethan Powell 2 |
$ | 60,088 | $ | 0 | $ | 0 | $ | 150,000 | ||||||||
Independent Trustees |
||||||||||||||||
Timothy K. Hui |
$ | 60,088 | $ | 0 | $ | 0 | $ | 150,000 | ||||||||
Bryan A. Ward |
$ | 60,088 | $ | 0 | $ | 0 | $ | 150,000 | ||||||||
Dr. Bob Froehlich |
$ | 60,088 | $ | 0 | $ | 0 | $ | 150,000 | ||||||||
John Honis 3 |
$ | 60,088 | $ | 0 | $ | 0 | $ | 150,000 |
1 | The Highland Fund Complex consists of NHF, each series of HFI, each series of HFII, FRO, GAFII, NexPoint Capital, Inc., a closed-end management investment company that has elected to be treated as a business development company under the 1940 Act, NexPoint Merger Arbitrage Fund, NexPoint Latin American Opportunities Fund, NexPoint Real Estate Strategies Fund, NexPoint Opportunistic Credit Fund, NexPoint Energy and Materials Opportunities Fund, NexPoint Discount Yield Fund and NexPoint Healthcare Opportunities Fund. |
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2 | Effective December 16, 2015, Mr. Powell is treated as an Interested Trustee of the Trust for all purposes other than compensation and the Funds code of ethics. |
3 | Effective May 1, 2015, Mr. Honis is treated as an Independent Trustee of the Trust. |
Each Independent Trustee receives an annual retainer of $150,000 payable in quarterly installments and allocated among each portfolio in the Highland Fund Complex.
Role of the Board of Trustees, Leadership Structure and Risk Oversight
The Role of the Board
The Board oversees the management and operations of the Trust. Like most registered investment companies, the day-to-day management and operation of the Trust is performed by various service providers to the Trust, such as the Adviser, underwriter, administrator, sub-administrator, custodian, and transfer agent, each of which is discussed in greater detail in this SAI. The Board has appointed senior employees of certain of these service providers as officers of the Trust, with responsibility to monitor and report to the Board on the Trusts operations. The Board receives regular reports from these officers and service providers regarding the Trusts operations. For example, the Treasurer provides reports as to financial reporting matters and investment personnel report on the performance of the Trusts portfolios. The Board has appointed a Chief Compliance Officer who administers the Trusts compliance program and regularly reports to the Board as to compliance matters. Some of these reports are provided as part of formal in person Board meetings which are typically held quarterly, in person, and involve the Boards review of, among other items, recent Trust operations. The Board also periodically holds telephonic meetings as part of its review of the Trusts activities. From time to time one or more members of the Board may also meet with management in less formal settings, between scheduled Board meetings, to discuss various topics. In all cases, however, the role of the Board and of any individual Trustee is one of oversight and not of management of the day-to-day affairs of the Trust and its oversight role does not make the Board a guarantor of the Trusts investments, operations or activities.
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Board Structure and Leadership
The Board has structured itself in a manner that it believes allows it to perform its oversight function effectively. The Board consists of five Trustees, four of whom are Independent Trustees. The remaining Trustee, Mr. Powell is an interested person of the Trust (each an Interested Trustee). Mr. Powell is treated as an Interested Trustee because of his previous positions with the Adviser and affiliates of the Adviser and the possibility that he may provide consulting services to the Adviser and affiliates of the Adviser. Mr. Powell also serves as Chairman of the Board. The Trustees meet periodically throughout the year in person and by telephone to oversee the Trusts activities, review contractual arrangements with service providers for the Trust and review the Trusts performance. The Board conducts much of its work through certain standing Committees, each of whose meetings are chaired by an Independent Trustee. On May 12, 2016, the Board approved a restructuring of the Funds standing committees and established an Audit and Qualified Legal Compliance Committee (formerly, the Audit Committee), a Governance Committee (formerly, the Nominating and Governance Committee), a Compliance Committee (formerly, the Litigation Committee), a Distribution Oversight Committee and an Alternatives Oversight Committee, which are discussed in greater detail below.
Audit and Qualified Legal Compliance Committee. The members of the Audit and Qualified Legal Compliance Committee (formerly named the Audit Committee) are Messrs. Froehlich, Hui, and Ward each of whom is independent for purposes of the 1940 Act. The Audit and Qualified Legal Compliance Committee is responsible for approving the Trusts independent accountants, reviewing with the Trusts independent accountants the plans and results of the audit engagement and the adequacy of the Trusts internal accounting controls, approving professional services provided by the Trusts independent accountants. The Audit and Qualified Legal Compliance Committee is charged with compliance with Rules 205.2(k) and 205.3(c) of Title 17 of the Code of Federal Regulations regarding alternative reporting procedures for attorneys representing the Trust who appear and practice before the SEC on behalf of the Trust. The Audit and Qualified Legal Compliance Committee is also responsible for reviewing and overseeing the valuation of debt and equity securities that are not publicly traded or for which current market values are not readily available pursuant to policies and procedures adopted by the Board. The Board and Audit and Qualified Legal Compliance Committee will use the services of one or more independent valuation firms to help them determine the fair value of these securities. In addition, each member of the Audit and Qualified Legal Compliance Committee meets the current independence and experience requirements of Rule 10A-3 under the Exchange Act.
The Audit and Qualified Legal Compliance Committee met five times during the fiscal year ended June 30, 2017. Mr. Ward acts as the Chairman of the Audit and Qualified Legal Compliance Committee and as the audit committee financial expert.
Governance Committee. The Trusts Governance Committees function is to oversee and make recommendations to the full Board or the Independent Trustees, as applicable, with respect to the governance of the Trust, selection and nomination of Trustees, compensation of Trustees, and related matters. The Governance Committee is also responsible for at least annually evaluating each Trustee and determining whether to recommend each Trustees continued service in that capacity. The Governance Committee will consider recommendations for Trustee nominees from shareholders sent to the Secretary of the Trust, 300 Crescent Court, Suite 700, Dallas, Texas 75201. A nomination submission must include all information relating to the recommended nominee that is required to be disclosed in solicitations or proxy statements for the election of Trustees, as well as information sufficient to evaluate the recommended nominees ability to meet the responsibilities of a Trustee of the Trust. Nomination submissions must be accompanied by a written consent of the individual to stand for election if nominated by the Board and to serve if elected by the shareholders,
39
and such additional information must be provided regarding the recommended nominee as reasonably requested by the Governance Committee. The Governance Committee is currently comprised of Messrs. Hui, Ward and Powell. Mr. Powell serves as the Chairman of the Governance Committee. The Governance Committee met three times during the fiscal year ended June 30, 2017.
Compliance Committee. The Compliance Committees (formerly named the Litigation Committee) function is to oversee and assist Board oversight of the Trusts compliance with legal and regulatory requirements and to seek to address any potential conflicts of interest between the Trust and HCMFA in connection with any potential or existing litigation or other legal proceeding relating to securities held by the Trust and HCMFA or Sub-Adviser or another client of HCMFA. The Compliance Committee is currently comprised of Messrs. Hui, Froehlich and Powell. Mr. Hui acts as the Chairman of the Compliance Committee. The Compliance Committee met two times during the fiscal year ended June 30, 2017.
The Alternatives Oversight Committee. The members of the Alternatives Oversight Committee are Messrs. Honis and Ward. The Alternatives Oversight Committee is responsible for overseeing any Funds that in the Boards determination employ alternative investment strategies. Mr. Honis serves as Chairman of the Alternatives Oversight Committee. The Alternatives Oversight Committee met two times during the fiscal year ended June 30, 2017.
The Distribution Oversight Committee. The members of the Distribution Oversight Committee are Messrs. Froehlich and Honis. The Distribution Oversight Committee is responsible for overseeing and making recommendations to the Board with respect to the appointment and oversight of sub-advisers to the Funds and Fund payments to financial intermediaries. Mr. Froehlich serves as Chairman of the Distribution Oversight Committee. The Distribution Oversight Committee met four times during the fiscal year ended June 30, 2017.
The Trust does not have a lead Independent Trustee. As noted above, the Boards leadership structure features committees each made up of a majority of Independent Trustees. In addition, although the Independent Trustees recognize that having a lead Independent Trustee may in some circumstances help coordinate communications with management and otherwise assist a board in the exercise of its oversight duties, the Independent Trustees believe that because of the relatively small size of the Board, the ratio of Independent Trustees to Interested Trustees and the good working relationship among the Board members, it has not been necessary to designate a lead Independent Trustee. Additionally, while Mr. Powell is treated as an Interested Trustee, he no longer has an executive role at the Adviser.
The Board periodically reviews its leadership structure, including the role of the Chairman. The Board also completes an annual self-assessment during which it reviews its leadership and Committee structure and considers whether its structure remains appropriate in light of the Trusts current operations. The Board believes that its leadership structure, including the current percentage of the Board who are Independent Trustees, is appropriate given its specific characteristics. These characteristics include: (i) the extent to which the work of the Board is conducted through the standing committees; (ii) the extent to which the Independent Trustees meet as needed, together with their independent legal counsel, in the absence of members of management and members of the Board who are interested persons of the Trust; and (iii) Mr. Powells previous positions with the Adviser and an affiliate of the Adviser and the possibility that he may provide consulting services to the Adviser and affiliates of the Adviser and Mr. Honis previous position with an affiliate of the Adviser, which enhances the Boards understanding of the operations of the Adviser.
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Board Oversight of Risk Management
The Boards role is one of oversight, rather than active management. This oversight extends to the Trusts risk management processes. These processes are embedded in the responsibilities of officers of, and service providers to, the Trust. For example, the Adviser and other service providers to the Trust are primarily responsible for the management of the Trusts investment risks. The Board has not established a formal risk oversight committee; however, much of the regular work of the Board and its standing Committees addresses aspects of risk oversight. For example, the Trustees seek to understand the key risks facing the Trust, including those involving conflicts of interest; how management identifies and monitors these risks on an ongoing basis; how management develops and implements controls to mitigate these risks; and how management tests the effectiveness of those controls.
In the course of providing that oversight, the Board receives a wide range of reports on the Trusts activities from the Adviser and other service providers, including reports regarding the Funds investment portfolios, the compliance of the Funds with applicable laws, and the Funds financial accounting and reporting. The Board also meets periodically with the Trusts Chief Compliance Officer to receive reports regarding the compliance of the Funds with the federal securities laws and the Trusts internal compliance policies and procedures, and meets with the Trusts Chief Compliance Officer periodically, including at least annually, to review the Chief Compliance Officers annual report, including the Chief Compliance Officers risk-based analysis for the Trust. The Boards Audit Committee also meets regularly with the Treasurer and Trusts independent registered public accounting firm to discuss, among other things, the internal control structure of the Trusts financial reporting function. The Board also meets periodically with the portfolio managers of each Fund to receive reports regarding the management of the Fund, including its investment risks.
Share Ownership
The following table shows the dollar range of equity securities beneficially owned by the Trustees in each Fund and the aggregate dollar range of equity securities owned by the Trustees in all funds overseen by the Trustees in the Highland Fund Complex as of December 31, 2016.
Name of Trustee |
Dollar Range of
Equity Securities Owned in Long/Short Equity Fund |
Dollar Range of
Equity Securities Owned in Long/Short Healthcare Fund |
Dollar Range
of Equity Securities Owned in Opportunistic Credit Fund 1 |
Dollar Range
of Equity Securities Owned in Merger Arbitrage Fund 2 |
Aggregate Dollar
Range of Equity Securities Owned in All Funds Overseen by Trustee in the Highland Fund Complex 3 |
|||||||||||||||
Interested Trustee |
|
|||||||||||||||||||
Ethan Powell | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $100,001 - $500,000 | |||||||||||
Independent Trustees | ||||||||||||||||||||
Timothy K. Hui | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $50,001 - $100,000 | |||||||||||
John Honis 4 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | None | |||||||||||
Dr. Bob Froehlich | $ | 10,001 - $50,001 | $ | 10,001 - $50,001 | $ | 10,001 - $50,001 | $ | 0 | $100,001 - $500,000 | |||||||||||
Bryan A. Ward | $ | 0 | $ | 0 | $ | 0 | $ | 0 | None 5 |
1 | The Opportunistic Credit Fund commenced operations on July 1, 2014. |
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2 | The Merger Arbitrage Fund commenced operations as a registered investment company on August 19, 2016. |
3 | The Highland Fund Complex consists of NHF, each series of HFI, each series of HFII, FRO, GAFII, NexPoint Capital, Inc., a closed-end management investment company that has elected to be treated as a business development company under the 1940 Act and NexPoint Merger Arbitrage Fund, NexPoint Latin American Opportunities Fund, NexPoint Real Estate Strategies Fund, NexPoint Opportunistic Credit Fund, NexPoint Energy and Materials Opportunities Fund, NexPoint Discount Yield Fund and NexPoint Healthcare Opportunities Fund. |
4 | Effective May 1, 2015, Mr. Honis is treated as an Independent Trustee of the Trust. |
5 | As of September 30, 2017, Mr. Ward had approximately $100,001-$500,000 in equity securities in the Highland Fund Complex. |
Trustee Positions
As of December 31, 2016, no Independent Trustee or any of his immediate family members owned beneficially or of record any class of securities of the Adviser or Underwriter (as defined below under Underwriter) or any person controlling, controlled by or under common control with any such entities.
Code of Ethics
The Funds, the Adviser and the Funds principal underwriter, HCFD have each adopted codes of ethics that essentially prohibit certain of their personnel, including the Funds portfolio managers, from engaging in personal investments that compete or interfere with, or attempt to take advantage of a clients, including each Funds, anticipated or actual portfolio transactions, and are designed to assure that the interests of clients, including Fund shareholders, are placed before the interests of personnel in connection with personal investment transactions. Under each of the codes of ethics of the Funds, the Adviser and the Distributor, personal trading is permitted by such persons subject to certain restrictions; however, they are generally required to pre-clear most securities transactions with the appropriate compliance officer and to report all transactions on a regular basis.
Anti-Money Laundering Compliance
The Funds and their service providers may be required to comply with various anti-money laundering laws and regulations. Consequently, a Fund and its service providers may request additional information from you to verify your identity. If at any time a Fund believes a shareholder may be involved in suspicious activity or if certain account information matches information on government lists of suspicious persons, the Fund may choose not to establish a new account or may be required to freeze a shareholders account. A Fund and its service providers also may be required to provide a governmental agency with information about transactions that have occurred in a shareholders account or to transfer monies received to establish a new account, transfer an existing account or transfer the proceeds of an existing account to a governmental agency. In some circumstances, the Fund or its service providers may not be permitted to inform the shareholder that it has taken the actions described above.
Proxy Voting Policies
The Board has delegated the responsibility for voting proxies in respect of each Funds portfolio holdings to the Adviser, to vote each Funds proxies in accordance with the Advisers Proxy Voting Policy. The Board has approved the Proxy Voting Policy. Pursuant to the Proxy Voting Policy, the Adviser will vote proxies related to Fund securities in the best interests of each Fund and its shareholders. The Advisers Proxy Voting Policies are attached as Appendix B.
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As applicable, each Funds proxy voting record for the most recent 12-month period ended June 30 is available (i) without charge, upon request, by calling (877) 665-1287 and (ii) on the SECs website (http://www.sec.gov). Information as of June 30 each year will generally be available on or about the following August 31.
Policy on Disclosure of Portfolio Holdings
Each Funds uncertified complete list of portfolio holdings information may be provided regularly pursuant to a standing request, such as on a monthly or quarterly basis, to (i) third party service providers, rating and ranking agencies, Financial Advisors and affiliated persons of the Fund and (ii) clients of the Adviser or its affiliates that invest in the Fund or such clients consultants. No compensation or other consideration is received by the Funds, the Adviser or any other person for these disclosures. Financial Advisors means any financial advisor, broker-dealer or other financial intermediary from which shares of the Funds may be purchased and that has entered into an agreement with the Underwriter or Boston Financial Data Services, Inc., the Funds transfer agent (the Transfer Agent), with respect to the sale of shares of the Funds. A list of the entities that receive the Funds portfolio holdings information on such basis, the earliest frequency with which it may be provided to them and the earliest length of the lag between the date of the information and the date it may be disclosed is provided below:
Company |
Frequency | Lag | ||
MorningStar Inc. |
Quarterly | 65 days after quarter end | ||
Lipper, Inc. |
Quarterly | 65 days after quarter end | ||
Thomson Financial |
Quarterly | 65 days after quarter end | ||
Bloomberg |
Quarterly | 65 days after quarter end | ||
Factset |
Quarterly | 65 days after quarter end |
The largest five portfolio holdings are published in the Funds Fact Sheets, which are posted to the Trusts website on a quarterly basis. In addition, certain service providers to the Funds, Adviser, Transfer Agent or Underwriter, such as rating and ranking agencies, pricing services, proxy voting service providers, accountants, attorneys, custodians, securities lending agents, brokers in connection with Fund transactions and providing pricing quotations, members of a bank syndicate providing a committed line of credit to the Funds, transfer agents and entities providing contingent deferred sales charge (CDSC) financing, may for legitimate business purposes receive the Funds portfolio holdings information earlier than 30 days after month end. If a Fund redeems a shareholder in kind, the shareholder generally receives its proportionate share of that Funds portfolio holdings and, therefore, the shareholder and its agent may receive such information earlier than 30 days after month end.
Disclosure of a Funds portfolio securities as an exception to the Funds normal business practice requires a Fund officer (other than the Treasurer) to identify a legitimate business purpose for the disclosure and submit the proposal to the Funds Treasurer for approval following business and compliance review. Additionally, no compensation or other consideration is received by the Funds, the Adviser or any other person for these disclosures. The Trustees will review annually a list of such entities that received such information, the frequency of such disclosures and the business purpose therefor. These procedures are designed to address conflicts of interest between the Funds shareholders on the one hand and the Adviser or any affiliated person of the Funds or such entities on the other hand by creating a structured review and approval process that seeks to ensure that disclosure of information about the Funds portfolio securities is in the best interests of the Funds shareholders. There can be no assurance, however, that the Funds policies and procedures with respect to the disclosure of portfolio holdings information will prevent the misuse of such information by individuals or firms in possession of such information.
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Holdings are released to all of the persons and entities described above on conditions of confidentiality, which include appropriate trading prohibitions. Conditions of confidentiality include confidentiality terms included in written agreements, implied by the nature of the relationship ( e.g. , attorney-client relationship), or required by fiduciary or regulatory principles ( e.g. , custody services provided by financial institutions).
Portfolio holdings of the Funds are disclosed on a quarterly basis on forms required to be filed with the SEC as follows: (i) portfolio holdings as of the end of each fiscal year will be filed as part of the annual report filed on Form N-CSR; (ii) portfolio holdings as of the end of the first and third fiscal quarters will be filed on Form N-Q; and (iii) portfolio holdings as of the end of the six-month fiscal period will be filed as part of the semi-annual report filed on Form N-CSR. The Trusts Form N-CSRs and Form N-Qs are available on the SECs website at www.sec.gov.
Each Funds top five holdings, including the top five long holdings and top five short holdings for the Long/Short Equity Fund and Long/Short Healthcare Fund, are published in the Funds Fact Sheets, which are posted on the Funds website at www.highlandfunds.com no sooner than 15 days after the end of each quarter. The day after this information has been made available to the public by means of posting on that website, it may also be included in other advertising and marketing material concerning the Funds.
Finally, each Fund releases information concerning any and all portfolio holdings when required by law. Such releases may include providing information concerning holdings of a specific security to the issuer of such security.
Highland Capital Management Fund Advisors, L.P. serves as the Funds investment adviser pursuant to separate Investment Advisory Agreements with each Fund. HCMFA is controlled by James Dondero and Mark Okada, by virtue of their respective share ownership, and its general partner, Strand Advisors XVI, Inc., of which Mr. Dondero is the sole stockholder.
Under the Investment Advisory Agreements with Long/Short Equity Fund and Long/Short Healthcare Fund, HCMFA receives a monthly fee, computed and accrued daily, at the annual rate of 2.25% and 1.00%, respectively, of the Average Daily Managed Assets of the respective Fund. Average Daily Managed Assets of a Fund means the average daily value of the total assets of that Fund, less all accrued liabilities of that Fund (other than the aggregate amount of any outstanding borrowings constituting financial leverage). The Adviser has contractually agreed to waive 1.25% of the Long/Short Equity Funds management fee. This fee waiver will continue through at least October 31, 2018, and may not be terminated prior to this date without the action or consent of the Funds Board.
Under the Investment Advisory Agreement with Merger Arbitrage Fund, HCMFA receives a monthly fee, computed and accrued daily, at the annual rate of 1.20%, of the Average Daily Managed Assets of the Fund. Average Daily Managed Assets of the Fund means the average daily value of the total assets of the Fund, less all accrued liabilities of the Fund (other than the aggregate amount of any outstanding borrowings constituting financial leverage). The Adviser has contractually agreed to limit the total annual operating expenses (exclusive of fees paid by the Fund pursuant to its
44
distribution plan under Rule 12b-1 under the Investment Company Act of 1940, as amended, taxes, dividend expenses on short sales, interest payments, brokerage commissions and other transaction costs, acquired fund fees and expenses, and extraordinary expenses) to 1.50% of Merger Arbitrage Funds average daily net assets. This expense limitation will continue through at least October 31, 2018, and may not be terminated prior to this date without the action or consent of the Funds Board.
Under the Investment Advisory Agreement with the Opportunistic Credit Fund, HCMFA receives a monthly fee, computed and accrued daily, at the annual rate of 1.00% of the Funds Average Daily Managed Assets. The Adviser has contractually agreed to limit the total annual operating expenses (exclusive of fees paid by the Fund pursuant to its distribution plan under Rule 12b-1 under the Investment Company Act of 1940, as amended, taxes, dividend expenses on short sales, interest payments, brokerage commissions and other transaction costs, acquired fund fees and expenses, and extraordinary expenses) to 0.90% of Opportunistic Credit Funds average daily net assets. This expense limitation will continue through at least October 31, 2018, and may not be terminated prior to this date without the action or consent of the Funds Board.
Under each Investment Advisory Agreement, HCMFA, among other things: (i) continuously furnishes an investment program for each Fund; (ii) places orders for the purchase and sale of securities for the accounts of each Fund; and (iii) votes, exercises consents and exercises all other rights pertaining to such securities on behalf of each Fund, or hires a sub-adviser to do so. Pursuant to a separate administration agreement, HCMFA also provides certain administration services to certain of the Funds. See Section Administrator/Sub-Administrator below.
HCMFA carries out its duties under each Investment Advisory Agreement at its own expense. Each Fund pays its own ordinary operating and activity expenses, such as legal and auditing fees, investment advisory fees, administrative fees, custodial fees, transfer agency fees, the cost of communicating with shareholders and registration fees, as well as other operating expenses such as interest, taxes, brokerage, insurance, bonding, compensation of Independent Trustees of the Funds and extraordinary expenses.
Each Investment Advisory Agreement provides that in the absence of willful misfeasance, bad faith or gross negligence in the performance (or reckless disregard) of its obligations or duties thereunder on the part of HCMFA shall not be subject to liability to a Fund for any error of judgment or mistake of law or for any loss suffered by a Fund in connection with the matters to which the Investment Advisory Agreement relates.
Additionally, each Investment Advisory Agreement remains in force for an initial two year period and from year to year thereafter, subject to annual approval by (a) the Board or (b) a vote of the majority of the Funds outstanding voting securities; provided that in either event continuance is also approved by a majority of the Independent Trustees, by a vote cast in person at a meeting called for the purpose of voting such approval. Each Investment Advisory Agreement may be terminated at any time, without payment of any penalty, by vote of the Trusts Board, or by a vote of a majority of the outstanding voting securities (as defined in the 1940 Act) of the Fund, or by the Adviser, in each case on not more than 60 days nor less than 30 days prior written notice to the other party. Each Investment Advisory Agreement will automatically terminate in the event of its assignment, as defined by the 1940 Act and the rules thereunder, or upon the termination of the relevant Investment Advisory Agreement.
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The table below sets forth the advisory fees paid by the Long/Short Equity Fund, as well as any fee waiver, for the past three fiscal years:
Fiscal Year Ended
June 30, 2017 |
Fiscal Year Ended
June 30, 2016 |
Fiscal Year Ended
June 30, 2015 |
||||||||||
Gross Advisory Fee |
$ | 11,300,319 | $ | 18,686,241 | $ | 20,684,901 | ||||||
Fee Waiver 1 |
$ | (6,277,955 | ) | $ | (10,381,245 | ) | $ | (11,491,612 | ) | |||
Net Advisory Fee |
$ | 5,022,364 | $ | 8,304,996 | $ | 9,193,289 |
1 | HCMFA had contractually agreed to waive 1.25% of the Funds management fee through October 31, 2017. |
The table below sets forth the advisory fees paid by the Long/Short Healthcare Fund, as well as any fee waiver, for the past three fiscal years:
Fiscal Year Ended
June 30, 2017 |
Fiscal Year Ended
June 30, 2016 |
Fiscal Year Ended
June 30, 2015 |
||||||||||
Gross Advisory Fee |
$ | 1,958,243 | $ | 5,962,673 | $ | 4,520,807 | ||||||
Fee Waiver |
$ | 0 | $ | 0 | $ | 0 | ||||||
Net Advisory Fee |
$ | 1,958,243 | $ | 5,962,673 | $ | 4,520,807 |
The table below sets forth the advisory fees paid by the Merger Arbitrage Fund, as well as any fee waiver, for the past three fiscal years:
Fiscal Year Ended
June 30, 2017 1 |
Fiscal Period Ended
December 31, 2016 2 |
Fiscal Year Ended
June 30, 2015 |
||||||||
Gross Advisory Fee |
$ | 160,236 | $ | 78,594 | N/A | |||||
Fee Waiver 3 |
$ | (181,470 | ) | $ | (204,077 | ) | N/A | |||
Net Advisory Fee |
$ | (21,234 | ) | $ | (125,483 | ) | N/A |
1 | The Merger Arbitrage Fund had a fiscal year end change from December 31 to June 30 in 2017. The period shown represents the six months ended June 30, 2017. |
2 | For the period from commencement of operations as a registered investment company on August 19, 2016 to December 31, 2016. |
3 | HCMFA had contractually agreed to limit the total annual fund operating expenses of the Fund to 1.50% of average daily net assets attributable to any class of the Fund through October 31, 2017. |
The table below sets forth the advisory fees paid by the Opportunistic Credit Fund, as well as any fee waiver, for the past three fiscal years:
Fiscal Year Ended
June 30, 2017 |
Fiscal Year Ended
June 30, 2016 |
Fiscal Year Ended
June 30, 2015 |
||||||||||
Gross Advisory Fee |
$ | 752,486 | $ | 732,840 | $ | 483,699 | ||||||
Fee Waiver 1 |
$ | (377,527 | ) | $ | (388,222 | ) | $ | (501,010 | ) | |||
Net Advisory Fee |
$ | 374,959 | $ | 344,618 | $ | (17,311 | ) |
1 | HCMFA had contractually agreed to limit the total annual fund operating expenses of the Fund to 0.90% of average daily net assets attributable to any class of the Fund through October 31, 2017. |
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INFORMATION REGARDING PORTFOLIO MANAGERS
The following table identifies: (i) the portfolio managers identified in the Prospectus who are primarily responsible for the day-to-day management of the Funds, (ii) the number of registered investment companies managed by each portfolio manager on a day-to-day basis and the corresponding total assets managed in such investment companies, (iii) the number of other pooled investment vehicles managed by each portfolio manager on a day-to-day basis and the corresponding total assets managed in such pooled investment vehicles, (iv) the number of other accounts managed by each portfolio manager on a day-to-day basis and the corresponding total assets managed in such other accounts, and (v) for each of the foregoing categories, the number of accounts and total assets in the accounts whose fees are based on performance, if any. All information is provided as of June 30, 2017.
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Long/Short Equity Fund
The portfolio managers of Long/Short Equity Fund are Jonathan Lamensdorf and Michael McLochlin.
As of June 30, 2017, Jonathan Lamensdorf managed the following client accounts:
Type of Accounts |
Total
# of Accounts Managed |
Total
Assets (millions) |
# of Accounts
Managed with Performance- Based Advisory Fee |
Total Assets
with Performance- Based Advisory Fee (millions) |
||||||||||||
Registered Investment Companies: |
1 | $ | 30.15 | 0 | $ | 0 | ||||||||||
Other Pooled Investment Vehicles: |
0 | $ | 0 | 0 | $ | 0 | ||||||||||
Other Accounts: |
0 | $ | 0 | 0 | $ | 0 |
As of June 30, 2017, Michael McLochlin managed the following other client accounts:
Type of Accounts |
Total
# of Accounts Managed |
Total
Assets (millions) |
# of Accounts
Managed with Performance- Based Advisory Fee |
Total Assets with
Performance- Based Advisory Fee (millions) |
||||||||||||
Registered Investment Companies: |
0 | $ | 0 | 0 | $ | 0 | ||||||||||
Other Pooled Investment Vehicles: |
0 | $ | 0 | 0 | $ | 0 | ||||||||||
Other Accounts: |
0 | $ | 0 | 0 | $ | 0 |
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Long/Short Healthcare Fund
The portfolio manager of Long/Short Healthcare Fund is Michael D. Gregory.
As of June 30, 2017, Michael D. Gregory managed the following client accounts:
Type of Accounts |
Total
# of Accounts Managed |
Total
Assets (millions) |
# of Accounts
Managed with Performance- Based Advisory Fee |
Total Assets with
Performance- Based Advisory Fee (millions) |
||||||||||||
Registered Investment Companies: |
4 | $ | 316.42 | 0 | $ | 0 | ||||||||||
Other Pooled Investment Vehicles: |
0 | $ | 0 | 0 | $ | 0 | ||||||||||
Other Accounts: |
0 | $ | 0 | 0 | $ | 0 |
Merger Arbitrage Fund
The portfolio managers of Merger Arbitrage Fund are James Dondero and Jonathan Lamensdorf.
As of June 30, 2017, James Dondero managed the following client accounts:
Type of Accounts |
Total
# of Accounts Managed |
Total
Assets (millions) |
# of Accounts
Managed with Performance- Based Advisory Fee |
Total Assets with
Performance- Based Advisory Fee (millions) |
||||||||||||
Registered Investment Companies: |
8 | $ | 1,595.94 | 0 | $ | 0 | ||||||||||
Other Pooled Investment Vehicles: |
2 | $ | 624.73 | 2 | $ | 624.73 | ||||||||||
Other Accounts: |
0 | $ | 0 | 0 | $ | 0 |
As of June 30, 2017, Jonathan Lamensdorf managed the following client accounts:
Type of Accounts |
Total
# of Accounts Managed |
Total
Assets (millions) |
# of Accounts
Managed with Performance- Based Advisory Fee |
Total Assets
with Performance- Based Advisory Fee (millions) |
||||||||||||
Registered Investment Companies: |
1 | $ | 394.83 | 0 | $ | 0 | ||||||||||
Other Pooled Investment Vehicles: |
0 | $ | 0 | 0 | $ | 0 | ||||||||||
Other Accounts: |
0 | $ | 0 | 0 | $ | 0 |
49
Opportunistic Credit Fund
The portfolio managers of the Opportunistic Credit Fund are James Dondero and Trey Parker.
As of June 30, 2017, James Dondero managed the following client accounts:
Type of Accounts |
Total
# of Accounts Managed |
Total
Assets (millions) |
# of Accounts
Managed with Performance- Based Advisory Fee |
Total Assets with
Performance- Based Advisory Fee (millions) |
||||||||||||
Registered Investment Companies: |
8 | $ | 1,542.71 | 0 | $ | 0 | ||||||||||
Other Pooled Investment Vehicles: |
2 | $ | 624.73 | 2 | $ | 624.73 | ||||||||||
Other Accounts: |
0 | $ | 0 | 0 | $ | 0 |
As of June 30, 2017, Trey Parker managed the following client accounts:
Type of Accounts |
Total
# of Accounts Managed |
Total
Assets (millions) |
# of Accounts
Managed with Performance- Based Advisory Fee |
Total Assets with
Performance- Based Advisory Fee (millions) |
||||||||||||
Registered Investment Companies: |
0 | $ | 0 | 0 | $ | 0 | ||||||||||
Other Pooled Investment Vehicles: |
3 | $ | 430.39 | 2 | $ | 323.38 | ||||||||||
Other Accounts: |
3 | $ | 833.99 | 2 | $ | 448.99 |
50
Compensation Structure HCMFA
HCMFAs financial arrangements with its portfolio managers, its competitive compensation and its career path emphasis at all levels reflect the value senior management places on key resources. Compensation may include a variety of components and may vary from year to year based on a number of factors, including the pre-tax relative performance of a portfolio managers underlying account, the pre-tax combined performance of the portfolio managers underlying accounts, and the pre-tax relative performance of the portfolio managers underlying accounts measured against other employees. The principal components of compensation include a base salary, a discretionary bonus, various retirement benefits and one or more of the incentive compensation programs established by HCMFA, such as its Short-Term Incentive Plan and its Long-Term Incentive Plan, described below.
Portfolio managers are compensated generally based on their investment performance. The portfolio managers and other investment professionals are ranked based on the alpha generated by their portfolio versus their target index benchmark. Their investment performance is evaluated both versus a target index benchmark return and also compared to the returns of their peers at HCMFA and its affiliates. Other attributes which may be considered in the evaluation process are communication, teamwork, attitude and leadership.
Compensation of the Funds portfolio managers may also be based, in part, on the one and three-year performance of each Fund relative to its applicable market index or category: with respect to the Long/Short Equity Fund and the Long/Short Healthcare Fund, the Morningstar Long/Short Equity Category; with respect to the Opportunistic Credit Fund, the Credit Suisse Leveraged Loan Index; and with respect to the Merger Arbitrage Fund, the Morningstar Market Neutral Category.
HCMFA is owned by Highland Capital Management Services, Inc., a Delaware corporation (HCM Services) and its general partner, Strand Advisors XVI, Inc., of which Mr. James Dondero is the sole stockholder. HCM Services is controlled by Mr. Dondero and Mr. Mark Okada by virtue of their respective share ownership. Mr. Dondero does not receive compensation based upon investment performance of Opportunistic Credit Fund or Merger Arbitrage Fund, both of which he serves as portfolio manager and instead shares in the profits of HCMFA.
Base compensation. Generally, portfolio managers receive base compensation based on their seniority and/or their position with HCMFA, which may include the amount of assets supervised and other management roles within HCMFA. Base compensation is determined by taking into account current industry norms and market data to ensure that HCMFA pays a competitive base compensation.
Discretionary compensation. In addition to base compensation, portfolio managers may receive discretionary compensation, which can be a substantial portion of total compensation. Discretionary compensation can include a discretionary cash bonus paid to recognize specific business contributions and to ensure that the total level of compensation is competitive with the market, as well as participation in incentive plans, including one or more of the following:
Short-Term Incentive PlanThe purpose of this plan is to attract and retain the highest quality employees for positions of substantial responsibility, and to provide additional incentives to a select group of management or highly-compensated employees of HCMFA in order to promote the success of HCMFA.
51
Long-Term Incentive PlanThe purpose of this plan is to create positive morale and teamwork, to attract and retain key talent and to encourage the achievement of common goals. This plan seeks to reward participating employees based on the increased value of HCMFA.
Because each persons compensation is based on his or her individual performance, HCMFA does not have a typical percentage split among base salary, bonus and other compensation. Senior portfolio managers who perform additional management functions may receive additional compensation in these other capacities. Compensation is structured such that key professionals benefit from remaining with HCMFA.
Conflicts of Interest HCMFA
Because each portfolio manager manages other accounts, including accounts that may pay higher fees, potential conflicts of interest exist, including potential conflicts between the investment strategy of a Fund and the investment strategy of the other accounts managed by the portfolio manager and potential conflicts in the allocation of investment opportunities between a Fund and the other accounts. HCMFA has policies and procedures in place that are reasonably designed to mitigate these conflicts of interest, which are also described below.
HCMFA and/or its general partner, limited partners, officers, affiliates and employees provide investment advice to other parties and manage other accounts and private investment vehicles similar to the Funds. For the purposes of this section, the term Highland shall include HCMFA and its affiliated investment advisors, including Highland Capital Management, L.P. and all affiliates listed on its Form ADV, as filed with the SEC March 30, 2017 (CRD No. 149653). In connection with such other investment management activities, HCMFA and/or its general partner, limited partners, officers, affiliates and employees may decide to invest the funds of one or more other accounts or recommend the investment of funds by other parties, rather than a Funds monies, in a particular security or strategy. In addition, HCMFA and such other persons will determine the allocation of funds from a Fund and such other accounts to investment strategies and techniques on whatever basis they consider appropriate or desirable in their sole and absolute discretion.
HCMFA has built a professional working environment, a firm-wide compliance culture and compliance procedures and systems designed to protect against potential incentives that may favor one account over another. HCMFA has adopted policies and procedures that address the allocation of investment opportunities, execution of portfolio transactions, personal trading by employees and other potential conflicts of interest that are designed to ensure that all client accounts are treated equitably over time. Nevertheless, HCMFA furnishes advisory services to numerous clients in addition to the Funds, and HCMFA may, consistent with applicable law, make investment recommendations to other clients or accounts (including accounts that have performance or higher fees paid to HCMFA or in which portfolio managers have a personal interest in the receipt of such fees) that may be the same as or different from those made to the Fund. In addition, HCMFA, its affiliates and any of their partners, directors, officers, stockholders or employees may or may not have an interest in the securities whose purchase and sale HCMFA recommends to the Funds. Actions with respect to securities of the same kind may be the same as or different from the action that HCMFA, or any of its affiliates, or any of their partners, directors, officers, stockholders or employees or any member of their families may take with respect to the same securities. Moreover, HCMFA may refrain from rendering any advice or services concerning securities of companies of which any of HCMFAs (or its affiliates) partners, directors, officers or employees are directors or officers, or companies as to which HCMFA or any of its affiliates or partners, directors, officers and employees of any of them has any substantial economic interest or possesses material non-public information. In addition to its various policies and procedures designed to address these issues, HCMFA includes disclosure regarding these matters to its clients in both its Form ADV and investment advisory agreements.
52
HCMFA, its affiliates or their partners, directors, officers or employees similarly serve or may serve other entities that operate in the same or related lines of business, including accounts managed by an investment adviser affiliated with the Adviser. Accordingly, these individuals may have obligations to investors in those entities or funds or to other clients, the fulfillment of which might not be in the best interests of the Fund. As a result, HCMFA will face conflicts in the allocation of investment opportunities to the Funds and other funds and clients. In order to enable such affiliates to fulfill their fiduciary duties to each of the clients for which they have responsibility, HCMFA will endeavor to allocate investment opportunities in a fair and equitable manner which may, subject to applicable regulatory constraints, involve pro rata co-investment by the Funds and such other clients or may involve a rotation of opportunities among the Funds and such other clients. To mitigate any actual or perceived conflicts of interest, allocation of limited offering securities (such as IPOs and registered secondary offerings) to principal accounts that do not include third party investors may only be made after all other client account orders for the security have been filled. However, there can be no assurance that such policies and procedures will in every case ensure fair and equitable allocations of investment opportunities, particularly when considered in hindsight.
Conflicts may arise in cases when clients invest in different parts of an issuers capital structure, including circumstances in which one or more clients own private securities or obligations of an issuer and other clients may own public securities of the same issuer. In addition, one or more clients may invest in securities, or other financial instruments, of an issuer that are senior or junior to securities, or financial instruments, of the same issuer that are held by or acquired for, one or more other clients. For example, if such issuer encounters financial problems, decisions related to such securities (such as over the terms of any workout or proposed waivers and amendments to debt covenants) may raise conflicts of interests. In such a distressed situation, a client holding debt securities of the issuer may be better served by a liquidation of the issuer in which it may be paid in full, whereas a client holding equity securities of the issuer might prefer a reorganization that holds the potential to create value for the equity holders. In the event of conflicting interests within an issuers capital structure, Highland will generally pursue the strategy that Highland believes will maximize value for Highland accounts overall (without regard to the nature of the accounts involved or fees received from such accounts). This strategy may be recommended by one or more Highland investment professionals. A single person may represent more than one part of an issuers capital structure. The recommended course of action will be presented to the conflicts committee for final determination as to how to proceed, Highland may elect, but is not required, to assign different teams to make recommendations for different parts of the capital structure as the conflicts committee determines in its discretion. In the event any Highland personnel serve on the board of the subject company, they generally recuse themselves from voting on any board matter with respect to a transaction that has an asymmetrical impact on the capital structure. Highland personnel board members may still make recommendations to the conflicts committee. If any such persons are also on the conflicts committee, they may recuse themselves from the committees determination. A Portfolio Manager with respect to any applicable Highland registered investment company clients (Retail Accounts) participates in such discussions, but makes an independent determination as to which course of action he or she determines is in the best interest of the applicable Retail Accounts. Highland may use external counsel for guidance and assistance.
HCMFA and its affiliates have both subjective and objective procedures and policies in place designed to manage potential conflicts of interest involving clients so that, for example, investment opportunities are allocated in a fair and equitable manner among the Funds and such other clients. An investment opportunity that is suitable for multiple clients of HCMFA and its affiliates may not be capable of being shared among some or all of such clients due to the limited scale of the opportunity
53
or other factors, including regulatory restrictions imposed by the 1940 Act. There can be no assurance that HCMFAs or its affiliates efforts to allocate any particular investment opportunity fairly among all clients for whom such opportunity is appropriate will result in an allocation of all or part of such opportunity to the Funds. Not all conflicts of interest can be expected to be resolved in favor of the Funds.
Another type of conflict may arise if HCMFA causes one client account of an affiliated advisor to buy a security and another client account to sell or short the same security. Currently, such opposing positions are generally not permitted within the same account without prior trade approval by the Chief Compliance Officer. However, a portfolio manager may enter into opposing positions for different clients to the extent each such client has a different investment objective and each such position is consistent with the investment objective of the applicable client. In addition, transactions in investments by one or more affiliated client accounts may have the effect of diluting or otherwise disadvantaging the values, prices or investment strategies of other client accounts.
Because certain client accounts may have investment objectives, strategies or legal, contractual, tax or other requirements that differ (such as the need to take tax losses, realize profits, raise cash, diversification, etc.), an affiliated advisor may purchase, sell or continue to hold securities for certain client accounts contrary to other recommendations. In addition, an affiliated advisor may be permitted to sell securities or instruments short for certain client accounts and may not be permitted to do so for other affiliated client accounts.
Ownership of Securities
The following table sets forth the dollar range of equity securities of the Funds beneficially owned by each portfolio manager. This information is provided as of the fiscal year ended June 30, 2017.
Name of Portfolio Manager |
Name of Fund |
Dollar Range of Equity
Securities Beneficially Owned by Portfolio Manager 1 |
||
Jonathan Lamensdorf |
Long/Short Equity Fund |
$500,001 - $1,000,000 | ||
Michael McLochlin |
Long/Short Equity Fund |
$100,001 - $500,000 | ||
Michael D. Gregory |
Long/Short Healthcare Fund |
$500,001 - $1,000,000 2 | ||
James D. Dondero 3 |
Merger Arbitrage Fund |
Over $1,000,000 | ||
Jonathan Lamensdorf |
Merger Arbitrage Fund |
$100,001 - $500,000 | ||
James D. Dondero 3 |
Opportunistic Credit Fund |
Over $1,000,000 | ||
Trey Parker |
Opportunistic Credit Fund |
$100,001 - $500,000 |
1 | Mr. Gregorys and Parkers beneficial ownership of these shares includes the value of deferred compensation payments that are determined as if the amount had been invested, as of the date awarded, in shares of the respective Fund. |
2 | As of October 17, 2017. |
3 | Mr. Dondero controls HCM. Through his control of HCM, Mr. Dondero may be viewed as having voting and dispositive power over all of the shares of Merger Arbitrage Funds common stock and Highland Opportunistic Credit Funds common stock directly owned by HCM. |
54
ADMINISTRATOR/SUB-ADMINISTRATOR
HCMFA provides administration services to the Long/Short Equity Fund and the Long/Short Healthcare Fund, for a monthly administration fee, computed and accrued daily, at an annual rate of 0.20% of each Funds Average Daily Managed Assets. In such capacity, HCMFA generally assists each Fund in all aspects of its administration and operations. Under a separate sub-administration agreement, HCFMA has delegated certain administrative functions, as of January 14, 2013, to State Street, One Lincoln Street, Boston, Massachusetts 02111, and pays State Street a portion of the fee it receives from the Fund. Under the sub-administration agreement, State Street has agreed to provide corporate secretarial services; prepare and file various reports with the appropriate regulatory agencies; assist in preparing various materials required by the SEC; and prepare various materials required by any state securities commission having jurisdiction over the Funds.
55
The table below sets forth the administration fees paid by the Long/Short Equity Fund and the Long/Short Healthcare Fund as well as any fee waiver or reimbursement, for the past three fiscal years.
Fiscal Year
Ended June 30, 2017 |
Fiscal Year
Ended June 30, 2016 |
Fiscal Year
Ended June 30, 2015 |
||||||||||
Long/Short Equity Fund |
||||||||||||
Gross Administration Fee |
$ | 1,004,473 | $ | 1,660,999 | $ | 1,838,658 | ||||||
Fee Waiver/Reimbursement |
$ | 0 | $ | 0 | $ | 0 | ||||||
Net Administration Fee |
$ | 1,004,473 | $ | 1,660,999 | $ | 1,838,658 | ||||||
Long/Short Healthcare Fund |
||||||||||||
Gross Administration Fee |
$ | 391,649 | $ | 1,192,534 | $ | 904,162 | ||||||
Fee Waiver |
$ | 0 | $ | 0 | $ | 0 | ||||||
Net Administration Fee |
$ | 391,649 | $ | 1,192,534 | $ | 904,162 |
For the fiscal year ended June 30, 2017, June 30, 2016 and June 30, 2015 for all Funds, HCMFA or its affiliates, as applicable, paid $381,015, $499,201 and $537,989, respectively, to State Street for its services as sub-administrator.
With respect to the Merger Arbitrage Fund and Opportunistic Credit Fund, the Trust has entered into an administration agreement with State Street, One Lincoln Street, Boston, Massachusetts 02111 and pays State Street a fee for administration services. State Street has agreed to provide corporate secretarial services; prepare and file various reports with the appropriate regulatory agencies; assist in preparing various materials required by the SEC; and prepare various materials required by any state securities commission having jurisdiction over the Funds. HCMFA generally assists in all aspects of the Trusts administration and operations and furnishes offices, necessary facilities, equipment and personnel.
56
The table below sets forth the administration fees paid by the Merger Arbitrage Fund and the Opportunistic Credit Fund, as well as any fee waiver or reimbursement, for the past three fiscal years.
Fiscal Year
Ended June 30, 2017 |
Fiscal Year
Ended June 30, 2016 |
Fiscal Year
Ended June 30, 2015 |
||||||||||
Merger Arbitrage Fund |
||||||||||||
Gross Administration Fee |
$ | 4,027 | 1 | $ | 1,959 | 2 | N/A | |||||
Fee Waiver |
$ | 0 | $ | 0 | N/A | |||||||
Net Administration Fee |
$ | 4,027 | 1 | $ | 1,959 | 2 | N/A | |||||
Opportunistic Credit Fund |
||||||||||||
Gross Administration Fee |
$ | 26,072 | $ | 24,319 | $ | 15,621 | ||||||
Fee Waiver |
$ | 0 | $ | 0 | $ | 0 | ||||||
Net Administration Fee |
$ | 26,072 | $ | 24,319 | $ | 15,621 |
1 | The Merger Arbitrage Fund had a fiscal year end change from December 31 to June 30 in 2017. The period shown represents the six months ended June 30, 2017. |
2 | For the period of commencement of operations as a registered investment company on August 19, 2016 to December 31, 2016. |
Shares of each Fund are offered for sale on a continuous basis through the Funds principal underwriter, HCFD, 200 Crescent Court, Suite 700, Dallas, Texas 75201, an affiliate of the Adviser. Prior to April 1, 2014, Foreside Funds Distributors LLC., 400 Berwyn Park, 899 Cassatt Road, Berwyn, Pennsylvania 19312 (Foreside.) served as the principal underwriter for Long/Short Equity Fund and Long/Short Healthcare Fund. Foreside and HCFD are collectively referred to as the Underwriter. HCFD will use all reasonable efforts in connection with distribution of shares of the Funds.
The Funds have agreed to pay all expenses in connection with registration of their shares with the SEC, auditing and filing fees in connection with registration of their shares under the various state blue sky laws, the cost of preparation of the Prospectus and other expenses.
The Underwriter was paid the following aggregate commissions on sales of Class A Shares and Class C Shares of the Funds during the past three fiscal years.
Fiscal Year
Ended June 30, 2017 |
Fiscal Year
Ended June 30, 2016 |
Fiscal Year
Ended June 30, 2015 |
||||||||||
Long/Short Equity Fund |
||||||||||||
Class A Shares |
$ | 2,743 | $ | 18,133 | $ | 10,203 | ||||||
Class C Shares |
$ | 0 | $ | 0 | $ | 0 | ||||||
Long/Short Healthcare Fund |
||||||||||||
Class A Shares |
$ | 6,062 | $ | 118,975 | $ | 153,384 | ||||||
Class C Shares |
$ | 0 | $ | 0 | $ | 0 | ||||||
Merger Arbitrage Fund |
||||||||||||
Class A Shares |
$ | 5,197 | 1 | $ | 837 | 2 | N/A | |||||
Class C Shares |
$ | 0 | 1 | $ | 0 | 2 | N/A | |||||
Opportunistic Credit Fund |
||||||||||||
Class A Shares |
$ | 8,622 | $ | 0 | $ | 0 | ||||||
Class C Shares |
$ | 0 | $ | 0 | $ | 0 |
1 | The Merger Arbitrage Fund had a fiscal year end change from December 31 to June 30 in 2017. The period shown represents the six months ended June 30, 2017. |
2 | For the period of commencement of operations as a registered investment company on August 19, 2016 to December 31, 2016. |
57
HCMFA performs certain services and incurs certain expenses with respect to the promotion and distribution of Fund shares. The Underwriter pays HCMFA for promotion and distribution expenses incurred by it in respect of the Funds (service payments). Such service payments are made out of commissions retained by the Underwriter after it has first been paid its own compensation and been reimbursed for its own expenses (including amounts paid by the Underwriter to financial intermediaries in connection with sales of the Funds) (underwriter concessions), provided that in no event shall the Underwriter be required to use in excess of 50% of the underwriter concessions retained by the Underwriter to make such service payments. During some periods, underwriter concessions received by the Underwriter may be insufficient to pay HCMFA fully for its promotional and distribution expenses. In such cases, the Underwriter agrees to pay such service payments to the extent of the available underwriter concessions and pay the balance of such service payments as the Underwriter receives underwriter concessions in future periods.
Effective April 21, 2014 for the Long/Short Equity Fund and Long/Short Healthcare Fund, the Underwriter pays Financial Advisors the following increased cumulative commissions for purchases of $500,000 or more of Class A shares: 1.00% for amounts less than $5 million, 0.40% for amounts greater than or equal to $5 million but less than $25 million and 0.25% for amounts greater than or equal to $25 million. The terms and conditions with respect to CDSCs and brokerage commissions for Class A Shares purchased prior to April 21, 2014 are unchanged.
58
In addition, effective April 21, 2014, Class A Shares of Long/Short Equity Fund and Long/Short Healthcare Fund bought without an initial sales charge in accounts aggregating $500,000 or more at the time of purchase are subject to a 1.00% CDSC if the shares are sold within eighteen months of purchase.
The following table shows the amount of service payments paid by the Underwriter to HCMFA during the past three fiscal years.
Fiscal Year
Ended June 30, 2017 |
Fiscal Year
Ended June 30, 2016 |
Fiscal Year
Ended June 30, 2015 |
||||||||||
Long/Short Equity Fund |
$ | 0 | $ | 0 | $ | 0 | ||||||
Long/Short Healthcare Fund |
$ | 0 | $ | 0 | $ | 0 | ||||||
Merger Arbitrage Fund |
$ | 0 | 1 | $ | 0 | 2 | $ | 0 | ||||
Opportunistic Credit Fund |
$ | 0 | $ | 0 | $ | 0 |
1 | The Merger Arbitrage Fund had a fiscal year end change from December 31 to June 30 in 2017. The period shown represents the six months ended June 30, 2017. |
2 | For the period of commencement of operations as a registered investment company on August 19, 2016 to December 31, 2016. |
DISTRIBUTION AND SERVICE FEE PLAN
The Distribution and Service Fee Plan (the Plan) requires the payment of a monthly service fee and distribution fee to the Underwriter.
For Long/Short Equity Fund, Long/Short Healthcare Fund and Merger Arbitrage Fund, the Plan requires the payment of (i) a monthly service fee at the annual rate of 0.25% of the average daily net assets attributable to Class A Shares and 0.25% of average daily net assets attributable to Class C Shares and (ii) a distribution fee at the annual rates of 0.10% of the average daily net assets of its Class A Shares and 0.75% of the average daily net assets of its Class C Shares.
For Opportunistic Credit Fund, the Plan requires the payment of (i) a monthly service fee to the Underwriter at the annual rate of 0.25% of the average daily net assets attributable to Class A Shares and 0.25% of average daily net assets attributable to Class C Shares and (ii) a distribution fee at the annual rates of 0.10% of the average daily net assets of its Class A Shares and 0.60% of the average daily net assets of its Class C Shares, if any.
The Underwriter may pay all or a portion of these fees to Financial Advisors whose clients own shares of the Fund. The Trustees of the Funds have concluded, in the exercise of their reasonable business judgment and in light of their fiduciary duties, that there is a reasonable likelihood that the Plan will benefit the Funds and their shareholders. For instance, asset growth resulting from the Plan can be expected to benefit each Funds shareholders through the realization of economies of scale and potentially lower expense levels.
The Underwriter may pay certain Financial Advisors whose clients own shares of a Fund monthly distribution fees with respect to a given share class at a rate greater than that set forth above,
59
so long as the total payments paid by the Fund to the Underwriter for each share class under a Plan for distribution fees do not exceed the stated percentages. In the event that there are insufficient assets in the Plan to make a contractually required payment to a Financial Advisor, the Adviser has agreed to pay such Financial Advisor at its own expense out of its own financial resources. See Shareowner Guide How to Invest in the Highland FundsDistribution and Service Fees in the Funds Prospectus for additional information on revenue sharing payments. The Underwriter and the Adviser will not agree to make distribution payments to Financial Advisors from assets of the Plan in an amount exceeding the Distribution Fees noted above with respect to each Share class. Any shareholder purchasing shares of a Fund through a Financial Advisor should check with the Financial Advisor to determine the distribution fees it is receiving.
The following table sets forth the distribution fees and service fees paid by the Funds to the Underwriter for the fiscal year ended June 30, 2017.
Fiscal Year Ended
June 30, 2017 Distribution and Service Fees |
||||
Long/Short Equity Fund |
||||
Class A |
$ | 123,907 | ||
Class C |
$ | 374,395 | ||
Long/Short Healthcare Fund |
||||
Class A |
$ | 207,300 | ||
Class C |
$ | 378,172 | ||
Merger Arbitrage Fund 1 |
||||
Class A |
$ | 1,691 | ||
Class C |
$ | 3,836 | ||
Opportunistic Credit Fund |
||||
Class A |
$ | 28,649 | ||
Class C |
$ | 12,636 |
1 | The Merger Arbitrage Fund had a fiscal year end change from December 31 to June 30 in 2017. The period shown represents the six months ended June 30, 2017. |
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During the fiscal year ended June 30, 2017, the Underwriter incurred the following expenses on behalf of the Funds in connection with distributions under the Plan.
Advertising |
Printing and
Mailing of Prospectus to other than Current Shareholders |
Compensation
to Underwriters |
Compensation to
Broker-Dealers |
Compensation
to Sales Personnel |
Interest,
Carrying or other Financing Charges |
|||||||||||||||||||
Long/Short Equity Fund |
||||||||||||||||||||||||
Class A |
$ | 3,615 | $ | 2,492 | $ | 0 | $ | 98,465 | $ | 15,077 | $ | 0 | ||||||||||||
Class C |
$ | 27,168 | $ | 7,868 | $ | 124,507 | $ | 306,203 | $ | 23,456 | $ | 0 | ||||||||||||
Long/Short Healthcare Fund |
||||||||||||||||||||||||
Class A |
$ | 11,853 | $ | 5,770 | $ | 0 | $ | 155,458 | $ | 31,097 | $ | 0 | ||||||||||||
Class C |
$ | 16,600 | $ | 8,218 | $ | 714,232 | $ | 319,954 | $ | 27,140 | $ | 0 | ||||||||||||
Merger Arbitrage Fund 1 |
||||||||||||||||||||||||
Class A |
$ | 0 | $ | 0 | $ | 0 | $ | 241 | $ | 15 | $ | 0 | ||||||||||||
Class C |
$ | 399 | $ | 235 | $ | 0 | $ | 0 | $ | 344 | $ | 0 | ||||||||||||
Opportunistic Credit Fund |
||||||||||||||||||||||||
Class A |
$ | 418 | $ | 314 | $ | 0 | $ | 16,921 | $ | 3,250 | $ | 0 | ||||||||||||
Class C |
$ | 806 | $ | 425 | $ | 1,962 | $ | 807 | $ | 1,007 | $ | 0 |
1 | The Merger Arbitrage Fund had a fiscal year end change from December 31 to June 30 in 2017. The period shown represents the six months ended June 30, 2017. |
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TRANSFER AGENT AND DIVIDEND PAYING AGENT
Boston Financial Data Services Inc. (BFDS), located at 2000 Crown Colony Drive Quincy, Massachusetts 02169-09534, serves as the transfer agent and dividend paying agent of the Funds investments. As transfer agent, BFDS is responsible for processing purchase and redemption requests and crediting dividends to the accounts of shareholders of a Fund. For its services, BFDS receives monthly fees charged to a Fund, plus certain charges for securities transactions.
State Street, located at One Lincoln Street, Boston, Massachusetts 02111, is the custodian for the Funds. State Street is responsible for holding all securities, other investments and cash, receiving and paying for securities purchased, delivering against payment securities sold, receiving and collecting income from investments, making all payments covering expenses and performing other administrative duties, all as directed by authorized persons. State Street does not exercise any supervisory function in such matters as purchase and sale of portfolio securities, payment of dividends or payment of expenses.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The independent registered public accounting firm for the Funds is KPMG LLP, located at Two Financial Center, 60 South Street, Boston, Massachusetts 02111. The independent registered public accounting firm audits and reports on the annual financial statements, reviews certain regulatory reports and U.S. federal income tax returns, and performs other professional accounting, auditing and tax services when engaged to do so.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Selection of Broker-Dealers; Order Placement
Subject to the overall review of the Funds Board, the Adviser is responsible for decisions to buy and sell securities and other portfolio holdings of the Funds, for selecting the broker or dealer to be used and for negotiating any commission rates paid. In underwritten offerings, securities usually are purchased at a fixed price that includes an amount of compensation to the underwriter, generally referred to as the underwriters concession or discount. On occasion, certain money market instruments may be purchased directly from an issuer, in which case no commissions or discounts are paid.
The Adviser and its affiliates manage other accounts, including private funds and individual accounts that invest in Fund investments. Although investment decisions for the Funds are made independently from those of such other accounts, investments of the type the Funds may make also may be made on behalf of such other accounts. When a Fund and one or more other accounts is prepared to invest in, or desires to dispose of, the same investment, available investments or opportunities for each are allocated in a manner believed by the Adviser to be equitable over time. The Adviser may (but is not obligated to) aggregate orders, which may include orders for accounts in which the Adviser or its affiliates have an interest, to purchase and sell securities to obtain favorable execution or lower brokerage commissions, to the extent permitted by applicable laws and regulations. Although the Adviser believes that, over time, the potential benefits of participating in volume transactions and negotiating lower transaction costs should benefit all participating accounts, in some cases these activities may adversely affect the price paid or received or the size of the position obtained by or disposed of for the Funds. Where trades are aggregated, the investments or
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proceeds, as well as the expenses incurred, will be allocated by the Adviser in a manner designed to be equitable and consistent with the Advisers fiduciary duty to the Funds and its other clients (including its duty to seek to obtain best execution of client trades).
Commission Rates; Brokerage and Research Services
The Adviser seeks to obtain best execution, considering the execution price and overall commission costs paid and other factors. The Adviser routes its orders to various broker-dealers for execution at its discretion. Factors involved in selecting brokerage firms include the size, type and difficulty of the transaction, the nature of the market for the security, the reputation, experience and financial stability of the broker-dealer involved, the quality of service, the quality of research and investment information provided and the firms risk in positioning a block of securities. Within the framework of the policy of obtaining the most favorable price and efficient execution, the Adviser does consider brokerage and research services (as defined in the Securities Exchange Act of 1934, as amended) provided by brokers who effect portfolio transactions with the Adviser or the Funds. Brokerage and research services are services that brokerage houses customarily provide to institutional investors and include statistical and economic data and research reports on particular issuers and industries.
In addition, the investment advisory agreement between the Trust and the Adviser relating to each Fund authorizes the Adviser, on behalf of the Fund, in selecting brokers or dealers to execute a particular transaction and in evaluating the best overall terms available, to consider the brokerage and research services (as those terms are defined in Section 28(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act)) provided to the Fund and/or other accounts over which the Adviser or its affiliates exercise investment discretion. The fees under the investment advisory agreement relating to a Fund will not be reduced by reason of the Funds receiving brokerage and research services. Such services include analyses and reports regarding issuers, industries, economic trends, portfolio strategy, and may effect securities transactions and perform certain functions related thereto. In addition, such services may include advice concerning the advisability of investing in, purchasing or selling securities and the availability of particular securities or buyers or sellers of securities. The research services received from broker-dealers that execute transactions on behalf of a Fund may be useful to the Adviser in servicing that Fund as well as all of the Advisers accounts and not all of these services may be used in connection with the particular Fund or Funds generating the commissions. Consistent with limits established by the Federal securities laws, a Fund may pay broker-dealer commissions for agency transactions that exceed the amount of commissions charged by other broker-dealers in recognition of their research and brokerage services.
The following tables show the amount of brokerage commissions paid by the Funds over the past three fiscal years. Variations in the amount of brokerage commissions paid by the Funds from year to year may result from changing asset levels, market conditions or changes in the Advisers outlook.
Fiscal Year
Ended June 30, 2017 |
Fiscal Year
Ended June 30, 2016 |
Fiscal Year
Ended June 30, 2015 |
||||||||||
Long/Short Equity Fund |
$ | 3,726,962 | $ | 6,290,261 | $ | 5,072,409 | ||||||
Long/Short Healthcare Fund |
$ | 6,174,797 | $ | 12,877,332 | $ | 4,357,147 | ||||||
Merger Arbitrage Fund 1 |
$ | 166,995 | 2 | $ | 64,643 | 3 | N/A | |||||
Opportunistic Credit Fund |
$ | 11,749 | $ | 10,793 | $ | 11,932 |
1 | The Merger Arbitrage Fund commenced operations as a registered investment company on August 19, 2016. |
2 | The Merger Arbitrage Fund had a fiscal year end change from December 31 to June 30 in 2017. The period shown represents the six months ended June 30, 2017. |
3 | For the period from commencement of operations as a registered investment company on August 19, 2016 to December 31, 2016. |
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The following table shows the dollar amount of brokerage commissions paid to firms that provided research and brokerage services and the approximate dollar amount of transactions involved during the fiscal year ended June 30, 2017. Funds that are not listed paid no brokerage commissions to firms that provided such services.
Fund |
Commissions Paid
to Firms for Brokerage and Research Services |
Total Amount of
Transactions to Firms for Brokerage and Research Services |
||||||
Long/Short Equity Fund |
$ | 2,971,234 | $ | 8,888,787,448 | ||||
Long/Short Healthcare Fund |
$ | 5,802,195 | $ | 6,415,922,794 | ||||
Merger Arbitrage Fund |
$ | 166,995 | $ | 579,806,639 |
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The following table shows the dollar amount of brokerage commissions paid to each firm that provided research and brokerage services obtained in compliance with Section 28(e) of the Exchange Act and the approximate dollar amount of transactions involved during the fiscal year ended June 30, 2017.
Broker |
Commissions Paid
to Firms for Brokerage and Research Services |
Total Amount of
Transactions to Firms for Brokerage and Research Services |
||||||
Bank of America Merrill Lynch |
$ | 912,271 | $ | 2,516,430,608 | ||||
Morgan Stanley & Co, Inc. |
$ | 850,663 | $ | 1,423,011,352 | ||||
Oppenheimer & Co., Inc. |
$ | 817,604 | $ | 187,475,920 | ||||
JPMorgan Chase Bank, N.A. |
$ | 747,471 | $ | 2,758,882,839 | ||||
Jefferies & Company, Inc. |
$ | 725,996 | $ | 405,665,174 | ||||
Goldman Sachs |
$ | 637,970 | $ | 2,373,460,103 | ||||
Leerink Swann & Co., Inc. |
$ | 531,048 | $ | 327,283,624 | ||||
Liquidnet, Inc. |
$ | 315,782 | $ | 602,852,009 | ||||
Deutsche Bank AG, New York Branch |
$ | 238,846 | $ | 227,620,921 | ||||
Barclays Capital Inc. |
$ | 227,735 | $ | 704,210,464 | ||||
Citibank, N.A. |
$ | 211,116 | $ | 271,629,470 | ||||
SG Cowen & Co., LLC |
$ | 188,552 | $ | 32,022,282 | ||||
MKM Partners LLC |
$ | 165,615 | $ | 234,844,751 | ||||
Raymond James and Associates |
$ | 142,532 | $ | 188,062,183 | ||||
Cantor Fitzgerald & Co. |
$ | 142,331 | $ | 193,841,445 | ||||
RBC Capital Markets |
$ | 130,630 | $ | 169,192,515 | ||||
SunTrust Capital Markets, Inc. |
$ | 128,611 | $ | 148,502,219 | ||||
Wells Fargo Securities LLC |
$ | 123,393 | $ | 98,792,796 | ||||
E D & F Man |
$ | 122,844 | $ | 11,526,800 | ||||
Auerbach Grayson & Co. |
$ | 111,673 | $ | 292,820,813 | ||||
Wallachbeth Capital LLC |
$ | 101,515 | $ | 800,048,893 | ||||
KeyBanc Capital Markets Inc. |
$ | 100,484 | $ | 110,788,932 | ||||
Stifel Nicolaus |
$ | 97,799 | $ | 131,797,359 | ||||
BTIG-BASS TRADING |
$ | 96,455 | $ | 128,459,593 | ||||
Sanford C. Bernstein and Co. |
$ | 95,817 | $ | 446,590,484 | ||||
Robert W. Baird & Co. Incorporated |
$ | 91,562 | $ | 127,903,872 | ||||
ISI Group, Inc. |
$ | 88,565 | $ | 103,748,179 | ||||
Keefe Bruyette and Woods Inc. |
$ | 85,016 | $ | 82,545,797 | ||||
Sandler ONeill & Partners, LP |
$ | 77,071 | $ | 86,537,927 | ||||
Height Securities, LLC |
$ | 76,561 | $ | 95,375,799 | ||||
Stephens Inc. |
$ | 72,450 | $ | 89,027,501 | ||||
William Blair & Company LLC |
$ | 63,643 | $ | 67,920,824 | ||||
Piper Jaffray & Co. |
$ | 63,315 | $ | 61,004,360 | ||||
JMP Securities LLC |
$ | 51,392 | $ | 47,509,243 | ||||
Tudor Pickering |
$ | 49,425 | $ | 54,712,995 | ||||
BMO Capital Markets |
$ | 43,705 | $ | 65,152,702 | ||||
Knight Equity Markets, LP |
$ | 36,624 | $ | 40,103,475 | ||||
Wolfe Research |
$ | 35,871 | $ | 55,429,612 | ||||
Guggenheim |
$ | 34,080 | $ | 56,846,165 | ||||
CIBC |
$ | 33,985 | $ | 5,070,200 |
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Broker |
Commissions Paid
to Firms for Brokerage and Research Services |
Total Amount of
Transactions to Firms for Brokerage and Research Services |
||||||
Jones and Associates Inc. |
$ | 26,898 | $ | 16,411,768 | ||||
FBR Investments |
$ | 22,561 | $ | 16,474,595 | ||||
Maxim Group LLC |
$ | 14,290 | $ | 15,227,948 | ||||
Societe Generale |
$ | 5,720 | $ | 420,400 | ||||
Janney Montgomery |
$ | 1,736 | $ | 1,374,931 | ||||
Luminex |
$ | 1,201 | $ | 9,905,039 | ||||
|
|
|
|
|||||
Grand Total |
$ | 8, 940,424 | $ | 15,884,516,881 | ||||
|
|
|
|
Certain Affiliations
The Funds, HCMFA and HCFD are currently affiliated with NexBank Securities, Inc. (NexBank), a FINRA member broker-dealer that is indirectly controlled by the principals of HCMFA and HCFD. Absent an exemption from the SEC or other regulatory relief, the Funds are generally precluded from effecting certain principal transactions with affiliated brokers. The Funds may utilize affiliated brokers for agency transactions, subject to compliance with policies and procedures adopted pursuant to the 1940 Act and the rules promulgated thereunder. These policies and procedures are designed to provide that commissions, fees or other remuneration received by any affiliated broker or its affiliates for agency transactions are reasonable and fair compared to the remuneration received by other brokers in comparable transactions.
The Funds did not pay any brokerage commissions on transactions with NexBank for the fiscal year ended June 30, 2017, 2016 or 2015.
In addition, the Funds, HCMFA and HCFD, as outlined above, are affiliated with NexBank, which also does business as Barrier Advisors, NexBank SSB, a state chartered bank, and Governance Re Ltd. (Governance Re), an insurance company, both of which are indirectly controlled by the principals of HCMFA and HCFD. NexBank and Governance Re may offer certain services to portfolio companies whose securities, including loans, are owned by one or more registered investment companies advised by HCMFA (the Portfolio Companies). For example, NexBank SSB may provide agent services for Portfolio Companies under credit agreements pursuant to which a Fund may be a lender or may offer strategic, financial and operational advisory services to Portfolio Companies; and Governance Re may offer insurance services to the Portfolio Companies. NexBank, Governance Re and other affiliated service providers may receive fees from Portfolio Companies or other parties for services provided.
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The Funds Board will, in accordance with specific procedures and policies adopted by the Board, review any investment or operational decisions that are brought to the attention of the Board and that may present potential conflicts of interest between HCMFA and the Fund.
DESCRIPTION OF THE FUNDS SHARES
Each Fund is a series of the Trust, a Delaware statutory trust formed on February 28, 2006. The Trust is authorized to issue an unlimited number of its shares of beneficial interest in separate series and classes of each series. The Trust is not required to hold regular annual shareholder meetings, but may hold special meetings for consideration of proposals requiring shareholder approval, such as changing fundamental policies or upon the written request of 10% of the Trusts shares to replace its Trustees. The Trusts Board is authorized to classify or reclassify the unissued shares of the Trust into one or more separate series of shares representing a separate, additional investment portfolio or one or more separate classes of new or existing series. Each Fund currently offers Class A, Class C and Class Z Shares. Shares of all series will have identical voting rights, except where by law certain matters must be approved by the requisite proportion of the shares of the affected series. Each share of any class when issued has equal dividend, liquidation (see Redemption of Shares) and voting rights within the class for which it was issued and each fractional share has those rights in proportion to the percentage that the fractional share represents a whole share. Shares will be voted in the aggregate except where otherwise required by law and except that each class of each series will vote separately on certain matters pertaining to its distribution and shareholder servicing arrangements.
There are no conversion or preemptive rights in connection with any shares of the Funds. All shares, when issued in accordance with the terms of the offering, will be fully paid and non-assessable. At the option of the shareholder, shares will be redeemed at net asset value (NAV), subject, however, in limited circumstances to a redemption fee or a CDSC, all as described in the applicable Prospectus.
The shares of the Funds have noncumulative voting rights, which means that the holders of more than 50% of the shares of the Trust can elect 100% of the Trustees if the holders choose to do so, and, in that event, the holders of the remaining shares will not be able to elect any person or persons to the Board. Unless specifically requested by an investor who is a shareholder of record, the Funds do not issue certificates evidencing their shares.
Description of the Trust
Under Delaware law, shareholders of a statutory trust shall have the same limitation of personal liability that is extended to stockholders of private corporations for profit organized under Delaware law, unless otherwise provided in the trusts governing instrument. The Trusts Agreement and Declaration of Trust (the Declaration of Trust) provides that shareholders shall not be personally liable to any person in connection with any and all property, real or personal, tangible or intangible, that at such time is owned or held by or for the account of a particular series. Moreover, the Declaration of Trust expressly provides that the shareholders shall have the same limitation of personal liability that is extended to shareholders of a private corporation for profit incorporated in the State of Delaware.
The Declaration of Trust provides that no Trustee, officer, employee or agent of the Trust or any series of the Trust shall be subject in such capacity to any personal liability whatsoever to any person, unless, as to liability to the Trust or its shareholders, the Trustees engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of their offices.
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The Trust shall continue without limitation of time subject to the provisions in the Declaration of Trust concerning termination by action of the Trustees, and without any vote of the Trusts shareholders, except as may be required under the 1940 Act.
Trust Matters
The Trust reserves the right to create and issue a number of series shares, in which case the shares of each series would participate equally in the earnings, dividends and assets of the particular series and would vote separately to approve investment advisory agreements or changes in fundamental investment policies, but shares of all series would vote together in the election or selection of Trustees and on any other matters as may be required by applicable law.
Upon liquidation of the Trust or any series, shareholders of the affected series would be entitled to share pro rata in the net assets of their respective series available for distribution to such shareholders.
Shareholder Approval
Other than elections of Trustees, which is by plurality, any matter for which shareholder approval is required by the 1940 Act requires the affirmative vote of a majority of the outstanding voting securities of the Fund(s) or the Trust at a meeting called for the purpose of considering such approval. For other matters, generally an affirmative vote of a majority of the shares present in person or represented by proxy and entitled to vote on such matter (assuming a quorum is present) shall be required for approval of such matter.
Information for Shareholders
All shareholder inquiries regarding administrative procedures, including the purchase and redemption of shares should be directed to: HCFD, 200 Crescent Court, Suite 700, Dallas, Texas 75201. For assistance, call (877) 665-1287 or visit the Funds website at www.highlandfunds.com.
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CONTROL PERSONS AND PRINCIPAL SHAREHOLDERS
As of September 30, 2017, the Trustees and officers of each Fund as a group owned less than 1% of the then outstanding shares of each class of shares of each Fund.
Control persons are presumed to control a Fund for purposes of voting on matters submitted to a vote of shareholders due to their beneficial ownership of 25% or more of a Funds outstanding voting securities. Unless otherwise noted, as of September 30, 2017, the only persons known by the Funds to own of record, or beneficially 25% or more of the outstanding shares of the Funds were as follows:
Name and Address of Record Owner |
Percent of Shares Held (%) | |||
LONG/SHORT EQUITY FUND CHARLES SCHWAB & CO INC CUST ATTN: MUTUAL FUNDS DEPT 101 MONTGOMERY ST SAN FRANCISCO, CA 94104-4151 |
25.89 | % | ||
LONG/SHORT HEALTHCARE FUND MORGAN STANLEY SMITH BARNEY, LLC 1 NEW YORK PLZ, FL 12 NEW YORK, NY 10004-1901 |
28.74 | % | ||
OPPORTUNISTIC CREDIT FUND CHARLES SCHWAB & CO INC CUST ATTN: MUTUAL FUNDS DEPT 101 MONTGOMERY ST SAN FRANCISCO, CA 94104-4151 |
55.49 | % | ||
MERGER ARBITRAGE FUND HIGHLAND GLOBAL ALLOCATION FUND 200 CRESCENT COURT, SUITE 700 DALLAS, TX 75201 |
45.71 | % |
A person who beneficially owns, either directly or indirectly, more than 25% of the voting securities of a Fund or acknowledges the existence of such control may be presumed to control the Fund. A control person could potentially control the outcome of any proposal submitted to the shareholders for approval, including changes to a Funds fundamental policies or terms of the investment advisory agreement with the Adviser.
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A principal shareholder is any person who owns (either of record or beneficially) 5% or more of any class of outstanding shares of a Fund. Unless otherwise noted, as of September 30, 2017, the only persons known by a Fund to own of record or beneficially 5% or more of its outstanding shares were as follows (certain of the investors below are believed to hold the indicated shares as nominee):
Name and Address |
Outstanding Shares Held |
Percentage of
Class (%) |
||||||
LONG/SHORT EQUITY FUND CLASS A MORGAN STANLEY SMITH BARNEY, LLC 1 NEW YORK PLZ, FL 12 NEW YORK, NY 10004-1901 |
358,043.25 | 13.21 | % | |||||
LONG/SHORT EQUITY FUND CLASS A NATIONAL FINANCIAL SERVICES LLC FOR EXCLUSIVE BENEFIT OF OUR CUSTOMERS ATTN: MUTUAL FUNDS DEPT 4 TH FLR 499 WASHINGTON BLVD JERSEY CITY, NJ 07310-2010 |
144,643.62 | 5.34 | % | |||||
LONG/SHORT EQUITY FUND CLASS A WELLS FARGO CLEARING SERVICES LLC SPECIAL CUSTODY ACCT FOR THE EXCLUSIVE BENEFIT OF CUSTOMER 2801 MARKET STREET ST LOUIS, MO 63103-2523 |
235,023.29 | 8.67 | % |
70
Name and Address |
Outstanding Shares Held |
Percentage of
Class (%) |
||||||
LONG/SHORT EQUITY FUND CLASS A CHARLES SCHWAB & CO INC CUST ATTN: MUTUAL FUNDS DEPT 101 MONTGOMERY ST SAN FRANCISCO, CA 94104-4151 |
776,912.22 | 28.67 | % | |||||
LONG/SHORT EQUITY FUND CLASS C MORGAN STANLEY SMITH BARNEY, LLC 1 NEW YORK PLZ, FL 12 NEW YORK, NY 10004-1901 |
469,121.40 | 22.24 | % |
71
Name and Address |
Outstanding Shares Held |
Percentage of
Class (%) |
||||||
LONG/SHORT EQUITY FUND CLASS C CHARLES SCHWAB & CO INC CUST ATTN: MUTUAL FUNDS DEPT 101 MONTGOMERY ST SAN FRANCISCO, CA 94104-4151 |
118,603.15 | 5.62 | % | |||||
LONG/SHORT EQUITY FUND CLASS C WELLS FARGO CLEARING SERVICES LLC SPECIAL CUSTODY ACCT FOR THE EXCLUSIVE BENEFIT OF CUSTOMER 2801 MARKET STREET ST LOUIS, MO 63103-2523 |
535,049.82 | 25.36 | % | |||||
LONG/SHORT EQUITY FUND CLASS C MERRILL LYNCH PIERCE FENNER & SMITH FOR THE SOLE BENEFIT OF ITS CUSTOMERS ATTN: FUND ADMINISTRATION #97425 4800 DEER LAKE DR E FL 2 JACKSONVILLE, FL 32246-6484 |
466,928.23 | 22.13 | % | |||||
LONG/SHORT EQUITY FUND CLASS Z NATIONAL FINANCIAL SERVICES LLC FOR EXCLUSIVE BENEFIT OF OUR CUSTOMERS ATTN: MUTUAL FUNDS DEPT 4 TH FLR 499 WASHINGTON BLVD JERSEY CITY, NJ 07310-2010 |
2,002,038.65 | 7.62 | % | |||||
LONG/SHORT EQUITY FUND CLASS Z WELLS FARGO CLEARING SERVICES LLC SPECIAL CUSTODY ACCT FOR THE EXCLUSIVE BENEFIT OF CUSTOMER 2801 MARKET STREET ST LOUIS, MO 63103-2523 |
5,365,812.65 | 20.42 | % | |||||
LONG/SHORT EQUITY FUND CLASS Z MERRILL LYNCH PIERCE FENNER & SMITH FOR THE SOLE BENEFIT OF ITS CUSTOMERS ATTN: FUND ADMINISTRATION #97425 4800 DEER LAKE DR E FL 2 JACKSONVILLE, FL 32246-6484 |
1,777,743.02 | 6.77 | % |
72
Name and Address |
Outstanding Shares Held |
Percentage of
Class (%) |
||||||
LONG/SHORT EQUITY FUND CLASS Z CHARLES SCHWAB & CO INC CUST ATTN: MUTUAL FUNDS DEPT 101 MONTGOMERY ST SAN FRANCISCO, CA 94104-4151 |
7,278,436.48 | 27.70 | % | |||||
LONG/SHORT EQUITY FUND CLASS Z BAND & CO C/O U.S. BANK N.A. P.O. BOX 1787 MILWAUKEE, WI 53201-1787 |
6,700,926.76 | 25.50 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS A MORGAN STANLEY SMITH BARNEY, LLC 1 NEW YORK PLZ, FL 12 NEW YORK, NY 10004-1901 |
535,708.17 | 23.13 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS A NATIONAL FINANCIAL SERVICES LLC FOR EXCLUSIVE BENEFIT OF OUR CUSTOMERS ATTN: MUTUAL FUNDS DEPT 4 TH FLR 499 WASHINGTON BLVD JERSEY CITY, NJ 07310-2010 |
307,680.76 | 13.28 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS A PERSHING LLC 1 PERSHING PLZ JERSEY CITY, NJ 07399-0002 |
205,394.09 | 8.87 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS A CHARLES SCHWAB & CO INC CUST SPECIAL CUSTODY ACCT (FBO) 101 MONTGOMERY ST SAN FRANCISCO, CA 94104-4151 |
158,746.45 | 6.85 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS A WELLS FARGO CLEARING SERVICES LLC SPECIAL CUSTODY ACCT FOR THE EXCLUSIVE BENEFIT OF CUSTOMER 2801 MARKET STREET ST LOUIS, MO 63103-2523 |
362,257.22 | 15.64 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS A CHARLES SCHWAB & CO INC CUST ATTN: MUTUAL FUNDS DEPT 101 MONTGOMERY ST SAN FRANCISCO, CA 94104-4151 |
175,143.69 | 7.56 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS C MORGAN STANLEY SMITH BARNEY, LLC 1 NEW YORK PLZ, FL 12 NEW YORK, NY 10004-1901 |
588,147.71 | 32.67 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS C NATIONAL FINANCIAL SERVICES LLC FOR EXCLUSIVE BENEFIT OF OUR CUSTOMERS ATTN: MUTUAL FUNDS DEPT 4 TH FLR 499 WASHINGTON BLVD JERSEY CITY, NJ 07310-2010 |
163,888.42 | 9.10 | % |
73
Name and Address |
Outstanding Shares Held |
Percentage of
Class (%) |
||||||
LONG/SHORT HEALTHCARE FUND CLASS C PERSHING LLC 1 PERSHING PLZ JERSEY CITY, NJ 07399-0002 |
166,119.69 | 9.23 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS C CHARLES SCHWAB & CO INC CUST SPECIAL CUSTODY ACCT (FBO) 101 MONTGOMERY ST SAN FRANCISCO, CA 94104-4151 |
140,737.21 | 7.82 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS C WELLS FARGO CLEARING SERVICES LLC SPECIAL CUSTODY ACCT FOR THE EXCLUSIVE BENEFIT OF CUSTOMER 2801 MARKET STREET ST LOUIS, MO 63103-2523 |
362,128.37 | 20.11 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS Z MORGAN STANLEY SMITH BARNEY, LLC 1 NEW YORK PLZ, FL 12 NEW YORK, NY 10004-1901 |
1,204,501.02 | 29.52 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS Z NATIONAL FINANCIAL SERVICES LLC FOR EXCLUSIVE BENEFIT OF OUR CUSTOMERS ATTN: MUTUAL FUNDS DEPT 4 TH FLR 499 WASHINGTON BLVD JERSEY CITY, NJ 07310-2010 |
753,823.75 | 18.48 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS Z WELLS FARGO CLEARING SERVICES LLC SPECIAL CUSTODY ACCT FOR THE EXCLUSIVE BENEFIT OF CUSTOMER 2801 MARKET STREET ST LOUIS, MO 63103-2523 |
711,989.23 | 17.45 | % | |||||
LONG/SHORT HEALTHCARE FUND CLASS Z CHARLES SCHWAB & CO INC CUST ATTN: MUTUAL FUNDS DEPT 101 MONTGOMERY ST SAN FRANCISCO, CA 94104-4151 |
632,446.26 | 15.50 | % | |||||
OPPORTUNISTIC CREDIT FUND CLASS A CHARLES SCHWAB & CO INC CUST ATTN: MUTUAL FUNDS DEPT 101 MONTGOMERY ST SAN FRANCISCO, CA 94104-4151 |
658,411.25 | 50.16 | % | |||||
OPPORTUNISTIC CREDIT FUND CLASS A NATIONAL FINANCIAL SERVICES LLC FOR EXCLUSIVE BENEFIT OF OUR CUSTOMERS ATTN: MUTUAL FUNDS DEPT 4 TH FLR 499 WASHINGTON BLVD JERSEY CITY, NJ 07310-2010 |
133,479.60 | 10.17 | % | |||||
OPPORTUNISTIC CREDIT FUND CLASS A PERSHING LLC 1 PERSHING PLZ JERSEY CITY, NJ 07399-0001 |
227,539.32 | 17.33 | % |
74
Name and Address |
Outstanding Shares Held |
Percentage of
Class (%) |
||||||
OPPORTUNISTIC CREDIT FUND CLASS A LPL FINANCIAL 4707 EXECUTIVE DRIVE SAN DIEGO, CA 92121-3091 |
98,267.06 | 7.49 | % | |||||
OPPORTUNISTIC CREDIT FUND CLASS C PERSHING LLC 1 PERSHING PLZ JERSEY CITY, NJ 07399-0001 |
217,192.16 | 21.89 | % | |||||
OPPORTUNISTIC CREDIT FUND CLASS C CETERA INVESTMENT SERVICES (FBO) YU ZHAO 13006 NE 3RD PL BELLEVUE, WA 98005-3320 |
68,965.52 | 6.95 | % | |||||
OPPORTUNISTIC CREDIT FUND CLASS C CETERA INVESTMENT SERVICES (FBO) HUIDU 3660 W MERCER WAY MERCER ISLAND, WA 98040-3316 |
70,588.24 | 7.11 | % | |||||
OPPORTUNISTIC CREDIT FUND CLASS C CETERA INVESTMENT SERVICES (FBO) TA-LI LIU 7001 SANDERS LN PLANO, TX 75025-3415 |
49,966.47 | 5.04 | % | |||||
OPPORTUNISTIC CREDIT FUND CLASS Z NATIONAL FINANCIAL SERVICES LLC FOR EXCLUSIVE BENEFIT OF OUR CUSTOMERS ATTN: MUTUAL FUNDS DEPT 4 TH FLR 499 WASHINGTON BLVD JERSEY CITY, NJ 07310-2010 |
1,880,545.39 | 13.68 | % | |||||
OPPORTUNISTIC CREDIT FUND CLASS Z FFB & CO ATTN TRUST OPERATIONS 18101 VON KARMAM AVE STE 750 IRVINE, CA 92612-0005 |
790,030.97 | 5.75 | % | |||||
OPPORTUNISTIC CREDIT FUND CLASS Z CHARLES SCHWAB & CO INC CUST ATTN: MUTUAL FUNDS DEPT 101 MONTGOMERY ST SAN FRANCISCO, CA 94104-4151 |
7,915,906.26 | 57.60 | % | |||||
OPPORTUNISTIC CREDIT FUND CLASS Z JEFFRIES LLC 431-00932-26 101 HUDSON ST FL 11 JERSEY CITY, NJ 07302-3915 |
1,234,665.45 | 8.98 | % | |||||
MERGER ARBITRAGE FUND CLASS A PERSHING LLC 1 PERSHING PLZ JERSEY CITY, NJ 07399-0001 |
20,532.81 | 23.94 | % |
75
Name and Address |
Outstanding Shares Held |
Percentage of
Class (%) |
||||||
MERGER ARBITRAGE FUND CLASS A CETERA INVESTMENT SERVICES (FBO) LIN TAI NO 2 BLDG 24 ERLI ERQU BEIJING |
27,188.18 | 31.70 | % | |||||
MERGER ARBITRAGE FUND CLASS A CETERA INVESTMENT SERVICES (FBO) JING ZHANG 1650 4 1501 PUDONG JINXIU RD SHANGHAI |
31,663.49 | 36.91 | % | |||||
MERGER ARBITRAGE FUND CLASS A CHARLES SCHWAB & CO INC CUST ATTN: MUTUAL FUNDS DEPT 101 MONTGOMERY ST SAN FRANCISCO, CA 94104-4151 |
4,822.54 | 5.62 | % | |||||
MERGER ARBITRAGE FUND CLASS C PERSHING LLC 1 PERSHING PLZ JERSEY CITY, NJ 07399-0001 |
11,347.44 | 17.64 | % | |||||
MERGER ARBITRAGE FUND CLASS C CETERA INVESTMENT SERVICES (FBO) YONG ZOU 1110 TREVINA TERRACE SAN JOSE, CA 95120 |
7,212.03 | 11.21 | % | |||||
MERGER ARBITRAGE FUND CLASS C CETERA INVESTMENT SERVICES (FBO) LI YUAN 19 ZHAOGONGDI XIHU DISTRICT HANGZHOU 310000 |
8,822.14 | 13.71 | % | |||||
MERGER ARBITRAGE FUND CLASS C CETERA INVESTMENT SERVICES (FBO) JIE LI 906 B DANJIANJIAYUAN DANDONG |
3,973.13 | 6.18 | % | |||||
MERGER ARBITRAGE FUND CLASS C CETERA INVESTMENT SERVICES (FBO) CHUNLING ZHANG 13016 SE 21ST PL BELLEVUE WA 98005-3933 |
4,968.83 | 7.72 | % | |||||
MERGER ARBITRAGE FUND CLASS C CETERA INVESTMENT SERVICES (FBO) HAIZHEN LI DOOR 4 UNIT 101 BLDG 10 NONGDA BEIJING |
7,006.01 | 10.89 | % | |||||
MERGER ARBITRAGE FUND CLASS C CETERA INVESTMENT SERVICES (FBO) MICHAEL J LOLLIS 12814 48 TH DR NE MARYSVILLE, WA 98271-8628 |
3,540.38 | 5.50 | % | |||||
MERGER ARBITRAGE FUND CLASS Z PERSHING LLC 1 PERSHING PLZ JERSEY CITY, NJ 07399-0001 |
94,259.19 | 5.95 | % |
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Name and Address |
Outstanding Shares Held |
Percentage of
Class (%) |
||||||
MERGER ARBITRAGE FUND CLASS Z CHARLES SCHWAB & CO INC CUST ATTN: MUTUAL FUNDS DEPT 101 MONTGOMERY ST SAN FRANCISCO, CA 94104-4151 |
289,839.27 | 18.30 | % | |||||
MERGER ARBITRAGE FUND CLASS Z HIGHLAND GLOBAL ALLOCATION FUND 200 CRESCENT COURT, SUITE 700 DALLAS, TX 75201 |
657,039.22 | 41.49 | % | |||||
MERGER ARBITRAGE FUND CLASS Z HIGHLAND LONG/SHORT EQUITY FUND 200 CRESCENT COURT, SUITE 700 DALLAS, TX 75201 |
299,699.24 | 18.93 | % | |||||
MERGER ARBITRAGE FUND CLASS Z HIGHLAND PREMIER GROWTH EQUITY FUND 200 CRESCENT COURT, SUITE 700 DALLAS, TX 75201 |
176,919.84 | 11.17 | % |
PROGRAMS FOR REDUCING OR ELIMINATING SALES CHARGES
The following information supplements the discussion of methods for reducing or eliminating sales charges in the Class A and Class C Shares Prospectus. The availability of certain sales charge waivers and discounts will depend on whether you purchase your shares directly from a Fund or through a financial intermediary. Intermediaries may have different policies and procedures regarding the availability of front-end sales charge waivers or CDSC waivers, which are discussed below. In all instances, it is the purchasers responsibility to notify the Fund or the purchasers financial intermediary at the time of purchase of any relationship or other facts qualifying the purchaser for sales charge waivers or discounts. For waivers and discounts not available through a particular intermediary, shareholders will have to purchase Fund shares directly from a Fund or through another intermediary to receive these waivers or discounts. Shares purchased through certain financial intermediaries (a Specified Intermediary ) may be subject to different initial sales charges or the initial sales charge or CDSC may be waived in certain circumstances.
Right of Accumulation (Class A Shares Only)
Reduced sales charges on Class A Shares of the Funds can be obtained by combining a current purchase with prior purchases of all classes of any Participating Funds (as defined in the Prospectus). The applicable sales charge is based on the combined total of:
1. | the current purchase; and |
2. | the value at the public offering price at the close of business on the previous day of a Funds and any Participating Funds classes of shares held by the shareholder, the shareholders spouse or domestic partner or the shareholders minor children. |
The Underwriter and the shareholders Financial Advisor must be promptly notified of each purchase that entitles a shareholder to a reduced sales charge. Such reduced sales charge will be applied upon confirmation of the shareholders holdings by the Transfer Agent. The Funds may terminate or amend this Right of Accumulation at any time without notice.
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Letter of Intent (Class A Shares Only)
Any person may qualify for reduced sales charges on purchases of Class A Shares of the Funds made within a 13-month period pursuant to a Letter of Intent (Letter). A shareholder may include, as an accumulation credit toward the completion of such Letter, the value of all shares (of any class) of any Participating Funds held by the shareholder on the date of the Letter. The value is determined at the public offering price on the date of the Letter. Purchases made through reinvestment of distributions do not count toward satisfaction of the Letter. Upon request, a Letter may reflect purchases within the previous 90 days.
During the term of a Letter, the Transfer Agent will hold shares in escrow to secure payment of the higher sales charge applicable to Class A Shares actually purchased if the terms of the Letter are not satisfied. Dividends and capital gains will be paid on all escrowed shares, and these shares will be released (upon satisfaction of any amount owed for sales charges if the terms of the Letter are not satisfied) when the amount indicated has been purchased or at the end of the period covered by the Letter, whichever occurs first. A Letter does not obligate the investor to buy or the Funds to sell the amount specified in the Letter.
If a shareholder exceeds the amount specified in the Letter and reaches an amount that would qualify for a further quantity discount, a retroactive price adjustment will be made at the time of expiration of the Letter. The resulting difference in offering price will purchase additional shares for the shareholders account at the applicable offering price. As a part of this adjustment, the shareholders Financial Advisor shall return to the Underwriter the excess commission previously paid to the Financial Advisor during the 13-month period.
If the amount specified in the Letter is not purchased, the shareholder shall remit to the Underwriter an amount equal to the difference between the sales charge paid and the sales charge that should have been paid. If the shareholder fails within 20 days after a written request to pay such a difference in sales charge, the Transfer Agent will redeem that number of escrowed Class A Shares to equal such difference. The additional amount of Financial Advisor discount from the applicable offering price shall be remitted by the Underwriter to the shareholders Financial Advisor of record.
Additional information about, and the terms of, Letters of Intent are available from your Financial Advisor, or from the Transfer Agent at (877) 665-1287.
Reinstatement Privilege (Class A and C Shares Only)
A shareholder who has redeemed Class A or Class C Shares of a Fund may, upon request, reinstate within one year a portion or all of the proceeds of such sale in Class A Shares or Class C Shares, respectively, of the Fund or another Participating Fund at the NAV next determined after receipt by such shareholders Financial Advisor or the Transfer Agent receives a reinstatement request and payment. The Underwriter will not pay your Financial Advisor a commission on any reinvested amount. Any CDSC paid at the time of the redemption will be credited to the shareholder upon reinstatement. The period between the redemption and the reinstatement will not be counted in aging the reinstated shares for purposes of calculating any CDSC or conversion date. Shareholders who desire to exercise this privilege should contact their Financial Advisor or the Transfer Agent. Shareholders may exercise this privilege an unlimited number of times. Exercise of this privilege does not alter the U.S. federal income tax treatment of any capital gains realized on the prior sale of Fund shares, but to the extent any such shares were sold at a loss, some or all of the loss may be disallowed for tax purposes. Please consult your tax adviser.
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Privileges of Financial Advisors
Class A Shares of the Funds may be sold at NAV, without a sales charge, to registered representatives and employees of Financial Advisors (including their affiliates) and such persons families and their beneficial accounts.
Privileges of Certain Shareholders
Any shareholder eligible to buy Class Z Shares of any Participating Fund may acquire, through purchase or exchange, Class A Shares of another Participating Fund at NAV in those cases where Class Z Shares are not available. Qualifying shareholders will not be subject to the initial sales charge or CSDC on Class A Shares, although they will be subject to the annual Rule 12b-1 distribution and service fees on Class A Shares.
Sponsored Arrangements
Class A Shares of the Funds may be purchased at reduced or no sales charge pursuant to sponsored arrangements, which include programs under which an organization makes recommendations to, or permits group solicitation of, its employees, members or participants in connection with the purchase of shares of the Funds on an individual basis. The amount of the sales charge reduction will reflect the anticipated reduction in sales expense associated with sponsored arrangements. The reduction in sales expense, and therefore the reduction in sales charge, will vary depending on factors such as the size and stability of the organizations group, the term of the organizations existence and certain characteristics of the members of its group. The Funds reserve the right to revise the terms of or to suspend or discontinue sales pursuant to sponsored plans at any time.
Class A shares may also be purchased at a reduced or zero sales charge by (i) clients of any Financial Advisor that has entered into an agreement with the Underwriter or the Funds pursuant to which a Fund is included as an investment option in programs involving fee-based compensation arrangements; (ii) clients of any Financial Advisor that has entered into an agreement with the Underwriter pursuant to which such Financial Advisor offers Fund shares through self-directed investment brokerage accounts that do not charge transaction fees to its clients; and (iii) participants in certain retirement plans. Whether a sales charge waiver is available for your retirement plan or charitable account depends upon the policies and procedures of your intermediary. Please consult your Financial Adviser for further information. Please refer to the Appendix to the Funds Prospectus for the sales charge or CDSC waivers that are applicable to each Specified Intermediary.
Waiver of CDSCs
CDSCs may be waived on redemptions in the following situations with the proper documentation:
1. |
Death . CDSCs may be waived on redemptions within one year following the death of (i) the sole shareholder on an individual account, (ii) a joint tenant where the surviving joint tenant is the deceaseds spouse or (iii) the beneficiary of a Uniform Gifts to Minors Act (UGMA), Uniform Transfers to Minors Act (UTMA) or other custodial account. If, upon the occurrence of one of the foregoing, the account is transferred to an account |
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registered in the name of the deceaseds estate, the CDSC will be waived on any redemption from the estate account occurring within one year after the death. If Class C Shares are not redeemed within one year of the death, they will remain subject to the applicable CDSC when redeemed from the transferees account. If the account is transferred to a new registration and then a redemption is requested, the applicable CDSC will be charged. |
2. | Disability . CDSCs may be waived on redemptions occurring within one year after the sole shareholder on an individual account or a joint tenant on a spousal joint tenant account becomes disabled (as defined in Section 72(m)(7) of the Internal Revenue Code of 1986, as amended (the Code). To be eligible for such waiver, (i) the disability must arise after the purchase of shares, (ii) the disabled shareholder must have been under age 65 at the time of the initial determination of disability, and (iii) a letter must be produced from a physician signed under penalty of perjury stating the nature of the disability. If the account is transferred to a new registration and then a redemption is requested, the applicable CDSC will be charged. |
3. | Death of a trustee . CDSCs may be waived on redemptions occurring upon dissolution of a revocable living or grantor trust following the death of the sole trustee where (i) the grantor of the trust is the sole trustee and the sole life beneficiary, (ii) death occurs following the purchase, and (iii) the trust document provides for dissolution of the trust upon the trustees death. If the account is transferred to a new registration (including that of a successor trustee), the applicable CDSC will be charged upon any subsequent redemption. |
4. | Returns of excess contributions . CDSCs may be waived on redemptions required to return excess contributions made to retirement plans or individual retirement accounts, so long as the Financial Advisor agrees to return all or the agreed-upon portion of the commission received on the shares being redeemed. |
5. | Qualified Retirement Plans . CDSCs may be waived on redemptions required to make distributions from qualified retirement plans following normal retirement age (as stated in the document). |
The CDSC also may be waived if the Financial Advisor agrees to return all or an agreed-upon portion of the commission received on the sale of the shares being redeemed.
The following discussion of U.S. federal income tax consequences of an investment in the Funds is based on the Code, U.S. Treasury regulations, and other applicable authority, as of the date of this SAI. These authorities are subject to change by legislative, administrative, or judicial action, possibly with retroactive effect. The following discussion is only a summary of some of the important U.S. federal tax considerations generally applicable to investments in a Fund. There may be other tax considerations applicable to particular shareholders. Shareholders should consult their own tax advisers regarding their particular situation and the possible application of U.S. federal, state, local, foreign and other tax laws.
Taxation of the Funds
Each Fund has elected to be treated as a regulated investment company (RIC) under Subchapter M of the Code and intends each year to qualify and to be eligible to be treated as such.
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In order to qualify for the favorable tax treatment accorded RICs and their shareholders, each Fund must, among other things:
(a) | derive at least 90% of its gross income for each taxable year from (i) dividends, interest, payments with respect to certain securities loans, and gains from the sale or other disposition of stock, securities or foreign currencies, or other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies and (ii) net income derived from interests in qualified publicly traded partnerships (as described below); |
(b) | diversify its holdings so that, at the end of each quarter of the Funds taxable year, (i) at least 50% of the market value of the Funds total assets consists of cash and cash items, U.S. government securities, securities of other RICs, and other securities limited in respect of any one issuer to a value not greater than 5% of the value of the Funds total assets and not more than 10% of the outstanding voting securities of such issuer, and (ii) not more than 25% of the value of the Funds total assets is invested, including through corporations in which the Fund owns a 20% or more voting stock interest, (x) in the securities (other than those of the U.S. government or other RICs) of any one issuer or of two or more issuers that the Fund controls and that are engaged in the same, similar or related trades or businesses, or (y) in the securities of one or more qualified publicly traded partnerships (as described below); and |
(c) | distribute with respect to each taxable year at least 90% of the sum of its investment company taxable income (as that term is defined in the Code without regard to the deduction for dividends paidgenerally taxable ordinary income and the excess, if any, of net short-term capital gains over net long-term capital losses) and net tax-exempt income, for such year. |
In general, for purposes of the 90% gross income requirement described in (a) above, income derived from a partnership will be treated as qualifying income only to the extent such income is attributable to items of income of the partnership which would be qualifying income if realized directly by the RIC. However, 100% of the net income derived from an interest in a qualified publicly traded partnership (generally, a partnership (x) the interests in which are traded on an established securities market or are readily tradable on a secondary market or the substantial equivalent thereof, and (y) that derives less than 90% of its income from the qualifying income sources described in paragraph (a)(i) above) will be treated as qualifying income. In general, such entities will be treated as partnerships for U.S. federal income tax purposes because they meet the passive income requirement under Code Section 7704(c)(2). In addition, although in general the passive loss rules of the Code do not apply to RICs, such rules do apply to a RIC with respect to items attributable to an interest in a qualified publicly traded partnership.
For purposes of meeting the diversification requirement described in (b) above, the term outstanding voting securities of such issuer will include the equity securities of a qualified publicly traded partnership. Also, for purposes of the diversification requirement described in (b) above, the identification of the issuer (or, in some cases, issuers) of a particular Fund investment can depend on the terms and conditions of that investment. In some cases, identification of the issuer (or issuers) is uncertain under current law, and an adverse determination or future guidance by the Internal Revenue Service (IRS) with respect to issuer identification for a particular type of investment may adversely affect a Funds ability to meet diversification test in (b) above.
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If a Fund qualifies as a RIC that is accorded favorable tax treatment, that Fund will not be subject to U.S. federal income tax on income or gains distributed in a timely manner to its shareholders in the form of dividends (including Capital Gain Dividends, as defined below).
If a Fund were to fail to meet the income, diversification or distribution test (described respectively in (a), (b) and (c) above), the Fund could in some cases cure such failure, including by paying a Fund-level tax, paying interest, making additional distributions or disposing of certain assets. If the Fund were ineligible to or otherwise did not cure such failure for any taxable year, or if the Fund were otherwise to fail to qualify as a RIC accorded favorable tax treatment for such year, the Fund would be subject to tax on its taxable income at corporate rates, and all distributions from earnings and profits, including any distributions of net tax-exempt income and net long-term capital gains, would be taxable to shareholders as ordinary income. Some portions of such distributions might be eligible for the dividends received deduction in the case of corporate shareholders and to be treated as qualified dividend income and thus taxable at the lower net capital gain rate in the case of shareholders taxed as individuals, provided in both cases, the shareholder meets certain holding period and other requirements in respect of the Funds shares (as described below). In addition, the Fund could be required to recognize unrealized gains, pay substantial taxes and interest and make substantial distributions before requalifying as a RIC that is accorded favorable tax treatment.
Each Fund intends to distribute at least annually to its shareholders all or substantially all of its investment company taxable income (computed without regard to the dividends-paid deduction) and its net capital gain (that is, the excess of net long-term capital gain over net short-term capital loss, in each case determined with reference to any loss carryforwards). Any investment company taxable income retained by a Fund will be subject to Fund-level tax at regular corporate rates. If a Fund retains any net capital gain, it also will be subject to Fund-level tax at regular corporate rates on the amount retained, but may designate the retained amount as undistributed capital gain in a timely notice to its shareholders who would then, in turn, be (i) required to include in income for U.S. federal income tax purposes, as long-term capital gain, their shares of such undistributed amount, and (ii) entitled to credit their proportionate shares of the tax paid by that Fund on such undistributed amount against their U.S. federal income tax liabilities, if any, and to claim refunds on a properly-filed U.S. tax return to the extent the credit exceeds such liabilities. If a Fund makes this designation, for U.S. federal income tax purposes, the tax basis of shares owned by a shareholder of the Fund would be increased by an amount equal to the difference between the amount of undistributed capital gains included in the shareholders gross income under clause (i) of the preceding sentence and the tax deemed paid by the shareholder under clause (ii) of the preceding sentence. A Fund is not required to, and there can be no assurance a Fund will, make this designation if it retains all or a portion of its net capital gain in a taxable year.
With respect to the Merger Arbitrage Fund, the assets of the Merger Arbitrage Predecessor Fund transferred to the Merger Arbitrage Fund in exchange for shares of the Merger Arbitrage Fund reflected net unrealized capital gains, in the amount of approximately $20,000 (approximately 2% of the assets transferred to the Merger Arbitrage Fund), which were acquired by the Merger Arbitrage Fund. To the extent the Merger Arbitrage Fund realizes any of those capital gains, it may be required to pay a Fund-level tax on such gains and/or to distribute such gains to all shareholders of the Merger Arbitrage Fund, which could result in payment of taxes by such shareholders.
In determining its net capital gain, including in connection with determining the amount available to support a Capital Gain Dividend (as defined below), its taxable income and its earnings and profits, a Fund generally may elect to treat part or all of any post-October capital loss (defined as any net capital loss attributable to the portion, if any, of the taxable year after October 31, or, if there is no such loss, the net long-term capital loss or net short-term capital loss attributable to any such portion of the taxable year) or late-year ordinary loss (generally, the sum of (i) its net ordinary loss, if
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any, from the sale, exchange or other taxable disposition of property, attributable to the portion, if any, of the taxable year after October 31, and (ii) its other net ordinary loss, if any, attributable to the portion, if any, of the taxable year after December 31) as if incurred in the succeeding taxable year.
If a Fund were to fail to distribute in a calendar year at least an amount equal to the sum of 98% of its ordinary income for such year and 98.2% of its capital gain net income for the one-year period ending October 31 of such year, plus any such amounts retained from the prior year, the Fund would be subject to a nondeductible 4% excise tax on the undistributed amounts. For purposes of the required excise tax distribution, a Funds ordinary gains and losses from the sale, exchange or other taxable disposition of property that would otherwise be taken into account after October 31 of a calendar year generally are treated as arising on January 1 of the following calendar year. Also for these purposes, a Fund will be treated as having distributed any amount on which it has been subject to corporate income tax in the taxable year ending within the calendar year. Each Fund intends generally to make distributions sufficient to avoid imposition of the 4% excise tax, although there can be no assurance that it will be able to do so. In that event, a Fund will be liable for the excise tax only on the amount by which it does not meet the foregoing distribution requirement.
A dividend paid to shareholders in January of a year generally is deemed to have been paid by a Fund on December 31 of the preceding year, if the dividend was declared and payable to shareholders of record on a date in October, November or December of that preceding year.
Each Fund distributes its net investment income and capital gains to shareholders as dividends at least annually to the extent required to qualify as a RIC under the Code and generally to avoid U.S. federal income or excise tax. Under current law, a Fund may treat the portion of redemption proceeds paid to redeeming shareholders that represents the redeeming shareholders portion of the undistributed investment company taxable income and capital gain of that Fund as a distribution of investment company taxable income and net capital gain on that Funds tax return. This practice, which involves the use of tax equalization, will reduce the amount of income and gains that a Fund is required to distribute as dividends to shareholders in order for that Fund to avoid U.S. federal income tax and excise tax, which may include reducing the amount of distributions that otherwise would be required to be paid to non-redeeming shareholders. A Funds net asset value generally will not be reduced by the amount of any undistributed income or gains allocated to redeeming shareholders under this practice and thus the total return on a shareholders investment generally will not be reduced as a result of this practice.
Capital losses in excess of capital gains (net capital losses) are not permitted to be deducted against a Funds net investment income. Instead, subject to certain limitations, a Fund may carry net capital losses forward to subsequent taxable years to offset capital gains, if any, realized during such subsequent taxable year. Capital loss carryforwards are reduced to the extent they offset current-year net realized capital gains, whether a Fund retains or distributes such gains. If a Fund incurs or has incurred net capital losses in taxable years beginning after December 22, 2010 (post-2010 losses), those losses will be carried forward to one or more subsequent taxable years without expiration; any such carryforward losses will retain their character as short-term or long-term. If a Fund incurred net capital losses in a taxable year beginning on or before December 22, 2010 (pre-2011 losses), the Fund is permitted to carry such losses forward for eight taxable years; in the year to which they are carried forward, such losses are treated as short-term capital losses that first offset any short-term capital gains, and then offset any long-term capital gains. A Fund must use any post-2010 losses, which will not expire, before it uses any pre-2011 losses. This increases the likelihood that pre-2011 losses will expire unused at the conclusion of the eight-year carryforward period. A Funds ability to
83
use net capital losses to offset gains may be limited as a result of certain (i) acquisitive reorganizations and (ii) shifts in the ownership of the Fund by a shareholder owning or treated as owning 5% or more of the stock of the Fund. Each Funds available capital loss carryforwards will be set forth in its annual shareholder report for each fiscal year.
Fund Distributions
Distributions are taxable to shareholders even if they are paid from gains earned by a Fund before a shareholders investment (and thus were included in the price the shareholder paid). Distributions are taxable whether shareholders receive them in cash or reinvest them in additional shares.
Each Fund will send you information after the end of each calendar year setting forth the amount and tax status of any distributions paid to you by the Fund. Ordinary income dividends and Capital Gain Dividends (defined below) may also be subject to state, local or other taxes.
For U.S. federal income tax purposes, distributions of investment income are generally taxable to shareholders as ordinary income. Taxes on distributions of capital gains are determined by how long a Fund owned the investments that generated them, rather than how long a shareholder has owned his or her shares. In general, a Fund will recognize long-term capital gain or loss on investments it has owned (or is deemed to have owned) for more than one year, and short-term capital gain or loss on investments it has owned (or is deemed to have owned) for one year or less. Distributions of net capital gain that are properly reported by a Fund as capital gain dividends (Capital Gain Dividends) will be taxable to shareholders as long-term capital gains includible in net capital gain and taxed to individuals at reduced rates. Distributions of net short-term capital gain (as reduced by any net long-term capital loss for the taxable year) will be taxable to shareholders as ordinary income. Distributions of investment income reported by a Fund as derived from qualified dividend income will be taxed in the hands of individuals at the rates applicable to net capital gain, provided holding period and other requirements are met at both the shareholder and Fund level.
In order for some portion of the dividends received by a Fund shareholder to be qualified dividend income, a Fund must meet holding period and other requirements with respect to some portion of the dividend-paying stocks in its portfolio and the shareholder must meet holding period and other requirements with respect to that Funds shares. In general, a dividend will not be treated as qualified dividend income (at either the Fund or shareholder level) (1) if the dividend is received with respect to any share of stock held for fewer than 61 days during the 121-day period beginning on the date which is 60 days before the date on which such share becomes ex-dividend with respect to such dividend (or, in the case of certain preferred stock, 91 days during the 181-day period beginning 90 days before such date), (2) to the extent that the recipient is under an obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property, (3) if the recipient elects to have the dividend income treated as investment income for purposes of the limitation on deductibility of investment interest, or (4) if the dividend is received from a foreign corporation that is (a) not eligible for the benefits of a comprehensive income tax treaty with the United States (with the exception of dividends paid on stock of such a foreign corporation readily tradable on an established securities market in the United States) or (b) treated as a passive foreign investment company.
In general, distributions of investment income reported by a Fund as derived from qualified dividend income will be treated as qualified dividend income by a shareholder taxed as an individual, provided the shareholder meets the holding period and other requirements described above with respect to that Funds shares. If the aggregate qualified dividends received by a Fund during any taxable year are 95% or more of its gross income (excluding long-term capital gain over net short-term
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capital loss), then 100% of the Funds dividends (other than dividends properly reported as Capital Gain Dividends) will be eligible to be treated as qualified dividend income. The Opportunistic Credit Fund does not expect a significant portion of its distributions to be eligible for treatment as qualified dividend income.
Dividends of net investment income received by corporate shareholders of a Fund generally will qualify for the 70% dividends-received deduction generally available to corporations to the extent of the amount of eligible dividends received by that Fund from domestic corporations for the taxable year. A dividend received by a Fund will not be treated as a dividend eligible for the dividends-received deduction (1) if it has been received with respect to any share of stock that the Fund has held for less than 46 days (91 days in the case of certain preferred stock) during the 91-day period beginning on the date which is 45 days before the date on which such share becomes ex-dividend with respect to such dividend (during the 181-day period beginning 90 days before such date in the case of certain preferred stock) or (2) to the extent that the Fund is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property. Moreover, the dividends-received deduction may otherwise be disallowed or reduced (1) if the corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of that Fund or (2) by application of the Code (for instance, the dividends-received deduction is reduced in the case of a dividend received on debt-financed portfolio stock (generally, stock acquired with borrowed funds)). The Opportunistic Credit Fund does not expect a significant portion of its distributions to be eligible for this dividends-received deduction.
If a Fund receives dividends from another investment company that qualifies as a RIC and the investment company reports such dividends as qualified dividend income or as eligible for the dividends-received deduction, then the Fund is permitted in turn to report a portion of its distributions as qualified dividend income or as eligible for the dividends received deduction, as applicable, provided the Fund meets holding period and other requirements with respect to shares of the investment company.
A Funds dividends representing distributions of interest income and capital gains or distributions from entities that are not corporations for U.S. tax purposes will not constitute qualified dividend income to individual shareholders and will not be eligible for the dividends-received deduction for corporate shareholders. In addition, any distribution of income that is attributable to (i) income received by a Fund in lieu of dividends with respect to securities on loan pursuant to a securities lending transaction or (ii) dividend income received by a Fund on securities it temporarily purchased from a counterparty pursuant to a repurchase agreement that is treated for U.S. federal income tax purposes as a loan by that Fund, will not constitute qualified dividend income to individual shareholders and will not be eligible for the dividends-received deduction for corporate shareholders.
Section 1411 of the Code generally imposes a 3.8% Medicare contribution tax on the net investment income of certain individuals, trusts and estates to the extent their income exceeds certain threshold amounts. For these purposes, net investment income generally includes, among other things, (i) distributions paid by a Fund of net investment income and capital gains as described above, and (ii) any net gain from the sale, redemption, exchange or other taxable disposition of Fund shares. Shareholders are advised to consult their tax advisers regarding the possible implications of this additional tax on their investment in a Fund.
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Return of Capital Distributions
If a Fund makes a distribution with respect to any taxable year to a shareholder in excess of that Funds current and accumulated earnings and profits, the excess distribution will be treated as a return of capital to the extent of such shareholders tax basis in its shares, and thereafter as capital gain. A return of capital is not taxable, but it reduces a shareholders tax basis in its shares, thus reducing any loss or increasing any gain on a subsequent taxable disposition by the shareholder of its shares.
Dividends and distributions on a Funds shares are generally subject to U.S. federal income tax as described herein to the extent they do not exceed that Funds realized income and gains, even though such dividends and distributions may economically represent a return of a particular shareholders investment. Such distributions are likely to occur in respect of shares purchased at a time when a Funds net asset value reflects either unrealized gains or realized but undistributed income or gains that were therefore included in the price that the shareholder paid. Such distributions may reduce the net asset value of a Funds shares below the shareholders cost basis in those shares. As described above, each Fund is required to distribute realized income and gains regardless of whether that Funds net asset value also reflects unrealized losses.
Tax Implications of Certain Fund Investments
Some debt obligations with a fixed maturity date of more than one year from the date of issuance (and zero-coupon debt obligations with a fixed maturity date of more than one year from the date of issuance) that are acquired by a Fund will be treated as debt obligations that are issued originally at a discount. Generally, the amount of the original issue discount (OID) is treated as interest income and is included in a Funds income (and required to be distributed by the Fund) over the term of the debt security, even though payment of that amount is not received until a later time, upon partial or full repayment or disposition of the debt security.
Some debt obligations with a fixed maturity date of more than one year from the date of issuance that are acquired by a Fund in the secondary market may be treated as having market discount. Very generally, market discount is the excess of the stated redemption price of a debt obligation (or in the case of an obligation issued with OID, its revised issue price) over the purchase price of such obligation. Generally, any gain recognized on the disposition of, and any partial payment of principal on, a debt security having market discount is treated as ordinary income to the extent the gain, or principal payment, does not exceed the accrued market discount on such debt security. Alternatively, a Fund may elect to accrue market discount currently and thus distribute it over the term of the debt security, even though the payment of that amount is not received until a later time, upon partial or full repayment or disposition of the debt security. The rate at which the market discount accrues, and thus is included in a Funds income, will depend upon which of the permitted accrual methods the Fund elects.
Some debt obligations with a fixed maturity date of one year or less from the date of issuance that are acquired by a Fund may be treated as having OID or acquisition discount (very generally, the excess of the stated redemption price over the purchase price). Generally, a Fund will be required to include the OID or acquisition discount in income (as ordinary income) over the term of the debt security, even though payment of that amount is not received until a later time, upon partial or full repayment or disposition of the debt security. The rate at which OID or acquisition discount accrues, and thus is included in a Funds income, will depend upon which of the permitted accrual methods the Fund elects.
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A substantial portion of the Opportunistic Credit Funds investments in loans and other debt obligations will be treated as having market discount and/or OID, which, in some cases, could be significant.
Some preferred securities may include provisions that permit the issuer, at its discretion, to defer the payment of distributions for a stated period without any adverse consequences to the issuer. If a Fund owns a preferred security that is deferring the payment of its distributions, the Fund may be required to report income for U.S. federal income tax purposes to the extent of any such deferred distribution even though the Fund has not yet actually received the cash distribution.
If a Fund holds the foregoing kinds of obligations, or other obligations subject to special rules under the Code, it may be required to pay out as an income distribution each year an amount which is greater than the total amount of cash interest the Fund actually received. Such distributions may be made from the cash assets of the Fund or, if necessary, by liquidation of portfolio securities (including at a time when it may not be advantageous to do so). A Fund may realize gains or losses from such liquidations. In the event a Fund realizes net long-term or short-term capital gains from such transactions, its shareholders may receive a larger Capital Gain Dividend or ordinary dividend, respectively, than they would in the absence of such transactions.
Very generally, where a Fund purchases a bond at a price that exceeds the redemption price at maturity that is, at a premium the premium is amortizable over the remaining term of the bond. In the case of a taxable bond, if a Fund makes an election applicable to all such bonds it purchases, which election is irrevocable without consent of the IRS, the Fund reduces the current taxable income from the bond by the amortized premium and reduces its tax basis in the bond by the amount of such offset; upon the disposition or maturity of such bonds acquired on or after January 4, 2013, the Fund is permitted to deduct any remaining premium allocable to a prior period. In the case of a tax-exempt bond, tax rules require a Fund to reduce its tax basis by the amount of amortized premium.
Investments in high-yield debt obligations or other distressed debt obligations that are at risk of or in default present special tax issues for a Fund investing in or holding such obligations. Tax rules are not entirely clear about issues such as whether or to what extent a Fund should recognize market discount on a debt obligation; when a Fund may cease to accrue interest, OID or market discount; when and to what extent a Fund may take deductions for bad debts or worthless securities and how a Fund should allocate payments received on obligations in default between principal and income. These and other related issues will be addressed by each Fund as necessary, in order to seek to ensure that it distributes sufficient income to preserve its eligibility for treatment as a RIC and does not become subject to U.S. federal income or excise tax.
A portion of the OID paid or accrued on certain high-yield discount obligations owned by a Fund may not be deductible to the issuer and will instead be treated as a dividend paid by the issuer for purposes of the dividends-received deduction. In such cases, if the issuer of the obligation is a domestic corporation, dividend payments by the Fund may be eligible for the dividends-received deduction to the extent of the deemed dividend portion of such OID.
A Fund may invest directly or indirectly in residual interests in real estate mortgage investment conduits (REMICs) (including by investing in residual interests in CMOs with respect to which an election to be treated as a REMIC is in effect) or equity interests in taxable mortgage pools (TMPs). Under a notice issued by the IRS in October 2006 and Treasury regulations that have yet to be issued but may apply retroactively, a portion of a Funds income (including income allocated to the Fund from a pass-through entity) that is attributable to a residual interest in a REMIC or an equity interest in a TMP (referred to in the Code as an excess inclusion) will be subject to U.S. federal income tax in all events. This notice also provides, and the regulations are expected to provide, that excess inclusion
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income of a RIC will be allocated to shareholders of the RIC in proportion to the dividends received by such shareholders, with the same consequences as if the shareholders held the related interest directly. As a result, a Fund investing in such interests may not be a suitable investment for charitable remainder trusts. See Tax-Exempt Shareholders below.
In general, excess inclusion income allocated to shareholders (i) cannot be offset by net operating losses (subject to a limited exception for certain thrift institutions), (ii) will constitute unrelated business taxable income (UBTI) to entities (including a qualified pension plan, an individual retirement account, a 401(k) plan, a Keogh plan or other tax-exempt entity) subject to tax on UBTI, thereby potentially requiring such an entity that is allocated excess inclusion income, and otherwise might not be required to file a tax return, to file a tax return and pay tax on such income, and (iii) in the case of a non-U.S. shareholder, will not qualify for any reduction in U.S. federal withholding tax. A shareholder will be subject to U.S. federal income tax on such inclusions notwithstanding any exemption from such income tax otherwise available under the Code.
A Funds transactions in foreign currencies, foreign currency-denominated debt obligations and certain foreign currency options, futures contracts or forward contracts (or similar instruments) may give rise to ordinary income or loss to the extent such income or loss results from fluctuations in the value of the foreign currency concerned. Such ordinary income treatment may accelerate Fund distributions to shareholders and increase the distributions taxed to shareholders as ordinary income. Any net ordinary losses so created cannot be carried forward by a Fund to offset income or gains earned in subsequent years.
Any equity investments by a Fund in certain passive foreign investment companies (PFICs) could potentially subject that Fund to a U.S. federal income tax (including interest charges) on distributions received from the PFIC or on proceeds received from the disposition of shares in the PFIC. This tax cannot be eliminated by making distributions to Fund shareholders. However, a Fund may elect to avoid the imposition of that tax. For example, a Fund may elect to treat a PFIC as a qualified electing fund ( i.e. , make a QEF election), in which case that Fund will be required to include its share of the PFICs income and net capital gains annually, regardless of whether it receives any distribution from the PFIC. A Fund also may make an election to mark the gains (and to a limited extent losses) in such holdings to the market as though it had sold and repurchased its holdings in those PFICs on the last day of that Funds taxable year. Such gains and losses are treated as ordinary income and loss. The QEF and mark-to-market elections may accelerate the recognition of income (without the receipt of cash) and increase the amount required to be distributed by a Fund to avoid taxation. Making either of these elections therefore may require a Fund to liquidate other investments (including when it is not advantageous to do so) to meet its distribution requirement, which also may accelerate the recognition of gain and affect that Funds total return. Dividends paid by PFICs will not be eligible to be treated as qualified dividend income. Because it is not always possible to identify a foreign corporation as a PFIC, a Fund may incur the tax and interest charges described above in some instances.
A Funds investments in foreign countries may be subject to foreign withholding and other taxes on dividends, interest, capital gains, or other income or proceeds. These withholding and other taxes will decrease a Funds yield on the securities subject to such taxes. Tax treaties between certain countries and the U.S. may reduce or eliminate such taxes. If more than 50% of a Funds assets at taxable year end consists of the securities of foreign corporations, the Fund may elect to permit shareholders to claim a credit or deduction on their income tax returns for their pro rata portions of qualified taxes paid by the Fund to foreign countries in respect of foreign securities that the Fund has held for at least the minimum period specified in the Code. In such a case, shareholders will include in gross income from foreign sources their pro rata shares of such taxes paid by the Fund. A shareholders ability to claim an offsetting foreign tax credit or deduction in respect of foreign taxes
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paid by a Fund is subject to certain limitations imposed by the Code, which may result in the shareholders not receiving a full credit or deduction (if any) for the amount of such taxes. Shareholders who do not itemize on their U.S. federal income tax returns may claim a credit (but not a deduction) for such foreign taxes. Shareholders that are not subject to U.S. federal income tax, and those who invest in a Fund through tax-advantaged accounts (including those who invest through individual retirement accounts or other tax-advantaged retirement plans), generally will receive no benefit from any tax credit or deduction passed through by a Fund. Even if eligible in a particular taxable year, a Fund may determine not to make this election, in which case shareholders will not be entitled to claim a credit or deduction for foreign taxes directly or indirectly paid by the Fund in such year. Shareholders of the Long/Short Equity Fund, Long/Short Healthcare Fund and Opportunistic Credit Fund generally will not be entitled to claim a credit or deduction with respect to foreign taxes paid by or withheld from a Fund.
A Funds derivatives transactions, as well as any hedging, straddle and short sale transactions, generally are subject to one or more special tax rules (including, for instance, notional principal contract, mark-to-market, constructive sale, straddle, wash sale and short sale rules). These rules may affect whether gains and losses recognized by a Fund are treated as ordinary or capital and/or as short-term or long-term, accelerate the recognition of income or gains to a Fund, defer losses to a Fund, and cause adjustments in the holding periods of a Funds securities. These rules could therefore affect the amount, timing and/or character of distributions to shareholders. In addition, because these and other tax rules applicable to derivative financial instruments are in some cases uncertain under current law, an adverse determination or future guidance by the IRS with respect to these rules (which determination or guidance could be retroactive) may affect whether a Fund has made sufficient distributions, and otherwise satisfied the relevant requirements, to maintain its qualification as a RIC and avoid a Fund-level tax.
In addition, certain of a Funds investments in derivative instruments and foreign currency-denominated debt instruments, as well as any of a Funds transactions in foreign currencies and hedging activities, are likely to produce a difference between a Funds book income and the sum of its taxable income and net tax-exempt income (if any). If a Funds book income exceeds the sum of its taxable income (including net realized capital gains) and net tax-exempt income (if any), the distribution (if any) of such excess generally will be treated as (i) a dividend to the extent of that Funds remaining earnings and profits (including earnings and profits arising from tax-exempt income), (ii) thereafter, as a return of capital to the extent of the recipients basis in its shares, and (iii) thereafter, as gain from the sale or exchange of a capital asset. If a Funds book income is less than the sum of its taxable income and net tax-exempt income (if any), the Fund could be required to make distributions exceeding book income to qualify as a RIC that is accorded favorable tax treatment.
To the extent a Fund participates in short sales by contracting for the sale of securities it does not own and later purchasing securities necessary to close the sale, the character of the gain or loss realized on such a short sale is determined by reference to the property used to close the short sale and is thus generally short-term. Because net short-term capital gain (after reduction by any long-term capital loss) is generally taxed at ordinary income rates, a Funds short sale transactions can increase the percentage of a Funds gains that are taxable to shareholders as ordinary income.
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Sale, Exchange or Redemption of Fund Shares
The sale, exchange or redemption of Fund shares may give rise to a gain or loss to the shareholder. In general, any gain or loss realized upon a taxable disposition of shares will be treated as long-term capital gain or loss if the shares have been held for more than 12 months. Otherwise, the gain or loss on the taxable disposition of Fund shares will be treated as short-term capital gain or loss. However, any loss realized upon a taxable disposition of shares held for six months or less will be treated as long-term, rather than short-term, to the extent of any Capital Gain Dividends received (or deemed received) by the shareholder with respect to those shares. In addition, all or a portion of any loss realized upon a taxable disposition of Fund shares will be disallowed under the wash-sale rule of the Code if other substantially identical shares are purchased within 30 days before or after the disposition. In such a case, the basis of the newly purchased shares will be adjusted to reflect the disallowed loss.
Shareholders may be entitled to offset their Capital Gain Dividends with capital loss from other sources. The Code contains a number of statutory provisions affecting the circumstances under which capital loss may be offset against capital gain and limiting the use of loss from certain investments and activities. Accordingly, shareholders that have capital losses are urged to consult their tax advisers.
Upon the redemption or exchange of Fund shares, the Fund or, in the case of shares purchased through an intermediary, the intermediary may be required to provide you and the IRS with cost basis and certain other related tax information about the Fund shares you redeemed or exchanged. See the Funds Prospectus for more information.
Backup Withholding
A Fund (or if Fund shares are purchased through an intermediary, the intermediary) generally is required to withhold and remit to the U.S. Treasury a percentage of the taxable distributions and redemption proceeds paid to any individual shareholder who fails to properly furnish the Fund (or intermediary) with a correct taxpayer identification number (TIN), who has under-reported dividend or interest income, or who fails to certify to the Fund (or intermediary) that he or she is not subject to such withholding. Backup withholding is not an additional tax. Any amounts withheld may be credited against the shareholders U.S. federal income tax liability, provided the appropriate information is furnished to the IRS.
Tax Shelter Reporting Regulations
Under Treasury regulations, if a shareholder recognizes a loss of $2 million or more for an individual shareholder or $10 million or more for a corporate shareholder, the shareholder must file with the IRS a disclosure statement on IRS Form 8886. Direct holders of portfolio securities are in many cases excepted from this reporting requirement, but under current guidance, shareholders of a RIC are not excepted. Future guidance may extend the current exception from this reporting requirement to shareholders of most or all RICs. The fact that a loss is reportable under these regulations does not affect the legal determination of whether the taxpayers treatment of the loss is proper. Shareholders should consult their tax advisers to determine the applicability of these regulations in light of their individual circumstances.
Non-U.S. Shareholders
Distributions by a Fund to shareholders that are not U.S. persons within the meaning of the Code (foreign shareholders) properly reported by the Fund as (1) Capital Gain Dividends, (2) short-term capital gain dividends, and (3) interest-related dividends, each as defined and subject to certain conditions described below, generally will not be subject to withholding of U.S. federal income tax.
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In general, the Code defines (1) short-term capital gain dividends as distributions of net short-term capital gains in excess of net long-term capital losses and (2) interest-related dividends as distributions from U.S. source interest income of types similar to those not subject to U.S. federal income tax if earned directly by an individual foreign shareholder, in each case to the extent such distributions are properly reported as such by the Fund in a written notice to shareholders.
The exceptions to withholding for Capital Gain Dividends and short-term capital gain dividends do not apply to (A) distributions to an individual foreign shareholder who is present in the United States for a period or periods aggregating 183 days or more during the year of the distribution and (B) distributions attributable to gain that is treated as effectively connected with the conduct by the foreign shareholder of a trade or business within the United States under special rules regarding the disposition of U.S. real property interests (USRPI) as described below. The exception to withholding for interest-related dividends does not apply to distributions to a foreign shareholder that (A) has not provided a satisfactory statement that the beneficial owner is not a U.S. person, (B) to the extent that the dividend is attributable to certain interest on an obligation if the foreign shareholder is the issuer or is a 10% shareholder of the issuer, (C) that is within certain foreign countries that have inadequate information exchange with the United States, or (D) to the extent the dividend is attributable to interest paid by a person that is a related person of the foreign shareholder and the foreign shareholder is a controlled foreign corporation. A Fund is permitted to report such part of its dividends as interest-related or short-term capital gain dividends as are eligible, but is not required to do so. In the case of shares held through an intermediary, the intermediary may withhold even if the Fund reports all or a portion of a payment as an interest-related or short-term capital gain dividend to shareholders. Foreign shareholders should contact their intermediaries regarding the application of these rules to their accounts.
Distributions by the Fund to foreign shareholders other than Capital Gain Dividends, short-term capital gain dividends, and interest-related dividends (e.g., dividends attributable to dividend and foreign-source interest income or to short-term capital gains or U.S. source interest income to which the exception from withholding described above does not apply) are generally subject to withholding of U.S. federal income tax at a rate of 30% (or lower applicable treaty rate).
A foreign shareholder is not, in general, subject to U.S. federal income tax on gains (and is not allowed a deduction for losses) realized on the sale of shares of a Fund unless (i) such gain is effectively connected with the conduct of a trade or business carried on by such holder within the United States, (ii) in the case of an individual holder, the holder is present in the United States for a period or periods aggregating 183 days or more during the year of the sale and certain other conditions are met, or (iii) the special rules relating to gain attributable to the sale or exchange of USRPIs apply to the foreign shareholders sale of shares of the Fund (as described below).
Foreign shareholders with respect to whom income from a Fund is effectively connected with a trade or business conducted by the foreign shareholder within the United States will, in general, be subject to U.S. federal income tax on the income derived from the Fund at the graduated rates applicable to U.S. citizens, residents or domestic corporations, whether such income is received in cash or reinvested in shares of the Fund and, in the case of a foreign corporation, may also be subject to a branch profits tax.
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If a foreign shareholder is eligible for the benefits of a tax treaty, any effectively connected income or gain will generally be subject to U.S. federal income tax on a net basis only if it is also attributable to a permanent establishment maintained by the shareholder in the United States. More generally, foreign shareholders who are residents in a country with an income tax treaty with the United States may obtain different tax results than those described herein and are urged to consult their tax advisers.
Special rules apply to distributions to certain foreign shareholders from a RIC that is a qualified investment entity (QIE) because it is either a U.S. real property holding corporation (USRPHC) or former USRPHC or would be a USRPHC absent certain exclusions from the definition of USRPIs. Very generally, a USRPHC is a domestic corporation that holds USRPIs USRPIs are defined generally as any interest in U.S. real property or any equity interest in a USRPHC the fair market value of which, during specified testing periods, equals or exceeds 50% of the sum of the fair market values of the corporations USRPIs, interests in real property located outside the United States and other assets. The Funds generally do not expect that they will be USRPHCs or would be USRPHCs but for the operation of the special exceptions referred to above, and thus do not expect these special tax rules to apply.
In order to qualify for any exemption from withholding described above (to the extent applicable) or for lower withholding tax rates under applicable income tax treaties, or to establish an exemption from backup withholding, a foreign shareholder must comply with applicable certification requirements relating to its non-U.S. status (including, in general, furnishing an IRS Form W-8BEN, W-8BEN-E or substitute form). Foreign shareholders should contact their tax advisers in this regard.
A foreign shareholder may be subject to state and local tax and to the U.S. federal estate tax in addition to the U.S. federal tax on income referred to above.
Tax-Exempt Shareholders
Under current law, a Fund serves to block (that is, prevent the attribution to shareholders of) UBTI from being realized by tax-exempt shareholders. Notwithstanding this blocking effect, a tax-exempt shareholder could realize UBTI by virtue of its investment in a Fund if shares in that Fund constitute debt-financed property in the hands of the tax-exempt shareholder within the meaning of Code Section 514(b).
A tax-exempt shareholder may also recognize UBTI if a Fund recognizes excess inclusion income derived from direct or indirect investments in residual interests in REMICS or equity interests in TMPs if the amount of such income recognized by the Fund exceeds the Funds investment company taxable income (after taking into account deductions for dividends paid by the Fund).
In addition, special tax consequences apply to charitable remainder trusts (CRTs) that invest in RICs that invest directly or indirectly in residual interests in REMICs or equity interests in TMPs. Under legislation enacted in December 2006, a CRT (as defined in section 664 of the Code) that realizes any UBTI for a taxable year must pay an excise tax annually of an amount equal to such UBTI. Under IRS guidance issued in October 2006, a CRT will not recognize UBTI as a result of investing in a Fund to the extent it recognizes excess inclusion income. Rather, if at any time during any taxable year a CRT (or one of certain other tax-exempt shareholders, such as the United States, a state or political subdivision, or an agency or instrumentality thereof, and certain energy cooperatives) is a record holder of a Fund and the Fund recognizes excess inclusion income, then the Fund will be subject to a tax on that portion of its excess inclusion income for the taxable year that is allocable to such shareholders at the highest federal corporate income tax rate. The extent to which this IRS guidance remains applicable in light of the December 2006 legislation is unclear. To
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the extent permitted under the 1940 Act, a Fund may elect to specially allocate any such tax to the applicable CRT, or other shareholder, and thus reduce such shareholders distributions for the year by the amount of the tax that relates to such shareholders interest in the Fund.
CRTs and other tax-exempt investors are urged to consult their tax advisers concerning the consequences of investing in a Fund.
Shareholder Reporting Obligations With Respect to Foreign Bank and Financial Accounts
Shareholders that are U.S. persons and own, directly or indirectly, more than 50% of a Fund could be required to report annually their financial interest in the Funds foreign financial accounts, if any, on FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). Shareholders should consult a tax adviser, and persons investing in a Fund through an intermediary should contact their intermediary, regarding the applicability to them of this reporting requirement.
Other Reporting and Withholding Requirements
Sections 1471-1474 of the Code and the U.S. Treasury and IRS guidance issued thereunder (collectively, FATCA) generally require a Fund to obtain information sufficient to identify the status of each of its shareholders under FATCA or under an applicable intergovernmental agreement (an IGA) between the United States and a foreign government. If a shareholder fails to provide the requested information or otherwise fails to comply with FATCA or an IGA, a Fund may be required to withhold under FATCA at a rate of 30% with respect to that shareholder on ordinary dividends it pays and 30% of the gross proceeds of redemptions or exchanges of Fund shares and certain Capital Gain Dividends the Fund pays on or after January 1, 2019. If a payment by a Fund is subject to FATCA withholding, the Fund or its agent is required to withhold even if such payment would otherwise be exempt from withholding under the rules applicable to foreign shareholders described above ( e.g. , Capital Gain Dividends, short-term capital gain dividends and interest-related dividends).
Each prospective investor is urged to consult its tax adviser regarding the applicability of FATCA and any other reporting requirements with respect to the prospective investors own situation. Persons investing in a Fund through an intermediary should contact their intermediary regarding the application of this reporting and withholding regime to their investments in a Fund.
Shares Purchased Through Tax Qualified Plans
Special tax rules apply to investments through defined contribution plans and other tax-qualified plans or tax-advantaged arrangements. Shareholders should consult their tax advisers to determine the suitability of shares of a Fund as an investment through such plans and arrangements and the precise effect of an investment on their particular tax situation.
General Considerations
The U.S. federal income tax discussion set forth above is for general information only. Prospective investors should consult their tax advisers regarding the specific U.S. federal tax consequences of purchasing, holding, and disposing of shares of a Fund, as well as the effects of state, local, foreign and other tax law and any proposed tax law changes.
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The audited financial statements and notes thereto of the Funds Annual Report to Shareholders for the fiscal year ended June 30, 2017 are incorporated into this SAI by reference and have been audited by KPMG LLP, an independent registered public accounting firm, whose report, along with the financial statements, appears in the Funds 2017 Annual Report to Shareholders for the fiscal year ended June 30, 2017, as filed with the SEC on September 6, 2017 (file # 811-21866).
The audited financial statements incorporated by reference into the Funds Prospectus and this SAI have been so incorporated in reliance upon the reports of KPMG LLP, given on its authority as an expert in auditing and accounting. The Funds Annual Report is available without charge by calling the Funds at (877) 665-1287 or on the SECs website at http://www.sec.gov.
On July 1, 2014, the Opportunistic Credit Fund acquired the assets of the HSSF Predecessor Fund. The Opportunistic Credit Fund is the successor to the accounting and performance information of the HSSF Predecessor Fund.
On May 12, 2016, the Merger Arbitrage Fund acquired the assets of the Merger Arbitrage Predecessor Fund. The Merger Arbitrage Fund is the successor to the performance information of the Merger Arbitrage Predecessor Fund.
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APPENDIX A RATINGS CATEGORIES
Ratings in General. A rating of a rating service represents the services opinion as to the credit quality of the security being rated. However, the ratings are general and are not absolute standards of quality or guarantees as to the creditworthiness of an issuer. Consequently, the Adviser believes that the quality of debt securities should be continuously reviewed and that individual analysts give different weightings to the various factors involved in credit analysis. A rating is not a recommendation to purchase, sell or hold a security because it does not take into account market value or suitability for a particular investor. When a security has received a rating from more than one service, each rating should be evaluated independently. Ratings are based on current information furnished by the issuer or obtained by the rating services from other sources that they consider reliable. Ratings may be changed, suspended or withdrawn as a result of changes in or unavailability of such information, or for other reasons. The following is a description of the characteristics of ratings used by Moodys Investors Service (Moodys) and Standard & Poors (S&P).
Moodys
Global Long-term Rating Scale
Ratings assigned on Moodys global long-term rating scales are forward-looking opinions of the relative credit risks of financial obligations issued by non-financial corporates, financial institutions, structured finance vehicles, project finance vehicles, and public sector entities. Long-term ratings are assigned to issuers or obligations with an original maturity of one year or more and reflect both on the likelihood of a default on contractually promised payments and the expected financial loss suffered in the event of default.
Aaa
Obligations rated Aaa are judged to be of the highest quality, subject to the lowest level of credit risk.
Aa
Obligations rated Aa are judged to be of high quality and are subject to very low credit risk.
A
Obligations rated A are judged to be upper-medium grade and are subject to low credit risk.
Baa
Obligations rated Baa are judged to be medium-grade and subject to moderate credit risk and as such may possess certain speculative characteristics.
Ba
Obligations rated Ba are judged to be speculative and are subject to substantial credit risk.
B
Obligations rated B are considered speculative and are subject to high credit risk.
Caa
Obligations rated Caa are judged to be speculative of poor standing and are subject to very high credit risk.
A-1
Ca
Obligations rated Ca are highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest.
C
Obligations rated C are the lowest rated and are typically in default, with little prospect for recovery of principal or interest.
Note: Moodys appends numerical modifiers 1, 2, and 3 to each generic rating classification from Aa through Caa. The modifier 1 indicates that the obligation ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generic rating category. Additionally, a (hyb) indicator is appended to all ratings of hybrid securities issued by banks, insurers, finance companies, and securities firms.*
* | By their terms, hybrid securities allow for the omission of scheduled dividends, interest, or principal payments, which can potentially result in impairment if such an omission occurs. Hybrid securities may also be subject to contractually allowable write-downs of principal that could result in impairment. Together with the hybrid indicator, the long-term obligation rating assigned to a hybrid security is an expression of the relative credit risk associated with that security. |
Global Short-Term Rating Scale
Ratings assigned on Moodys global short-term rating scales are forward-looking opinions of the relative credit risks of financial obligations issued by non-financial corporates, financial institutions, structured finance vehicles, project finance vehicles, and public sector entities. Short-term ratings are assigned to obligations with an original maturity of thirteen months or less and reflect the likelihood of a default on contractually promised payments.
Moodys employs the following designations to indicate the relative repayment ability of rated issuers:
P-1
Issuers (or supporting institutions) rated Prime-1 have a superior ability to repay short-term debt obligations.
P-2
Issuers (or supporting institutions) rated Prime-2 have a strong ability to repay short-term debt obligations.
P-3
Issuers (or supporting institutions) rated Prime-3 have an acceptable ability to repay short-term obligations.
NP
Issuers (or supporting institutions) rated Not Prime do not fall within any of the Prime rating categories.
A-2
S&P
Long-Term Issue Credit Ratings
Issue credit ratings are based, in varying degrees, on S&Ps analysis of the following considerations: (i) likelihood of payment capacity and willingness of the obligor to meet its financial commitment on an obligation in accordance with the terms of the obligation; (ii) nature of and provisions of the obligation, and the promise we impute; and (iii) protection afforded by, and relative position of, the obligation in the event of bankruptcy, reorganization, or other arrangement under the laws of bankruptcy and other laws affecting creditors rights.
Issue ratings are an assessment of default risk, but may incorporate an assessment of relative seniority or ultimate recovery in the event of default. Junior obligations are typically rated lower than senior obligations, to reflect the lower priority in bankruptcy, as noted above. (Such differentiation may apply when an entity has both senior and subordinated obligations, secured and unsecured obligations, or operating company and holding company obligations.)
AAA
An obligation rated AAA has the highest rating assigned by S&P. The obligors capacity to meet its financial commitment on the obligation is extremely strong.
AA
An obligation rated AA differs from the highest-rated obligations only to a small degree. The obligors capacity to meet its financial commitment on the obligation is very strong.
A
An obligation rated A is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligors capacity to meet its financial commitment on the obligation is still strong.
BBB
An obligation rated BBB exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.
BB, B, CCC, CC, and C
Obligations rated BB, B, CCC, CC, and C are regarded as having significant speculative characteristics. BB indicates the least degree of speculation and C the highest. While such obligations will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to adverse conditions.
BB
An obligation rated BB is less vulnerable to nonpayment than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions which could lead to the obligors inadequate capacity to meet its financial commitment on the obligation.
B
An obligation rated B is more vulnerable to nonpayment than obligations rated BB, but the obligor currently has the capacity to meet its financial commitment on the obligation. Adverse business, financial, or economic conditions will likely impair the obligors capacity or willingness to meet its financial commitment on the obligation.
A-3
CCC
An obligation rated CCC is currently vulnerable to nonpayment, and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation.
CC
An obligation rated CC is currently highly vulnerable to nonpayment. The CC rating is used when a default has not yet occurred, but S&P expects default to be a virtual certainty, regardless of the anticipated time to default.
C
An obligation rated C is currently highly vulnerable to nonpayment, and the obligation is expected to have lower relative seniority or lower ultimate recovery compared to obligations that are rated higher.
D
An obligation rated D is in default or in breach of an imputed promise. For non-hybrid capital instruments, the D rating category is used when payments on an obligation are not made on the date due, unless S&P believes that such payments will be made within five business days in the absence of a stated grace period or within the earlier of the stated grace period or 30 calendar days. The D rating also will be used upon the filing of a bankruptcy petition or the taking of similar action and where default on an obligation is a virtual certainty, for example due to automatic stay provisions. An obligations rating is lowered to D if it is subject to a distressed exchange offer.
Plus (+) or minus (-)
The ratings from AA to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories.
NR
This indicates that no rating has been requested, or that there is insufficient information on which to base a rating, or that S&P does not rate a particular obligation as a matter of policy.
Short-Term Issue Credit Ratings
A-1
A short-term obligation rated A-1 is rated in the highest category by S&P. The obligors capacity to meet its financial commitment on the obligation is strong. Within this category, certain obligations are designated with a plus sign (+). This indicates that the obligors capacity to meet its financial commitment on these obligations is extremely strong.
A-2
A short-term obligation rated A-2 is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher rating categories. However, the obligors capacity to meet its financial commitment on the obligation is satisfactory.
A-4
A-3
A short-term obligation rated A-3 exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.
B
A short-term obligation rated B is regarded as vulnerable and has significant speculative characteristics. The obligor currently has the capacity to meet its financial commitments; however, it faces major ongoing uncertainties which could lead to the obligors inadequate capacity to meet is financial commitments.
C
A short-term obligation rated C is currently vulnerable to nonpayment and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitments.
D
A short-term obligation rated D is in default or in breach of an imputed promise. For non-hybrid capital instruments, the D rating category is used when payments on an obligation are not made on the date due, unless S&P believes that such payments will be made within any stated grace period. However, any stated grace period longer than five business days will be treated as five business days. The D rating also will be used upon the filing of a bankruptcy petition or the taking of a similar action and where default on an obligation is a virtual certainty, for example due to automatic stay provisions. An obligations rating is lowered to D if it subject to a distressed exchange offer.
SPUR (S&P Underlying Rating)
A SPUR rating is an opinion about the stand-alone capacity of an obligor to pay debt service on a credit-enhanced debt issue, without giving effect to the enhancement that applies to it. These ratings are published only at the request of the debt issuer/obligor with the designation SPUR to distinguish them from the credit-enhanced rating that applies to the debt issue. S&P maintains surveillance of an issue with a published SPUR.
A-5
HIGHLAND CAPITAL MANAGEMENT FUND ADVISORS, L.P.
POLICY REGARDING PROXY VOTING
Purpose and Scope
The purpose of these voting policies and procedures (the Policy) is to set forth the principles and procedures by which HCMLP (the Company) votes or gives consents with respect to the securities owned by Clients for which the Company exercises voting authority and discretion. 1 For avoidance of doubt, this includes any proxy and any shareholder vote or consent, including a vote or consent for a private company or other issuer that does not involve a proxy. These policies and procedures have been designed to help ensure that votes are cast in the best interests of Clients in accordance with the Companys fiduciary duties and Rule 206(4)-6 under the Investment Advisers Act of 1940 (the Advisers Act).
This Policy applies to securities held in all Client accounts (including Retail Funds and other pooled investment vehicles) as to which the Company has explicit or implicit voting authority. Implicit voting authority exists where the Companys voting authority is implied by a general delegation of investment authority without reservation of proxy voting authority to the Client.
If the Company has delegated voting authority to an investment sub-adviser with respect to any Retail Fund, such sub-adviser will be responsible for voting all proxies for such Retail Funds in accordance with the sub-advisers proxy voting policies. The Compliance Department, to provide oversight over the proxy voting by sub-advisers and to ensure that votes are executed in the best interests of the Retail Funds, shall (i) review the proxy voting policies and procedures of each Retail Fund sub-adviser to confirm that they comply with Rule 206(4)-6, both upon engagement of the sub-adviser and upon any material change to the sub-advisers proxy voting policies and procedures, and (ii) require each such sub-adviser to provide quarterly certifications that all proxies were voted pursuant to the sub-advisers policies and procedures or to describe any inconsistent votes.
1 | In any case where a Client has instructed the Company to vote in a particular manner on the Clients behalf, those instructions will govern in lieu of parameters set forth in the Policy. |
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General Principles
The Company and its affiliates engage in a broad range of activities, including investment activities for their own accounts and for the accounts of various Clients and providing investment advisory and other services to Clients. In the ordinary course of conducting the Companys activities, the interests of a Client may conflict with the interests of the Company, other Clients and/or the Companys affiliates and their clients. Any conflicts of interest relating to the voting of proxies, regardless of whether actual or perceived, will be addressed in accordance with these policies and procedures. The guiding principle by which the Company votes all proxies is to vote in the best interests of each Client by maximizing the economic value of the relevant Clients holdings, taking into account the relevant Clients investment horizon, the contractual obligations under the relevant advisory agreements or comparable documents and all other relevant facts and circumstances at the time of the vote. The Company does not permit voting decisions to be influenced in any manner that is contrary to, or dilutive of, this guiding principle.
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Voting Procedures
Third-Party Proxy Advisors
The Company may engage a third-party proxy advisor (Proxy Advisor) to provide proxy voting recommendations with respect to Client proxies. Proxy Advisor voting recommendation guidelines are generally designed to increase investors potential financial gain. When considering whether to retain or continue retaining any particular Proxy Advisor, the Compliance Department will ascertain, among other things, whether the Proxy Advisor has the capacity and competency to adequately analyze proxy issues. In this regard, the Compliance Department will consider, among other things: the adequacy and quality of the Proxy Advisors staffing and personnel; the robustness of its policies and procedures regarding its ability to (a) ensure that its proxy voting recommendations are based on current and accurate information and (b) identify and address any conflicts of interest and any other considerations that the Compliance Department determines would be appropriate in considering the nature and quality of the services provided by the Proxy Advisor. To identify and address any conflicts that may arise on the part of the Proxy Advisor, the Compliance Department will ensure that the Proxy Advisor notifies the Compliance Department of any relevant business changes or changes to its policies and procedures regarding conflicts.
Third-Party Proxy Voting Services
The Company may utilize a third-party proxy voting service (Proxy Voting Service) to monitor holdings in Client accounts for purposes of determining whether there are upcoming shareholder meetings or similar corporate actions and to execute Client proxies on behalf of the Company pursuant to the Companys instructions, which shall be given in a manner consistent with this Policy. The Compliance Department will oversee each Proxy Voting Service to ensure that proxies have been voted in a manner consistent with the Companys instructions.
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Monitoring
Subject to the procedures regarding Nonstandard Proxy Notices described below, the Compliance Department of the Company shall have responsibility for monitoring Client accounts for proxy notices. Except as detailed below, if proxy notices are received by other employees of the Company, such employees must promptly forward all proxy or other voting materials to the Compliance Department.
Portfolio Manager Review and Instruction
From time to time, the settlement group of the Company may receive nonstandard proxy notices, regarding matters including, but not limited to, proposals regarding corporate actions or amendments (Nonstandard Proxy Notices) with respect to securities held by Clients. Upon receipt of a Nonstandard Proxy Notice, a member of the settlement group (the Settlement Designee) shall send an email notification containing all relevant information to the Portfolio Manager(s) with responsibility for the security and [ .com ] . Generally, the relevant Portfolio Manager(s) shall deliver voting instructions for Nonstandard Proxy Notices by replying to the email notice sent to the Portfolio Manager(s) and [ .com ] by the Settlement Designee or by sending voting instructions to [ .com ] and copying [ .com ] . Any conflicts for Nonstandard Proxy Notices should also be disclosed to the Compliance Department. In the event a Portfolio Manager orally conveys voting instructions to the Settlement Designee or any other member of the Companys settlement group, that Settlement Designee or member of the Companys settlement group shall respond to the original notice email sent to [ .com ] detailing the Portfolio Manager(s) voting instructions.
With regard to standard proxy notices, on a weekly basis, the Compliance Department will send a notice of upcoming proxy votes related to securities held by Clients and the corresponding voting recommendations of the Proxy Advisor to the relevant Portfolio Manager(s). Upon receipt of a proxy notice from the Compliance Department, the Portfolio Manager(s) will review and evaluate the upcoming votes and recommendations. The Portfolio Managers may rely on any information and/or research available to him or her and may, in his or her discretion, meet with members of an issuers management to discuss matters of importance to the relevant Clients and their economic interests. Should the Portfolio Manager determine that deviating from the Proxy Advisors recommendation is in a Clients best interest, the Portfolio Manager shall communicate his or her voting instructions to the Compliance Department.
In the event that more than one Portfolio Manager is responsible for making a particular voting decision and such Portfolio Managers are unable to arrive at an agreement as to how to vote with respect to a particular proposal, they should consult with the applicable Chief Compliance Officer (the CCO) for guidance.
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Voting
Upon receipt of the relevant Portfolio Managers voting instructions, if any, the Compliance Department will communicate the instructions to the Proxy Voting Service to execute the proxy votes.
Non-Votes
It is the general policy of the Company to vote or give consent on all matters presented to security holders in any vote, and these policies and procedures have been designated with that in mind. However, the Company reserves the right to abstain on any particular vote if, in the judgment of the CCO, or the relevant Portfolio Manager, the effect on the relevant Clients economic interests or the value of the portfolio holding is insignificant in relation to the Clients portfolio, if the costs associated with voting in any particular instance outweigh the benefits to the relevant Clients or if the circumstances make such an abstention or withholding otherwise advisable and in the best interests of the relevant Clients not to vote. Such determination may apply in respect of all Client holdings of the securities or only certain specified Clients, as the Company deems appropriate under the circumstances. As examples, a Portfolio Manager may determine: (a) not to recall securities on loan if, in his or her judgment, the matters being voted upon are not material events affecting the securities and the negative consequences to Clients of disrupting the securities lending program would outweigh the benefits of voting in the particular instance or (b) not to vote proxies relating to certain foreign securities if, in his or her judgment, the expense and administrative inconvenience outweighs the benefits to Clients of voting the securities.
Conflicts of Interest
The Companys Compliance Department is responsible for monitoring voting decisions for any conflicts of interest, regardless of whether they are actual or perceived. All voting decisions contrary to the recommendation of a Proxy Advisor require a mandatory conflicts of interest review by the Compliance Department, which will include a consideration of whether the Company or any Portfolio Manager or other person recommending or providing input on how to vote has an interest in the vote that may present a conflict of interest.
In addition, all Company investment professionals are expected to perform their tasks relating to the voting of proxies in accordance with the principles set forth above, according the first priority to the best interest of the relevant Clients. If at any time a Portfolio Manager or any other investment professional becomes aware of a potential or actual conflict of interest regarding any particular voting decision, he or she must contact the Compliance Department promptly and, if in connection with a proxy that has yet to be voted, prior to such vote. If any investment professional is pressured or lobbied, whether from inside or outside the Company, with respect to any particular voting decision, he or she should contact the Compliance Department promptly. The CCO will use his or her best judgment to address any such conflict of interest and ensure that it is resolved in accordance with his or her independent assessment of the best interests of the relevant Clients.
B-5
In the event of a conflict, the Company may choose to address such conflict by: (i) voting in accordance with the Proxy Advisors recommendation; (ii) the CCO determining how to vote the proxy (if the CCO approves deviation from the Proxy Advisors recommendation, then the CCO shall document the rationale for the vote); (iii) echo voting or mirror voting the proxy in the same proportion as the votes of other proxy holders that are not Clients; or (iv) with respect to Clients other than Retail Funds, notifying the affected Client of the material conflict of interest and seeking a waiver of the conflict or obtaining such Clients voting instructions. Where the Compliance Department deems appropriate, third parties may be used to help resolve conflicts. In this regard, the CCO or his or her delegate shall have the power to retain fiduciaries, consultants or professionals to assist with voting decisions and/or to delegate voting or consent powers to such fiduciaries, consultants or professionals.
Where a conflict of interest arises with respect to a voting decision for a Retail Fund, the Company shall disclose the conflict and the rationale for the vote taken to the Retail Funds Board of Directors/Trustees at the next regularly scheduled quarterly meeting. The Compliance Department will maintain a log documenting the basis for the decision and will furnish the log to the Board of Trustees.
Material Conflicts of Interest
The following relationships or circumstances are examples of situations that may give rise to a material conflict of interest for purposes of this Policy. This list is not exclusive or determinative; any potential conflict (including payments of the types described below but less than the specified threshold) should be identified to the Companys Compliance Department:
(i) | The issuer is a Client of the Company, or of an affiliate, accounting for more than 5% of the Companys or affiliates annual revenues. |
(ii) | The issuer is an entity that reasonably could be expected to pay the Company or its affiliates more than $1 million through the end of the Companys next two full fiscal years. |
(iii) | The issuer is an entity in which a Covered Person (as defined in the Companys Policies and Procedures Designed to Detect and Prevent Insider Trading and to Comply with Rule 17j-1 of the Investment Company Act of 1940, as amended (the Code of Ethics)) has a beneficial interest contrary to the position held by the Company on behalf of Clients. |
(iv) |
The issuer is an entity in which an officer or partner of the Company or a relative of any such person is or was an officer, director or employee, or such person or relative otherwise has received more than $150,000 in fees, compensation and other payment from the issuer during the Companys last three fiscal years; provided, however, that the Compliance Department may |
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deem such a relationship not to be a material conflict of interest if the Company representative serves as an officer or director of the issuer at the direction of the Company for purposes of seeking control over the issuer. |
(v) | The matter under consideration could reasonably be expected to result in a material financial benefit to the Company or its affiliates through the end of the Companys next two full fiscal years (for example, a vote to increase an investment advisory fee for a Retail Fund advised by the Company or an affiliate). |
(vi) | Another Client or prospective Client of the Company, directly or indirectly, conditions future engagement of the Company on voting proxies in respect of any Clients securities on a particular matter in a particular way. |
(vii) | The Company holds various classes and types of equity and debt securities of the same issuer contemporaneously in different Client portfolios. |
(viii) | Any other circumstance where the Companys duty to serve its Clients interests, typically referred to as its duty of loyalty, could be compromised. |
Notwithstanding the foregoing, a conflict of interest described above shall not be considered material for the purposes of this Policy in respect of a specific vote or circumstance if:
The securities in respect of which the Company has the power to vote account for less than 1% of the issuers outstanding voting securities, but only if: (i) such securities do not represent one of the 10 largest holdings of such issuers outstanding voting securities and (ii) such securities do not represent more than 2% of the Clients holdings with the Company.
The matter to be voted on relates to a restructuring of the terms of existing securities or the issuance of new securities or a similar matter arising out of the holding of securities, other than common equity, in the context of a bankruptcy or threatened bankruptcy of the issuer.
Recordkeeping
Following the submission of a proxy vote, the Fund will maintain a report of the vote and all relevant documentation.
The Fund shall retain records relating to the voting of proxies and the Company shall conduct due diligence, including on Proxy Voting Services and Proxy
B-7
Advisors, as applicable, to ensure the following records are adequately maintained by the appropriate party:
(i) | Copies of this Policy and any amendments thereto. |
(ii) | A current copy of the Proxy Advisors voting guidelines, as amended. |
(iii) | A copy of each proxy statement that the Company receives regarding Client securities. The Company may rely on a third party to make and retain, on the Companys behalf, a copy of a proxy statement, provided that the Company has obtained an undertaking from the third party to provide a copy of the proxy statement promptly upon request. |
(iv) | Records of each vote cast by the Company on behalf of Clients. The Company may satisfy this requirement by relying on a third party to make and retain, on the Companys behalf, a record of the vote cast, provided that the Company has obtained an undertaking from the third party to provide a copy of the record promptly upon request. |
(v) | A copy of any documents created by the Company that were material to making a decision how to vote or that memorializes the basis for that decision. |
(vi) | A copy of each written request for information on how the Company voted proxies on behalf of the Client, and a copy of any written response by the Company to any (oral or written) request for information on how the Company voted. |
These records shall be maintained and preserved in an easily accessible place for a period of not less than five years from the end of the Companys fiscal year during which the last entry was made in the records, the first two years in an appropriate office of the Company. 1
1 | If the Company has essentially immediate access to a book or record (on the Companys proprietary system or otherwise) through a computer located at an appropriate office of the Company, then that book or record will be considered to be maintained at an appropriate office of the Company. Immediate access to books and records includes that the Company has the ability to provide promptly to Securities and Exchange Commission (the SEC) examination staff hard copies of the books and records or access to the storage medium. The party responsible for the applicable books and records as described above shall also be responsible for ensuring that those books and records for the first two years are either physically maintained in an appropriate office of the Company or that the Company otherwise has essentially immediate access to the required books and records for the first two years. |
B-8
Enforcement of this Policy
It shall be the responsibility of the Compliance Department to handle or coordinate the enforcement of this Policy. The Compliance Department will periodically sample proxy voting records to ensure that proxies have been voted in accordance with this Policy, with a particular focus on any proxy votes that require additional analysis (e.g., proxies voted contrary to the recommendations of a Proxy Advisor).
If the Compliance Department determines that a Proxy Advisor or Proxy Voting Service may have committed a material error, the Compliance Department will investigate the error, taking into account the nature of the error, and seek to determine whether the Proxy Advisor or Proxy Voting Service is taking reasonable steps to reduce similar errors in the future.
In addition, no less frequently than annually, the Compliance Department will review the adequacy of this Policy to ensure that it has been implemented effectively and to confirm that this Policy continues to be reasonably designed to ensure that proxies are voted in the best interest of Clients.
Disclosures to Clients and Investors
The Company includes a description of its policies and procedures regarding proxy voting in Part 2 of Form ADV, along with a statement that Clients can contact the CCO to obtain a copy of these policies and procedures and information about how the Company voted with respect to a Clients securities. This Policy is, however, subject to change at any time without notice.
As a matter of policy, the Company does not disclose how it expects to vote on upcoming proxies. Additionally, the Company does not disclose the way it voted proxies to unaffiliated third parties without a legitimate need to know such information.
B-9
Statement of Additional Information Dated October 31, 2017
HIGHLAND/iBOXX SENIOR LOAN ETF
Ticker: SNLN
Principal U.S. Listing Exchange: NASDAQ, Inc.
This Statement of Additional Information (SAI) is not a prospectus. It relates to the prospectus of the Highland/iBoxx Senior Loan ETF (the Fund), dated October 31, 2017, and any supplements thereto (the Prospectus), and should be read in conjunction therewith. Copies of the Funds Prospectus and the Funds annual report are available free of charge by calling the Fund at (855) 799-4757, visiting the Funds website (http://www.highlandfunds.com) or writing to the Fund, 200 Crescent Court, Suite 700, Dallas, TX 75201. Capitalized terms used in this SAI and not otherwise defined have the meanings given them in the Funds Prospectus. The principal U.S. national stock exchange on which the Highland/iBoxx Senior Loan ETF is listed is NASDAQ, Inc. (the Exchange).
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APPENDIX B HIGHLAND CAPITAL MANAGEMENT FUND ADVISORS, L.P. PROXY VOTING POLICY |
B-1 |
2
Highland/iBoxx Senior Loan ETF (the Fund) is a non-diversified series of Highland Funds I (the Trust), an open-end management investment company organized as a Delaware statutory trust on February 28, 2006. Highland/iBoxx Senior Loan ETF commenced investment operations on November 6, 2012. This SAI relates only to the Fund.
The Fund is an exchange-traded fund (ETF) and Shares of Highland/iBoxx Senior Loan ETF are listed on NASDAQ, Inc. For purposes of this SAI, the Exchange shall mean NASDAQ, Inc. The shares will trade on the Exchange at market prices that may differ to some degree from the shares net asset value (NAV). The Fund issues and redeems shares on a continuous basis at NAV in large, specified numbers of shares called Creation Units. Creation Units are issued and redeemed in-kind for securities included in the Funds underlying index (the Underlying Index) and/or for cash at the discretion of the Fund. Except when aggregated in Creation Units, shares are not redeemable securities of the Fund. Retail investors, therefore, generally will not be able to purchase the shares directly from the Fund. Rather, most retail investors will purchase shares in the secondary market with the assistance of a broker.
The name of the Trust was changed from Highland Funds I to Pyxis Funds I effective January 9, 2012. The name of the Trust was changed from Pyxis Funds I to Highland Funds I effective February 8, 2013.
Exchange Listing and Trading
There can be no assurance that the requirements of the Exchange necessary to maintain the listing of shares of the Fund will be met. The Exchange may remove the Fund from listing under certain circumstances.
As in the case of all equities traded on the Exchange, brokers commissions on transactions in the Fund will be based on negotiated commission rates at customary levels for retail customers.
In order to provide current share pricing information, the Exchange, market data vendors or other information providers disseminate an updated Indicative Optimized Portfolio Value (IOPV) for the Fund. The Trust is not involved in, or responsible for, any aspect of the calculation or dissemination of the IOPV and makes no warranty as to the accuracy of the IOPV. The IOPV is expected to be disseminated every 15 seconds during regular trading hours of the Exchange. The Funds IOPV disseminated during the Exchanges trading hours should not be viewed as a real-time update of the Funds NAV, which is calculated only once a day.
DESCRIPTION OF INVESTMENTS AND RISK FACTORS
The following information supplements the discussion of the investment policies and strategies of the Fund as described in the Prospectus. In pursuing its objective, the Fund will invest as described in the Prospectus and as described below with respect to the following additional investment policies and strategies.
The Underlying Index is sponsored by Markit Indices Limited, an organization that is independent of the Fund. The Underlying Index is calculated at the end of each business day and re-balanced at the end of each month. The Index Provider annually reviews the parameters used in the selection of component securities of the Underlying Index (Component Securities), including the target number of loans and the eligibility criteria, to ensure that the Underlying Index continues to reflect the underlying loans market. The review consists of a qualitative and quantitative assessment of any developments in the loans market in terms of market size, depth and overall liquidity conditions of the market.
The Fund may change its benchmark or its Underlying Index at any time, including if, for example, the Underlying Index becomes unavailable; the Board of Trustees (the Board) believes that the Underlying Index no longer serves the investment needs of a majority of shareholders or that another index may better serve their needs; or if the financial or economic environment makes it difficult for the Funds investment results to correspond sufficiently to its current benchmark or the Underlying Index. The Fund may specify a benchmark index that is leveraged or proprietary. There can be no assurance that the Fund will achieve its objective.
The Fund engages in representative sampling, which is investing in a sample of securities selected by Highland Capital Management Fund Advisors, L.P. (HCMFA or the Adviser) (formerly, Pyxis Capital L.P.) to
1
have a collective investment profile similar to that of the Underlying Index. Securities selected have aggregate investment characteristics (based on market capitalization and industry weightings), fundamental characteristics (such as yield, credit rating, maturity and duration) and liquidity measures similar to those of the Underlying Index. Because the Fund uses representative sampling, it generally does not hold all of the securities that are in its Underlying Index.
The Fund generally invests at least 80% of its assets in Component Securities. The Fund may invest the remainder of its assets in securities not included in its Underlying Index, but which the Adviser believes will help the Fund track the Underlying Index. For example, the Fund may invest in securities that are not components of its Underlying Index to reflect various corporate actions (such as mergers) and other changes in the Underlying Index (such as reconstitutions, additions and deletions). The Fund may invest without limitation in warrants and may also use derivatives, primarily swaps (including equity, variance and volatility swaps), options and futures contracts on securities, interest rates, non-physical commodities and/or currencies, as substitutes for direct investments the Fund can make. The Fund may also use derivatives such as swaps, options (including options on futures), futures, and foreign currency transactions (e.g., foreign currency swaps, futures and forwards) to any extent deemed by the Adviser to be in the best interest of the Fund, and to the extent permitted by the Investment Company Act of 1940, as amended (the 1940 Act), to hedge various investments for risk management and speculative purposes. The Fund may also invest in cash and cash equivalents.
In addition, the Adviser may also invest some of the Funds assets in short-term U.S. government obligations, certificates of deposit, commercial paper and other money market instruments to enable the Fund to make investments quickly and to serve as collateral with respect to certain of its investments. The Fund may purchase securities on a when-issued or forward commitment basis. The Fund may also invest its assets in high yield bonds (also known as junk bonds) which are bonds typically rated below investment grade by one or more nationally recognized statistical ratings organizations (NRSROs). NRSROs generally regard high-yield debt securities as predominately speculative with respect to ability to pay interest and repay principal and riskier than higher-rated debt securities. Appendix A contains additional information concerning the characteristics of the ratings used by certain NRSROs. From time to time, in the sole discretion of the Adviser, cash balances of the Fund may be placed in a money market fund or investments may be made in shares of other investment companies, including other ETFs, subject to the applicable limits under the 1940 Act.
Limited Role in Affairs of Portfolio Companies. Although the Adviser does not take an active role in the affairs of the companies in which the Fund has positions other than voting proxies with respect to the Funds portfolio holdings, it is the policy of the Fund to take such steps as are necessary to protect its economic interests. If the opportunity presents itself, the Adviser reserves the option for any of its partners to accept a role on the board of directors of any company, regardless of whether the Fund holds any of the companys securities.
Financial Futures. The Adviser is registered as a commodity pool operator and commodity trading adviser under the Commodity Exchange Act (CEA). However, pursuant to Commodity Futures Trading Commission (the CFTC) Rule 4.5, the Adviser has claimed an exclusion from the definition of the term commodity pool operator under the CEA; therefore, the Adviser, with respect to the Fund, is not subject to registration or regulation as a commodity pool operator under the CEA. To remain eligible for the exclusion under CFTC Rule 4.5, the Fund will be limited in its ability to use certain derivative instruments regulated under the CEA (commodity interests), including futures, swaps and options on futures. In the event the Funds investments in commodity interests exceed a certain threshold, the Adviser may be required to register as a commodity pool operator and/or commodity trading advisor with the CFTC with respect to the Fund. The Funds eligibility to claim the exclusion will be based upon the level and scope of its investment in commodity interests, the purposes of such investments and the manner in which the Fund holds out its use of commodity interests. For example, CFTC Rule 4.5 requires the fund with respect to which the sponsor is claiming the exclusion to, among other things, satisfy one of the two following trading thresholds: (i) the aggregate initial margin and premiums required to establish positions in commodity interests cannot exceed 5% of the liquidation value of the funds portfolio, after taking into account unrealized profits and unrealized losses; or (ii) the aggregate net notional value of commodity interests not used solely for bona fide hedging purposes, determined at the time the most recent position was established, cannot generally exceed 100% of the liquidation value of the funds portfolio, after taking into account unrealized profits and unrealized losses on any such positions it has entered into. In the event the Adviser becomes unable to rely on the exclusion in Rule 4.5 and the Adviser is required to register with the CFTC as a commodity pool operator with respect to the Fund, the Funds expenses may increase.
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The CFTC and certain futures exchanges have established limits, referred to as position limits, on the maximum net long or net short positions which any person may hold or control in particular options and futures contracts; those position limits may in the future also apply to certain other derivatives positions the Fund may wish to take. All positions owned or controlled by the same person or entity, even if in different accounts, may in the future be aggregated for purposes of determining whether the applicable position limits have been exceeded. Thus, even if the Fund does not intend to exceed applicable position limits, it is possible that different clients managed by the Adviser and its affiliates may be aggregated for this purpose. Therefore, it is possible that in the future the trading decisions of the Adviser may have to be modified and that positions held by the Fund may have to be liquidated in order to avoid exceeding such limits. The modification of investment decisions or the elimination of open positions, if it occurs, may adversely affect the performance of the Fund.
Fixed-Income and Other Debt Securities
Fixed-income and other debt instrument securities include all bonds, high yield or junk bonds, municipal bonds, debentures, U.S. Government securities, mortgage-related securities, zero coupon securities and custodial receipts. The market value of fixed-income obligations of the Fund will be affected by general changes in interest rates, which will result in increases or decreases in the value of the obligations held by the Fund. The market value of the fixed-income obligations held by the Fund can be expected to vary inversely to changes in prevailing interest rates. As a result, the market value of the fixed-income obligations held by the Fund generally will increase when prevailing interest rates are declining and generally will decrease when prevailing interest rates are rising. In addition, in periods of declining interest rates, the Funds yield will tend to be somewhat higher than prevailing market rates and, in periods of rising interest rates, the Funds yield will tend to be somewhat lower. Also, when interest rates are falling, the inflow of net new money to the Fund from the continuous sale of its shares will tend to be invested in instruments producing lower yields than the balance of its portfolio, thereby reducing the Funds current yield. In periods of rising interest rates, the opposite can be expected to occur. In addition, securities in which the Fund may invest may not yield as high a level of current income as might be achieved by investing in securities with less liquidity, less creditworthiness or longer maturities.
Ratings made available by NRSROs are relative and subjective and are not absolute standards of quality. The Index Provider will assign each loan it considers for inclusion in the Underlying Index a composite index rating based on the ratings from Moodys and Standard & Poors. If more than one agency publishes a rating for a loan, the average of the ratings determines the composite rating. These ratings comprise part of its criteria for selection of Component Securities. The Index Provider will consider other factors as well, such as the loans type, size, liquidity, spread and time to maturity.
Fixed-income securities may be purchased on a when-issued or delayed-delivery basis. See When-Issued Securities and Forward Commitments below.
Commercial Paper. Commercial paper consists of short-term (usually from 1 to 270 days) unsecured promissory notes issued by corporations in order to finance their current operations. A variable amount master demand note (which is a type of commercial paper) represents a direct borrowing arrangement involving periodically fluctuating rates of interest under a letter agreement between a commercial paper issuer and an institutional lender pursuant to which the lender may determine to invest varying amounts.
Medium-, Lower-Rated and Unrated Securities . Securities rated in the fourth highest category by a NRSRO, although considered investment grade, may possess speculative characteristics, and changes in economic or other conditions are more likely to impair the ability of issuers of these securities to make interest and principal payments than is the case with respect to issuers of higher grade bonds.
Generally, medium- or lower-rated securities and unrated securities of comparable quality, sometimes referred to as junk bonds, offer a higher current yield than is offered by higher rated securities, but also (i) will likely have some quality and protective characteristics that, in the judgment of the rating organizations, are outweighed by large uncertainties or major risk exposures to adverse conditions and (ii) are predominantly speculative with respect to the issuers capacity to pay interest and repay principal in accordance with the terms of the obligation. The yield of junk bonds will fluctuate over time.
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The market values of certain of these securities also tend to be more sensitive to individual corporate developments and changes in economic conditions than higher quality bonds. In addition, medium- and lower-rated securities and comparable unrated securities generally present a higher degree of credit risk. The risk of loss due to default by these issuers is significantly greater because medium- and lower-rated securities, and unrated securities of comparable quality, generally are unsecured and frequently are subordinated to the prior payment of senior indebtedness.
In addition, the market for securities in lower-rated categories is more volatile than that for higher-rated securities, and the markets in which medium- and lower-rated or unrated securities are traded are more limited than those in which higher-rated securities are traded. The existence of limited markets may make it more difficult for the Fund to obtain accurate market quotations for purposes of valuing its portfolio and calculating its net asset value. Moreover, the lack of a liquid trading market may restrict the availability of securities for the Fund to purchase and may also have the effect of limiting the ability of the Fund to sell securities at their fair value either to meet redemption requests or to respond to changes in the economy or the financial markets.
Lower-rated debt obligations also present risks based on payment expectations. If an issuer calls the obligation for redemption, the Fund may have to replace the security with a lower yielding security, resulting in a decreased return. Also, as the principal value of bonds moves inversely with movements in interest rates, in the event of rising interest rates the value of the securities held by the Fund may decline relatively proportionately more than a portfolio consisting of higher rated securities. Investments in zero coupon bonds may be more speculative and subject to greater fluctuations in value due to changes in interest rates than bonds that pay interest currently.
Subsequent to its purchase by the Fund, an issue of securities may cease to be rated or its rating may be reduced. Neither event will require sale of these securities by the Fund, but the Index Provider will consider this event in its determination of whether the securities will be removed from the Underlying Index.
The market for lower-rated debt securities may be thinner and less active than that for higher rated debt securities, which can adversely affect the prices at which the former are sold. If market quotations are not available, lower-rated debt securities will be valued in accordance with procedures established by the Board, including the use of outside pricing services. Judgment plays a greater role in valuing high yield corporate debt securities than is the case for securities for which more external sources for quotations and last sale information is available. Adverse publicity and changing investor perception may affect the ability of outside pricing services to value lower-rated debt securities and the ability to dispose of these securities.
The Fund may choose, at its expense or in conjunction with others, to pursue litigation or otherwise exercise its rights as a security holder to seek to protect the interest of security holders if it determines this to be in the best interest of the Fund.
Investments in high-yield debt obligations (known as junk) or other debt obligations that are at risk of, or are in, default present special tax issues for the Fund investing in or holding such securities. See Income Tax Considerations below.
Certificates of Deposit, Bankers Acceptances and Time Deposits. Certificates of deposit are receipts issued by a depository institution in exchange for the deposit of funds. The issuer agrees to pay the amount deposited plus interest to the bearer of the receipt on the date specified on the certificate. The certificate usually can be traded in the secondary market prior to maturity. Bankers acceptances typically arise from short-term credit arrangements designed to enable businesses to obtain funds to finance commercial transactions. Generally, an acceptance is a time draft drawn on a bank by an exporter or an importer to obtain a stated amount of funds to pay for specific merchandise. The draft is then accepted by a bank that, in effect, unconditionally guarantees to pay the face value of the instrument on its maturity date. The acceptance may then be held by the accepting bank as an earning asset or it may be sold in the secondary market at the going rate of discount for a specific maturity. Although maturities for acceptances can be as long as 270 days, most acceptances have maturities of six months or less.
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Time deposits are non-negotiable deposits maintained in a banking institution for a specified period of time at a stated interest rate. Investments in time deposits maturing in more than seven days will be subject to the Securities and Exchange Commissions (SEC) restrictions that limit investments in illiquid securities to no more than 15% of the value of the Funds net assets.
U.S. Government Securities. U.S. Government securities are obligations issued or guaranteed by the U.S. Government, its agencies, authorities or instrumentalities. Some U.S. Government securities, such as U.S. Treasury bills, Treasury notes and Treasury bonds, which differ only in their interest rates, maturities and times of issuance, are supported by the full faith and credit of the United States. Others are supported by: (i) the right of the issuer to borrow from the U.S. Treasury, such as securities of the Federal Home Loan Banks; (ii) the discretionary authority of the U.S. Government to purchase the agencys obligations, such as securities of the Federal National Mortgage Association or (iii) only the credit of the issuer, such as securities of the Student Loan Marketing Association. No assurance can be given that the U.S. Government will provide financial support in the future to U.S. Government agencies, authorities or instrumentalities that are not supported by the full faith and credit of the United States. To the extent the Fund invests in U.S. Government securities that are not backed by the full faith and credit of the U.S. Treasury, such investments may involve a greater risk of loss of principal and interest since the Fund must look principally or solely to the issuing or guaranteeing agency or instrumentality for repayment.
Securities guaranteed as to principal and interest by the U.S. Government, its agencies, authorities or instrumentalities include: (i) securities for which the payment of principal and interest is backed by an irrevocable letter of credit issued by the U.S. Government or any of its agencies, authorities or instrumentalities; and (ii) participation interests in loans made to foreign governments or other entities that are so guaranteed. The secondary market for certain of these participation interests is limited and, therefore, may be regarded as illiquid.
U.S. Treasury Bills . U.S. Treasury Bills are issued with maturities of up to one year. Three month bills are currently offered by the Treasury on a 13-week cycle and are auctioned each week by the Treasury. Bills are issued in bearer form only and are sold only on a discount basis, and the difference between the purchase price and the maturity value (or the resale price if they are sold before maturity) constitutes the interest income for the investor.
Mortgage-Related Securities. There are several risks associated with mortgage-related securities. One is that the monthly cash inflow from the underlying loans may not be sufficient to meet the monthly payment requirements of the mortgage-related security. Prepayment of principal by mortgagors or mortgage foreclosures will shorten the term of the underlying mortgage pool for a mortgage-related security. Early returns of principal will affect the average life of the mortgage-related securities remaining in the Fund. The occurrence of mortgage prepayments is affected by factors including the level of interest rates, general economic conditions, the location and age of the mortgage and other social and demographic conditions. In periods of rising interest rates, the rate of prepayment tends to decrease, thereby lengthening the average life of a pool of mortgage-related securities. Conversely, in periods of falling interest rates, the rate of prepayment tends to increase, thereby shortening the average life of a pool. Reinvestment of prepayments may occur at higher or lower interest rates than the original investment, thus affecting the yield of the Fund. Because prepayments of principal generally occur when interest rates are declining, it is likely that the Fund will have to reinvest the proceeds of prepayments at lower interest rates than those at which the assets were previously invested. If this occurs, the Funds yield will correspondingly decline. Thus, mortgage-related securities may have less potential for capital appreciation in periods of falling interest rates than other fixed-income securities of comparable maturity, although these securities may have a comparable risk of decline in market value in periods of rising interest rates. To the extent that the Fund purchases mortgage-related securities at a premium, unscheduled prepayments, which are made at par, will result in a loss equal to any unamortized premium.
Zero Coupon Securities. Zero coupon U.S. Government securities are debt obligations that are issued or purchased at a significant discount from face value. The discount approximates the total amount of interest the security will accrue and compound over the period until maturity or the particular interest payment date at a rate of interest reflecting the market rate of the security at the time of issuance. Zero coupon securities do not require the periodic payment of interest. These investments benefit the issuer by mitigating its need for cash to meet debt service, but also require a higher rate of return to attract investors who are willing to defer receipt of cash. These investments may experience greater volatility in market value than U.S. Government securities that make regular
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payments of interest. The Fund accrues income on these investments for tax and accounting purposes, which must be distributed to shareholders in order to avoid taxation. Because no cash is received at the time of accrual, this may require the liquidation of other portfolio securities (including when not advantageous to do so) to satisfy the Funds distribution obligations (see Income Tax Considerations below), in which case the Fund will forego the purchase of additional income producing assets with these funds. Zero coupon securities include Separately Traded Registered Interest and Principal Securities (STRIPS). STRIPS are securities underwritten by securities dealers or banks that evidence ownership of future interest payments, principal payments or both on certain notes or bonds issued by the U.S. Government, its agencies, authorities or instrumentalities. They also include Coupons Under Book Entry Safekeeping (CUBES), which are component parts of U.S. Treasury bonds and represent scheduled interest and principal payments on the bonds.
Custodial Receipts . Custodial receipts or certificates include Certificates of Accrual on Treasury Securities (CATS), Treasury Investment Growth Receipts (TIGRs) and Financial Corporation certificates (FICO STRIPS). CATS, TIGRs and FICO STRIPS are securities underwritten by securities dealers or banks that evidence ownership of future interest payments, principal payments or both on certain notes or bonds issued by the U.S. Government, its agencies, authorities or instrumentalities. The underwriters of these certificates or receipts purchase a U.S. Government security and deposit the security in an irrevocable trust or custodial account with a custodian bank, which then issues receipts or certificates that evidence ownership of the periodic unmatured coupon payments and the final principal payment on the U.S. Government security. Custodial receipts evidencing specific coupon or principal payments have the same general attributes as zero coupon U.S. Government securities, described above. Although typically under the terms of a custodial receipt the Fund is authorized to assert its rights directly against the issuer of the underlying obligation, the Fund may be required to assert through the custodian bank such rights as may exist against the underlying issuer. Thus, if the underlying issuer fails to pay principal and/or interest when due, the Fund may be subject to delays, expenses and risks that are greater than those that would have been involved if the Fund had purchased a direct obligation of the issuer. In addition, if the trust or custodial account in which the underlying security has been deposited were determined to be an association taxable as a corporation, instead of a non-taxable entity, the yield on the underlying security would be reduced in respect of any taxes paid.
Payment-in-Kind Securities. The value of payment-in-kind securities (PIKs) held by the Fund may be more sensitive to fluctuations in interest rates than other securities. PIKs pay all or a portion of their interest or dividends in the form of additional securities. Federal tax law requires that the interest on PIK bonds be accrued as income to the Fund regardless of the fact that the Fund will not receive cash until such securities mature. Since the income must be distributed to shareholders in order to avoid taxation, the Fund may be forced to liquidate other securities in order to make the required distribution.
Loans and Other Direct Debt Instruments. These are instruments in amounts owed by a corporate, governmental or other borrower to another party. They may represent amounts owed to lenders or lending syndicates (loans and loan participations), to suppliers of goods or services (trade claims or other receivables) or to other parties. Direct debt instruments purchased by the Fund may have a maturity of any number of days or years, may be secured or unsecured, and may be of any credit quality. Direct debt instruments involve the risk of loss in the case of default or insolvency of the borrower. Direct debt instruments may offer less legal protection to the Fund in the event of fraud or misrepresentation. In addition, loan participations involve a risk of insolvency of the lending bank or other financial intermediary. Direct debt instruments also may include standby financing commitments that obligate the Fund to supply additional cash to the borrower on demand at a time when the Fund would not have otherwise done so, even if the borrowers condition makes it unlikely that the amount will ever be repaid.
Because loans are not ordinarily registered with the SEC or any state securities commission or listed on any securities exchange, there is usually less publicly available information about such instruments. In addition, loans may not be considered securities for purposes of the anti-fraud provisions under the federal securities laws and, as a result, as a purchaser of these instruments, we may not be entitled to the anti-fraud protections of the federal securities laws. In the course of investing in such instruments, we may come into possession of material nonpublic information and, because of prohibitions on trading in securities of issuers while in possession of such information, we may be unable to enter into a transaction in a publicly-traded security of that issuer when it would otherwise be advantageous for us to do so. Alternatively, we may choose not to receive material nonpublic information about an issuer of such loans, with the result that we may have less information about such issuers than other investors who transact in such assets.
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These instruments will be considered illiquid securities and so will be limited in accordance with the Funds restrictions on illiquid securities.
Illiquid Securities
Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act of 1933, as amended (the 1933 Act), securities that are otherwise not readily marketable and repurchase agreements having a maturity of longer than seven days. Securities that have not been registered under the 1933 Act are referred to as private placements or restricted securities and are purchased directly from the issuer or in the secondary market. Open-end investment companies do not typically hold a significant amount of these restricted securities or other illiquid securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have an adverse effect on the marketability of portfolio securities and an investment company might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions within seven days. An investment company might also have to register such restricted securities in order to dispose of them, which would result in additional expense and delay. Adverse market conditions could impede such a public offering of securities. The Fund may not acquire any illiquid securities if, as a result thereof, more than 15% of the market value of the Funds net assets would be in investments that are illiquid or otherwise not readily marketable.
In recent years, however, a large institutional market has developed for certain securities that are not registered under the 1933 Act, including repurchase agreements, commercial paper, foreign securities, municipal securities and corporate bonds and notes. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuers ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale of such investments to the general public or to certain institutions may not be indicative of their liquidity.
Rule 144A Securities. The SEC has adopted Rule 144A, which allows a broader institutional trading market for securities otherwise subject to restriction on their resale to the general public. Rule 144A establishes a safe harbor from the registration requirements of the 1933 Act on resales of certain securities to qualified institutional buyers. The Index Provider will monitor the liquidity of Rule 144A securities in the Underlying Index and will re-balance each month as necessary based on the securitys liquidity and other eligibility criteria.
The Fund may purchase securities in the United States that are not registered for sale under federal securities laws but which can be resold to institutions under SEC Rule 144A or under an exemption from such laws. Provided that a dealer or institutional trading market in such securities exists, these restricted securities or Rule 144A securities are treated as exempt from the Funds limit on illiquid securities. The Index Provider will determine the liquidity of restricted securities or Rule 144A securities by looking at factors such as sources quote, frequency of quotes, number of sources with size, bid-offer spreads, average quote size and movers count. If institutional trading in restricted securities or Rule 144A securities were to decline, the Funds illiquidity could increase and the Fund could be adversely affected.
Section 4(a)(2) Commercial Paper. The Fund may invest in commercial paper issued in reliance on the exemption from registration afforded by Section 4(a)(2) of the 1933 Act. Section 4(a)(2) commercial paper is restricted as to disposition under federal securities laws and is generally sold to institutional investors who agree that they are purchasing the paper for investment purposes and not with a view to public distribution. Any resale by the purchaser must be in an exempt transaction. Section 4(a)(2) commercial paper is normally resold to other institutional investors through or with the assistance of the issuer or investment dealers who make a market in Section 4(a)(2) commercial paper, thus providing liquidity. The Adviser believes that Section 4(a)(2) commercial paper and possibly certain other restricted securities that meet the criteria for liquidity established by the Board are quite liquid. The Fund intends therefore, to treat the restricted securities which meet the criteria for liquidity established by the Board, including Section 4(a)(2) commercial paper, as determined by the Adviser, as liquid and not subject to the investment limitation applicable to illiquid securities. In addition, because Section 4(a)(2) commercial paper is liquid, the Fund does not intend to subject such paper to the limitation applicable to restricted securities. The Fund will not invest more than 10% of its total assets in restricted securities (excluding Rule 144A securities).
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Borrowing and Lending
Borrowing. The Fund may borrow money from banks (including its custodian bank) or from other lenders to the extent permitted under applicable law. The 1940 Act requires the Fund maintain asset coverage of at least 300% for all such borrowings, and should such asset coverage at any time fall below 300%, the Fund would be required to reduce its borrowings within three days to the extent necessary to meet the requirements of the 1940 Act. The Fund will not make any borrowing that would cause its outstanding borrowings to exceed one-third of the value of its total assets (including the proceeds of such borrowing) immediately following such borrowing. To reduce its borrowings, the Fund might be required to sell securities at a time when it would be disadvantageous to do so. In addition, because interest on money borrowed is an expense that it would not otherwise incur, the Fund may have less net investment income during periods when its borrowings are substantial. The interest paid by the Fund on borrowings may be more or less than the yield on the securities purchased with borrowed funds, depending on prevailing market conditions.
Derivatives
The Fund may invest in various derivatives instruments. Generally, a derivative is a financial arrangement, the value of which is based on, or derived from, a traditional security, asset or market index. There are, in fact, many different types of derivatives and many different ways to use them. There is a range of risks associated with those uses. Futures and options are commonly used for traditional hedging purposes, among other purposes, to attempt to protect the Fund from exposure to changing interest rates, securities prices or currency exchange rates and as a low-cost method of gaining exposure to a particular securities market without investing directly in those securities. However, some derivatives are used for leverage, which tends to magnify the effects of an instruments price changes as market conditions change. Leverage involves the use of a small amount of money to control a large amount of financial assets, and can in some circumstances lead to significant losses.
In addition, the SEC recently proposed a rule under the 1940 Act regulating the use by registered investment companies of derivatives and many related instruments. That rule, if adopted as proposed, would, among other things, restrict a Funds ability to engage in derivatives transactions or so increase the cost of derivatives transactions that a Fund would be unable to implement its investment strategy.
Options. An option on a security is a contract that gives the holder of the option, in return for a premium, the right to buy from (in the case of a call) or sell to (in the case of a put) the writer of the option the security underlying the option at a specified exercise or strike price.
The Fund may write (sell) covered call and put options (covered options) on stocks, securities, futures contracts, non-physical commodities, indices and foreign currencies, among other assets, in an attempt to track the performance of such underlying asset or index. When the Fund writes a covered call option, it gives the purchaser of the option the right to buy, and obligates the writer to sell, the underlying security at the price specified in the option (the exercise price) by exercising the option at any time during the option period. If the option expires unexercised, the Fund will realize income in an amount equal to the premium received for writing the option. If the option is exercised, a decision over which the Fund has no control, the Fund must sell the underlying security to the option holder at the exercise price. By writing a covered call option, the Fund foregoes, in exchange for the premium less the commission (net premium), the opportunity to profit during the option period from an increase in the market value of the underlying security above the exercise price.
When the Fund writes a covered put option, it gives the purchaser of the option the right to sell, and obligates the writer to buy, the underlying security to the Fund at the specified exercise price at any time during the option period. If the option expires unexercised, the Fund will realize income in the amount of the premium received for writing the option. If the put option is exercised, a decision over which the Fund has no control, the Fund must purchase the underlying security from the option holder at the exercise price. By writing a covered put option, the Fund, in exchange for the premium received, accepts the risk of a decline in the market value of the underlying security below the exercise price.
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The Fund may terminate its obligation as the writer of a call or put option by purchasing an option with the same exercise price and expiration date as the option previously written. This transaction is called a closing purchase transaction. With respect to writing covered options, the Fund will realize a profit or loss for a closing purchase transaction if the amount paid to purchase an option is less or more, as the case may be, than the amount received from the sale thereof. To close out a position as a purchaser of an option, the Fund may make a closing sale transaction which involves liquidating the Funds position by selling the option previously purchased. Where the Fund cannot effect a closing purchase transaction, it may be forced to incur brokerage commissions or dealer spreads in selling securities it receives or it may be forced to hold underlying securities until an option is exercised or expires.
When the Fund writes a call option, it will cover its outstanding obligation by owning and earmarking the underlying security or other assets on the books of the Funds custodian. When the Fund writes a put option, it will cover its outstanding obligation by earmarking assets at the Funds custodian.
The Fund may purchase call and put options on any securities in which it may invest. The purchase of a call option would entitle the Fund, in exchange for the premium paid, to purchase a security at a specified price during the option period. The Fund would ordinarily have an economic gain if the value of the securities increased above the exercise price sufficiently to cover the premium and would have an economic loss if the value of the securities remained at or below the exercise price plus the premium during the option period.
The purchase of a put option would entitle the Fund, in exchange for the premium paid, to sell a security, which may or may not be held in the Funds portfolio, at a specified price during the option period. Put options also may be purchased by the Fund for the purpose of affirmatively benefiting from a decline in the price of securities which the Fund does not own. Upon exercise, the Fund would ordinarily realize a gain if the value of the securities decreased below the exercise price sufficiently to cover the premium and would realize a loss if the value of the securities remained at or above the exercise price, less the premium. Gains and losses on the purchase of put options would tend to be offset by countervailing changes in the value of underlying portfolio securities.
Options on Securities Indices . The Fund may purchase and write put and call options on securities indices listed on domestic and on foreign exchanges. Such options give the holder the right to receive a cash settlement during the term of the option based upon the difference between the exercise price and the value of the index. Options on securities indices entail risks in addition to the risks of options on securities. The absence of a liquid secondary market to close out options positions on securities indices is more likely to occur. Use of options on securities indices also entails the risk that trading in such options may be interrupted if trading in certain securities included in the index is interrupted.
Because options on securities indices require settlement in cash, the Adviser may be forced to liquidate portfolio securities to meet settlement obligations. When the Fund writes a put or call option on a securities index, it will cover the position by earmarking assets with the Funds custodian.
Futures Contracts and Related Options. To the extent consistent with applicable law, the Fund may invest in futures contracts on, among other things, individual equity securities, securities indices, interest rates, currencies, non-physical commodities, and inflation indices. The sale of a futures contract creates an obligation by the Fund, as seller, to deliver the specific type of financial instrument called for in the contract at a specified future time for a specified price. At the time a futures contract is purchased or sold, the Fund must allocate cash or securities as a deposit payment (initial margin). It is expected that the initial margin that the Fund will pay may range from approximately 1% to approximately 5% or greater of the value of the specified amount of securities or commodities underlying the contract. In certain circumstances, however, such as periods of high volatility, the Fund may be required by an exchange to increase the level of its initial margin payment. Certain futures contracts are physically settled (i.e., involve the making and taking of delivery of a specified amount of an underlying security or other asset). Some futures contracts, however, are cash settled, which means that the purchase price is subtracted from the current market value of the instrument and the net amount, if positive, is paid to the purchaser by the seller of the futures contract and, if negative, is paid by the purchaser to the seller of the futures contract.
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Options on futures contracts are similar to options on securities except that an option on a futures contract gives the purchaser the right in return for the premium paid to assume a position in a futures contract (a long position if the option is a call and a short position if the option is a put).
The Funds ability to engage in the futures and options on futures strategies depends on the liquidity of the markets in those instruments. Trading interest in various types of futures and options on futures cannot be predicted. Therefore, no assurance can be given that the Fund will be able to utilize these instruments effectively. In addition, there can be no assurance that a liquid market will exist at a time when the Fund seeks to close out a futures or option on a futures contract position, and the Fund would remain obligated to meet margin requirements until the position is closed. The liquidity of a secondary market in a futures contract may be adversely affected by daily price fluctuation limits established by commodity exchanges to limit the amount of fluctuation in a futures contract price during a single trading day.
When the Fund purchases or sells a futures contract, it is only required to deposit initial and variation margin as required by relevant regulations, the rules of the contract market and, from time to time, the Funds clearing broker. Because the purchase of a futures contract obligates the Fund to purchase the underlying security or other instrument at a set price on a future date, the Funds net asset value will fluctuate with the value of the security or other instrument as if it were already in the Funds portfolio. Futures transactions have the effect of investment leverage to the extent the Fund does not maintain liquid assets equal to the face amount of the contract. If the Fund combines short and long positions, in addition to possible declines in the values of its investment securities, the Fund will incur losses if the index underlying the long futures position underperforms the index underlying the short futures position.
Other Investment Policies
Swap Agreements. To help enhance the value of its portfolio or manage its exposure to different types of investments, the Fund may enter into credit default swap agreements, interest rate, currency and mortgage swap agreements and may purchase and sell interest rate caps, floors and collars.
In a standard over-the-counter (OTC) swap transaction, two parties agree to exchange the returns (or differentials in rates of return) on different currencies, securities, baskets of currencies or securities, indices or other instruments or assets, which may also include separately managed accounts, and the returns are calculated based on a notional value, (i.e., the designated reference amount of exposure to the underlying instruments). The Fund intends to enter into swaps primarily on a net basis, i.e., the two payment streams are netted out, with the Fund receiving or paying, as the case may be, only the net amount of the two payments. If the other party to a swap contract entered into on net basis defaults, the Funds risk of loss will consist of the net amount of payments that the Fund is contractually entitled to receive. The net amount of the excess, if any, of the Funds obligations over its entitlements will be maintained in a segregated account by the Funds custodian. The Fund will not enter into swap agreements unless the claims-paying ability of the other party thereto is considered to be an acceptable credit risk to the Fund by the Adviser. If there is a default by the other party to such a transaction, the Fund will have contractual remedies pursuant to the agreements related to the transaction. Many swap instruments are not exchange-listed securities and may be traded only in the OTC market.
Interest rate swaps are generally traded on exchanges and cleared through clearinghouses. In a typical interest rate swap agreement, one party agrees to make regular payments to a clearing broker equal to a floating interest rate on a specified amount (the notional principal amount) in return for payments equal to a fixed interest rate on the same amount for a specified period. If a swap agreement provides for payment in different currencies, the parties may also agree to exchange the notional principal amount. Mortgage swap agreements are similar to interest rate swap agreements, except that notional principal amount is tied to a reference pool of mortgages and may not be traded on an exchange or cleared through a clearinghouse. In a cap or floor, one party agrees, usually in return for a fee, to make payments under particular circumstances. For example, the purchaser of an interest rate cap has the right to receive payments to the extent a specified interest rate exceeds an agreed level; the purchaser of an interest rate floor has the right to receive payments to the extent a specified interest rate falls below an agreed level. A collar entitles the purchaser to receive payments to the extent a specified interest rate falls outside an agreed range.
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Investments in swaps involve the exchange by the Fund with another party of their respective commitments. Use of swaps subjects the Fund to risk of default by the counterparty. If there is a default by the counterparty to such a transaction, there may be contractual remedies pursuant to the agreements related to the transaction although contractual remedies may not be sufficient in the event the counterparty is insolvent. However, the swap market has grown substantially in recent years with a large number of banks and investment banking firms acting both as principals and agents utilizing standardized swap documentation. As a result, the swap market has become relatively liquid in comparison with the markets for other similar instruments which are traded in the interbank market. Swap agreements are sophisticated financial instruments that typically involve a small investment of cash relative to the magnitude of risks assumed. Swaps may involve leverage and can be highly volatile and may have a considerable impact on the Funds performance, as the potential gain or loss on any swap transaction is not necessarily subject to any fixed limit. OTC swap agreements are generally considered as illiquid securities and, therefore, will be limited, along with all of the Funds other illiquid securities, to 15% of the Funds net assets. In certain circumstances, swaps may be considered liquid if the Fund is permitted to early terminate the swap transaction.
The Fund may enter into exchange-traded and OTC credit default swap agreements. The buyer in a credit default contract is obligated to pay the seller a periodic stream of payments over the term of the contract provided that no event of default on an underlying reference obligation has occurred. If an event of default occurs, the seller must pay the buyer the par value (generally, the full notional value) of the reference obligation in exchange for the reference obligation. The Fund may be either the buyer or seller in the transaction. If the Fund is a buyer and no event of default occurs, the Fund loses its investment and recovers nothing. However, if an event of default occurs, the buyer receives full notional value for a reference obligation that may have little or no value. As a seller, the Fund receives income throughout the term of the contract, which typically is between six months and three years, provided that there is no default event.
Credit default swap agreements are subject to greater risk than direct investment in the reference obligation. OTC credit default swaps are subject to liquidity, credit and counterparty risks. A buyer in a credit default swap contract will lose its investment and recover nothing should no event of default occur. If an event of default were to occur, the value of the reference obligation received by the seller, coupled with the periodic payments previously received, may be less than the full notional value it pays to the buyer, resulting in a loss of value to the seller. In addition, collateral posting requirements for OTC credit default swaps are individually negotiated and there is currently no regulatory requirement that a counterparty post collateral to secure its obligations under a credit default swap. Furthermore, there is no requirement that a party be informed in advance when a credit default swap agreement is sold. Accordingly, the Fund may have difficulty identifying the party responsible for payment of its claims. The notional value of credit default swaps with respect to a particular investment is often larger than the total par value of such investment outstanding and, in event of a default, there may be difficulties in making the required deliveries of the reference investments, possibly delaying payments.
The market for credit default swaps has become more volatile recently as the creditworthiness of certain counterparties has been questioned and/or downgraded. If a counterpartys credit becomes significantly impaired, multiple requests for collateral posting in a short period of time could increase the risk that the Fund may not receive adequate collateral. The Fund generally may exit its obligations under an OTC credit default swap only by terminating the contract and paying applicable breakage fees, or, in the case of both OTC and exchange-traded credit default swaps, by entering into an offsetting credit default swap position, which may cause the Fund to incur more losses. If the Fund uses credit default swaps to leverage its portfolio, it will be exposed to additional risks, including the risk that the Funds use of leverage will magnify the effect of any losses the Fund incurs since if an event of default occurs the seller must pay the buyer the full notional value of the reference obligation.
When-Issued Securities and Forward Commitments . The Fund may enter into forward commitments for the purchase or sale of portfolio securities, including on a when-issued or delayed delivery basis in excess of customary settlement periods for the type of security involved. In some cases, a forward commitment may be conditioned upon the occurrence of a subsequent event, such as approval and consummation of a merger, corporate reorganization or debt restructuring (i.e., a when, as and if issued security). When such transactions are negotiated, the price is fixed at the time of the commitment, with payment and delivery taking place in the future, generally a month or more after the date of the commitment. While the Fund will only enter into a forward commitment with the
11
intention of actually acquiring the security, the Fund may sell the security before the settlement date if it is deemed advisable. Securities purchased by the Fund under a forward commitment are subject to market fluctuation, and no interest (or dividends) accrues to the Fund prior to the settlement date. For forward commitments that are cash settled, the Fund will designate or segregate liquid assets in an amount equal to the Funds daily marked-to-market value of such commitments.
Purchases of securities on a forward commitment basis may involve more risk than other types of purchases. Securities purchased on a forward commitment basis and the securities held in the Funds portfolio are subject to changes in value based upon the publics perception of the creditworthiness of the issuer and changes, real or anticipated, in the level of interest rates. Purchasing securities on a forward commitment basis can involve the risk that the yields available in the market when the delivery takes place may actually be higher or lower than those obtained in the transaction itself. On the settlement date of the forward commitment transaction, the Fund will meet its obligations from then available cash flow, sale of securities reserved for payment of the commitment, sale of other securities or, although it would not normally expect to do so, from sale of the forward commitment securities themselves (which may have a value greater or lesser than the Funds payment obligations). The sale of securities to meet such obligations may result in the realization of capital gains or losses. Purchasing securities on a forward commitment basis can also involve the risk of default by the other party on its obligation, delaying or preventing the Fund from recovering the collateral or completing the transaction.
Euro-Relate d Risk. The global economic crisis brought several small economies in Europe to the brink of bankruptcy and many other economies into recession and weakened the banking and financial sectors of many European countries. For example, the governments of Greece, Spain, Portugal, and the Republic of Ireland have all experienced large public budget deficits, the effects of which are still yet unknown and may slow the overall recovery of the European economies from the global economic crisis. In addition, due to large public deficits, some European countries may be dependent on assistance from other European governments and institutions or other central banks or supranational agencies such as the International Monetary Fund. Assistance may be dependent on a countrys implementation of reforms or reaching a certain level of performance. Failure to reach those objectives or an insufficient level of assistance could result in a deep economic downturn which could significantly affect the value of the Funds European investments.
The Economic and Monetary Union of the European Union (EMU) is comprised of the European Union members that have adopted the euro currency. By adopting the euro as its currency, a member state relinquishes control of its own monetary policies. As a result, European countries are significantly affected by fiscal and monetary policies implemented by the EMU and European Central Bank. The euro currency may not fully reflect the strengths and weaknesses of the various economies that comprise the EMU and Europe generally.
It is possible that one or more EMU member countries could abandon the euro and return to a national currency and/or that the euro will cease to exist as a single currency in its current form. The effects of such an abandonment or a countrys forced expulsion from the euro on that country, the rest of the EMU, and global markets are impossible to predict, but are likely to be negative. The exit of any country out of the euro may have an extremely destabilizing effect on other eurozone countries and their economies and a negative effect on the global economy as a whole. Such an exit by one country may also increase the possibility that additional countries may exit the euro should they face similar financial difficulties. In addition, in the event of one or more countries exit from the euro, it may be difficult to value investments denominated in euros or in a replacement currency. On June 23, 2016, the United Kingdom approved a referendum to leave the European Union. On March 29, 2017 the United Kingdom invoked Article 50 of the Lisbon Treaty which gives the United Kingdom and the European Union two years to agree to the terms of the United Kingdoms exit. The United Kingdom is currently scheduled to leave the European Union on Friday March 29, 2019. While the United Kingdom is not a part of the euro currency system, significant uncertainty remains in the market regarding the ramifications of that development, and the range and potential implications of possible political, regulatory, economic and market outcomes are difficult to predict.
Money Market Instruments. The Fund may invest in money market instruments. Money market securities are high-quality, dollar-denominated, short-term instruments. They consist of (i) bankers acceptances, certificates of deposit, notes and time deposits of highly-rated U.S. banks and U.S. branches of foreign banks; (ii) U.S. Treasury
12
obligations and obligations issued or guaranteed by agencies and instrumentalities of the U.S. Government; (iii) high-quality commercial paper issued by U.S. foreign corporations; and (iv) debt obligations with a maturity of one year or less issued by corporations with outstanding high-quality commercial paper ratings.
Convertible Securities. Convertible securities may offer higher income than the common stocks into which they are convertible and include fixed-income or zero coupon debt securities, which may be converted or exchanged at a stated or determinable exchange ratio into underlying shares of common stock. Prior to their conversion, convertible securities may have characteristics similar to both non-convertible debt securities and equity securities. While convertible securities generally offer lower yields than non-convertible debt securities of similar quality, their prices may reflect changes in the value of the underlying common stock. Convertible securities entail less credit risk than the issuers common stock.
Asset Coverage. To assure that the Funds use of futures and related options, as well as when issued and delayed-delivery transactions, forward currency contracts and swap transactions, are not used to achieve investment leverage, the Fund will cover such transactions, as required under applicable SEC interpretations, either by owning the underlying securities or by earmarking liquid securities with its custodian in an amount at all times equal to or exceeding the Funds outstanding commitment with respect to these instruments or contracts.
Warrants and Rights. Warrants are options to purchase equity securities at a specified price and are valid for a specific time period. Rights are similar to warrants, but normally have a short duration and are distributed by the issuer to its shareholders. The Fund may purchase warrants and rights, provided that the Fund presently does not intend to invest more than 20% of its net assets at the time of purchase in warrants and rights other than those that have been acquired in units or attached to other securities.
Equity Securities. Because it may purchase common stocks and other equity securities, the Fund is subject to the risk that stock prices will fall over short or long periods of time. In addition, common stocks represent a share of ownership in a company, and rank after bonds and preferred stock in their claim on the companys assets in the event of bankruptcy.
Securities of Other Investment Companies. Such investments are subject to limitations prescribed by the 1940 Act unless an SEC exemption is applicable or as may be permitted by rules under the 1940 Act or SEC staff interpretations thereof. The 1940 Act limitations currently provide, in part, that the Fund may not purchase shares of an investment company if (a) such a purchase would cause the Fund to own in the aggregate more than 3% of the total outstanding voting stock of the investment company; (b) such a purchase would cause the Fund to have more than 5% of its total assets invested in the investment company; or (c) more than 10% of the Funds total assets would be invested in the aggregate in all investment companies. These investment companies typically incur fees that are separate from those fees incurred directly by the Fund. The Funds purchase of such investment company securities results in the layering of expenses, such that shareholders would indirectly bear a proportionate share of the operating expenses of such investment companies, including advisory fees, in addition to paying Fund expenses.
Privately-Placed Securities. The Fund may invest in securities that are neither listed on a stock exchange nor traded over-the-counter, including privately placed securities. Investing in such unlisted securities, including investments in new and early stage companies, may involve a high degree of business and financial risk that can result in substantial losses. As a result of the absence of a public trading market for these securities, they may be less liquid than publicly traded securities. Although these securities may be resold in privately negotiated transactions, the prices realized from these sales could be less than those originally paid by the Fund, or less than what may be considered the fair value of such securities. Further, companies whose securities are not publicly traded may not be subject to the disclosure and other investor protection requirements that might be applicable if their securities were publicly traded. If such securities are required to be registered under the securities laws of one or more jurisdictions before being resold, the Fund may be required to bear the expenses of registration.
Operating Deficits. The expenses of operating the Fund (including the fees payable to the Adviser) may exceed its income, thereby requiring that the difference be paid out of the Funds capital, reducing the Funds investments and potential for profitability.
Accuracy of Public Information. To the extent that the Fund invests any of its assets in securities not included in the Underlying Index, the Adviser selects investments for the Fund, in part, on the basis of information
13
and data filed by issuers with various government regulators or made directly available to the Adviser by the issuers or through sources other than the issuers. Although the Adviser evaluates all such information and data and ordinarily seeks independent corroboration when the Adviser considers it appropriate and when such corroboration is reasonably available, the Adviser is not in a position to confirm the completeness, genuineness or accuracy of such information and data.
Trading Limitations. For all securities listed on a securities exchange, including options listed on a public exchange, the exchange generally has the right to suspend or limit trading under certain circumstances. Such suspensions or limits could render certain strategies difficult to complete or continue and subject the Fund to loss. Also, such a suspension could render it impossible for the Fund to liquidate positions thereby exposing it to potential losses. Finally, to the extent that advisory personnel of the Adviser acquire material non-public information in the course of service on the board of directors or creditors committee of a company, the Fund may be prevented from buying or selling securities of that company.
Risks of Inverse Floaters. As interest rates rise, inverse floaters produce less current income. A change in prevailing interest rates will often result in a greater change in the interest rate paid by an inverse floater. As a result, inverse floaters may have a greater degree of volatility than other types of interest-bearing securities of similar credit quality.
Tracking and Correlation. While the Fund does not expect that its daily returns will deviate significantly from its daily investment objective, several factors may affect the Funds ability to achieve this correlation. Among these factors are: (1) the Funds expenses, including brokerage (which may be increased by high portfolio turnover) and the cost of the investment techniques employed by the Fund; (2) less than all of the securities in the benchmark index being held by the Fund and securities not included in the benchmark index being held by the Fund; (3) an imperfect correlation between the performance of instruments held by the Fund, such as swaps, futures contracts and other derivatives, and the performance of the underlying securities in the cash market; (4) bid-ask spreads (the effect of which may be increased by portfolio turnover); (5) holding instruments traded in a market that has become illiquid or disrupted; (6) the Funds share prices being rounded to the nearest cent; (7) changes to the benchmark index that are not disseminated in advance; (8) the need to conform the Funds portfolio holdings to comply with investment restrictions or policies or regulatory or tax law requirements; (9) actual purchases and sales of the shares of the Fund may differ from estimated transactions reported prior to the time share prices are calculated; (10) limit up or limit down trading halts on options or futures contracts which may prevent the Fund from purchasing or selling options or futures contracts; and (11) early and unanticipated closings of the markets on which the holdings of the Fund trade, resulting in the inability of the Fund to execute intended portfolio transactions. While a close correlation of the Fund to its benchmark may be achieved on any single trading day, over time the cumulative percentage increase or decrease in the NAV of the shares of the Fund may diverge significantly from the cumulative percentage decrease or increase in the benchmark due to a compounding effect.
CONSTRUCTION AND MAINTENANCE STANDARDS FOR THE MARKIT INDEX
The Markit Indices Limited (for purposes of this section, the Underlying Index) measures the performance of senior secured bank loans from the largest, most liquid issuers. The Underlying Index is a rules-based index consisting of approximately 100 liquid, U.S. dollar-denominated senior secured bank loans that seeks to maximize liquidity while maintaining representation of the broader senior secured loan market. The Underlying Index is sponsored by the Index Provider, which is independent of the Fund and the Adviser.
Index Methodology. The Underlying Index is a subset of the broader senior secured bank loan universe. The Index Provider will consider both fully funded term loans and defaulted loans. Loans in the Underlying Index are selected from the universe of eligible loans using defined rules. More specifically, loans eligible for inclusion in the Underlying Index (eligible loans) must meet set criteria related to loan type, minimum size, liquidity and depth of market, spread, credit rating and minimum time to maturity, including the following:
| the size of eligible loans must be at least $500 million; |
|
the number of prices available for an eligible loan and the length of time such number of prices have been |
14
available (a measure of liquidity of the loan) must be, respectively, at least two and at least 50% of all trading days in the prior three-month period (or, for loans that have not yet traded for three months, there must be at least three prices available for at least 50% of all trading days since its issue date); |
| eligible loans must be sub-investment grade, as measured either by a composite credit rating based on both Moodys and Standard & Poors ratings, or if unrated, must meet the credit spread described below; |
| eligible loans must have a minimum interest rate, which must be at least 125 basis points (1.25%) higher than the interest rate of the London Interbank Offered Rate (LIBOR) (LIBOR is a floating rate that banks charge one another for the use of short-term money, and is often used as a peg for setting other interest rates); and |
| eligible loans must have a minimum maturity of one year at the time of inclusion in the Underlying Index. |
If the number of loans eligible for inclusion in the index exceeds the target number of loans, then the final index constituents will be determined by an additional liquidity ranking procedure that scores all loans in the Markit WSO database daily based on metrics for sources quote, frequency of quotes, number of sources with size, bid-offer spreads, average quote size and movers count. The Index Provider will calculate the Underlying Index daily on the basis of end-of-day prices provided by Markit Loan Pricing services and will re-balance the Underlying Index monthly. Additionally, the Index Provider will conduct an annual review of the parameters used in the selection process, including the target number of loans and the eligibility criteria, with qualitative and quantitative assessment of any developments in the loans market in terms of market size, depth and overall liquidity conditions.
The Index Provider will not provide any information relating to changes to the Underlying Indexs methodology for the inclusion of Component Securities, the inclusion or exclusion of specific Component Securities, or methodology for the calculation of the return of Component Securities, in advance of a public announcement of such changes by the Index Provider. In addition, the Index Provider will not provide recommendations to the Fund regarding the purchase or sale of specific securities.
The frequency and amount of portfolio purchases and sales (known as the turnover rate) will vary from year to year. The portfolio turnover rate may vary greatly from year to year and will not be a limiting factor when the Adviser deems portfolio changes appropriate nor will it affect when the Index Provider deems re-balancing of the Underlying Index appropriate. Although the Fund generally does not intend to trade for short-term profits, the securities held by the Fund will be sold whenever the Adviser believes it is appropriate to do so, without regard to the length of time a particular security may have been held. Higher portfolio turnover involves correspondingly greater transaction costs, including any brokerage commissions that the Fund will bear directly, and can cause the Fund to recognize more short-term capital gains (which currently are taxable to shareholders at higher rates than long-term capital gains). For the fiscal years ended June 30, 2017 and June 30, 2016, the Funds turnover rate was 115% and 51%, respectively. Increased capital activity and increased issuer refinancings resulted in a portfolio turnover rate for the year ended June 30, 2017 that was higher compared to the prior fiscal year.
The fundamental investment restrictions below may be changed only with the approval of a vote of a majority of the outstanding voting securities of the Fund. A vote of a majority of the outstanding voting securities of the Fund means the lesser of (i) 67% or more of the shares at a meeting if the holders of more than 50% of the outstanding shares are present or represented by proxy or (ii) more than 50% of the outstanding shares. Except for investment restrictions designated as fundamental in the Funds Prospectus or in this SAI, the investment policies described in the Funds Prospectus or this SAI are not fundamental and may be changed without shareholder approval.
15
If a percentage policy set forth in the Prospectus or one of the following percentage investment restrictions is adhered to at the time a security is purchased, later changes in a percentage will not be considered a violation of the policy or restriction unless any excess or deficiency exists immediately after and as a result of such purchase or pertains to the Funds limitations on borrowing and investment in illiquid securities.
Fundamental Investment Restrictions. The following investment restrictions are fundamental policies and, as such, may not be changed without the approval of a vote of a majority of the outstanding voting securities). The Fund may not:
1. | Purchase any security that would cause the Fund to concentrate (invest 25% or more of its total assets) in securities of issuers primarily engaged in any particular industry or group of industries (other than securities issued or guaranteed by the U.S. government or any of its agencies or instrumentalities), except that the Fund will concentrate to approximately the same extent that its Underlying Index concentrates in the securities of such particular industry or group of industries. For purposes of this restriction as applied to the Fund, senior loans and loan participations will be considered investments in the industry of the underlying borrower, rather than that of any agent that administers the senior loan or the seller of the loan participation; |
2. | Issue senior securities or borrow in excess of the amounts permitted by the 1940 Act |
3. | Underwrite securities of other issuers, except to the extent that the Fund, in disposing of Fund securities, may be deemed an underwriter within the meaning of the 1933 Act; |
4. | Purchase or sell real estate, except that the Fund may (a) invest in securities or other instruments directly or indirectly secured by real estate, (b) invest in securities or other instruments issued by issuers that invest in real estate, and (c) hold for prompt sale, real estate or interests in real estate to which it may gain an ownership interest through the forfeiture of collateral securing loans or debt securities held by it; |
5. | Purchase or sell commodities or commodity contracts, but this shall not prevent the Fund from purchasing, selling and entering into financial futures contracts (including futures contracts on indices of securities, interest rates and currencies), options on financial futures contracts, swaps, forward contracts, foreign currency spot and forward contracts or other derivative instruments that are not related to physical commodities; and |
6. | Lend any property or make any loan if, as a result, more than 33 1/3% of its total assets would be loaned to other parties (including the value of collateral received for loans of portfolio securities), but this limitation does not apply to the purchase of debt securities and other Senior Loans in which it is authorized to invest in accordance with its investment objective and policies or to repurchase agreements. |
Non-Fundamental Investment Restrictions. The Fund is also subject to the following non-fundamental investment restrictions and policies that may be changed by the Board without shareholder approval. The Fund may not:
1. | Acquire any illiquid securities if, as a result thereof, more than 15% of the market value of the Funds net assets would be in investments that are illiquid; |
2. | Acquire securities of other investment companies, except as permitted by the 1940 Act (currently under the 1940 Act, the Fund may invest up to 10% of its total assets in the aggregate in shares of other investment companies and up to 5% of its total assets in any one investment company, provided the investment does not represent more than 3% of the voting stock of the acquired investment company at the time such shares are purchased, and may also invest in other investment companies pursuant to exemptions provided in or under the 1940 Act and in accordance with no-action positions of the staff of the SEC); |
16
3. | Borrow on margin, notwithstanding, fundamental investment restriction number 2, unless such activity is permitted by applicable law; and |
4. | If the Fund is invested in by another series of the Trust or by a series of Highland Funds II in reliance on Section 12(d)(1)(G), it may not acquire securities of registered open-end investment companies or registered unit investment trusts in reliance on Sections 12(d)(1)(F) or 12(d)(1)(G) of the 1940 Act. |
Other Information. The following commentary is intended to help investors better understand the meaning of the Funds fundamental policies by briefly describing limitations, if any, imposed by the 1940 Act. References to the 1940 Act below may encompass rules, regulations or orders issued by the SEC and, to the extent deemed appropriate by the Fund, interpretations and guidance provided by the SEC staff. These descriptions are intended as brief summaries of such limitations as of the date of this SAI; they are not comprehensive and they are qualified in all cases by reference to the 1940 Act (including any rules, regulations or orders issued by the SEC and any relevant interpretations and guidance provided by the SEC staff). These descriptions are subject to change based on evolving guidance by the appropriate regulatory authority and are not part of the Funds fundamental policies.
The 1940 Act currently permits an open-end investment company to borrow money from a bank so long as immediately after any such borrowing the ratio that the value of the total assets of the investment company (including the amount of any such borrowing), less the amount of all liabilities and indebtedness (other than such borrowing) of the investment company, bears to the amount of such borrowing is at least 300%. A lender to the Fund may require that the Fund pledge its assets as collateral. If the Fund were to default on a loan secured by pledged assets, the lender would be entitled to foreclose on and dispose of the pledged assets, but the lender could retain only the amount of assets (or the disposition proceeds of such assets) necessary to pay off the defaulted loan.
Under the 1940 Act, the Fund may not issue senior securities or borrow in excess of 33 1/3% of the Funds total assets (after giving effect to any such borrowing), which amount excludes borrowing for temporary purposes and in an amount not more than 5% of the Funds total assets at the time the borrowing for temporary purposes is made.
For purposes of non-fundamental investment restriction number 1 above, the purchase of Senior Loans, corporate debt securities, and other investment assets with the proceeds of a permitted borrowing, as well as margin payments or other arrangements in connection with transactions in short sales, futures contracts, options, and other financial instruments are not considered to constitute the purchase of securities on margin.
For avoidance of doubt, with respect to this Fundamental Investment Restriction number 6, the Fund has no current intention to engage in reverse repurchase agreements and securities lending, but the Fund may change this intention at any time without shareholder approval.
The Funds classification as a non-diversified investment company means that the proportion of the Funds assets that may be invested in the securities of a single issuer is not limited by the 1940 Act. The Fund, however, intends to qualify as a regulated investment company (RIC) accorded special tax treatment under the Internal Revenue Code of 1986, as amended (Code), which imposes its own diversification requirements on the Fund that are less restrictive than the requirements applicable to the diversified investment companies under the 1940 Act. As a non-diversified fund, a relatively high percentage of the Funds assets may be invested in the securities of a limited number of issuers, primarily within the same economic sector. The Funds portfolio securities, therefore, may be more susceptible to any single economic, political, or regulatory occurrence than the portfolio securities of a more diversified investment company.
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EXPEDITED SETTLEMENT AGREEMENT
The Fund has entered into an Expedited Settlement Agreement with a major dealer in the floating rate loan market, pursuant to which the Fund has the right to designate certain loans it sells to the dealer to settle on or prior to three days from the trade date in exchange for a quarterly fee (the Agreement). This Agreement is designed to reduce settlement times from the standard seven days to three days for eligible loans.
While the Agreement is intended to provide the Fund with additional liquidity with respect to such loans, and may not represent the exclusive method of expedited settlement of such loans, no assurance can be given that the Agreement or other methods for expediting settlements will provide the Fund with sufficient liquidity in the event of abnormally large redemptions
The Board of Trustees (the Board) provides broad oversight of the operations and affairs of the Fund and protects the interests of shareholders. The Board has overall responsibility to manage and control the business affairs of the Fund, including the complete and exclusive authority to establish policies regarding the management, conduct and operation of the Funds business. The names and birthdates of the Trustees and officers of the Fund, the year each was first elected or appointed to office, their principal business occupations during the last five years, the number of funds overseen by each Trustee and other directorships or trusteeships they hold are shown below. The business address for each Trustee and officer of the Fund is c/o Highland Capital Management Fund Advisors, L.P., 200 Crescent Court, Suite 700, Dallas, Texas 75201.
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Name and Date
|
Position(s)
with the Trust |
Term of
|
Principal Occupation(s)
During
Five Years |
Number of
Portfolios in Highland Fund Complex Overseen by the Trustees 2 |
Other
|
Experience, Qualifications,
Attributes,
Skills
|
||||||
INDEPENDENT TRUSTEES | ||||||||||||
Timothy K. Hui
(6/13/1948) |
Trustee |
Indefinite Term; Trustee
since inception in 2006. |
Dean of Educational Resources since July 2012 at Cairn University. | 25 | None | Significant experience on this board of directors/trustees; administrative and managerial experience; legal training and practice. | ||||||
Bryan A. Ward
(2/4/1955) |
Trustee | Indefinite Term; Trustee since inception in 2006. | Private Investor, BW Consulting, LLC since 2014; Senior Manager, Accenture, LLP (a consulting firm) from 2002 until retirement in 2014. | 25 | Director of Equity Metrix, LLC. | Significant experience on this and/or other boards of directors/trustees; significant managerial and executive experience; significant experience as a management consultant. | ||||||
Dr. Bob Froehlich
(4/28/1953) |
Trustee | Indefinite Term; Trustee since December 2013. | Executive Vice President and Chief Investment Strategist, The Hartford Mutual Funds from 2009 until retirement in 2012. | 25 | Trustee of ARC Realty Finance Trust, Inc. (from January 2013 to May 2016); Director of KC Concessions, Inc.; Trustee of Realty Capital Income Funds Trust; Director of American Realty Capital Healthcare Trust II (from January 2013 to June 2016); Director, American Realty Capital | Significant experience in the financial industry; significant managerial and executive experience; significant experience on other boards of directors, including as a member of several audit committees. |
19
Name and Date
|
Position(s)
with the Trust |
Term
of
|
Principal Occupation(s)
During
Five Years |
Number of
Portfolios in Highland Fund Complex Overseen by the Trustees 2 |
Other
|
Experience, Qualifications,
Attributes,
Skills
|
||||||
Daily Net Asset Value Trust, Inc. (from November 2012 to July 2016); Director of American Sports Enterprise, Inc.; Director of Davidson Investment Advisors (July 2009 to July 2016); Chairman and owner, Kane County Cougars Baseball Club; Advisory Board of Directors, Internet Connectivity Group, Inc. (January 2014 to April 2016); Director of AR Capital Acquisition Corp.; Director of The Midwest League of Professional Baseball Clubs, Inc.; Director of Kane County Cougars Foundation, Inc.; Director of Galen Robotics, Inc. | ||||||||||||
John Honis
3
(6/16/1958) |
Trustee | Indefinite Term; Trustee since July 2013. | President of Rand Advisors, LLC since August 2013; Partner of Highland Capital Management, L.P. (HCM) from February 2007 until his resignation in November 2014. | 25 | Manager of Turtle Bay Resort, LLC | Significant experience in the financial industry; significant managerial and executive experience, including experience as |
20
Name and Date
|
Position(s)
with the Trust |
Term of
|
Principal Occupation(s)
During
Five Years |
Number of
Portfolios in Highland Fund Complex Overseen by the Trustees 2 |
Other
|
Experience, Qualifications,
Attributes,
Skills
|
||||||
president, chief executive officer or chief restructuring officer of five telecommunication firms; experience on other boards of directors. | ||||||||||||
INTERESTED TRUSTEE | ||||||||||||
Ethan Powell
4
(6/20/1975) |
Trustee;
Chairman of the Board |
Indefinite Term; Trustee since December 2013; Chairman of the Board since December 2013; Executive Vice President and Principal Executive Officer from June 2012 until December 2015. | President and Founder of Impact Shares LLC (a registered investment advisor dedicated to building a platform to create better socially responsible investment solutions) since December 2015; Trustee/Director of the Highland Fund Complex from June 2012 until July 2013 and since December 2013; Chief Product Strategist of Highland Capital Management Fund Advisors, L.P. (HCMFA) from 2012 until December 2015; Senior Retail Fund Analyst of HCM from 2007 until December 2015 and HCMFA from its inception until December 2015; Secretary of NexPoint Credit Strategies Fund (NHF) from November 2010 until June 2012; President and Principal | 25 |
Trustee of Impact Shares Funds I Trust |
Significant experience in the financial industry; significant executive experience including past service as an officer of funds in the Highland Fund Complex; significant administrative and managerial experience. |
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Name and Date
|
Position(s)
with the Trust |
Term of
|
Principal Occupation(s)
During
Five Years |
Number of
Portfolios in Highland Fund Complex Overseen by the Trustees 2 |
Other
|
Experience, Qualifications,
Attributes,
Skills
|
||||||||||
Executive Officer of NHF from June 2012 until May 2015; Secretary of NHF from May 2015 until December 2015; Executive Vice President and Principal Executive Officer of Highland Funds I (HFI) and Highland Funds II (HFII) from June 2012 until December 2015; and Secretary of HFI and HFII from November 2010 to May 2015. |
OFFICERS
Name and
Date of Birth |
Position(s)
|
Term of
|
Principal Occupation(s) During Past Five Years |
|||
J. Bradley Ross (5/13/59) | President and Principal Executive Officer | Indefinite Term; President and Principal Executive Officer since December 2015 | Principal Executive Officer of Highland Floating Rate Opportunities Fund (FRO) and Highland Global Allocation Fund II (GAFII) since August 2017; Principal Executive Officer of HFI and HFII since December 2015; President of Highland Capital Funds Distributor, Inc. (HCFD) |
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since February 2014; President of HCMFA since June 2012; Member of the Sales Force Marketing Committee of the Investment Company Institute since 2003; Executive Vice President and National Sales Director of Ivy Funds from 2003 until June 2012. | ||||||
Trey Parker
(1/27/1976) |
Executive Vice President | Indefinite Term; Executive Vice President since September 2017. | Executive Vice President of HCMFA, NexPoint Advisors, L.P., HFI, HFII, FRO, and GAFII since September 2017, Executive Vice President; Assistant Secretary of Highland Restoration Capital Partners GP, LLC since September 2017; Assistant Secretary of Highland SunBridge GP, LLC since December 2015; Assistant Secretary of HCM since August 2015; Director of JHT Holdings, Inc. since August 2013; Director of TerreStar Corporation since March 2013; Director of OmniMax International, Inc. since March 2012; and Secretary of Granite Bay Advisors, L.P. since February 2012. | |||
Frank Waterhouse
|
Treasurer, Principal Financial Officer and Principal Accounting Officer |
Indefinite Term; Treasurer since May 2015. Principal Financial Officer and Principal Accounting Officer since October 2017. |
Principal Financial Officer and Principal Accounting Officer of FRO, GAFII, NexPoint Capital, Inc., NHF, HFI, HFII, and NexPoint Real Estate Advisors, L.P. |
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since October 2017; Treasurer of FRO and GAFII since August 2017; Assistant Treasurer of Acis Capital Management, L.P. from December 2011 until February 2012; Treasurer of Acis Capital Management, L.P. since February 2012; Assistant Treasurer of HCM from November 2011 until April 2012; Treasurer of HCM since April 2012; Assistant Treasurer of HCMFA from December 2011 until October 2012; Treasurer of HCMFA since October 2012; Treasurer of NexPoint Advisors, L.P. since March 2012 and Treasurer of NexPoint Capital, Inc., NHF, HFI, HFII, and NexPoint Real Estate Advisors, L.P. since May 2015 and Treasurer of NexPoint Real Estate Strategies Fund since March 2016. | ||||||
Clifford Stoops
|
Assistant Treasurer |
Indefinite Term; Assistant Treasurer since March 2017. |
Assistant Treasurer of FRO and GAFII since August 2017; Assistant Treasurer of HFI, HFII, NHF, NexPoint Capital, Inc. and NexPoint Real Estate Strategies Fund since March 2017; Chief Accounting Officer at HCM since December 2011. |
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Jason Post
(1/9/1979) |
Chief Compliance Officer | Indefinite Term; Chief Compliance Officer since September 2015. | Chief Compliance Officer and Anti-Money Laundering Officer of FRO and GAII since August 2017; Chief Compliance Officer and Anti-Money Laundering Officer since September 2015 of HFI, HFII, NexPoint Credit Strategies, NexPoint Capital, Inc., NexPoint Real Estate Strategies Fund, and Chief Compliance Officer for HCMFA and NexPoint Advisors, L.P. Prior to this role served as Deputy Chief Compliance Officer and Director of Compliance for HCM. | |||
Dustin Norris
(1/6/1984) |
Secretary | Indefinite Term; Secretary since October 2017. | Secretary of FRO, GAFII, HFI and HFII since October 2017; Assistant Secretary of FRO and GAFII from August 2017 to October 2017; Chief Product Strategist at HCMFA since September 2015, Director of Product Strategy at HCMFA from May 2014 to September 2015; Secretary of NHF since December 2015; Assistant Secretary of HFI and HFII from March 2017 to October 2017; Assistant Treasurer of Highland Funds I and Highland Funds II from November 2012 to March 2017; Assistant Treasurer of NHF from November 2012 to December 2015; Secretary of NexPoint Capital, Inc. since 2014; Secretary of NexPoint Real Estate Strategies Fund since March 2016; and Senior Accounting Manager at HCMFA from August 2012 to May 2014. |
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1 | On an annual basis, as a matter of Board policy, the Governance Committee reviews each Trustees performance and determines whether to extend each such Trustees service for another year. Effective June 2013, the Board adopted a retirement policy wherein the Governance Committee shall not recommend the continued service as a Trustee of a Board member who is older than 80 years of age at the time the Governance Committee reports its findings to the Board. |
2 | The Highland Fund Complex consists of NHF, each series of HFI, each series of HFII, FRO, GAFII, NexPoint Merger Arbitrage Fund, NexPoint Latin American Opportunities Fund, NexPoint Real Estate Strategies Fund, NexPoint Opportunistic Credit Fund, NexPoint Energy and Materials Opportunities Fund, NexPoint Discount Yield Fund, NexPoint Healthcare Opportunities Fund, and NexPoint Capital, Inc., a closed-end management investment company that has elected to be treated as a business development company under the 1940 Act. |
3 | Since May 1, 2015, Mr. Honis has been treated as an Independent Trustee of the Trust. Prior to that date, Mr. Honis was treated as an Interested Trustee because he was a partner of an investment adviser affiliated with the Adviser until his resignation in November 2014. As of September 30, 2017, Mr. Honis was entitled to receive aggregate severance and/or deferred compensation payments of approximately $880,000 from another affiliate of the Adviser. Mr. Honis also serves as a director of a portfolio company affiliated with the Adviser. During the Trusts last two fiscal years, Mr. Honis aggregate compensation from this portfolio company for his services as a director was approximately $50,000. |
In addition, Mr. Honis serves as a trustee of a trust that owns substantially all of the economic interest in an investment adviser affiliated with the Adviser. Mr. Honis indirectly receives an asset-based fee in respect of such interest, which is projected to range from $100,000-$150,000 annually. In light of these relationships between Mr. Honis and affiliates of the Adviser, it is possible that the SEC might in the future determine Mr. Honis to be an interested person of the Trust.
4 | Effective December 4, 2015, Mr. Powell resigned from his position with the Adviser. Although the Trust believes that Mr. Powell is technically no longer an interested person of the Trust, in light of his previous employment and the possibility that he may provide consulting services to the Adviser and affiliates of the Adviser, it is possible that the SEC might in the future determine Mr. Powell to be an interested person of the Trust. Therefore, the Trust treats Mr. Powell as an Interested Trustee of the Trust for all purposes other than compensation and the Funds code of ethics (Mr. Powell will be compensated at the same rate as the Independent Trustees) from December 16, 2015 until at least December 4, 2017 (the second anniversary of his resignation). |
Qualifications of Trustees
The following provides an overview of the considerations that led the Board to conclude that each individual serving as a Trustee of the Trust should so serve. Among the factors the Board considered when concluding that an individual should serve on the Board were the following: (i) the individuals business and professional experience and accomplishments; (ii) the individuals ability to work effectively with the other members of the Board; (iii) the individuals prior experience, if any, serving on company boards (including public companies and, where relevant, other investment companies) and the boards of other complex enterprises and organizations; and (iv) how the individuals skills, experiences and attributes would contribute to an appropriate mix of relevant skills and experience on the Board.
In respect of each current Trustee, the individuals professional accomplishments and prior experience, including, in some cases, in fields related to the operations of the Trust, were a significant factor in the determination that the individual should serve as a Trustee of the Trust. Each Trustees professional experience and additional considerations that contributed to the Boards conclusion that an individual should serve on the Board are summarized in the table above.
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Trustees Compensation
The officers of the Trust and those of its Trustees who are interested persons (as defined in the 1940 Act) of the Fund receive no direct remuneration from the Trust. The following table sets forth the aggregate compensation paid to each of the Trustees who is not an interested person (as defined in the 1940 Act) of the Trust (the Independent Trustees) by the Trust and the total compensation paid to each of the Trustees by the Highland Fund Complex for the fiscal year ended June 30, 2017.
Name of Trustee |
Aggregate
Compensation From the Trust |
Pension or
Retirement Benefits Accrued as Part of the Funds Expense |
Estimated
Annual Benefits Upon Retirement |
Total Compensation
From the Highland Fund Complex 1 |
||||||||||||
Interested Trustee |
||||||||||||||||
Ethan Powell 2 |
$ | 60,088 | $ | 0 | $ | 0 | $ | 150,000 | ||||||||
Independent Trustees |
||||||||||||||||
Timothy K. Hui |
$ | 60,088 | $ | 0 | $ | 0 | $ | 150,000 | ||||||||
Bryan A. Ward |
$ | 60,088 | $ | 0 | $ | 0 | $ | 150,000 | ||||||||
Dr. Bob Froehlich |
$ | 60,088 | $ | 0 | $ | 0 | $ | 150,000 | ||||||||
John Honis 3 |
$ | 60,088 | $ | 0 | $ | 0 | $ | 150,000 |
1 | The Highland Fund Complex consists of NHF, each series of HFI, each series of HFII, FRO, GAFII, NexPoint Capital, Inc., a closed-end management investment company that has elected to be treated as a business development company under the 1940 Act, NexPoint Merger Arbitrage Fund, NexPoint Latin American Opportunities Fund, NexPoint Real Estate Strategies Fund, NexPoint Opportunistic Credit Fund, NexPoint Energy and Materials Opportunities Fund, NexPoint Discount Yield Fund and NexPoint Healthcare Opportunities Fund. |
2 | Effective December 16, 2015, Mr. Powell is treated as an Interested Trustee of the Trust for all purposes other than compensation and the Funds code of ethics. |
3 | Effective May 1, 2015, Mr. Honis is treated as an Independent Trustee of the Trust. |
Each Independent Trustee receives an annual retainer of $150,000 payable in quarterly installments and allocated among each portfolio in the Highland Fund Complex.
Role of the Board of Trustees, Leadership Structure and Risk Oversight
The Role of the Board of Trustees
The Board oversees the management and operations of the Trust. Like most registered investment companies, the day-to-day management and operation of the Trust is performed by various service providers to the Trust, such as the Adviser, distributor, administrator, custodian, and transfer agent, each of which is discussed in greater detail in this SAI. The Board has appointed senior employees of certain of these service providers as officers of the Trust, with responsibility to monitor and report to the Board on the Trusts operations. The Board receives regular reports from these officers and service providers regarding the Trusts operations. For example, the Treasurer provides reports as to financial reporting matters and investment personnel report on the performance of the Trusts portfolios. The Board has appointed a Chief Compliance Officer who administers the Trusts compliance program and regularly reports to the Board as to compliance matters. Some of these reports are provided as part of formal in person Board meetings which are typically held quarterly, in person, and involve the Boards review of, among other items, recent Trust operations. The Board also periodically holds telephonic meetings as part of its review of the Trusts activities. From time to time one or more members of the Board may also meet with
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management in less formal settings, between scheduled Board meetings, to discuss various topics. In all cases, however, the role of the Board and of any individual Trustee is one of oversight and not of management of the day-to-day affairs of the Trust and its oversight role does not make the Board a guarantor of the Trusts investments, operations or activities.
Board Structure and Leadership
The Board has structured itself in a manner that it believes allows it to perform its oversight function effectively. The Board consists of five Trustees, four of whom are Independent Trustees. The remaining Trustee, Mr. Powell is an interested person of the Trust (each an Interested Trustee). Mr. Powell is treated as an Interested Trustee because of his previous positions with the Adviser and affiliates of the Adviser and his ongoing provision of consulting services to the Adviser and affiliates of the Adviser. Mr. Powell also serves as Chairman of the Board. The Trustees meet periodically throughout the year in person and by telephone to oversee the Trusts activities, review contractual arrangements with service providers for the Trust and review the Trusts performance. The Board conducts much of its work through certain standing Committees, each of whose meetings are chaired by an Independent Trustee. On May 12, 2016, the Board approved a restructuring of the Funds standing committees and established an Audit and Qualified Legal Compliance Committee (formerly, the Audit Committee), a Governance Committee (formerly, the Nominating and Governance Committee), a Compliance Committee (formerly, the Litigation Committee), a Distribution Oversight Committee and an Alternatives Oversight Committee, which are discussed in greater detail below.
Audit and Qualified Legal Compliance Committee . The members of the Audit and Qualified Legal Compliance Committee (formerly named the Audit Committee) are Messrs. Froehlich, Hui, and Ward each of whom is independent for purposes of the 1940 Act. The Audit and Qualified Legal Compliance Committee is responsible for approving the Trusts independent accountants, reviewing with the Trusts independent accountants the plans and results of the audit engagement and the adequacy of the Trusts internal accounting controls, approving professional services provided by the Trusts independent accountants. The Audit and Qualified Legal Compliance Committee is charged with compliance with Rules 205.2(k) and 205.3(c) of Title 17 of the Code of Federal Regulations regarding alternative reporting procedures for attorneys representing the Trust who appear and practice before the SEC on behalf of the Trust. The Audit and Qualified Legal Compliance Committee is also responsible for reviewing and overseeing the valuation of debt and equity securities that are not publicly traded or for which current market values are not readily available pursuant to policies and procedures adopted by the Board. The Board and Audit and Qualified Legal Compliance Committee will use the services of one or more independent valuation firms to help them determine the fair value of these securities. In addition, each member of the Audit and Qualified Legal Compliance Committee meets the current independence and experience requirements of Rule 10A-3 under the Exchange Act.
The Audit and Qualified Legal Compliance Committee met five times during the fiscal year ended June 30, 2017. Mr. Ward acts as the Chairman of the Audit and Qualified Legal Compliance Committee and as the audit committee financial expert.
Governance Committee. The Trusts Governance Committees function is to oversee and make recommendations to the full Board or the Independent Trustees, as applicable, with respect to the governance of the Trust, selection and nomination of Trustees, compensation of Trustees, and related matters. The Governance Committee is also responsible for at least annually evaluating each Trustee and determining whether to recommend each Trustees continued service in that capacity. The Governance Committee will consider recommendations for Trustee nominees from shareholders sent to the Secretary of the Trust, 200 Crescent Court, Suite 700, Dallas, Texas 75201. A nomination submission must include all information relating to the recommended nominee that is required to be disclosed in solicitations or proxy statements for the election of Trustees, as well as information sufficient to evaluate the recommended nominees ability to meet the responsibilities of a Trustee of the Trust. Nomination submissions must be accompanied by a written consent of the individual to stand for election if nominated by the Board and to serve if elected by the shareholders, and such additional information must be provided regarding the recommended nominee as reasonably requested by the Governance Committee. The Governance Committee is currently comprised of Messrs. Hui, Ward and Powell. Mr. Powell serves as the Chairman of the Governance Committee. The Governance Committee met three times during the fiscal year ended June 30, 2017.
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Compliance Committee. The Compliance Committees (formerly named the Litigation Committee) function is to oversee and assist Board oversight of the Trusts compliance with legal and regulatory requirements and to seek to address any potential conflicts of interest between the Trust and HCMFA in connection with any potential or existing litigation or other legal proceeding relating to securities held by the Trust and HCMFA or Sub-Adviser or another client of HCMFA. The Compliance Committee is currently comprised of Messrs. Hui, Froehlich and Powell. Mr. Hui acts as the Chairman of the Compliance Committee. The Compliance Committee met twice during the fiscal year ended June 30, 2017.
The Alternatives Oversight Committee. The members of the Alternatives Oversight Committee are Messrs. Honis and Ward. The Alternatives Oversight Committee is responsible for overseeing any Funds that in the Boards determination employ alternative investment strategies. Mr. Honis serves as Chairman of the Alternatives Oversight Committee. The Alternatives Oversight Committee met twice during the fiscal year ended June 30, 2017.
The Distribution Oversight Committee. The members of the Distribution Oversight Committee are Messrs. Froehlich and Honis. The Distribution Oversight Committee is responsible for overseeing and making recommendations to the Board with respect to the appointment and oversight of sub-advisers to the Funds and Fund payments to financial intermediaries. Mr. Froehlich serves as Chairman of the Distribution Oversight Committee. The Distribution Oversight Committee met four times during the fiscal year ended June 30, 2017.
The Trust does not have a lead Independent Trustee. As noted above, the Boards leadership structure features committees each made up of a majority of Independent Trustees. In addition, although the Independent Trustees recognize that having a lead Independent Trustee may in some circumstances help coordinate communications with management and otherwise assist a board in the exercise of its oversight duties, the Independent Trustees believe that because of the relatively small size of the Board, the ratio of Independent Trustees to Interested Trustees and the good working relationship among the Board members, it has not been necessary to designate a lead Independent Trustee. Additionally, while Mr. Powell is treated as an Interested Trustee, he no longer has an executive role at the Adviser.
The Board periodically reviews its leadership structure, including the role of the Chairman. The Board also completes an annual self-assessment during which it reviews its leadership and Committee structure and considers whether its structure remains appropriate in light of the Trusts current operations. The Board believes that its leadership structure, including the current percentage of the Board who are Independent Trustees, is appropriate given its specific characteristics. These characteristics include: (i) the extent to which the work of the Board is conducted through the standing committees; (ii) the extent to which the Independent Trustees meet as needed, together with their independent legal counsel, in the absence of members of management and members of the Board who are interested persons of the Trust; and (iii) Mr. Powells previous positions with the Adviser and affiliates of the Adviser and his ongoing provision of consulting services to the Adviser and affiliates of the Adviser and Mr. Honis previous position with an affiliate of the Adviser, which enhances the Boards understanding of the operations of the Adviser.
Board Oversight of Risk Management
The Boards role is one of oversight, rather than active management. This oversight extends to the Trusts risk management processes. These processes are embedded in the responsibilities of officers of, and service providers to, the Trust. For example, the Adviser and other service providers to the Trust are primarily responsible for the management of the Trusts investment risks. The Board has not established a formal risk oversight committee; however, much of the regular work of the Board and its standing Committees addresses aspects of risk oversight. For example, the Trustees seek to understand the key risks facing the Trust, including those involving conflicts of interest; how management identifies and monitors these risks on an ongoing basis; how management develops and implements controls to mitigate these risks; and how management tests the effectiveness of those controls.
In the course of providing that oversight, the Board receives a wide range of reports on the Trusts activities from the Adviser and other service providers, including reports regarding the Funds investment portfolios, the
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compliance of the Fund with applicable laws, and the Funds financial accounting and reporting. The Board also meets periodically with the Trusts Chief Compliance Officer to receive reports regarding the compliance of the Fund with the federal securities laws and the Trusts internal compliance policies and procedures, and meets with the Trusts Chief Compliance Officer periodically, including at least annually, to review the Chief Compliance Officers annual report, including the Chief Compliance Officers risk-based analysis for the Trust.
The Boards Audit Committee also meets regularly with the Treasurer and Trusts independent registered public accounting firm to discuss, among other things, the internal control structure of the Trusts financial reporting function. The Board also meets periodically with the portfolio manager of the Fund to receive reports regarding the management of the Fund, including its investment risks.
Share Ownership
The following table shows the dollar range of equity securities beneficially owned by the Trustees in the Fund and the aggregate dollar range of equity securities owned by the Trustees in all funds overseen by the Trustees in the Highland Fund Complex as of December 31, 2016.
Name of Trustee |
Dollar Range of Equity Securities
Owned in Highland/iBoxx Senior Loan ETF |
Aggregate Dollar Range of Equity
Securities Owned in All Funds Overseen by Trustee in the Highland Fund Complex 1 |
||||||
Interested Trustee |
||||||||
Ethan Powell |
$10,001-$50,000 | $100,001 - $500,000 | ||||||
Independent Trustees |
||||||||
Timothy K. Hui |
None | $50,001 - $100,000 | ||||||
John Honis 2 |
None | None | ||||||
Dr. Bob Froehlich |
None | $100,001 - $500,000 | ||||||
Bryan A. Ward |
None | None 3 |
1 | The Highland Fund Complex consists of NHF, each series of HFI, each series of HFII, FRO, GAFII, NexPoint Capital, Inc., a closed-end management investment company that has elected to be treated as a business development company under the 1940 Act and NexPoint Merger Arbitrage Fund, NexPoint Latin American Opportunities Fund, NexPoint Real Estate Strategies Fund, NexPoint Opportunistic Credit Fund, NexPoint Energy and Materials Opportunities Fund, NexPoint Discount Yield Fund and NexPoint Healthcare Opportunities Fund. |
2 | Effective May 1, 2015, Mr. Honis is treated as an Independent Trustee of the Trust. |
3 | As of September 30, 2017, Mr. Ward had approximately $100,001-$500,000 in equity securities in the Highland Fund Complex. |
Trustee Positions
As of December 31, 2016, no Independent Trustee nor any of his immediate family members owned beneficially or of record any class of securities of the Adviser or Distributor (as defined under Distributor) or any person controlling, controlled by or under common control with any such entities.
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Code of Ethics
The Fund, the Adviser and the Funds principal underwriter, SEI Investments Distribution Co. (SEI) have each adopted codes of ethics that essentially prohibit certain of their personnel, including the Funds portfolio manager, from engaging in personal investments that compete or interfere with, or attempt to take advantage of a clients, including the Funds, anticipated or actual portfolio transactions, and are designed to assure that the interests of clients, including Fund shareholders, are placed before the interests of personnel in connection with personal investment transactions. Under the codes of ethics of the Fund and the Adviser, personal trading is permitted by such persons subject to certain restrictions; however, they are generally required to pre-clear most securities transactions with the appropriate compliance officer and to report all transactions on a regular basis.
Anti-Money Laundering Compliance
The Fund and its service providers may be required to comply with various anti-money laundering laws and regulations. Consequently, the Fund and its service providers may request additional information from its Authorized Participants (as defined under Policy on Disclosure of Portfolio Holdings in this SAI) to verify the identity of its Authorized Participants. If at any time the Fund believes an Authorized Participant may be involved in suspicious activity or if certain account information matches information on government lists of suspicious persons, the Fund may choose not to establish a new account or may be required to freeze an Authorized Participants account. The Fund and its service providers also may be required to provide a governmental agency with information about transactions that have occurred in an Authorized Participants account or to transfer monies received to establish a new account, transfer an existing account or transfer the proceeds of an existing account to a governmental agency. In some circumstances, the Fund or its service providers may not be permitted to inform the Authorized Participant that it has taken the actions described above.
Proxy Voting Policies
The Board has delegated the responsibility for voting proxies in respect of the Funds portfolio holdings to the Adviser, to vote the Funds proxies in accordance with the Advisers Proxy Voting Policy. The Board has approved the Proxy Voting Policy. Pursuant to the Proxy Voting Policy, the Adviser will vote proxies related to Fund securities in the best interests of the Fund and its shareholders. The Advisers Proxy Voting Policy is attached as Appendix B.
The Funds proxy voting records for the most recent 12-month period ended June 30 will be available (i) without charge, upon request, by calling (855) 799-4757 and (ii) on the SECs website (http://www.sec.gov). Information as of June 30 each year will generally be available on or about the following August 31.
Policy on Disclosure of Portfolio Holdings
The Trust has adopted a policy regarding the disclosure of information about the Funds portfolio holdings, which is reviewed on an annual basis. The Board must approve all material amendments to this policy. A complete schedule of the Funds portfolio holdings as of the end of each fiscal quarter will be filed with the SEC (and publicly available) within 60 days of the end of the first and third fiscal quarters and within 70 days of the second and fourth quarters. In addition, the Fund disseminates information about its portfolio holdings each day the Fund is open for business through the Exchange, the National Securities Clearing Corporation (NSCC) and/or third party service providers. Limited information regarding the Funds portfolio holdings is available daily on (http://www.highlandfunds.com) the portfolio composition file (PCF) and the IOPV file, which contain equivalent portfolio holdings information, will be made available as frequently as daily to the Funds service providers to facilitate the provision of services to the Fund and to certain other entities (Entities) in connection with the dissemination of information necessary for transactions in Creation Units, as contemplated by exemptive orders issued by the SEC and other legal and business requirements pursuant to which the Fund creates and redeems shares. Entities are generally limited to NSCC members and subscribers to various fee-based services, including large institutional investors (Authorized Participants) that have been authorized by the Distributor to purchase and redeem Creation Units and other institutional market participants that provide information services. Each business day, Fund portfolio holdings information will be provided to the Distributor or other agent for dissemination through the facilities of the NSCC and/or through other fee-based services to NSCC members and/or subscribers to the fee-based services, including Authorized Participants, and to entities that publish and/or analyze such information in connection with the process of purchasing or redeeming Creation Units or trading shares of the Fund in the secondary market.
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Daily access to the PCF and IOPV file is permitted (i) to certain personnel of those service providers that are involved in portfolio management and providing administrative, operational, or other support to portfolio management, including Authorized Participants, and (ii) to other personnel of the Adviser and the Funds distributor, administrator, custodian and fund accountant who are involved in functions which may require such information to conduct business in the ordinary course.
Portfolio holdings information may not be provided prior to its public availability (Non-Standard Disclosure) in other circumstances except where appropriate confidentiality arrangements limiting the use of such information are in effect. Non-Standard Disclosure may be authorized by the Trusts Chief Compliance Officer or, in his absence, any other authorized officer of the Trust if he determines that such disclosure is in the best interests of the Funds shareholders, no conflict exists between the interests of the Funds shareholders and those of the Adviser or Distributor and such disclosure serves a legitimate business purpose. The length of lag, if any, between the date of the information and the date on which the information is disclosed shall be determined by the officer authorizing the disclosure.
Additionally, no compensation or other consideration is received by the Fund, the Adviser or any other person for Non Standard Disclosures. There can be no assurance, however, that the Funds policies and procedures with respect to the disclosure of portfolio holdings information will prevent the misuse of such information by individuals or firms in possession of such information.
Book Entry Only System
The Depository Trust Company (DTC) acts as securities depositary for the shares. The shares of the Fund are represented by global securities registered in the name of DTC or its nominee and deposited with, or on behalf of, DTC. Except as provided below, certificates will not be issued for shares.
DTC has advised the Fund as follows: it is a limited-purpose trust company organized under the laws of the State of New York, a member of the Federal Reserve System, a clearing corporation within the meaning of the New York Uniform Commercial Code and a clearing agency registered pursuant to the provisions of Section 17A of the 1934 Act. DTC was created to hold securities of its participants (DTC Participants) and to facilitate the clearance and settlement of securities transactions among the DTC Participants in such securities through electronic book-entry changes in accounts of the DTC Participants, thereby eliminating the need for physical movement of securities certificates. DTC Participants include securities brokers and dealers, banks, trust companies, clearing corporations and certain other organizations, some of whom (and/or their representatives) own DTC. More specifically, DTC is owned by a number of its DTC Participants and by NYSE Arca, Inc. and the Financial Industry Regulatory Authority, Inc. Access to the DTC system is also available to others such as banks, brokers, dealers and trust companies that clear through or maintain a custodial relationship with a DTC Participant, either directly or indirectly (Indirect Participants). DTC agrees with and represents to DTC Participants that it will administer its book-entry system in accordance with its rules and by-laws and requirements of law. Beneficial ownership of shares is limited to DTC Participants, Indirect Participants and persons holding interests through DTC Participants and Indirect Participants. Ownership of beneficial interests in shares (owners of such beneficial interests are referred to herein as Beneficial Owners) is shown on, and the transfer of ownership is effected only through, records maintained by DTC (with respect to DTC Participants) and on the records of DTC Participants (with respect to Indirect Participants and Beneficial Owners that are not DTC Participants).
Beneficial Owners will receive from or through the DTC Participant a written confirmation relating to their purchase of shares. The laws of some jurisdictions may require that certain purchasers of securities take physical delivery of such securities in definitive form. Such laws may impair the ability of certain investors to acquire beneficial interests in shares. Beneficial Owners of shares are not entitled to have shares registered in their names, will not receive or be entitled to receive physical delivery of certificates in definitive form and are not considered the registered holder thereof. Accordingly, each Beneficial Owner must rely on the procedures of DTC, the DTC Participant and any Indirect Participant through which such Beneficial Owner holds its interests, to exercise any rights of a holder of shares. The Fund understands that under existing industry practice, in the event the
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Fund requests any action of holders of shares, or a Beneficial Owner desires to take any action that DTC, as the record owner of all outstanding shares, is entitled to take, DTC would authorize the DTC Participants to take such action and that the DTC Participants would authorize the Indirect Participants and Beneficial Owners acting through such DTC Participants to take such action and would otherwise act upon the instructions of Beneficial Owners owning through them. As described above, the Fund recognizes DTC or its nominee as the owner of all shares for all purposes. Conveyance of all notices, statements and other communications to Beneficial Owners is effected as follows. Pursuant to the Depositary Agreement between the Fund and DTC, DTC is required to make available to the Fund upon request and for a fee to be charged to the Fund a listing of shares holdings of each DTC Participant. The Fund shall inquire of each such DTC Participant as to the number of Beneficial Owners holding shares, directly or indirectly, through such DTC Participant. The Fund shall provide each such DTC Participant with copies of such notice, statement or other communication, in such form, number and at such place as such DTC Participant may reasonably request, in order that such notice, statement or communication may be transmitted by such DTC Participant, directly or indirectly, to such Beneficial Owners. In addition, the Fund shall pay to each such DTC Participant a fair and reasonable amount as reimbursement for the expenses attendant to such transmittal, all subject to applicable statutory and regulatory requirements.
Distributions of shares shall be made to DTC or its nominee, Cede & Co., as the registered holder of all shares. DTC or its nominee, upon receipt of any such distributions, shall credit immediately DTC Participants accounts with payments in amounts proportionate to their respective beneficial interests in shares as shown on the records of DTC or its nominee. Payments by DTC Participants to Indirect Participants and Beneficial Owners of shares held through such DTC Participants will be governed by standing instructions and customary practices, as is now the case with securities held for the accounts of customers in bearer form or registered in a street name, and will be the responsibility of such DTC Participants. The Fund has no responsibility or liability for any aspects of the records relating to or notices to Beneficial Owners, or payments made on account of beneficial ownership interests in such shares, or for maintaining, supervising or reviewing any records relating to such beneficial ownership interests or for any other aspect of the relationship between DTC and the DTC Participants or the relationship between such DTC Participants and the Indirect Participants and Beneficial Owners owning through such DTC Participants.
DTC may determine to discontinue providing its service with respect to shares at any time by giving reasonable notice to the Fund and discharging its responsibilities with respect thereto under applicable law. Under such circumstances, the Fund shall take action either to find a replacement for DTC to perform its functions at a comparable cost or, if such a replacement is unavailable, to issue and deliver printed certificates representing ownership of shares, unless the Fund makes other arrangements with respect thereto satisfactory to the Exchange.
No dividend reinvestment service is provided by the Fund. However, certain brokers may make a dividend reinvestment service available to their clients. Brokers offering such services may require investors to adhere to specific procedures and timetables in order to participate. Investors interested in such a service should contact their broker for availability and other necessary details.
Highland Capital Management Fund Advisors, L.P. serves as the Funds investment adviser pursuant to an investment advisory agreement with the Fund (the Investment Advisory Agreement. HCMFA is owned by Highland Capital Management Services, Inc., a Delaware corporation (HCM Services, Inc.), and its general partner Strand Advisors XVI, Inc., of which James Dondero is the sole stockholder. HCM Services, Inc. is controlled by Mr. Dondero and Mark Okada by virtue of their respective share ownership.
Under the Investment Advisory Agreement, the Adviser is entitled to receive a monthly fee, computed and accrued daily, at the annual rate of 0.45% of the Funds Average Daily Managed Assets of the Fund. Average Daily Managed Assets of the Fund means the average daily value of the total assets of the Fund, less all accrued liabilities of the Fund (other than the aggregate amount of any outstanding borrowings constituting financial leverage).
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Under the Investment Advisory Agreement, HCMFA, among other things: (i) continuously furnishes an investment program for the Fund; (ii) places orders for the purchase and sale of securities for the accounts of the Fund; and (iii) votes, exercises consents and exercises all other rights pertaining to such securities on behalf of the Fund.
HCMFA carries out its duties under the Investment Advisory Agreement at its own expense. The Fund pays its own ordinary operating and activity expenses, such as legal and auditing fees, investment advisory fees, administrative fees, custodial fees, transfer agency fees, the cost of communicating with shareholders and registration fees, as well as other operating expenses such as interest, taxes, brokerage, insurance, bonding, compensation of Independent Trustees of the Fund and extraordinary expenses.
The Investment Advisory Agreement provides that in the absence of willful misfeasance, bad faith or gross negligence in the performance (or reckless disregard) of its obligations or duties thereunder on the part of HCMFA, HCMFA shall not be subject to liability to the Fund for any error of judgment or mistake of law or for any loss suffered by the Fund in connection with the matters to which the Investment Advisory Agreement relates.
Additionally, the Investment Advisory Agreement remains in force for an initial two year period and from year to year thereafter, subject to annual approval by (a) the Board or (b) a vote of the majority of the Funds outstanding voting securities; provided that in either event continuance is also approved by a majority of the Independent Trustees, by a vote cast in person at a meeting called for the purpose of voting such approval. Each Investment Advisory Agreement may be terminated at any time, without payment of any penalty, by vote of the Funds Board, or by a vote of a majority of the outstanding voting securities (as defined in the 1940 Act) of the Fund, or by the Adviser, in each case on not more than 60 days nor less than 30 days prior written notice to the other party. Each Investment Advisory Agreement will automatically terminate in the event of its assignment, as defined by the 1940 Act and the rules thereunder, or upon the termination of the relevant Investment Advisory Agreement.
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The table below sets forth the advisory fees paid by the Fund, as well as any fee waivers and/or expense reimbursements, for fiscal years ended June 30, 2017, June 30, 2016 and June 30, 2015:
Fiscal Year Ended
June 30, 2017 |
Fiscal Year Ended
June 30, 2016 |
Fiscal Year Ended
June 30, 2015 |
||||||||||
Gross Advisory Fee |
$ | 2,025,394 | $ | 1,392,925 | $ | 1,301,689 | ||||||
Expense Waiver/Reimbursement 1 |
($ | 866,942 | ) | ($ | 662,390 | ) | ($ | 526,374 | ) | |||
Net Advisory Fee/Reimbursement |
$ | 1,158,452 | $ | 730,535 | $ | 775,315 |
1 | The Adviser has contractually agreed to limit the total annual operating expenses (exclusive of taxes, brokerage commissions and other transaction costs, acquired fund fees and expenses and extraordinary expenses) of the Fund to 0.55% of Average Daily Managed Assets of the fund (the Expense Cap). The Expense Cap will continue through at least October 31, 2018, and may not be terminated prior to this date without the action or consent of the Funds Board. |
INFORMATION REGARDING PORTFOLIO MANAGER
The portfolio managers of Highland/iBoxx Senior Loan ETF are Mark Okada and Allan Smallwood. The following table provides information about funds and accounts, other than the Fund, for which the portfolio managers are primarily responsible for the day-to-day portfolio management.
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As of June 30, 2017, Mark Okada managed the following other client accounts:
Type of Accounts |
Total
# of Accounts Managed |
Total
Assets (millions) |
# of Accounts
Managed with Performance- Based Advisory Fee |
Total Assets with
Performance- Based Advisory Fee (millions) |
||||||||
Registered Investment Companies: |
1 | $ | 885.95 | 0 | $ | 0 | ||||||
Other Pooled Investment Vehicles: |
1 | $ | 10.94 | 1 | $ | 10.94 | ||||||
Other Accounts: |
0 | $ | 0 | 0 | $ | 0 |
As of June 30, 2017, Allan Smallwood managed the following other client accounts:
Type of Accounts |
Total
# of Accounts Managed |
Total
Assets (millions) |
# of Accounts
Managed with Performance- Based Advisory Fee |
Total Assets with
Performance- Based Advisory Fee (millions) |
||||||||
Registered Investment Companies: |
0 | $ | 0 | 0 | $ | 0 | ||||||
Other Pooled Investment Vehicles: |
0 | $ | 0 | 0 | $ | 0 | ||||||
Other Accounts: |
0 | $ | 0 | 0 | $ | 0 |
Compensation Structure HCMFA
HCMFAs financial arrangements with its portfolio managers, its competitive compensation and its career path emphasis at all levels reflect the value senior management places on key resources. Compensation may include a variety of components and may vary from year to year based on a number of factors, including the pre-tax relative performance of a portfolio managers underlying account, the pre-tax combined performance of the portfolio managers underlying accounts, and the pre-tax relative performance of the portfolio managers underlying accounts measured against other employees. Compensation of the Funds portfolio managers may also be based, in part, on the one and three-year performance of the Fund relative to the Markit iBoxx USD Liquid Leveraged Loan Index. The principal components of compensation include a base salary, a discretionary bonus, various retirement benefits and one or more of the incentive compensation programs established by HCMFA, such as its Short-Term Incentive Plan and its Long-Term Incentive Plan, described below.
Base compensation. Generally, portfolio managers receive base compensation based on their seniority and/or their position with HCMFA, which may include the amount of assets supervised and other management roles within HCMFA. Base compensation is determined by taking into account current industry norms and market data to ensure that HCMFA pays a competitive base compensation.
Discretionary compensation. In addition to base compensation, portfolio managers may receive discretionary compensation, which can be a substantial portion of total compensation. Discretionary compensation can include a discretionary cash bonus paid to recognize specific business contributions and to ensure that the total level of compensation is competitive with the market, as well as participation in incentive plans, including one or more of the following:
Short-Term Incentive PlanThe purpose of this plan is to attract and retain the highest quality employees for positions of substantial responsibility, and to provide additional incentives to a select group of management or highly-compensated employees of HCMFA in order to promote the success of HCMFA.
Long-Term Incentive PlanThe purpose of this plan is to create positive morale and teamwork, to attract and retain key talent and to encourage the achievement of common goals. This plan seeks to reward participating employees based on the increased value of HCMFA.
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Because each persons compensation is based on his or her individual performance, HCMFA does not have a typical percentage split among base salary, bonus and other compensation. Senior portfolio managers who perform additional management functions may receive additional compensation in these other capacities. Compensation is structured such that key professionals benefit from remaining with HCMFA.
Conflicts of Interest HCMFA
HCMFA and/or its general partner, limited partners, officers, affiliates and employees provide investment advice to other parties and manage other accounts and private investment vehicles similar to the Fund. For the purposes of this section, the term Highland shall include HCMFA and its affiliated investment advisors, including Highland Capital Management, L.P. and all affiliates listed on its Form ADV, as filed with the SEC March 30, 2017 (CRD No. 149653). In connection with such other investment management activities, HCMFA and/or its general partner, limited partners, officers, affiliates and employees may decide to invest the funds of one or more other accounts or recommend the investment of funds by other parties, rather than the Funds monies, in a particular security or strategy. In addition, HCMFA and such other persons will determine the allocation of funds from the Fund and such other accounts to investment strategies and techniques on whatever basis they consider appropriate or desirable in their sole and absolute discretion.
HCMFA has built a professional working environment, a firm-wide compliance culture and compliance procedures and systems designed to protect against potential incentives that may favor one account over another. HCMFA has adopted policies and procedures that address the allocation of investment opportunities, execution of portfolio transactions, personal trading by employees and other potential conflicts of interest that are designed to ensure that all client accounts are treated equitably over time. Nevertheless, HCMFA furnishes advisory services to numerous clients in addition to the Fund, and HCMFA may, consistent with applicable law, make investment recommendations to other clients or accounts (including accounts that are hedge funds or have performance or higher fees paid to HCMFA or in which portfolio managers have a personal interest in the receipt of such fees) that may be the same as or different from those made to the Fund. In addition, HCMFA, its affiliates and any of their partners, directors, officers, stockholders or employees may or may not have an interest in the securities whose purchase and sale HCMFA recommends to the Fund. Actions with respect to securities of the same kind may be the same as or different from the action that HCMFA, or any of its affiliates, or any of their partners, directors, officers, stockholders or employees or any member of their families may take with respect to the same securities. Moreover, HCMFA may refrain from rendering any advice or services concerning securities of companies of which any of HCMFAs (or its affiliates) partners, directors, officers or employees are directors or officers, or companies as to which HCMFA or any of its affiliates or partners, directors, officers and employees of any of them has any substantial economic interest or possesses material non-public information. In addition to its various policies and procedures designed to address these issues, HCMFA includes disclosure regarding these matters to its clients in both its Form ADV and investment advisory agreements.
HCMFA, its affiliates or their partners, directors, officers or employees similarly serve or may serve other entities that operate in the same or related lines of business, including accounts managed by an investment adviser affiliated with the Adviser. Accordingly, these individuals may have obligations to investors in those entities or funds or to other clients, the fulfillment of which might not be in the best interests of the Fund. As a result, HCMFA will face conflicts in the allocation of investment opportunities to the Fund and other funds and clients. In order to enable such affiliates to fulfill their fiduciary duties to each of the clients for which they have responsibility, HCMFA will endeavor to allocate investment opportunities in a fair and equitable manner which may, subject to applicable regulatory constraints, involve pro rata co-investment by the Fund and such other clients or may involve a rotation of opportunities among the Fund and such other clients.
Conflicts may arise in cases when clients invest in different parts of an issuers capital structure, including circumstances in which one or more clients own private securities or obligations of an issuer and other clients may own public securities of the same issuer. In addition, one or more clients may invest in securities, or other financial instruments, of an issuer that are senior or junior to securities, or financial instruments, of the same issuer that are held by or acquired for, one or more other clients. For example, if such issuer encounters financial problems, decisions related to such securities (such as over the terms of any workout or proposed waivers and amendments to debt covenants) may raise conflicts of interests. In such a distressed situation, a client holding debt securities of the
37
issuer may be better served by a liquidation of the issuer in which it may be paid in full, whereas a client holding equity securities of the issuer might prefer a reorganization that holds the potential to create value for the equity holders. In the event of conflicting interests within an issuers capital structure, Highland, will generally pursue the strategy that Highland believes will maximize value for Highland accounts overall (without regard to the nature of the accounts involved or fees received from such accounts). This strategy may be recommended by one or more Highland investment professionals. A single person may represent more than one part of an issuers capital structure. The recommended course of action will be presented to the conflicts committee for final determination as to how to proceed, Highland may elect, but is not required, to assign different teams to make recommendations for different parts of the capital structure as the conflicts committee determines in its discretion. In the event any Highland personnel serve on the board of the subject company, they generally recuse themselves from voting on any board matter with respect to a transaction that has an asymmetrical impact on the capital structure. Highland personnel board members may still make recommendations to the conflicts committee. If any such persons are also on the conflicts committee, they may recuse themselves from the committees determination. A Portfolio Manager with respect to any applicable Highland registered investment company clients (Retail Accounts) participates in such discussions, but makes an independent determination as to which course of action he or she determines is in the best interest of the applicable Retail Accounts. Highland may use external counsel for guidance and assistance.
HCMFA and its affiliates have both subjective and objective procedures and policies in place designed to manage potential conflicts of interest involving clients so that, for example, investment opportunities are allocated in a fair and equitable manner among the Fund and such other clients. An investment opportunity that is suitable for multiple clients of HCMFA and its affiliates may not be capable of being shared among some or all of such clients due to the limited scale of the opportunity or other factors, including regulatory restrictions imposed by the 1940 Act. There can be no assurance that HCMFAs or its affiliates efforts to allocate any particular investment opportunity fairly among all clients for whom such opportunity is appropriate will result in an allocation of all or part of such opportunity to the Fund. Not all conflicts of interest can be expected to be resolved in favor of the Fund.
Another type of conflict may arise if a Portfolio Manager causes one client account of an affiliated advisor to buy a security and another client account to sell or short the same security. Currently, such opposing positions are generally not permitted within the same account without prior trade approval by the Chief Compliance Officer. However, a portfolio manager may enter into opposing positions for different clients to the extent each such client has a different investment objective and each such position is consistent with the investment objective of the applicable client. In addition, transactions in investments by one or more affiliated client accounts may have the effect of diluting or otherwise disadvantaging the values, prices or investment strategies of other client accounts.
Because certain client accounts may have investment objectives, strategies or legal, contractual, tax or other requirements that differ (such as the need to take tax losses, realize profits, raise cash, diversification, etc.), an affiliated advisor may purchase, sell or continue to hold securities for certain client accounts contrary to other recommendations. In addition, an affiliated advisor may be permitted to sell securities or instruments short for certain client accounts and may not be permitted to do so for other affiliated client accounts.
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Ownership of Securities
The following table sets forth the dollar range of equity securities of the Fund beneficially owned by each portfolio manager. This information is provided as of June 30, 2017.
Name of Portfolio Manager |
Fund Name |
Dollar Range of Fund Equity Securities
Beneficially Owned by Portfolio Manager |
||
Mark Okada |
Highland/iBoxx Senior Loan ETF | $100,001 - $500,000 | ||
Allan Smallwood |
Highland/iBoxx Senior Loan ETF | $10,001 - $50,000 |
Under the Administration Agreement with SEI Investments Global Funds Services, One Freedom Valley Drive, Oaks, Pennsylvania 19456 (the Administrator), the Administrator provides administration services to the Fund, as well as other services including fund accounting, shareholder services and a contact center. The Administrator receives a monthly administration fee from the Fund, calculated and assessed in arrears based on the aggregate net assets of the Fund, subject to an annual minimum fee. For fiscal years ended June 30, 2017, June 30, 2016 and June 30, 2015, the Fund paid administration fees to the Administrator in the amount of $342,488, $251,269 and $265,484, respectively.
Under a Distribution Agreement with SEI Investments Distribution Co., One Freedom Valley Drive Oaks, Pennsylvania 19456 (the Distributor), shares of the Fund are offered for sale on a continuous basis only in Creation Units, as described in the Prospectus and in the Purchase and Redemption of Shares section of this SAI below. Fund shares in amounts less than Creation Units are not distributed by the Distributor. As of June 30, 2017, no fees were paid by the Fund to the Distributor.
The Fund has adopted a Rule 12b-1 Distribution Plan (the Plan) pursuant to which payments of up to 0.25% may be made as reimbursement or compensation for distribution related activities and other services with respect to the Fund. Under its terms, the Plan remains in effect from year to year, provided such continuance is approved annually by vote of the Board, including a majority of the Independent Trustees. The Plan may not be amended to increase materially the amount to be spent for the services provided by the Distributor without approval by the shareholders of the Fund, and all material amendments of the Plan also require Board approval. The Plan may be terminated at any time, without penalty, by vote of a majority of the Independent Trustees, or, by a vote of a majority of the outstanding voting securities of the Fund (as such vote is defined in the 1940 Act).
During each of the previous three fiscal years ending June 30, 2017, June 30, 2016 and June 30, 2015, the Fund did not pay any fees to the Distributor as compensation for services. During the fiscal year ended June 30, 2017, the Distributor did not incur expenses on behalf of any of the Fund in connection with distributions under the Plan.
State Street Bank and Trust Company, One Heritage Drive, 1st Floor, Quincy, MA 02171 (State Street) provides transfer agency and dividend disbursing services for the Fund. As part of these services, State Street maintains records pertaining to the sale, redemption and transfer of Fund shares and distributes the Funds securities and cash distributions to shareholders.
State Street is the custodian for the Fund. State Street is responsible for holding all securities, other investments and cash, receiving and paying for securities purchased, delivering against payment securities sold, receiving and collecting income from investments, making all payments covering expenses and performing other administrative duties, all as directed by authorized persons. State Street does not exercise any supervisory function in such matters as purchase and sale of portfolio securities, payment of dividends or payment of expenses.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The independent registered public accounting firm for the Fund is KPMG LLP, located at Two Financial Center, 60 South Street, Boston, Massachusetts 02111. The independent registered public accounting firm audits and reports on the annual financial statements, reviews certain regulatory reports and U.S. federal income tax returns, and performs other professional accounting, auditing and tax services when engaged to do so.
39
PORTFOLIO TRANSACTIONS AND BROKERAGE
Selection of Broker-Dealers; Order Placement
Subject to the overall review of the Funds Board, the Adviser is responsible for decisions to buy and sell securities and other portfolio holdings of the Fund, for selecting the broker or dealer to be used and for negotiating any commission rates paid. In underwritten offerings, securities usually are purchased at a fixed price that includes an amount of compensation to the underwriter, generally referred to as the underwriters concession or discount. On occasion, certain money market instruments may be purchased directly from an issuer, in which case no commissions or discounts are paid.
The Adviser and its affiliates manage other accounts, including private funds and individual accounts that invest in Fund investments. Although investment decisions for the Fund are made independently from those of such other accounts, investments of the type the Fund may make also may be made on behalf of such other accounts. When the Fund and one or more other accounts is prepared to invest in, or desires to dispose of, the same investment, available investments or opportunities for each are allocated in a manner believed by the Adviser to be equitable over time. The Adviser may (but is not obligated to) aggregate orders, which may include orders for accounts in which the Adviser or its affiliates have an interest, to purchase and sell securities to obtain favorable execution or lower brokerage commissions, to the extent permitted by applicable laws and regulations. Although the Adviser believes that, over time, the potential benefits of participating in volume transactions and negotiating lower transaction costs should benefit all participating accounts, in some cases these activities may adversely affect the price paid or received or the size of the position obtained by or disposed of for the Fund. Where trades are aggregated, the investments or proceeds, as well as the expenses incurred, will be allocated by the Adviser in a manner designed to be equitable and consistent with the Advisers fiduciary duty to the Fund and its other clients (including its duty to seek to obtain best execution of client trades).
Commission Rates; Brokerage and Research Services
The Adviser seeks to obtain best execution, considering the execution price and overall commission costs paid and other factors. The Adviser routes its orders to various broker-dealers for execution at its discretion. Factors involved in selecting brokerage firms include the size, type and difficulty of the transaction, the nature of the market for the security, the reputation, experience and financial stability of the broker-dealer involved, the quality of service, the quality of research and investment information provided and the firms risk in positioning a block of securities. Within the framework of the policy of obtaining the most favorable price and efficient execution, the Adviser does consider brokerage and research services (as defined in the Securities Exchange Act of 1934, as amended) provided by brokers who effect portfolio transactions with the Adviser or the Fund. Brokerage and research services are services that brokerage houses customarily provide to institutional investors and include statistical and economic data and research reports on particular issuers and industries.
In addition, the investment advisory agreement between the Trust and HCMFA relating to the Fund authorizes HCMFA, on behalf of the Fund, in selecting brokers or dealers to execute a particular transaction and in evaluating the best overall terms available, to consider the brokerage and research services (as those terms are defined in Section 28(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act)) provided to the Fund and/or other accounts over which HCMFA or its affiliates exercise investment discretion. The fees under the investment advisory agreement relating to the Fund will not be reduced by reason of the Funds receiving brokerage and research services. Such services include analyses and reports regarding issuers, industries, economic trends, portfolio strategy, and may effect securities transactions and perform certain functions related thereto. In addition, such services may include advice concerning the advisability of investing in, purchasing or selling securities and the availability of particular securities or buyers or sellers of securities. The research services received from broker-dealers that execute transactions on behalf of the Fund may be useful to HCMFA in servicing the Fund as well as all of HCMFAs accounts and not all of these services may be used in connection with the particular Fund or funds generating the commissions. Consistent with limits established by the Federal securities laws, the Fund may pay broker-dealer commissions for agency transactions that exceed the amount of commissions charged by other broker-dealers in recognition of their research and brokerage services.
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The following table shows the brokerage commissions paid for the fiscal years ended June 30, 2017, June 30, 2016 and June 30, 2015:
Fiscal Year Ended
June 30, 2017 |
Fiscal Year Ended
June 30, 2016 |
Fiscal Year Ended
June 30, 2015 |
||||||||||
Highland/iBoxx Senior Loan ETF |
$ | 6,021 | $ | 0 | $ | 0 |
The Fund did not pay any brokerage commissions to firms that provided research and brokerage services during the year ended June 30, 2017.
Certain Affiliations
The Fund and HCMFA are currently affiliated with NexBank Securities, Inc. (NexBank) and Highland Capital Funds Distributor, Inc. (HCFD), FINRA member broker-dealers that are indirectly controlled by the principals of HCMFA and HCFD. Absent an exemption from the SEC or other regulatory relief, the Fund is generally precluded from effecting certain principal transactions with affiliated brokers. The Fund may utilize affiliated brokers for agency transactions, subject to compliance with policies and procedures adopted pursuant to the 1940 Act and the rules promulgated thereunder. These policies and procedures are designed to provide that commissions, fees or other remuneration received by any affiliated broker or its affiliates for agency transactions are reasonable and fair compared to the remuneration received by other brokers in comparable transactions.
For fiscal years ended June 30, 2017, June 30, 2016 and June 30, 2015, the Fund paid no brokerage commissions to NexBank or HCFD.
In addition, the Fund and HCMFA are currently affiliated with NexBank, which also does business as Barrier Advisors, NexBank SSB, a state chartered bank, and Governance Re Ltd. (Governance Re), an insurance company, both of which are indirectly controlled by the principals of HCMFA and HCFD. NexBank and Governance Re may offer certain services to portfolio companies whose securities, including loans, are owned by one or more registered investment companies advised by HCMFA (the Portfolio Companies). For example, NexBank may provide agent services for Portfolio Companies under credit agreements pursuant to which the Fund may be a lender or may offer strategic, financial and operational advisory services to Portfolio Companies; and Governance Re may offer insurance services to the Portfolio Companies. NexBank, Governance Re and other affiliated service providers may receive fees from Portfolio Companies or other parties for services provided.
The Funds Board will, in accordance with specific procedures and policies adopted by the Board, review any investment or operational decisions that are brought to the attention of the Board and that may present potential conflicts of interest between HCMFA and the Fund.
DESCRIPTION OF THE FUNDS SHARES
The Fund is a series of the Trust, a Delaware statutory trust formed on February 28, 2006. The Trust is authorized to issue an unlimited number of its shares of beneficial interest in separate series and classes of each series. The Trust is not required to hold regular annual shareholder meetings, but may hold special meetings for consideration of proposals requiring shareholder approval, such as changing fundamental policies or upon the written request of 10% of the Trusts shares to replace its Trustees. The Trusts Board is authorized to classify or reclassify the unissued shares of the Trust into one or more separate series of shares representing a separate, additional investment portfolio or one or more separate classes of new or existing series. Shares of all series will have identical voting rights, except where by law certain matters must be approved by the requisite proportion of the shares of the affected series. Each share of any class when issued has equal dividend, liquidation (see Purchase and Redemption of Shares) and voting rights within the class for which it was issued and each fractional share has those rights in proportion to the percentage that the fractional share represents a whole share. Shares will be voted in the aggregate except where otherwise required by law and except that each class of each series will vote separately on certain matters pertaining to its distribution and shareholder servicing arrangements.
41
There are no conversion or preemptive rights in connection with any shares of the Fund. All shares, when issued in accordance with the terms of the offering, will be fully paid and nonassessable.
The shares of the Fund have noncumulative voting rights, which means that the holders of more than 50% of the shares of the Trust can elect 100% of the Trustees if the holders choose to do so, and, in that event, the holders of the remaining shares will not be able to elect any person or persons to the Board.
Description of the Trust
Under Delaware law, shareholders of a statutory trust shall have the same limitation of personal liability that is extended to stockholders of private corporations for profit organized under Delaware law, unless otherwise provided in the trusts governing instrument. The Trusts Agreement and Declaration of Trust (the Declaration of Trust) provides that shareholders shall not be personally liable to any person in connection with any and all property, real or personal, tangible or intangible, that at such time is owned or held by or for the account of a particular series. Moreover, the Declaration of Trust expressly provides that the shareholders shall have the same limitation of personal liability that is extended to shareholders of a private corporation for profit incorporated in the State of Delaware.
The Declaration of Trust provides that no Trustee, officer, employee or agent of the Trust or any series of the Trust shall be subject in such capacity to any personal liability whatsoever to any person, unless, as to liability to the Trust or its shareholders, the Trustees engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of their offices.
The Trust shall continue without limitation of time subject to the provisions in the Declaration of Trust concerning termination by action of the Trustees, and without any vote of the Trusts shareholders, except as may be required under the 1940 Act.
Trust Matters
The Trust reserves the right to create and issue a number of series shares, in which case the shares of each series would participate equally in the earnings, dividends and assets of the particular series and would vote separately to approve investment advisory agreements or changes in fundamental investment policies, but shares of all series would vote together in the election or selection of Trustees and on any other matters as may be required by applicable law.
Upon liquidation of the Trust or any series, shareholders of the affected series would be entitled to share pro rata in the net assets of their respective series available for distribution to such shareholders
Shareholder Approval
Other than elections of Trustees, which is by plurality, any matter for which shareholder approval is required by the 1940 Act requires the affirmative vote of a majority of the outstanding voting securities of the Fund or the Trust at a meeting called for the purpose of considering such approval. For other matters, generally an affirmative vote of a majority of the shares present in person or represented by proxy and entitled to vote on such matter (assuming a quorum is present) shall be required for approval of such matter.
Information for Shareholders
All shareholder inquiries regarding administrative procedures, including the purchase and redemption of shares, should be directed to the Distributor, SEI Investments Distribution Co., One Freedom Valley Drive, Oaks, Pennsylvania 19456. For assistance, call (855) 799-4757 or visit the Funds website at http://www.highlandfunds.com.
CONTROL PERSONS AND PRINCIPAL SHAREHOLDERS
As of September 30, 2017, the Trustees and officers of the Fund as a group owned less than 1% of the then outstanding shares of the Fund.
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A person who beneficially owns, either directly or indirectly, more than 25% of the voting securities of the Fund or acknowledges the existence of such control may be presumed to control the Fund. A control person could potentially control the outcome of any proposal submitted to the shareholders for approval, including changes to the Funds fundamental policies or terms of the investment advisory agreement with the Adviser.
As of September 30, 2017, TD Ameritrade Clearing, Inc. was a control person of Highland/iBoxx Senior Loan ETF.
A principal shareholder is any person who owns (either of record or beneficially) 5% or more of any class of outstanding shares of the Fund. Although the Trust does not have information concerning the beneficial ownership of shares nominally held by DTC, the name and percentage ownership of each DTC Participant that owned of record 5% or more of the outstanding shares of the Fund, as of September 30, 2017 is set forth below:
Name and Address |
Shares Held |
Percentage
Owned |
||||||
TD AMERITRADE CLEARING, INC 1005 N. AMERITRADE PL BELLEVUE, NE 68005 |
10,782,868 | 33.59 | % | |||||
BNY MELLON, US PROXY DEPARTMENT, 525 WILLIAM PENN PLACE, SUITE 0400, PITTSBURGH, PA 15259 |
5,372,394 | 16.74 | % | |||||
NATIONAL FINANCIAL SERVICES LLC 499 WASHINGTON BLVD JERSEY CITY, NJ 07310 |
2,233,392 | 6.96 | % | |||||
FIRST CLEARING LLC SPECIAL CUSTODY ACCT FOR THE EXCLUSIVE BENEFIT OF CUSTOMER 2801 MARKET STREET ST. LOUIS, MO 63103 |
2,148,128 | 6.69 | % | |||||
JP MORGAN SECURITIES LLC/JPMC 500 STANTON CHRISTIANA RD, OPS 4, 3RD FLOOR NEWARK, DE 19713 |
2,053,351 | 6.40 | % | |||||
MORGAN STANLEY & CO. LLC 901 S. BOND ST, 6TH FL BALTIMORE, MD 21231 |
2,002,563 | 6.24 | % | |||||
CHARLES SCHWAB & CO., INC., ATTN: PROXY, PO BOX 64930, PHOENIX, AZ 85082-4930 |
1,799,502 | 5.61 | % |
PURCHASE AND REDEMPTION OF SHARES
The Fund issues and redeems shares only in aggregations of Creation Units. A Creation Unit is comprised of 100,000 shares. The value of a Creation Unit at the Funds inception was $2,000,000.
The Board reserves the right to declare a split or a consolidation in the number of shares outstanding of the Fund, and may make a corresponding change in the number of shares constituting a Creation Unit, in the event that the per shares price in the secondary market rises (or declines) to an amount that falls outside the range deemed desirable by the Board.
Purchase and Issuance of Creation Units. The Fund issues and sells shares only in Creation Units on a continuous basis through the Distributor, without a sales load, at their NAV next determined after receipt, on any Business Day (as defined herein), of an order in proper form. A Business Day with respect to the Fund is any day on which the Exchange is open for business.
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Creation Units of shares may be purchased only by or through a DTC Participant that has entered into an Authorized Participant Agreement with the Distributor. Such Authorized Participant will agree pursuant to the terms of such Authorized Participant Agreement on behalf of itself or any investor on whose behalf it will act, as the case may be, to certain conditions, including that such Authorized Participant will make available an amount of cash sufficient to pay the Balancing Amount (as defined below) if required and the Transaction Fee described in the Prospectus. The Authorized Participant may require the investor to enter into an agreement with such Authorized Participant with respect to certain matters, including payment of the Balancing Amount. Investors who are not Authorized Participants must make appropriate arrangements with an Authorized Participant. Investors should be aware that their particular broker may not be a DTC Participant or may not have executed an Authorized Participant Agreement, and that therefore orders to purchase Creation Units of shares may have to be placed by the investors broker through an Authorized Participant. As a result, purchase orders placed through an Authorized Participant may result in additional charges to such investor. The Fund expects to enter into Authorized Participant Agreements with only a small number of DTC Participants.
Creation Deposit. The consideration for purchase of a Creation Unit of shares of the Fund generally consists of cash only (including the appropriate Transaction Fee). However, the Fund also reserves the right to permit or require the in-kind deposit of a designated portfolio of securities (Deposit Securities) constituting a representation of the Underlying Index, along with the Balancing Amount and the appropriate Transaction Fee (collectively, the Creation Deposit) as consideration for the purchase of a Creation Unit. The Balancing Amount will be the amount equal to the differential, if any, between the total aggregate market value of the Deposit Securities and the NAV of the Creation Units being purchased and will be paid to, or received from, the Trust after the NAV has been calculated.
The Custodian, using information provided by the Administrator, makes available through the NSCC on each Business Day, either immediately prior to the opening of business on the Exchange or the night before, the list of the names and the required number of shares of each Deposit Security to be included in the current Creation Deposit (based on information at the end of the previous Business Day). Such Creation Deposit is applicable, subject to any adjustments as described below, in order to effect purchases of Creation Units of shares the Fund until such time as the next-announced Creation Deposit composition is made available. The Custodian, using information provided by the Administrator, will also make available through the NSCC on each Business Day information about the previous days Balancing Amount.
The identity and number of shares of the Deposit Securities required for a Creation Deposit for the Fund changes as rebalancing adjustments and corporate action events are reflected from time to time by the Adviser with a view to the investment objective of the Fund. The composition of the Deposit Securities may also change in response to adjustments to the weighting or composition of the securities constituting the relevant securities index. In addition, the Trust reserves the right to permit or require the substitution of an amount of cash (i.e., a cash in lieu amount) to be added to the Balancing Amount to replace any Deposit Security or Deposit Securities which may not be available in sufficient quantity for delivery or for other similar reasons. The adjustments described above will reflect changes, known to the Adviser on the date of announcement to be in effect by the time of delivery of the Creation Deposit, in the composition of the subject index being tracked by the Fund, or resulting from stock splits and other corporate actions.
In addition to the list of names and numbers of securities constituting the current Deposit Securities of a Creation Deposit, on each Business Day, the Balancing Amount effective through and including the previous Business Day, per outstanding share of the Fund, will be made available.
Shares may be issued in advance of receipt by the Trust of all or a portion of the applicable Deposit Securities as described below. In these circumstances, the initial deposit will have a greater value than the NAV of the shares on the date the order is placed in proper form since, in addition to the available Deposit Securities, cash must be deposited in an amount equal to the sum of (i) the Balancing Amount, plus (ii) 105% of the market value of the undelivered Deposit Securities (the Additional Cash Deposit). An additional amount of cash shall be required to be deposited with the Trust, pending delivery of the missing Deposit Securities to the extent necessary to maintain
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the Additional Cash Deposit with the Trust in an amount at least equal to 115% of the daily mark-to-market value of the missing Deposit Securities. The Participation Agreement will permit the Trust to buy the missing Deposit Securities at any time. Authorized Participants will be liable to the Trust for the costs incurred by the Trust in connection with any such purchases. These costs will be deemed to include the amount by which the actual purchase price of the Deposit Securities exceeds the market value of such Deposit Securities on the day the purchase order was deemed received by the Distributor plus the brokerage and related transaction costs associated with such purchases. The Trust will return any unused portion of the Additional Cash Deposit once all of the missing Deposit Securities have been properly received by the Custodian or purchased by the Trust and deposited into the Trust. In addition, a Transaction Fee, as listed below, will be charged in all cases. The delivery of shares so purchased will occur no later than the third Business Day following the day on which the purchase order is deemed received by the Distributor.
All questions as to the number of shares of each security in the Deposit Securities and the validity, form, eligibility and acceptance for deposit of any securities to be delivered shall be determined by the Trust, and the Trusts determination shall be final and binding.
Purchases through and outside the Clearing Process. An Authorized Participant may place an order to purchase (or redeem) Creation Units (i) through the Continuous Net Settlement clearing processes of NSCC as such processes have been enhanced to effect purchases (and redemptions) of Creation Units, such processes being referred to herein as the Clearing Process, or (ii) outside the Clearing Process. To purchase or redeem through the Clearing Process, an Authorized Participant must be a member of NSCC that is eligible to use the Continuous Net Settlement system. For purchase orders placed through the Clearing Process, the Authorized Participant Agreement authorizes the Distributor to transmit through the Funds transfer agent (the Transfer Agent) to NSCC, on behalf of an Authorized Participant, such trade instructions as are necessary to effect the Authorized Participants purchase order. Pursuant to such trade instructions to NSCC, the Authorized Participant agrees to deliver the requisite deposit securities and the Balancing Amount to the Trust, together with the Transaction Fee and such additional information as may be required by the Distributor. A purchase order must be received by the Distributor at 4:00 p.m. Eastern time if transmitted by mail or by 3:00 p.m. Eastern time if transmitted by telephone, facsimile or other electronic means permitted under the Participant Agreement in order to receive that days Closing NAV per Share.
An Authorized Participant that wishes to place an order to purchase Creation Units outside the Clearing Process must state that it is not using the Clearing Process and that the purchase instead will be effected through a transfer of securities and cash directly through DTC. Purchases (and redemptions) of Creation Units settled outside the Clearing Process will be subject to a higher Transaction Fee than those settled through the Clearing Process. Purchase orders effected outside the Clearing Process are likely to require transmittal by the Authorized Participant earlier on the Transmittal Date than orders effected using the Clearing Process. The Creation Deposit transfer must be ordered on the Transmittal Date in a timely fashion so as to ensure the delivery of the requisite number of Deposit Securities through DTC to the account of the Fund by no later than 11:00 a.m. Eastern Time of the next Business Day immediately following such Transmittal Date. The cash equal to the Cash Amount must be transferred directly to the Fund through the Federal Reserve Bank wire transfer system in a timely manner so as to be received by the Fund no later than 2:00 p.m. Eastern Time on the next Business Day immediately following the Transmittal Date. Those persons placing orders outside the Clearing Process should ascertain the deadlines applicable to DTC and the Federal Reserve Bank wire system by contacting the operations department of the broker or depository institution effectuating such transfer.
Rejection of Purchase Orders. The Trust reserves the absolute right to reject a purchase order transmitted to it by the Distributor in respect to the Fund if (a) the order is not in proper form; (b) the purchaser or group of purchasers, upon obtaining the shares ordered, would own 80% or more of the currently outstanding shares of the Fund; (c) the deposit securities delivered are not as specified by the Adviser and the Adviser has not consented to acceptance of an in-kind deposit that varies from the designated deposit securities; (d) acceptance of the purchase transaction order would have certain adverse tax consequences to the Fund; (e) the acceptance of the purchase transaction order would, in the opinion of counsel, be unlawful; (f) the acceptance of the purchase order transaction would otherwise, in the discretion of the Trust or the Adviser, have an adverse effect on the Trust or the rights of beneficial owners; (g) the value of a cash purchase amount, or the value of the Balancing Amount to accompany an in-kind deposit, exceeds a purchase authorization limit extended to an Authorized Participant by the custodian and
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the Authorized Participant has not deposited an amount in excess of such purchase authorization with the custodian prior to the relevant cut-off time for the Fund on the Transmittal Date; or (h) in the event that circumstances outside the control of the Trust, the Distributor and the Adviser make it impractical to process purchase orders. The Trust shall notify a prospective purchaser of its rejection of the order of such person. The Trust and the Distributor are under no duty, however, to give notification of any defects or irregularities in the delivery of purchase transaction orders nor shall either of them incur any liability for the failure to give any such notification.
Redemption of Creation Units. Shares may be redeemed only in Creation Units at their NAV next determined after receipt of a redemption request in proper form by the Distributor on any Business Day. The Trust will not redeem shares in amounts less than Creation Units. Beneficial owners also may sell shares in the secondary market, but must accumulate enough shares to constitute a Creation Unit in order to have such shares redeemed by the Trust. There can be no assurance, however, that there will be sufficient liquidity in the public trading market at any time to permit assembly of a Creation Unit of shares. Investors should expect to incur brokerage and other costs in connection with assembling a sufficient number of shares to constitute a redeemable Creation Unit.
The Custodian, using information provided by the Administrator, through the NSCC, makes available prior to the opening of business on the Exchange on each Business Day, the identity of the Fund securities that will be applicable (subject to possible amendment or correction) to redemption requests received in proper form on that day. Fund securities received in redemption may not be identical to Deposit Securities that are applicable to creations of Creation Units. Redemption proceeds for a Creation Unit generally consist of cash; however, the Fund also reserves the right to make the redemptions entirely or partly in the announced Fund securities plus or minus cash in an amount equal to the difference between the NAV of the shares being redeemed, as next determined after a receipt of a request in proper form, and the value of the Fund securities, less a redemption transaction fee.
Redemptions of shares for Fund securities will be subject to compliance with applicable federal and state securities laws, and the Fund reserves the right to redeem Creation Units for cash if the Trust could not lawfully deliver specific Fund securities upon redemptions or could not do so without first registering the Fund securities under such laws. An Authorized Participant or an investor for which it is acting subject to a legal restriction with respect to a particular security included in the Fund securities applicable to the redemption of a Creation Unit may be paid an equivalent amount of cash. This would specifically prohibit delivery of Fund securities that are not registered in reliance upon Rule 144A under the Securities Act to a redeeming investor that is not a qualified institutional buyer, as such term is defined under Rule 144A of the Securities Act. The Authorized Participant may request the redeeming beneficial owner of the shares to complete an order form or to enter into agreements with respect to such matters as compensating cash payment.
The Fund, however, may suspend the right of redemption and postpone payment for more than seven days: (i) during periods when trading on the Exchange is closed on days other than weekdays or holidays; (ii) during periods when trading on the Exchange is restricted; (iii) during any emergency which makes it impractical for the Fund to dispose of its securities or fairly determine the NAV of the Fund; and (iv) during any other period permitted by the SEC for your protection.
Placement of Redemption Orders through and outside Clearing Process. Orders to redeem Creation Units of the Fund through the Clearing Process must be delivered through an Authorized Participant that is a member of NSCC that is eligible to use the Continuous Net Settlement System. A redemption order must be received by the Distributor prior to 4:00 p.m. Eastern Time if transmitted by mail or by 3:00 p.m. Eastern Time if transmitted by telephone, facsimile or other electronic means permitted under the Participant Agreement in order to receive that days closing NAV per Share. All other procedures set forth in the Participant Agreement must be followed in order for you to receive the NAV determined on that day. The requisite cash or Fund securities and the Balancing Amount will be transferred by the third NSCC Business Day following the date on which such request for redemption is deemed received.
Orders to redeem Creation Units of the Fund outside the Clearing Process must be delivered through a DTC Participant that has executed the Participant Agreement. A DTC Participant who wishes to place an order for redemption of Creation Units of the Fund to be effected outside the Clearing Process need not be a participating party under the Authorized Participant Agreement, but such orders must state that the DTC Participant is not using the Clearing Process and that redemption of Creation Units will instead be effected through transfer of Shares
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directly through DTC. A redemption order must be received by the Distributor prior to 4:00 p.m. Eastern Time if transmitted by mail or by 3:00 p.m. Eastern Time if transmitted by telephone, facsimile or other electronic means permitted under the Authorized Participant Agreement in order to receive that days closing NAV per Share. All other procedures set forth in the Authorized Participant Agreement must be followed in order for you to receive the NAV determined on that day. The order must be accompanied or preceded by the requisite number of shares of the Fund specified in such order, which delivery must be made through DTC to the Custodian no later than 11:00am Eastern Time on the next Business Day immediately following such Transmittal Date (DTC Cut-Off Time). All other procedures set forth in the Authorized Participant Agreement must be properly followed. After the Transfer Agent has deemed an order for redemption outside the Clearing Process received, the Transfer Agent will initiate procedures to transfer the requisite cash and, if applicable, Fund securities, which are expected to be delivered within three Business Days following the Transmittal Date on which such redemption order is deemed received by the Transfer Agent.
Transaction Fees. Authorized Participants are charged standard creation and redemption transaction fees (Transaction Fees) to offset transfer and other transaction costs associated with the issuance and redemption of Creation Units. There is a fixed and a variable component to the total Transaction Fee. A fixed Transaction Fee is applicable to each creation or redemption transaction, regardless of the number of Creation Units purchased or redeemed. In addition, a variable Transaction Fee equal to a percentage of the value of each Creation Unit purchased or redeemed is applicable to each creation or redemption transaction. An additional charge of up to 1% of the net asset value per Creation Unit, inclusive of the standard transaction fee, may be imposed for (i) in-kind creations effected outside the normal Clearing Process, and (ii) cash creations (to offset the Trusts brokerage and other transaction costs associated with using cash to purchase the requisite Deposit Securities).
Purchasers of shares in Creation Units are responsible for the costs of transferring the securities constituting the Deposit Securities to the account of the Trust. Investors will also bear the costs of transferring securities from the Fund to their account or on their order. Investors who use the services of a broker or other such intermediary may be charged a fee for such services.
Continuous Offering. The method by which Creation Units of shares are created and traded may raise certain issues under applicable securities laws. Because new Creation Units of shares are issued and sold by the Fund on an ongoing basis, at any point a distribution, as such term is used in the 1933 Act, may occur. Broker-dealers and other persons are cautioned that some activities on their part may, depending on the circumstances, result in their being deemed participants in a distribution in a manner which could render them statutory underwriters and subject them to the prospectus delivery and liability provisions of the 1933 Act. For example, a broker-dealer firm or its client may be deemed a statutory underwriter if it takes Creation Units after placing an order with the Distributor, breaks them down into constituent shares and sells some or all of the shares comprising such Creation Units directly to its customers; or if it chooses to couple the creation of a supply of new shares with an active selling effort involving solicitation of secondary market demand for shares. A determination of whether a person is an underwriter for the purposes of the 1933 Act depends upon all the facts and circumstances pertaining to that persons activities. Thus, the examples mentioned above should not be considered a complete description of all the activities that could lead to a categorization as an underwriter. Broker-dealer firms should also note that dealers who are effecting transactions in shares, whether or not participating in the distribution of shares, are generally required to deliver a prospectus. This is because the prospectus delivery exemption in Section 4(3) of the 1933 Act is not available in respect of such transactions as a result of Section 24(d) of the 1940 Act. The Trust has been granted an exemption by the SEC from this prospectus delivery obligation in ordinary secondary market transactions involving shares under certain circumstances, on the condition that purchasers of shares are provided with a product description of the shares. Broker-dealer firms should note that dealers who are not underwriters but are participating in a distribution (as contrasted to ordinary secondary market transaction), and thus dealing with shares that are part of an unsold allotment within the meaning of section 4(3)(C) of the 1933 Act, would be unable to take advantage of the prospectus delivery exemption provided by section 4(3) of the 1933 Act. Firms that incur a prospectus-delivery obligation with respect to shares are reminded that under 1933 Act Rule 153 a prospectus delivery obligation under Section 5(b)(2) of the 1933 Act owed to a national securities exchange member in connection with a sale on the national securities exchange is satisfied by the fact that the Funds Prospectus is available at the national securities exchange on which the shares of the Fund trade upon request. The prospectus delivery mechanism provided in Rule 153 is only available with respect to transactions on a national securities exchange and not with respect to upstairs transactions.
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The following discussion is a summary of some of the important U.S. federal income tax considerations generally applicable to an investment in the Fund. Your investment may have other tax implications. The discussion reflects provisions of the Code, existing Treasury regulations, rulings published by the Internal Revenue Service (IRS), and other applicable authorities, as of the date of this SAI. These authorities may be changed, possibly with retroactive effect, or subject to new legislative, administrative or judicial interpretations. No attempt is made to present a detailed explanation of all U.S. federal, state, local and foreign tax law concerns affecting the Fund and its shareholders (including shareholders owning large positions in the Fund), and the discussion set forth herein does not constitute tax advice. Please consult your tax advisor about foreign, federal, state, local or other tax laws applicable to you.
Taxation of the Fund
The Fund has elected to be treated and intends each year to qualify and to be eligible to be treated as a RIC under Subchapter M of the Code. In order to qualify for the special tax treatment accorded RICs and their shareholders, the Fund must, among other things:
(a) derive at least 90% of its gross income for each taxable year from (i) dividends, interest, payments with respect to certain securities loans, and gains from the sale or other disposition of stock, securities or foreign currencies, or other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies and (ii) net income derived from interests in qualified publicly traded partnerships (as described below);
(b) diversify its holdings so that, at the end of each quarter of the Funds taxable year, (i) at least 50% of the market value of the Funds total assets consists of cash and cash items, U.S. government securities, securities of other RICs, and other securities limited in respect of any one issuer to a value not greater than 5% of the value of the Funds total assets and not more than 10% of the outstanding voting securities of such issuer, and (ii) not more than 25% of the value of the Funds total assets is invested, including through corporations in which the Fund owns a 20% or more voting stock interest, (x) in the securities (other than those of the U.S. government or other RICs) of any one issuer or of two or more issuers that the Fund controls and that are engaged in the same, similar or related trades or businesses, or (y) in the securities of one or more qualified publicly traded partnerships (as described below); and
(c) distribute with respect to each taxable year at least 90% of the sum of its investment company taxable income (as that term is defined in the Code without regard to the deduction for dividends paidgenerally taxable ordinary income and the excess, if any, of net short-term capital gains over net long-term capital losses) and net tax-exempt income, for such year.
In general, for purposes of the 90% gross income requirement described in (a) above, income derived from a partnership will be treated as qualifying income only to the extent such income is attributable to items of income of the partnership which would be qualifying income if realized directly by the RIC. However, 100% of the net income derived from an interest in a qualified publicly traded partnership (generally, a partnership (x) the interests in which are traded on an established securities market or are readily tradable on a secondary market or the substantial equivalent thereof, and (y) that derives less than 90% of its income from the qualifying income sources described in paragraph (a)(i) above) will be treated as qualifying income. In general, such entities will be treated as partnerships for U.S. federal income tax purposes because they meet the passive income requirement under Code Section 7704(c)(2). In addition, although in general the passive loss rules of the Code do not apply to RICs, such rules do apply to a RIC with respect to items attributable to an interest in a qualified publicly traded partnership. Certain ETFs and certain master limited partnerships (MLPs) in which the Fund may invest may qualify as qualified publicly traded partnerships.
For purposes of meeting the diversification requirement described in (b) above, the term outstanding voting securities of such issuer will include the equity securities of a qualified publicly traded partnership. Also, for
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purposes of the diversification requirement described in (b) above, the identification of the issuer (or, in some cases, issuers) of a particular Fund investment can depend on the terms and conditions of that investment. In some cases, identification of the issuer (or issuers) is uncertain under current law, and an adverse determination or future guidance by the IRS with respect to issuer identification for a particular type of investment may adversely affect the Funds ability to meet diversification test in (b) above.
If the Fund qualifies as a RIC that is accorded special tax treatment, the Fund will not be subject to U.S. federal income tax on income or gains distributed in a timely manner to its shareholders in the form of dividends (including Capital Gain Dividends, as defined below).
If the Fund were to fail to meet the income, diversification or distribution test (described respectively in (a), (b) and (c) above), the Fund could in some cases cure such failure, including by paying a Fund-level tax, paying interest, making additional distributions or disposing of certain assets. If the Fund were ineligible to or otherwise did not cure such failure for any taxable year, or if the Fund were otherwise to fail to qualify as a RIC accorded special tax treatment for such year, the Fund would be subject to tax on its taxable income at corporate rates, and all distributions from earnings and profits, including any distributions of net tax-exempt income and net long-term capital gains, would be taxable to shareholders as ordinary income. Some portions of such distributions might be eligible for the dividends received deduction in the case of corporate shareholders and to be treated as qualified dividend income and thus taxable at the lower net capital gain rate in the case of shareholders taxed as individuals, provided in both cases, the shareholder meets certain holding period and other requirements in respect of the Funds shares (as described below). In addition, the Fund could be required to recognize unrealized gains, pay substantial taxes and interest and make substantial distributions before requalifying as a RIC that is accorded special tax treatment.
The Fund intends to distribute at least annually to its shareholders all or substantially all of its investment company taxable income (computed without regard to the dividends-paid deduction) and may distribute its net capital gain (that is, the excess of net long-term capital gain over net short-term capital loss, in each case determined with reference to any loss carryforwards). Any investment company taxable income retained by the Fund will be subject to Fund-level tax at regular corporate rates. The Fund may also retain for investment its net capital gain. If the Fund retains any net capital gain, it will be subject to Fund-level tax at regular corporate rates on the amount retained, but may designate the retained amount as undistributed capital gain in a timely notice to its shareholders who would then, in turn, be (i) required to include in income for U.S. federal income tax purposes, as long-term capital gain, their shares of such undistributed amount, and (ii) entitled to credit their proportionate shares of the tax paid by the Fund on such undistributed amount against their U.S. federal income tax liabilities, if any, and to claim refunds on a properly-filed U.S. tax return to the extent the credit exceeds such liabilities. If the Fund makes this designation, for U.S. federal income tax purposes, the tax basis of shares owned by a shareholder of the Fund would be increased by an amount equal to the difference between the amount of undistributed capital gains included in the shareholders gross income under clause (i) of the preceding sentence and the tax deemed paid by the shareholder under clause (ii) of the preceding sentence. The Fund is not required to, and there can be no assurance the Fund will, make this designation if it retains all or a portion of its net capital gain in a taxable year.
In determining its net capital gain, including in connection with determining the amount available to support a Capital Gain Dividend (defined below), its taxable income and its earnings and profits, the Fund generally may elect to treat part or all of any post-October capital loss (defined as any net capital loss attributable to the portion, if any, of the taxable year after October 31, or if there is no such loss, the net long-term capital loss or net short-term capital loss attributable to any such portion of the taxable year) or late-year ordinary loss (generally, the sum of its (i) net ordinary loss, if any, from the sale, exchange or other taxable disposition of property, attributable to the portion of the taxable year after October 31, and its (ii) other net ordinary loss, if any, attributable to the portion, if any, of the taxable year after December 31) as if incurred in the succeeding taxable year.
If the Fund were to fail to distribute in a calendar year at least an amount equal to the sum of 98% of its ordinary income (taking into account certain deferrals and elections) for such year and 98.2% of its capital gain net income for the one-year period ending October 31 of such year, plus any such amounts retained from the prior year, the Fund would be subject to a nondeductible 4% excise tax on the undistributed amounts. For purposes of the required excise tax distribution, the Funds ordinary gains and losses from the sale, exchange or other taxable
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disposition of property that would otherwise be taken into account after October 31 of a calendar year generally are treated as arising on January 1 of the following calendar year. Also for these purposes, the Fund will be treated as having distributed any amount on which it has been subject to corporate income tax in the taxable year ending within the calendar year.
A dividend paid to shareholders in January of a year generally is deemed to have been paid by the Fund on December 31 of the preceding year, if the dividend was declared and payable to shareholders of record on a date in October, November or December of that preceding year. The Fund intends generally to make distributions sufficient to avoid imposition of the 4% excise tax, although there can be no assurance that it will be able to do so. In that event, the Fund will be liable for the excise tax only on the amount by which it does not meet the foregoing distribution requirement.
Capital losses in excess of capital gains (net capital losses) are not permitted to be deducted against the Funds net investment income. Instead, subject to certain limitations, the Fund may carry net capital losses forward to subsequent taxable years to offset capital gains, if any, realized during such subsequent taxable year. Capital loss carryforwards are reduced to the extent they offset current-year net realized capital gains, whether the Fund retains or distributes such gains. Carryforward losses may be carried forward to one or more subsequent taxable years without expiration. Any such carryforward losses will retain their character as short-term or long-term. The Funds ability to use net capital losses to offset gains may be limited as a result of certain (i) acquisitive reorganizations and (ii) shifts in the ownership of the Fund by a shareholder owning or treated as owning 5% or more of the stock of the Fund. The Funds available capital loss carryforwards will be set forth in its annual shareholder report for each fiscal year.
Fund Distributions
Distributions are taxable to shareholders even if they are paid from gains earned by the Fund before a shareholders investment (and thus were included in the price the shareholder paid). Distributions are taxable whether shareholders receive them in cash or reinvest them in additional shares pursuant to DTCs Dividend Reinvestment Service (see Dividends and Other Distributions in the Funds Prospectus).
The Fund (or broker or other financial intermediary through which you own your shares) will send you information after the end of each calendar year setting forth the amount and tax status of any distributions paid to you by the Fund. Ordinary income dividends and Capital Gain Dividends (defined below) may also be subject to state, local or other taxes.
For U.S. federal income tax purposes, distributions of investment income are generally taxable to shareholders as ordinary income. Taxes on distributions of capital gains are determined by how long the Fund owned the investments that generated them, rather than how long a shareholder has owned his or her shares. In general, the Fund will recognize long-term capital gain or loss on investments it has owned (or is deemed to have owned) for more than one year, and short-term capital gain or loss on investments it has owned (or is deemed to have owned) for one year or less. Distributions of net capital gain that are properly reported by the Fund as capital gain dividends (Capital Gain Dividends) will be taxable to shareholders as long-term capital gains includible in net capital gain and taxed to individuals at reduced rates. Distributions of net short-term capital gain (as reduced by any net long-term capital loss for the taxable year) will be taxable to shareholders as ordinary income. Distributions of investment income reported by the Fund as derived from qualified dividend income will be taxed in the hands of individuals at the rates applicable to net capital gain, provided holding period and other requirements are met at both the shareholder and Fund level.
In order for some portion of the dividends received by the Fund shareholder to be qualified dividend income, the Fund must meet holding period and other requirements with respect to some portion of the dividend-paying stocks in its portfolio and the shareholder must meet holding period and other requirements with respect to the Funds shares. In general, a dividend will not be treated as qualified dividend income (at either the Fund or shareholder level) (1) if the dividend is received with respect to any share of stock held for fewer than 61 days during the 121-day period beginning on the date which is 60 days before the date on which such share becomes ex-dividend with respect to such dividend (or, in the case of certain preferred stock, 91 days during the 181-day period beginning 90 days before such date), (2) to the extent that the recipient is under an obligation (whether pursuant to a
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short sale or otherwise) to make related payments with respect to positions in substantially similar or related property, (3) if the recipient elects to have the dividend income treated as investment income for purposes of the limitation on deductibility of investment interest, or (4) if the dividend is received from a foreign corporation that is (a) not eligible for the benefits of a comprehensive income tax treaty with the United States (with the exception of dividends paid on stock of such a foreign corporation readily tradable on an established securities market in the United States) or (b) treated as a passive foreign investment company.
In general, distributions of investment income reported by the Fund as derived from qualified dividend income will be treated as qualified dividend income by a shareholder taxed as an individual, provided the shareholder meets the holding period and other requirements described above with respect to the Funds shares. If the aggregate dividends received by the Fund during any taxable year are 95% or more of its gross income (excluding long-term capital gain over net short-term capital loss), then 100% of the Funds dividends (other than dividends properly reported as Capital Gain Dividends) will be eligible to be treated as qualified dividend income. The Fund does not expect a significant portion of its distributions to be eligible for treatment as qualified dividend income.
Dividends of net investment income received by corporate shareholders of the Fund generally will qualify for the 70% dividends-received deduction generally available to corporations to the extent of the amount of eligible dividends received by the Fund from domestic corporations for the taxable year. A dividend received by the Fund will not be treated as a dividend eligible for the dividends-received deduction (1) if it has been received with respect to any share of stock that the Fund has held for less than 46 days (91 days in the case of certain preferred stock) during the 91-day period beginning on the date which is 45 days before the date on which such share becomes ex-dividend with respect to such dividend (during the 181-day period beginning 90 days before such date in the case of certain preferred stock) or (2) to the extent that the Fund is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property. Moreover, the dividends-received deduction may otherwise be disallowed or reduced (1) if the corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of the Fund or (2) by application of the Code (for instance, the dividends-received deduction is reduced in the case of a dividend received on debt-financed portfolio stock (generally, stock acquired with borrowed funds)). The Fund does not expect a significant portion of its distributions to be eligible for the dividends-received deduction.
If the Fund receives dividends from another investment company that qualifies as a RIC and the investment company reports such dividends as qualified dividend income or as eligible for the dividends-received deduction, then the Fund is permitted in turn to report a portion of its distributions as qualified dividend income or as eligible for the dividends received deduction, as applicable, provided the Fund meets holding period and other requirements with respect to shares of the investment company.
The Funds dividends representing distributions of interest income and capital gains or distributions from entities that are not corporations for U.S. tax purposes will not constitute qualified dividend income to individual shareholders and will not be eligible for the dividends-received deduction for corporate shareholders. In addition, any distribution of income that is attributable to (i) income received by the Fund in lieu of dividends with respect to securities on loan pursuant to a securities lending transaction or (ii) dividend income received by the Fund on securities it temporarily purchased from a counterparty pursuant to a repurchase agreement that is treated for U.S. federal income tax purposes as a loan by the Fund, will not constitute qualified dividend income to individual shareholders and will not be eligible for the dividends-received deduction for corporate shareholders.
Section 1411 of the Code generally imposes a Medicare contribution tax of 3.8% is imposed on the net investment income of certain individuals, estates and trusts to the extent their income exceeds certain threshold amounts. Net investment income generally includes for this purpose, among other things, (i) distributions paid by the Fund, including any capital gain dividends, and (ii) net gain recognized on the sale, exchange, redemption or other taxable disposition of shares of the Fund. Shareholders are advised to consult their tax advisers regarding the possible implications of this additional tax on their investment in the Fund.
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Return of Capital Distributions
If the Fund makes a distribution to a shareholder in excess of the Funds current and accumulated earnings and profits in any taxable year, the excess distribution will be treated as a return of capital to the extent of such shareholders tax basis in its shares, and thereafter as capital gain. A return of capital is not taxable, but it reduces a shareholders tax basis in its shares, thus reducing any loss or increasing any gain on a subsequent taxable disposition by the shareholder of its shares.
Dividends and distributions on the Funds shares are generally subject to U.S. federal income tax as described herein to the extent they do not exceed the Funds realized income and gains, even though such dividends and distributions may economically represent a return of a particular shareholders investment. Such distributions are likely to occur in respect of shares purchased at a time when the Funds net asset value reflects either unrealized gains or realized but undistributed income or gains that were therefore included in the price that the shareholder paid. Such distributions may reduce the fair market value of the Funds shares below the shareholders cost basis in those shares. As described above, the Fund is required to distribute realized income and gains regardless of whether the Funds net asset value also reflects unrealized losses.
Tax Implications of Certain Fund Investments
Some debt obligations with a fixed maturity date of more than one year from the date of issuance (and zero-coupon debt obligations with a fixed maturity date of more than one year from the date of issuance) that are acquired by the Fund will be treated as debt obligations that are issued originally at a discount. Generally, the amount of the original issue discount (OID) is treated as interest income and is included in the Funds income (and required to be distributed by the Fund) over the term of the debt security, even though payment of that amount is not received until a later time, upon partial or full repayment or disposition of the debt security.
Some debt obligations with a fixed maturity date of more than one year from the date of issuance that are acquired by the Fund in the secondary market may be treated as having market discount. Very generally, market discount is the excess of the stated redemption price of a debt obligation (or in the case of an obligation issued with OID, its revised issue price) over the purchase price of such obligation. Generally, any gain recognized on the disposition of, and any partial payment of principal on, a debt security having market discount is treated as ordinary income to the extent the gain, or principal payment, does not exceed the accrued market discount on such debt security. Alternatively, the Fund may elect to accrue market discount currently and thus distribute it over the term of the debt security, even though the payment of that amount is not received until a later time, upon partial or full repayment or disposition of the debt security. The rate at which the market discount accrues, and thus is included in the Funds income, will depend upon which of the permitted accrual methods the Fund elects.
Some debt obligations with a fixed maturity date of one year or less from the date of issuance may be treated as having OID or acquisition discount (very generally, the excess of the stated redemption price over the purchase price). Generally, the Fund will be required to include the OID or acquisition discount in income (as ordinary income) over the term of the debt security, even though payment of that amount is not received until a later time, upon partial or full repayment or disposition of the debt security. The rate at which OID or acquisition discount accrues, and thus is included in the Funds income, will depend upon which of the permitted accrual methods the Fund elects.
A portion of the Funds investments in loans and other debt obligations may be treated as having market discount, acquisition discount and/or OID, which, in some cases, could be significant.
Some preferred securities may include provisions that permit the issuer, at its discretion, to defer the payment of distributions for a stated period without any adverse consequences to the issuer. If the Fund owns a preferred security that is deferring the payment of its distributions, the Fund may be required to report income for U.S. federal income tax purposes to the extent of any such deferred distribution even though the Fund has not yet actually received the cash distribution.
If the Fund holds the foregoing kinds of obligations, or other obligations subject to special rules under the Code, it may be required to pay out as an income distribution each year an amount which is greater than the total amount of cash interest the Fund actually received. Such distributions may be made from the cash assets of the Fund
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or, if necessary, by liquidation of portfolio securities (including at a time when it may not be advantageous to do so). The Fund may realize gains or losses from such liquidations. In the event the Fund realizes net long-term or short-term capital gains from such transactions, its shareholders may receive a larger Capital Gain Dividend or ordinary dividend, respectively, than they would in the absence of such transactions.
Investments in high-yield debt obligations (known as junk) or other distressed debt obligations that are at risk of or in default present special tax issues for the Fund investing in or holding such securities. Tax rules are not entirely clear about issues such as whether or to what extent the Fund should recognize market discount on a debt obligation, when the Fund may cease to accrue interest, OID or market discount, when and to what extent the Fund may take deductions for bad debts or worthless securities and how the Fund should allocate payments received on obligations in default between principal and income. These and other related issues will be addressed by the Fund as necessary, in order to seek to ensure that it distributes sufficient income to preserve its eligibility for treatment as a RIC and does not become subject to U.S. federal income or excise tax.
A portion of the OID paid or accrued on certain high-yield discount obligations owned by the Fund may not be deductible to the issuer and will instead be treated as a dividend paid by the issuer for purposes of the dividends-received deduction. In such cases, if the issuer of the obligation is a domestic corporation, dividend payments by the Fund may be eligible for the dividends-received deduction to the extent of the deemed dividend portion of such OID.
Very generally, where the Fund purchases a bond at a price that exceeds the redemption price at maturity that is, at a premium the premium is amortizable over the remaining term of the bond. In the case of a taxable bond, if the Fund makes an election applicable to all such bonds it purchases, which election is irrevocable without consent of the IRS, the Fund reduces the current taxable income from the bond by the amortized premium and reduces its tax basis in the bond by the amount of such offset; upon the disposition or maturity of such bonds acquired on or after January 4, 2013, the Fund is permitted to deduct any remaining premium allocable to a prior period.
The Fund may invest directly or indirectly in residual interests in real estate mortgage investment conduits (REMICs) (including by investing in residual interests in collateralized mortgage obligations with respect to which an election to be treated as a REMIC is in effect) or equity interests in taxable mortgage pools (TMPs). Under a notice issued by the IRS in October 2006 and Treasury regulations that have yet to be issued but may apply retroactively, a portion of the Funds income (including income allocated to the Fund from a pass-through entity) that is attributable to a residual interest in a REMIC or an equity interest in a TMP (referred to in the Code as an excess inclusion) will be subject to U.S. federal income tax in all events. This notice also provides, and the regulations are expected to provide, that excess inclusion income of a RIC will be allocated to shareholder of the RIC in proportion to the dividends received by such shareholders, with the same consequences as if the shareholders held the related interest directly. As a result, the Fund investing in such interests may not be a suitable investment for charitable remainder trusts. See Tax-Exempt Shareholders below.
In general, excess inclusion income allocated to shareholders (i) cannot be offset by net operating losses (subject to a limited exception for certain thrift institutions), (ii) will constitute unrelated business taxable income (UBTI) to entities (including a qualified pension plan, an individual retirement account, a 401(k) plan, a Keogh plan or other tax-exempt entity) subject to tax on UBTI, thereby potentially requiring such an entity that is allocated excess inclusion income, and otherwise might not be required to file a tax return, to file a tax return and pay tax on such income, and (iii) in the case of a non-U.S. shareholder, will not qualify for any reduction in U.S. federal withholding tax. A shareholder will be subject to U.S. federal income tax on such inclusions notwithstanding any exemption from such income tax otherwise available under the Code.
Any transactions by the Fund in foreign currencies, foreign currency-denominated debt obligations or certain foreign currency options, futures contracts or forward contracts (or similar instruments) may give rise to ordinary income or loss to the extent such income or loss results from fluctuations in the value of the foreign currency concerned. Such ordinary income treatment may accelerate Fund distributions to shareholders and increase the distributions taxed to shareholders as ordinary income. Any net ordinary losses so created cannot be carried forward by the Fund to offset income or gains earned in subsequent years.
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Any equity investments by the Fund in certain passive foreign investment companies (PFICs) could potentially subject the Fund to a U.S. federal income tax (including interest charges) on distributions received from the PFIC or on proceeds received from the disposition of shares in the PFIC. This tax cannot be eliminated by making distributions to Fund shareholders. However, the Fund may elect to avoid the imposition of that tax. For example, the Fund may elect to treat a PFIC as a qualified electing fund (i.e., make a QEF election), in which case the Fund will be required to include its share of the PFICs income and net capital gains annually, regardless of whether it receives any distribution from the PFIC. The Fund also may make an election to mark the gains (and to a limited extent losses) in such holdings to the market as though it had sold and repurchased its holdings in those PFICs on the last day of the Funds taxable year. Such gains and losses are treated as ordinary income and loss. The QEF and mark-to-market elections may accelerate the recognition of income (without the receipt of cash) and increase the amount required to be distributed by the Fund to avoid taxation. Making either of these elections therefore may require the Fund to liquidate other investments (including when it is not advantageous to do so) to meet its distribution requirement, which also may accelerate the recognition of gain and affect the Funds total return. Dividends paid by PFICs will not be eligible to be treated as qualified dividend income. Because it is not always possible to identify a foreign corporation as a PFIC, the Fund may incur the tax and interest charges described above in some instances.
The Funds income from or its gains or proceeds in respect of the disposition of its investments in foreign countries may be subject to withholding and other taxes imposed by such countries. These withholding and other taxes will decrease the Funds yield on the securities subject to such taxes. Tax treaties between certain countries and the U.S. may reduce or eliminate such taxes.
The Funds derivatives transactions, as well as any hedging, straddle and short sale transactions, generally are subject to one or more special tax rules (including, for instance, notional principal contract, mark-to-market, constructive sale, straddle, wash sale and short sale rules). These rules may affect whether gains and losses recognized by the Fund are treated as ordinary or capital and/or as short-term or long-term, accelerate the recognition of income or gains to the Fund, defer losses to the Fund, and cause adjustments in the holding periods of the Funds securities. These rules could therefore affect the amount, timing and/or character of distributions to shareholders. In addition, because these and other tax rules applicable to derivative financial instruments are in some cases uncertain under current law, an adverse determination or future guidance by the IRS with respect to these rules (which determination or guidance could be retroactive) may affect whether the Fund has made sufficient distributions, and otherwise satisfied the relevant requirements, to maintain its qualification as a RIC and avoid a Fund-level tax.
In addition, certain of the Funds derivatives transactions and investments in foreign currency-denominated debt instruments as well as any of the Funds transactions in foreign currencies or its hedging activities are likely to produce a difference between the Funds book income and the sum of its taxable income and net tax-exempt income (if any). If the Funds book income exceeds the sum of its taxable income (including net realized capital gains) and net tax-exempt income (if any), the distribution (if any) of such excess generally will be treated as (i) a dividend to the extent of the Funds remaining earnings and profits (including earnings and profits arising from tax-exempt income), (ii) thereafter, as a return of capital to the extent of the recipients basis in its shares, and (iii) thereafter, as gain from the sale or exchange of a capital asset. If the Funds book income is less than the sum of its taxable income and net tax-exempt income (if any), the Fund could be required to make distributions exceeding book income to qualify as a RIC that is accorded special tax treatment.
To the extent the Fund participates in short sales by contracting for the sale of securities it does not own and later purchasing securities necessary to close the sale, the character of the gain or loss realized on such a short sale is determined by reference to the property used to close the short sale and is thus generally short-term. Because net short-term capital gain (after reduction by any long-term capital loss) is generally taxed at ordinary income rates, the Funds short sale transactions can increase the percentage of the Funds gains that are taxable to shareholders as ordinary income.
Backup Withholding
The Fund (or a broker or other financial intermediary through which shares are held) generally is required to withhold and remit to the U.S. Treasury a percentage of the taxable distributions and redemption proceeds paid to
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any individual shareholder who fails to properly furnish the Fund (or intermediary) with a correct taxpayer identification number (TIN), who has under-reported dividend or interest income, or who fails to certify to the Fund (or intermediary) that he or she is not subject to such withholding. The backup withholding tax rate is 28%. Backup withholding is not an additional tax. Any amounts withheld may be credited against the shareholders U.S. federal income tax liability, provided the appropriate information is furnished to the IRS.
Sale, Exchange or Redemption of Fund Shares
The sale, exchange or redemption of Fund shares may give rise to a gain or loss to the shareholder. In general, any gain or loss realized upon a taxable disposition of shares will be treated as long-term capital gain or loss if the shares have been held for more than 12 months. Otherwise, the gain or loss on the taxable disposition of Fund shares will be treated as short-term capital gain or loss. However, any loss realized upon a taxable disposition of shares held for six months or less will be treated as long-term, rather than short-term, to the extent of any Capital Gain Dividends received (or deemed received) by the shareholder with respect to those shares. In addition, all or a portion of any loss realized upon a taxable disposition of Fund shares will be disallowed under the wash-sale rule of the Code if other substantially identical shares of the Fund are purchased within 30 days before or after the disposition. In such a case, the basis of the newly purchased shares will be adjusted to reflect the disallowed loss.
Shareholders may be entitled to offset their Capital Gain Dividends with capital loss from other sources. The Code contains a number of statutory provisions affecting the circumstances under which capital loss may be offset against capital gain and limiting the use of loss from certain investments and activities. Accordingly, shareholders that have capital losses are urged to consult their tax advisers.
Upon the redemption or exchange of Fund shares, the Fund or, in the case of shares purchased through an intermediary, the intermediary may be required to provide you and the IRS with cost basis and certain other related tax information about the Fund shares you redeemed or exchanged. See the Prospectus for more information.
Tax Shelter Reporting Regulations
Under Treasury regulations, if a shareholder recognizes a loss of $2 million or more for an individual shareholder or $10 million or more for a corporate shareholder, the shareholder must file with the IRS a disclosure statement on Form 8886. Direct holders of portfolio securities are in many cases excepted from this reporting requirement, but under current guidance, shareholders of a RIC are not excepted. Future guidance may extend the current exception from this reporting requirement to shareholders of most or all RICs. The fact that a loss is reportable under these regulations does not affect the legal determination of whether the taxpayers treatment of the loss is proper. Shareholders should consult their tax advisers to determine the applicability of these regulations in light of their individual circumstances.
Non-U.S. Shareholders;
Distributions by the Fund to shareholders that are not U.S. persons within the meaning of the Code (foreign shareholders) properly reported by the Fund as (1) Capital Gain Dividends, (2) short-term capital gain dividends, and (3) interest-related dividends, each as defined and subject to certain conditions described below, generally will not be subject to withholding of U.S. federal income tax.
In general, the Code defines (1) short-term capital gain dividends as distributions of net short-term capital gains in excess of net long-term capital losses, and (2) interest-related dividends as distributions from U.S. source interest income of types similar to those not subject to U.S. federal income tax if earned directly by an individual foreign shareholder, in each case to the extent such distributions are properly reported as such by the Fund in a written notice to shareholders.
The exceptions to withholding for Capital Gain Dividends and short-term capital gain dividends do not apply to (A) distributions to an individual foreign shareholder who is present in the United States for a period or periods aggregating 183 days or more during the year of the distribution and (B) distributions attributable to gain that is treated as effectively connected with the conduct by the foreign shareholder of a trade or business within the United States under special rules regarding the disposition of U.S. real property interests (USRPI) as described below. The exception to withholding for interest-related dividends does not apply to distributions to a foreign shareholder that (A) has not provided a satisfactory statement that the beneficial owner is not a U.S. person, (B) to
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the extent that the dividend is attributable to certain interest on an obligation if the foreign shareholder is the issuer or is a 10% shareholder of the issuer, (C) that is within certain foreign countries that have inadequate information exchange with the United States, or (D) to the extent the dividend is attributable to interest paid by a person that is a related person of the foreign shareholder and the foreign shareholder is a controlled foreign corporation. The Fund is permitted to report such part of its dividends as interest-related or short-term capital gain dividends as are eligible, but is not required to do so. In the case of shares held through an intermediary, the intermediary may withhold even if the Fund reports all or a portion of a payment as an interest-related or short-term capital gain dividend to shareholders. Foreign shareholders should contact their intermediaries regarding the application of these rules to their accounts. Distributions by the Fund to foreign shareholders other than Capital Gain Dividends, short-term capital gain dividends, and interest-related dividends (e.g., dividends attributable to dividend and foreign-source interest income or to short-term capital gains or U.S. source interest income to which the exception from withholding described above does not apply) are generally subject to withholding of U.S. federal income tax at a rate of 30% (or lower applicable treaty rate). , Foreign shareholders should contact their intermediaries regarding the application of these rules to their accounts.
A foreign shareholder is not, in general, subject to U.S. federal income tax on gains (and is not allowed a deduction for losses) realized on the sale of shares of the Fund unless (i) such gain is effectively connected with the conduct of a trade or business carried on by such holder within the United States, (ii) in the case of an individual holder, the holder is present in the United States for a period or periods aggregating 183 days or more during the year of the sale and certain other conditions are met, or (iii) the special rules relating to gain attributable to the sale or exchange of USRPIs apply to the foreign shareholders sale of shares of the Fund (as described below).
Foreign shareholders with respect to whom income from the Fund is effectively connected with a trade or business conducted by the foreign shareholder within the United States will, in general, be subject to U.S. federal income tax on the income derived from the Fund at the graduated rates applicable to U.S. citizens, residents or domestic corporations, whether such income is received in cash or reinvested in shares of the Fund and, in the case of a foreign corporation, may also be subject to a branch profits tax.
If a foreign shareholder is eligible for the benefits of a tax treaty, any effectively connected income or gain will generally be subject to U.S. federal income tax on a net basis only if it is also attributable to a permanent establishment maintained by the shareholder in the United States. More generally, foreign shareholders who are residents in a country with an income tax treaty with the United States may obtain different tax results than those described herein and are urged to consult their tax advisers.
Special rules apply to distributions to certain foreign shareholders from a RIC that is a qualified investment entity (QIE) because it is either a U.S. real property holding corporation (USRPHC) or former USRPHC or would be a USRPHC absent certain exclusions from the definition of USRPIs. Very generally, a USRPHC is a domestic corporation that holds USRPIs USRPIs are defined generally as any interest in U.S. real property or any equity interest in a USRPHC or former USRPHC the fair market value of which, during specified testing periods, equals or exceeds 50% of the sum of the fair market values of the corporations USRPIs, interests in real property located outside the United States and other assets. The Fund generally does not expect that it will be a USRPHC or would be a USRPHC but for the operation of the special exceptions referred to above, and thus does not expect these special tax rules to apply.
In order to qualify for any exemption from withholding described above (to the extent applicable) or for lower withholding tax rates under applicable income tax treaties, or to establish an exemption from backup withholding, a foreign shareholder must comply with applicable certification requirements relating to its non-U.S. status (including, in general, furnishing an IRS Form W-8BEN, IRS Form W-8BEN-E or substitute form). Foreign shareholders should contact their tax advisers in this regard.
A foreign shareholder may be subject to state and local tax and to the U.S. federal estate tax in addition to the U.S. federal tax on income referred to above.
Tax-Exempt Shareholders
Under current law, a RIC serves to block (that is, prevent the attribution to shareholders of) unrelated business taxable income (UBTI) from being realized by tax-exempt shareholders. Notwithstanding this blocking
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effect, a tax-exempt shareholder could realize UBTI by virtue of its investment in a RIC if shares in that RIC constitute debt-financed property in the hands of the tax-exempt shareholder within the meaning of Code Section 514(b).
A tax-exempt shareholder may also recognize UBTI if a RIC recognizes excess inclusion income derived from direct or indirect investments in residual interests in REMICS or equity interests in TMPs if the amount of such income recognized by the RIC exceeds the RICs investment company taxable income (after taking into account deductions for dividends paid by the RIC).
In addition, special tax consequences apply to charitable remainder trusts (CRTs) that invest in RICs that invest directly or indirectly in residual interests in REMICs or equity interests in TMPs. Under legislation enacted in December 2006, a CRT (as defined in section 664 of the Code) that realizes any UBTI for a taxable year must pay an excise tax annually of an amount equal to such UBTI. Under IRS guidance issued in October 2006, a CRT will not recognize UBTI as a result of investing in a RIC to the extent it recognizes excess inclusion income. Rather, if at any time during any taxable year a CRT (or one of certain other tax-exempt shareholders, such as the United States, a state or political subdivision, or an agency or instrumentality thereof, and certain energy cooperatives) is a record holder of the RIC and that RIC recognizes excess inclusion income, then the RIC will be subject to a tax on that portion of its excess inclusion income for the taxable year that is allocable to such shareholders at the highest federal corporate income tax rate. The extent to which this IRS guidance remains applicable in light of the December 2006 legislation is unclear. To the extent permitted under the 1940 Act, a RIC may elect to specially allocate any such tax to the applicable CRT, or other shareholder, and thus reduce such shareholders distributions for the year by the amount of the tax that relates to such shareholders interest in the RIC.
CRTs and other tax-exempt investors are urged to consult their tax advisers concerning the consequences of investing in the Fund.
Shareholder Reporting Obligations With Respect to Foreign Bank and Financial Accounts
Shareholders that are U.S. persons and own, directly or indirectly, more than 50% of the Fund could be required to report annually their financial interest in the Funds foreign financial accounts, if any, on FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). Shareholders should consult a tax adviser, and persons investing in the Fund through an intermediary should contact their intermediary, regarding the applicability to them of this reporting requirement.
Other Reporting and Withholding Requirements
Sections 1471-1474 of the Code and the U.S. Treasury and IRS guidance issued thereunder (collectively, FATCA) generally require a Fund to obtain information sufficient to identify the status of each of its shareholders under FATCA or under an applicable intergovernmental agreement (an IGA) between the United States and a foreign government. If a shareholder fails to provide the requested information or otherwise fails to comply with FATCA or an IGA, a Fund may be required to withhold under FATCA at a rate of 30% with respect to that shareholder on ordinary dividends it pays and 30% of the gross proceeds of redemptions or exchanges of Fund shares and certain Capital Gain Dividends the Fund pays on or after January 1, 2019. If a payment by a Fund is subject to FATCA withholding, the Fund or its agent is required to withhold even if such payment would otherwise be exempt from withholding under the rules applicable to foreign shareholders described above (e.g., Capital Gain Dividends, short-term capital gain dividends and interest-related dividends).
Each prospective investor is urged to consult its tax adviser regarding the applicability of FATCA and any other reporting requirements with respect to the prospective investors own situation. Persons investing in the Fund through an intermediary should contact their intermediary regarding the application of this reporting and withholding regime to their investments in the Fund.
Creation and Redemption of Creation Units
An Authorized Participant that purchases Creation Units in exchange for cash, portfolio securities or a combination thereof is generally expected to recognize a gain or a loss on the exchange. The gain or loss generally will be equal to the difference between the market value of the Creation Units at the time and the sum of the cash
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paid by the Authorized Participant and the Authorized Participants aggregate basis in any securities surrendered by the Authorized Participant. An Authorized Participant that redeems Creation Units for cash and/or portfolio securities generally will recognize a gain or loss equal to the difference between the Authorized Participants basis in the Creation Units surrendered and the sum of the cash received by the Authorized Participant and the aggregate market value of any securities received by the Authorized Participant. In certain cases, however, the IRS may assert that a loss realized upon an exchange of securities for Creation Units cannot be deducted currently under the rules governing wash sales, or on the basis that there has been no significant change in economic position. Authorized Participants exchanging securities should consult their own tax adviser with respect to whether or when a loss might be deductible.
Gain or loss recognized by an Authorized Participant upon a purchase of Creation Units in exchange for Component Securities or other debt instruments may be capital or ordinary gain or loss depending on the circumstances. Any capital gain or loss realized upon a purchase of Creation Units in exchange for Component Securities or other debt instruments generally will be treated as long-term capital gain or loss if the securities have been held for more than one year. Any capital gain or loss realized upon a redemption of Creation Units generally will be treated as long-term capital gain or loss if the Creation Units have been held for more than one year. Otherwise, such capital gain or loss generally will be treated as short-term capital gain or loss. Authorized Participants should consult their own tax adviser with respect to the tax treatment to them of any creation or redemption transaction.
Substantial Share Purchases by Authorized Participants
The Fund has the right to reject an order for a purchase of shares of the Fund if the purchaser (or group of purchasers) would, upon obtaining the shares so ordered, own 80% or more of the outstanding shares of the Fund and if, pursuant to Section 351 of the Code, the Fund would have a basis in the securities different from the market value of such securities on the date of deposit. The Fund also has the right to require information necessary to determine beneficial share ownership for purposes of the 80% determination.
Shares Purchased Through Tax Qualified Plans
Special tax rules apply to investments through defined contribution plans and other tax-qualified plans or tax-advantaged arrangements. Shareholders should consult their tax advisers to determine the suitability of shares of the Fund as an investment through such plans and arrangements and the precise effect of an investment on their particular tax situation.
General Considerations
The U.S. federal income tax discussion set forth above is for general information only. Prospective investors should consult their tax advisers regarding the specific U.S. federal tax consequences of purchasing, holding, and disposing of shares of the Fund, as well as the effects of state, local, foreign and other tax law and any proposed tax law changes.
The audited financial statements and notes thereto of the Funds Annual Report to Shareholders for the fiscal year ended June 30, 2017 are incorporated into this SAI by reference and have been audited by KPMG LLP, an independent registered public accounting firm, whose report, along with the financial statements, appears in the Funds 2017 Annual Report to Shareholders for the fiscal year ended June 30, 2017, as filed with the SEC on September 6, 2017 (file # 811-21866).
The audited financial statements incorporated by reference into the Funds Prospectus and this SAI have been so incorporated in reliance upon the report of KPMG LLP, given on its authority as an expert in auditing and accounting. The Funds Annual Report is available without charge by calling the Fund at (855) 799-4757 or on the SECs website at http://www.sec.gov).
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APPENDIX A RATINGS CATEGORIES
Ratings in General. A rating of a rating service represents the services opinion as to the credit quality of the security being rated. However, the ratings are general and are not absolute standards of quality or guarantees as to the creditworthiness of an issuer. Consequently, the Adviser believes that the quality of debt securities should be continuously reviewed and that individual analysts give different weightings to the various factors involved in credit analysis. A rating is not a recommendation to purchase, sell or hold a security because it does not take into account market value or suitability for a particular investor. When a security has received a rating from more than one service, each rating should be evaluated independently. Ratings are based on current information furnished by the issuer or obtained by the rating services from other sources that they consider reliable. Ratings may be changed, suspended or withdrawn as a result of changes in or unavailability of such information, or for other reasons. The following is a description of the characteristics of ratings used by Moodys Investors Service (Moodys) and Standard & Poors (S&P).
Moodys
Global Long-term Rating Scale
Ratings assigned on Moodys global long-term rating scales are forward-looking opinions of the relative credit risks of financial obligations issued by non-financial corporates, financial institutions, structured finance vehicles, project finance vehicles, and public sector entities. Long-term ratings are assigned to issuers or obligations with an original maturity of one year or more and reflect both on the likelihood of a default on contractually promised payments and the expected financial loss suffered in the event of default.
Aaa
Obligations rated Aaa are judged to be of the highest quality, subject to the lowest level of credit risk.
Aa
Obligations rated Aa are judged to be of high quality and are subject to very low credit risk.
A
Obligations rated A are judged to be upper-medium grade and are subject to low credit risk.
Baa
Obligations rated Baa are judged to be medium-grade and subject to moderate credit risk and as such may possess certain speculative characteristics.
Ba
Obligations rated Ba are judged to be speculative and are subject to substantial credit risk.
B
Obligations rated B are considered speculative and are subject to high credit risk.
Caa
Obligations rated Caa are judged to be speculative of poor standing and are subject to very high credit risk.
Ca
Obligations rated Ca are highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest.
A-1
C
Obligations rated C are the lowest rated and are typically in default, with little prospect for recovery of principal or interest.
Note: Moodys appends numerical modifiers 1, 2, and 3 to each generic rating classification from Aa through Caa. The modifier 1 indicates that the obligation ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generic rating category. Additionally, a (hyb) indicator is appended to all ratings of hybrid securities issued by banks, insurers, finance companies, and securities firms.*
* | By their terms, hybrid securities allow for the omission of scheduled dividends, interest, or principal payments, which can potentially result in impairment if such an omission occurs. Hybrid securities may also be subject to contractually allowable write-downs of principal that could result in impairment. Together with the hybrid indicator, the long-term obligation rating assigned to a hybrid security is an expression of the relative credit risk associated with that security. |
Global Short-Term Rating Scale
Ratings assigned on Moodys global short-term rating scales are forward-looking opinions of the relative credit risks of financial obligations issued by non-financial corporates, financial institutions, structured finance vehicles, project finance vehicles, and public sector entities. Short-term ratings are assigned to obligations with an original maturity of thirteen months or less and reflect the likelihood of a default on contractually promised payments.
Moodys employs the following designations to indicate the relative repayment ability of rated issuers:
P-1
Issuers (or supporting institutions) rated Prime-1 have a superior ability to repay short-term debt obligations.
P-2
Issuers (or supporting institutions) rated Prime-2 have a strong ability to repay short-term debt obligations.
P-3
Issuers (or supporting institutions) rated Prime-3 have an acceptable ability to repay short-term obligations.
NP
Issuers (or supporting institutions) rated Not Prime do not fall within any of the Prime rating categories.
S&P
Long-Term Issue Credit Ratings
Issue credit ratings are based, in varying degrees, on S&Ps analysis of the following considerations: (i) likelihood of payment capacity and willingness of the obligor to meet its financial commitment on an obligation in accordance with the terms of the obligation; (ii) nature of and provisions of the obligation, and the promise we impute; and (iii) protection afforded by, and relative position of, the obligation in the event of bankruptcy, reorganization, or other arrangement under the laws of bankruptcy and other laws affecting creditors rights.
Issue ratings are an assessment of default risk, but may incorporate an assessment of relative seniority or ultimate recovery in the event of default. Junior obligations are typically rated lower than senior obligations, to reflect the lower priority in bankruptcy, as noted above. (Such differentiation may apply when an entity has both senior and subordinated obligations, secured and unsecured obligations, or operating company and holding company obligations.)
AAA
An obligation rated AAA has the highest rating assigned by S&P. The obligors capacity to meet its financial commitment on the obligation is extremely strong.
A-2
AA
An obligation rated AA differs from the highest-rated obligations only to a small degree. The obligors capacity to meet its financial commitment on the obligation is very strong.
A
An obligation rated A is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligors capacity to meet its financial commitment on the obligation is still strong.
BBB
An obligation rated BBB exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.
BB, B, CCC, CC, and C
Obligations rated BB, B, CCC, CC, and C are regarded as having significant speculative characteristics. BB indicates the least degree of speculation and C the highest. While such obligations will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to adverse conditions.
BB
An obligation rated BB is less vulnerable to nonpayment than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions which could lead to the obligors inadequate capacity to meet its financial commitment on the obligation.
B
An obligation rated B is more vulnerable to nonpayment than obligations rated BB, but the obligor currently has the capacity to meet its financial commitment on the obligation. Adverse business, financial, or economic conditions will likely impair the obligors capacity or willingness to meet its financial commitment on the obligation.
CCC
An obligation rated CCC is currently vulnerable to nonpayment, and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation.
CC
An obligation rated CC is currently highly vulnerable to nonpayment. The CC rating is used when a default has not yet occurred, but S&P expects default to be a virtual certainty, regardless of the anticipated time to default.
C
An obligation rated C is currently highly vulnerable to nonpayment, and the obligation is expected to have lower relative seniority or lower ultimate recovery compared to obligations that are rated higher.
D
An obligation rated D is in default or in breach of an imputed promise. For non-hybrid capital instruments, the D rating category is used when payments on an obligation are not made on the date due, unless S&P believes that such payments will be made within five business days in the absence of a stated grace period or within the earlier of the stated grace period or 30 calendar days. The D rating also will be used upon the filing of a bankruptcy petition or the taking of similar action and where default on an obligation is a virtual certainty, for example due to automatic stay provisions. An obligations rating is lowered to D if it is subject to a distressed exchange offer.
A-3
Plus (+) or minus (-)
The ratings from AA to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories.
NR
This indicates that no rating has been requested, or that there is insufficient information on which to base a rating, or that S&P does not rate a particular obligation as a matter of policy.
Short-Term Issue Credit Ratings
A-1
A short-term obligation rated A-1 is rated in the highest category by S&P. The obligors capacity to meet its financial commitment on the obligation is strong. Within this category, certain obligations are designated with a plus sign (+). This indicates that the obligors capacity to meet its financial commitment on these obligations is extremely strong.
A-2
A short-term obligation rated A-2 is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher rating categories. However, the obligors capacity to meet its financial commitment on the obligation is satisfactory.
A-3
A short-term obligation rated A-3 exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.
B
A short-term obligation rated B is regarded as vulnerable and has significant speculative characteristics. The obligor currently has the capacity to meet its financial commitments; however, it faces major ongoing uncertainties which could lead to the obligors inadequate capacity to meet is financial commitments.
C
A short-term obligation rated C is currently vulnerable to nonpayment and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitments.
D
A short-term obligation rated D is in default or in breach of an imputed promise. For non-hybrid capital instruments, the D rating category is used when payments on an obligation are not made on the date due, unless S&P believes that such payments will be made within any stated grace period. However, any stated grace period longer than five business days will be treated as five business days. The D rating also will be used upon the filing of a bankruptcy petition or the taking of a similar action and where default on an obligation is a virtual certainty, for example due to automatic stay provisions. An obligations rating is lowered to D if it subject to a distressed exchange offer.
SPUR (S&P Underlying Rating)
A SPUR rating is an opinion about the stand-alone capacity of an obligor to pay debt service on a credit-enhanced debt issue, without giving effect to the enhancement that applies to it. These ratings are published only at the request of the debt issuer/obligor with the designation SPUR to distinguish them from the credit-enhanced rating that applies to the debt issue. S&P maintains surveillance of an issue with a published SPUR.
A-4
HIGHLAND CAPITAL MANAGEMENT FUND ADVISORS, L.P.
POLICY REGARDING PROXY VOTING
Purpose and Scope
The purpose of these voting policies and procedures (the Policy) is to set forth the principles and procedures by which HCMLP (the Company) votes or gives consents with respect to the securities owned by Clients for which the Company exercises voting authority and discretion. 1 For avoidance of doubt, this includes any proxy and any shareholder vote or consent, including a vote or consent for a private company or other issuer that does not involve a proxy. These policies and procedures have been designed to help ensure that votes are cast in the best interests of Clients in accordance with the Companys fiduciary duties and Rule 206(4)-6 under the Investment Advisers Act of 1940 (the Advisers Act).
This Policy applies to securities held in all Client accounts (including Retail Funds and other pooled investment vehicles) as to which the Company has explicit or implicit voting authority. Implicit voting authority exists where the Companys voting authority is implied by a general delegation of investment authority without reservation of proxy voting authority to the Client.
If the Company has delegated voting authority to an investment sub-adviser with respect to any Retail Fund, such sub-adviser will be responsible for voting all proxies for such Retail Funds in accordance with the sub-advisers proxy voting policies. The Compliance Department, to provide oversight over the proxy voting by sub-advisers and to ensure that votes are executed in the best interests of the Retail Funds, shall (i) review the proxy voting policies and procedures of each Retail Fund sub-adviser to confirm that they comply with Rule 206(4)-6, both upon engagement of the sub-adviser and upon any material change to the sub-advisers proxy voting policies and procedures, and (ii) require each such sub-adviser to provide quarterly certifications that all proxies were voted pursuant to the sub-advisers policies and procedures or to describe any inconsistent votes.
1 | In any case where a Client has instructed the Company to vote in a particular manner on the Clients behalf, those instructions will govern in lieu of parameters set forth in the Policy. |
B-1
General Principles
The Company and its affiliates engage in a broad range of activities, including investment activities for their own accounts and for the accounts of various Clients and providing investment advisory and other services to Clients. In the ordinary course of conducting the Companys activities, the interests of a Client may conflict with the interests of the Company, other Clients and/or the Companys affiliates and their clients. Any conflicts of interest relating to the voting of proxies, regardless of whether actual or perceived, will be addressed in accordance with these policies and procedures. The guiding principle by which the Company votes all proxies is to vote in the best interests of each Client by maximizing the economic value of the relevant Clients holdings, taking into account the relevant Clients investment horizon, the contractual obligations under the relevant advisory agreements or comparable documents and all other relevant facts and circumstances at the time of the vote. The Company does not permit voting decisions to be influenced in any manner that is contrary to, or dilutive of, this guiding principle.
B-2
Voting Procedures
Third-Party Proxy Advisors
The Company may engage a third-party proxy advisor (Proxy Advisor) to provide proxy voting recommendations with respect to Client proxies. Proxy Advisor voting recommendation guidelines are generally designed to increase investors potential financial gain. When considering whether to retain or continue retaining any particular Proxy Advisor, the Compliance Department will ascertain, among other things, whether the Proxy Advisor has the capacity and competency to adequately analyze proxy issues. In this regard, the Compliance Department will consider, among other things: the adequacy and quality of the Proxy Advisors staffing and personnel; the robustness of its policies and procedures regarding its ability to (a) ensure that its proxy voting recommendations are based on current and accurate information and (b) identify and address any conflicts of interest and any other considerations that the Compliance Department determines would be appropriate in considering the nature and quality of the services provided by the Proxy Advisor. To identify and address any conflicts that may arise on the part of the Proxy Advisor, the Compliance Department will ensure that the Proxy Advisor notifies the Compliance Department of any relevant business changes or changes to its policies and procedures regarding conflicts.
Third-Party Proxy Voting Services
The Company may utilize a third-party proxy voting service (Proxy Voting Service) to monitor holdings in Client accounts for purposes of determining whether there are upcoming shareholder meetings or similar corporate actions and to execute Client proxies on behalf of the Company pursuant to the Companys instructions, which shall be given in a manner consistent with this Policy. The Compliance Department will oversee each Proxy Voting Service to ensure that proxies have been voted in a manner consistent with the Companys instructions.
B-3
Monitoring
Subject to the procedures regarding Nonstandard Proxy Notices described below, the Compliance Department of the Company shall have responsibility for monitoring Client accounts for proxy notices. Except as detailed below, if proxy notices are received by other employees of the Company, such employees must promptly forward all proxy or other voting materials to the Compliance Department.
Portfolio Manager Review and Instruction
From time to time, the settlement group of the Company may receive nonstandard proxy notices, regarding matters including, but not limited to, proposals regarding corporate actions or amendments (Nonstandard Proxy Notices) with respect to securities held by Clients. Upon receipt of a Nonstandard Proxy Notice, a member of the settlement group (the Settlement Designee) shall send an email notification containing all relevant information to the Portfolio Manager(s) with responsibility for the security and [ .com] . Generally, the relevant Portfolio Manager(s) shall deliver voting instructions for Nonstandard Proxy Notices by replying to the email notice sent to the Portfolio Manager(s) and [ .com] by the Settlement Designee or by sending voting instructions to [ .com] and copying [ .com] . Any conflicts for Nonstandard Proxy Notices should also be disclosed to the Compliance Department. In the event a Portfolio Manager orally conveys voting instructions to the Settlement Designee or any other member of the Companys settlement group, that Settlement Designee or member of the Companys settlement group shall respond to the original notice email sent to [ .com] detailing the Portfolio Manager(s) voting instructions.
With regard to standard proxy notices, on a weekly basis, the Compliance Department will send a notice of upcoming proxy votes related to securities held by Clients and the corresponding voting recommendations of the Proxy Advisor to the relevant Portfolio Manager(s). Upon receipt of a proxy notice from the Compliance Department, the Portfolio Manager(s) will review and evaluate the upcoming votes and recommendations. The Portfolio Managers may rely on any information and/or research available to him or her and may, in his or her discretion, meet with members of an issuers management to discuss matters of importance to the relevant Clients and their economic interests. Should the Portfolio Manager determine that deviating from the Proxy Advisors recommendation is in a Clients best interest, the Portfolio Manager shall communicate his or her voting instructions to the Compliance Department.
In the event that more than one Portfolio Manager is responsible for making a particular voting decision and such Portfolio Managers are unable to arrive at an agreement as to how to vote with respect to a particular proposal, they should consult with the applicable Chief Compliance Officer (the CCO) for guidance.
B-4
Voting
Upon receipt of the relevant Portfolio Managers voting instructions, if any, the Compliance Department will communicate the instructions to the Proxy Voting Service to execute the proxy votes.
Non-Votes
It is the general policy of the Company to vote or give consent on all matters presented to security holders in any vote, and these policies and procedures have been designated with that in mind. However, the Company reserves the right to abstain on any particular vote if, in the judgment of the CCO, or the relevant Portfolio Manager, the effect on the relevant Clients economic interests or the value of the portfolio holding is insignificant in relation to the Clients portfolio, if the costs associated with voting in any particular instance outweigh the benefits to the relevant Clients or if the circumstances make such an abstention or withholding otherwise advisable and in the best interests of the relevant Clients not to vote. Such determination may apply in respect of all Client holdings of the securities or only certain specified Clients, as the Company deems appropriate under the circumstances. As examples, a Portfolio Manager may determine: (a) not to recall securities on loan if, in his or her judgment, the matters being voted upon are not material events affecting the securities and the negative consequences to Clients of disrupting the securities lending program would outweigh the benefits of voting in the particular instance or (b) not to vote proxies relating to certain foreign securities if, in his or her judgment, the expense and administrative inconvenience outweighs the benefits to Clients of voting the securities.
Conflicts of Interest
The Companys Compliance Department is responsible for monitoring voting decisions for any conflicts of interest, regardless of whether they are actual or perceived. All voting decisions contrary to the recommendation of a Proxy Advisor require a mandatory conflicts of interest review by the Compliance Department, which will include a consideration of whether the Company or any Portfolio Manager or other person recommending or providing input on how to vote has an interest in the vote that may present a conflict of interest.
In addition, all Company investment professionals are expected to perform their tasks relating to the voting of proxies in accordance with the principles set forth above, according the first priority to the best interest of the relevant Clients. If at any time a Portfolio Manager or any other investment professional becomes aware of a potential or actual conflict of interest regarding any particular voting decision, he or she must contact
B-5
the Compliance Department promptly and, if in connection with a proxy that has yet to be voted, prior to such vote. If any investment professional is pressured or lobbied, whether from inside or outside the Company, with respect to any particular voting decision, he or she should contact the Compliance Department promptly. The CCO will use his or her best judgment to address any such conflict of interest and ensure that it is resolved in accordance with his or her independent assessment of the best interests of the relevant Clients.
In the event of a conflict, the Company may choose to address such conflict by: (i) voting in accordance with the Proxy Advisors recommendation; (ii) the CCO determining how to vote the proxy (if the CCO approves deviation from the Proxy Advisors recommendation, then the CCO shall document the rationale for the vote); (iii) echo voting or mirror voting the proxy in the same proportion as the votes of other proxy holders that are not Clients; or (iv) with respect to Clients other than Retail Funds, notifying the affected Client of the material conflict of interest and seeking a waiver of the conflict or obtaining such Clients voting instructions. Where the Compliance Department deems appropriate, third parties may be used to help resolve conflicts. In this regard, the CCO or his or her delegate shall have the power to retain fiduciaries, consultants or professionals to assist with voting decisions and/or to delegate voting or consent powers to such fiduciaries, consultants or professionals.
Where a conflict of interest arises with respect to a voting decision for a Retail Fund, the Company shall disclose the conflict and the rationale for the vote taken to the Retail Funds Board of Directors/Trustees at the next regularly scheduled quarterly meeting. The Compliance Department will maintain a log documenting the basis for the decision and will furnish the log to the Board of Trustees.
Material Conflicts of Interest
The following relationships or circumstances are examples of situations that may give rise to a material conflict of interest for purposes of this Policy. This list is not exclusive or determinative; any potential conflict (including payments of the types described below but less than the specified threshold) should be identified to the Companys Compliance Department:
(i) | The issuer is a Client of the Company, or of an affiliate, accounting for more than 5% of the Companys or affiliates annual revenues. |
(ii) | The issuer is an entity that reasonably could be expected to pay the Company or its affiliates more than $1 million through the end of the Companys next two full fiscal years. |
B-6
(iii) | The issuer is an entity in which a Covered Person (as defined in the Companys Policies and Procedures Designed to Detect and Prevent Insider Trading and to Comply with Rule 17j-1 of the Investment Company Act of 1940, as amended (the Code of Ethics)) has a beneficial interest contrary to the position held by the Company on behalf of Clients. |
(iv) | The issuer is an entity in which an officer or partner of the Company or a relative of any such person is or was an officer, director or employee, or such person or relative otherwise has received more than $150,000 in fees, compensation and other payment from the issuer during the Companys last three fiscal years; provided, however, that the Compliance Department may deem such a relationship not to be a material conflict of interest if the Company representative serves as an officer or director of the issuer at the direction of the Company for purposes of seeking control over the issuer. |
(v) | The matter under consideration could reasonably be expected to result in a material financial benefit to the Company or its affiliates through the end of the Companys next two full fiscal years (for example, a vote to increase an investment advisory fee for a Retail Fund advised by the Company or an affiliate). |
(vi) | Another Client or prospective Client of the Company, directly or indirectly, conditions future engagement of the Company on voting proxies in respect of any Clients securities on a particular matter in a particular way. |
(vii) | The Company holds various classes and types of equity and debt securities of the same issuer contemporaneously in different Client portfolios. |
(viii) | Any other circumstance where the Companys duty to serve its Clients interests, typically referred to as its duty of loyalty, could be compromised. |
B-7
Notwithstanding the foregoing, a conflict of interest described above shall not be considered material for the purposes of this Policy in respect of a specific vote or circumstance if:
The securities in respect of which the Company has the power to vote account for less than 1% of the issuers outstanding voting securities, but only if: (i) such securities do not represent one of the 10 largest holdings of such issuers outstanding voting securities and (ii) such securities do not represent more than 2% of the Clients holdings with the Company.
The matter to be voted on relates to a restructuring of the terms of existing securities or the issuance of new securities or a similar matter arising out of the holding of securities, other than common equity, in the context of a bankruptcy or threatened bankruptcy of the issuer.
Recordkeeping
Following the submission of a proxy vote, the Fund will maintain a report of the vote and all relevant documentation.
The Fund shall retain records relating to the voting of proxies and the Company shall conduct due diligence, including on Proxy Voting Services and Proxy Advisors, as applicable, to ensure the following records are adequately maintained by the appropriate party:
(i) | Copies of this Policy and any amendments thereto. |
(ii) | A current copy of the Proxy Advisors voting guidelines, as amended. |
(iii) | A copy of each proxy statement that the Company receives regarding Client securities. The Company may rely on a third party to make and retain, on the Companys behalf, a copy of a proxy statement, provided that the Company has obtained an undertaking from the third party to provide a copy of the proxy statement promptly upon request. |
(iv) | Records of each vote cast by the Company on behalf of Clients. The Company may satisfy this requirement by relying on a third party to make and retain, on the Companys behalf, a record of the vote cast, provided that the Company has obtained an undertaking from the third party to provide a copy of the record promptly upon request. |
(v) | A copy of any documents created by the Company that were material to making a decision how to vote or that memorializes the basis for that decision. |
B-8
(vi) | A copy of each written request for information on how the Company voted proxies on behalf of the Client, and a copy of any written response by the Company to any (oral or written) request for information on how the Company voted. |
B-9
These records shall be maintained and preserved in an easily accessible place for a period of not less than five years from the end of the Companys fiscal year during which the last entry was made in the records, the first two years in an appropriate office of the Company. 1
Enforcement of this Policy
It shall be the responsibility of the Compliance Department to handle or coordinate the enforcement of this Policy. The Compliance Department will periodically sample proxy voting records to ensure that proxies have been voted in accordance with this Policy, with a particular focus on any proxy votes that require additional analysis (e.g., proxies voted contrary to the recommendations of a Proxy Advisor).
If the Compliance Department determines that a Proxy Advisor or Proxy Voting Service may have committed a material error, the Compliance Department will investigate the error, taking into account the nature of the error, and seek to determine whether the Proxy Advisor or Proxy Voting Service is taking reasonable steps to reduce similar errors in the future.
In addition, no less frequently than annually, the Compliance Department will review the adequacy of this Policy to ensure that it has been implemented effectively and to confirm that this Policy continues to be reasonably designed to ensure that proxies are voted in the best interest of Clients.
Disclosures to Clients and Investors
The Company includes a description of its policies and procedures regarding proxy voting in Part 2 of Form ADV, along with a statement that Clients can contact the CCO to obtain a copy of these policies and procedures and information about how the Company voted with respect to a Clients securities. This Policy is, however, subject to change at any time without notice.
B-10
As a matter of policy, the Company does not disclose how it expects to vote on upcoming proxies. Additionally, the Company does not disclose the way it voted proxies to unaffiliated third parties without a legitimate need to know such information.
1 | If the Company has essentially immediate access to a book or record (on the Companys proprietary system or otherwise) through a computer located at an appropriate office of the Company, then that book or record will be considered to be maintained at an appropriate office of the Company. Immediate access to books and records includes that the Company has the ability to provide promptly to Securities and Exchange Commission (the SEC) examination staff hard copies of the books and records or access to the storage medium. The party responsible for the applicable books and records as described above shall also be responsible for ensuring that those books and records for the first two years are either physically maintained in an appropriate office of the Company or that the Company otherwise has essentially immediate access to the required books and records for the first two years. |
B-11
PART C: Other Information
Item 28. | Exhibits |
(a) | (1) | Amended and Restated Agreement and Declaration of Trust of the Registrant, dated September 14, 2012 is incorporated herein by reference to Post-Effective Amendment No. 34 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 19, 2012. | ||||
(2) | (i) | Certificate of Designation dated March 3, 2006 for Highland Long/Short Equity Fund (formerly, Pyxis Long/Short Equity Fund, Highland Long/Short Equity Fund, Highland Equity Opportunities Fund) (Long/Short Equity Fund) is incorporated herein by reference to Post-Effective Amendment No. 4 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on March 1, 2007. | ||||
(ii) | Certificate of Designation dated March 7, 2008 for Highland Long/Short Healthcare Fund (formerly, Pyxis Long/Short Healthcare Fund, Highland Long/Short Healthcare Fund, Highland Healthcare Fund) (Long/Short Healthcare Fund) is incorporated herein by reference to Post-Effective Amendment No. 8 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on March 14, 2008. | |||||
(iii) | Certificate of Designation dated September 14, 2012 for Pyxis/iBoxx Senior Loan ETF (Senior Loan ETF) is incorporated herein by reference to Post-Effective Amendment No. 34 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 19, 2012. | |||||
(iv) | Certificate of Designation dated February 21, 2014 for Highland Unconstrained Income Opportunities Fund is incorporated herein by reference to Post-Effective Amendment No. 42 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on June 30, 2014. | |||||
(v) | Amendment to Certificate of Designation dated June 6, 2014 for Highland Unconstrained Income Opportunities Fund, now known as Highland Opportunistic Credit Fund is incorporated herein by reference to Post-Effective Amendment No. 42 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on June 30, 2014. | |||||
(vi) | Amendment to Certificate of Designation dated June 27, 2014 for Highland Opportunistic Credit Fund, now known as Highland Unconstrained Credit Fund is incorporated herein by reference to Post-Effective Amendment No. 42 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on June 30, 2014. | |||||
(vii) | Amendment to Certificate of Designation dated June 30, 2014 for Highland Unconstrained Credit Fund, now known as Highland Opportunistic Credit Fund (Opportunistic Credit Fund) is incorporated herein by reference to Post-Effective Amendment No. 42 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on June 30, 2014. | |||||
(viii) | Certificate of Designation dated February 19, 2016 for Highland Merger Arbitrage Fund (Merger Arbitrage Fund) is incorporated herein by reference to Post-Effective Amendment No. 72 to the Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on May 12, 2016. | |||||
(ix) | Certificate of Designation dated September 25, 2017 for Highland Floating Rate Fund (Floating Rate Fund) is incorporated herein by reference to Post-Effective Amendment No. 83 to Registrants Registration Statement on Form N-1A, File No 333-132400, filed on September 25, 2017. |
(b) | By-laws of the Registrant are incorporated herein by reference to the Registrants initial Registration Statement on Form N-1A, File No. 333-132400, filed on March 14, 2006. | |||||
(c) | Not applicable. | |||||
(d) | (1) | Amended and Restated Investment Advisory Agreement dated as of December 4, 2006 as amended between Highland Capital Management Fund Advisors, L.P. (formerly, Pyxis Capital, L.P., Highland Capital Management, L.P.) (HCMFA) and the Registrant with respect to Long/Short Equity Fund, is incorporated herein by reference to Post-Effective Amendment No. 38 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 28, 2013. | ||||
(2) | Management Fee Waiver Agreement dated October 26, 2017 between HCMFA and the Registrant on behalf of Long/Short Equity Fund is filed herein. | |||||
(3) | Amended and Restated Investment Advisory Agreement dated as of May 1, 2010 as amended between HCMFA and the Registrant with respect to Long/Short Healthcare Fund is incorporated herein by reference to Post-Effective Amendment No. 38 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 28, 2013. | |||||
(4) | Investment Advisory Agreement dated September 21, 2012 between HCMFA and the Registrant with respect to Senior Loan ETF is incorporated herein by reference to Post-Effective Amendment No. 34 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 19, 2012. | |||||
(5) | Investment Advisory Agreement between HCMFA and the Registrant with respect to Opportunistic Credit Fund is incorporated herein by reference to Post-Effective Amendment No. 42 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on June 30, 2014. | |||||
(6) | Amended and Restated Investment Advisory Agreement dated as of June 5, 2017 as amended between HCMFA and the Registrant with respect to Merger Arbitrage Fund is filed herein. | |||||
(e) | (1) | Distribution Agreement dated March 31, 2014 between Highland Capital Funds Distributor, Inc. (HCFD) and the Registrant is incorporated herein by reference to Post-Effective Amendment No. 42 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on June 30, 2014. | ||||
(i) | Amended Schedule A dated July 1, 2014 to Distribution Agreement between HCFD and the Registrant is incorporated herein by reference to Post-Effective Amendment No. 44 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 29, 2014. | |||||
(ii) | Amended Schedule A dated August 5, 2016 to the Distribution Agreement between HCFD and the Registrant is incorporated herein by reference to Post-Effective Amendment No. 77 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on August 17, 2016. | |||||
(2) | Form of Selling Group Agreement is incorporated herein by reference to Post-Effective Amendment No. 18 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 30, 2009. |
(3) | Distribution Agreement dated September 25, 2012 between SEI Investments Distribution Co. (SEI) and the Registrant is incorporated herein by reference to Post-Effective Amendment No. 64 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 28, 2015. | |||||
(i) | Amendment No. 1 dated December 17, 2012 to Distribution Agreement between SEI and the Registrant with respect to Senior Loan ETF is incorporated herein by reference to Post-Effective Amendment No. 64 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 28, 2015. | |||||
(ii) | Amendment No. 2 dated August 11, 2015 to Distribution Agreement between SEI and the Registrant with respect to Senior Loan ETF is incorporated herein by reference to Post-Effective Amendment No. 64 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 28, 2015. | |||||
(4) | Form of Selling and/or Services Agreement is incorporated herein by reference to Post-Effective Amendment No. 81 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on April 27, 2017. | |||||
(f) | Not applicable. | |||||
(g) | (1) | Master Custodian Agreement dated October 1, 2012 between State Street Bank and Trust Company (State Street) and the Registrant with respect to Senior Loan ETF, Long/Short Equity Fund and Long/Short Healthcare Fund is incorporated herein by reference to Post-Effective Amendment No. 34 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 19, 2012. | ||||
(i) | Notice to Master Custodian Agreement between State Street and the Registrant is incorporated herein by reference to Post-Effective Amendment No. 44 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 29, 2014. | |||||
(ii) | Notice to Master Custodian Agreement between State Street and the Registrant with respect to Merger Arbitrage Fund is incorporated herein by reference to Post-Effective Amendment No. 77 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on August 17, 2016. | |||||
(h) | (1) | Administration Services Agreement dated December 4, 2006 between HCMFA and the Registrant is incorporated herein by reference to Post-Effective Amendment No. 38 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 28, 2013. | ||||
(i) | Amendment No. 1 dated June 6, 2008 to Administration Services Agreement between HCMFA and the Registrant is incorporated herein by reference to Post-Effective Amendment No. 9 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 16, 2008. | |||||
(ii) | Revised Exhibit A dated May 2, 2008 to Administration Services Agreement between HCMFA and the Registrant is incorporated herein by reference to Post-Effective Amendment No. 34 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 19, 2012. | |||||
(iii) | Revised Exhibit A dated February 18, 2016 to Administration Services Agreement between HCMFA and the Registrant is incorporated herein by reference to Post-Effective Amendment No. 77 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on August 17, 2016. | |||||
(iv) | Revised Exhibit A dated June 2, 2017 to Administration Services Agreement between HCMFA and the Registrant is filed herein. |
(2) | Administration Agreement dated September 25, 2012 between SEI Investments Global Funds Services and the Registrant with respect to Senior Loan ETF is incorporated herein by reference to Post-Effective Amendment No. 34 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 19, 2012. | |||||
(i) | Amendment No. 1 dated December 17, 2012 to the Administration Agreement between SEI Investments Global Funds Services and the Registrant with respect to Senior Loan ETF is incorporated herein by reference to Post-Effective Amendment No. 64 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 28, 2015. | |||||
(ii) | Amendment No. 2 dated January 22, 2013 to the Administration Agreement between SEI Investments Global Funds Services and the Registrant with respect to Senior Loan ETF is incorporated herein by reference to Post-Effective Amendment No. 64 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 28, 2015. | |||||
(iii) | Amendment No. 3 dated March 1, 2015 to the Administration Agreement between SEI Investments Global Funds Services and the Registrant with respect to Senior Loan ETF is incorporated herein by reference to Post-Effective Amendment No. 64 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 28, 2015. | |||||
(iv) | Amendment No. 4 dated May 1, 2015 to the Administration Agreement between SEI Investments Global Funds Services and the Registrant with respect to Senior Loan ETF is incorporated herein by reference to Post-Effective Amendment No. 64 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 28, 2015. | |||||
(v) | Amendment No. 5 dated November 30, 2016 to the Administration Agreement between SEI Investments Global Funds Services and the Registrant with respect to Senior Loan ETF is incorporated herein by reference to Post-Effective Amendment No. 81 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on April 27, 2017. | |||||
(vi) | Amendment No. 6 dated February 14, 2017 to the Administration Agreement between SEI Investments Global Funds Services and the Registrant with respect to Senior Loan ETF is incorporated herein by reference to Post-Effective Amendment No. 81 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on April 27, 2017. | |||||
(vii) | Amendment No. 7 dated April 17, 2017 to the Administration Agreement between SEI Investments Global Funds Services and the Registrant with respect to Senior Loan ETF is incorporated herein by reference to Post-Effective Amendment No. 81 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on April 27, 2017. | |||||
(3) | Form of Authorized Participant Agreement with respect to Senior Loan ETF is incorporated herein by reference to Post-Effective Amendment No. 34 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 19, 2012. | |||||
(4) | Transfer Agency and Services Agreement dated October 1, 2012 between State Street and the Registrant with respect to Senior Loan ETF is incorporated herein by reference to Post-Effective Amendment No. 34 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 19, 2012. | |||||
(5) | Master Sub-Administration Agreement dated January 7, 2013 between State Street and HCMFA with respect to the series of the Registrant listed on Schedule A thereto (as Schedule A may be amended from time to time) is incorporated herein by reference to Post-Effective Amendment No. 38 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 28, 2013. |
(i) | Notice to Master Sub-Administration Agreement dated March 30, 2016 between State Street and HCMFA with respect to Merger Arbitrage Fund is incorporated herein by reference to Post-Effective Amendment No. 77 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on August 17, 2016. | |||||
(ii) | Notice to Master Sub-Administration Agreement dated September 1, 2017 between State Street and HCMFA with respect to the series of the Registrant listed on Schedule A thereto (as Schedule A may be amended from time to time) is filed herein. | |||||
(6) | Transfer Agency and Service Agreement dated December 26, 2012 between Boston Financial Data Services, Inc. (BFDS) and the series of the Registrant listed on Schedule A thereto (as Schedule A may be amended from time to time), is incorporated herein by reference to Post-Effective Amendment No. 38 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 28, 2013. | |||||
(i) | Amendment to Transfer Agency and Service Agreement dated July 31, 2014 between BFDS and the series of the Registrant listed on Schedule A thereto (as Schedule A may be amended from time to time) is incorporated herein by reference to Post-Effective Amendment No. 44 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 29, 2014. | |||||
(ii) | Revised Schedule A dated July 27, 2016 to Transfer Agency and Service Agreement between BFDS and the series of the Registrant listed on Schedule A thereto is incorporated herein by reference to Post-Effective Amendment No. 77 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on August 17, 2016. | |||||
(7) | Securities Lending and Service Agreement dated March 4, 2013 between State Street and the Registrant is incorporated herein by reference to Post-Effective Amendment No. 38 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 28, 2013. | |||||
(8) | Expense Limitation and Recoupment Agreement dated October 26, 2017 between HCMFA and the Registrant on behalf of Senior Loan ETF is filed herein. | |||||
(9) | Expense Limitation and Recoupment Agreement dated October 26, 2017 between HCMFA and the Registrant on behalf of the Opportunistic Credit Fund is filed herein. | |||||
(10) | Expense Limitation and Recoupment Agreement dated October 26, 2017 between HCMFA and the Registrant on behalf of the Merger Arbitrage Fund is filed herein. | |||||
(11) | Master Administration Agreement dated January 7, 2013 between State Street and the series of the Registrant listed on Schedule A thereto (as Schedule A may be amended from time to time) is incorporated herein by reference to Post-Effective Amendment No. 42 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on June 30, 2014. | |||||
(i) | Notice to Master Administration Agreement between State Street and the series of the Registrant listed on Schedule A is incorporated herein by reference to Post-Effective Amendment No. 44 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 29, 2014. | |||||
(ii) | Amendment to the Master Administration Agreement dated June 5, 2017 between State Street and the series of the Registrant listed on Schedule A is filed herein. |
(n) | Amended and Restated Multi-Class Rule 18f-3 Plan with respect to the series of Highland Funds I listed on Exhibit A is incorporated herein by reference to Post-Effective Amendment No. 81 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on April 27, 2017. | |||||
(o) | Reserved. | |||||
(p) | (1) | Code of Ethics of the Registrant is incorporated herein by reference to Post-Effective Amendment No. 81 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on April 27, 2017. | ||||
(2) | Code of Ethics of HCMFA is filed herein. | |||||
(3) | Code of Ethics of HCFD is incorporated herein by reference to Post-Effective Amendment No. 81 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on April 27, 2017. | |||||
(4) | Code of Ethics of SEI, Distributor for Senior Loan ETF dated October 3, 2012 is incorporated herein by reference to Post-Effective Amendment No. 34 to Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on October 19, 2012. |
Item 29. | Persons Controlled by or Under Common Control with the Fund |
Not applicable.
Item 30. | Indemnification |
Section 4.2 of the Registrants Amended and Restated Agreement and Declaration of Trust provides as follows:
(a) Highland Funds I (the Trust) hereby agrees, solely out of the assets of the affected Series, to indemnify each Person who at any time serves as Trustee or officer of the Trust (each such Person being an indemnitee) against any liabilities and expenses, including amounts paid in satisfaction of judgments, in compromise or as fines and penalties, and reasonable counsel fees reasonably incurred by such indemnitee in connection with the defense or disposition of any action, suit or other proceeding, whether civil or criminal, before any court or administrative or investigative body in which he may be or may have been involved as a party or otherwise or with which he may be or may have been threatened, while acting in any capacity set forth above in this Article IV by reason of his having acted in any such capacity, except with respect to any matter as to which he shall not have acted in good faith in the reasonable belief that his action was in the best interest of the Trust or the respective Series of the Trust and furthermore, in the case of any criminal proceeding, as to which he shall have had reasonable cause to believe that the conduct was unlawful, provided, however, that no indemnitee shall be indemnified hereunder against any liability to any Person or any expense of such indemnitee arising by reason of (i) willful misfeasance, (ii) bad faith, (iii) gross negligence, or (iv) reckless disregard of the duties involved in the conduct of his position.
Notwithstanding the foregoing, with respect to any action, suit or other proceeding voluntarily prosecuted by any indemnitee as plaintiff, indemnification shall be mandatory only if the prosecution of such action, suit or other proceeding by such indemnitee was (1) authorized by a majority of the Trustees or (2) was instituted by the indemnitee to enforce his or her rights to indemnification hereunder in a case in which the indemnitee is found to be entitled to such indemnification. The rights to indemnification set forth in this Declaration shall continue as to a Person who has ceased to be a Trustee or officer of the Trust and shall inure to the benefit of his or her heirs, executors and personal and legal representatives. No amendment or restatement of this Declaration or repeal of any of its provisions shall limit or eliminate any of the benefits provided to any Person who at any time is or was a Trustee or officer of the Trust or otherwise entitled to indemnification hereunder in respect of any act or omission that occurred prior to such amendment, restatement or repeal.
(b) Notwithstanding the foregoing, no indemnification shall be made hereunder unless there has been a determination (1) by a final decision on the merits by a court or other body of competent jurisdiction before whom the issue of entitlement to indemnification hereunder was brought that such indemnitee is entitled to indemnification hereunder or, (2) in the absence of such a decision, by (i) a majority vote of a quorum (being one-third of such Trustees) of those Trustees who are neither Interested Persons of the Trust nor parties to the proceeding (Disinterested Non-Party Trustees), that the indemnitee is entitled to indemnification hereunder, or (ii) if such quorum is not obtainable or even if obtainable, if such majority so directs, independent legal counsel in a written opinion conclude that the indemnitee should be entitled to indemnification hereunder. All determinations to make advance payments in connection with the expense of defending any proceeding shall be authorized and made in accordance with the immediately succeeding paragraph (c) below.
(c) The Trust shall make advance payments in connection with the expenses of defending any action with respect to which indemnification might be sought hereunder if the Trust receives a written affirmation by the indemnitee of the indemnitees good faith belief that the standards of conduct necessary for indemnification have been met and a written undertaking to reimburse the Trust unless it is subsequently determined that indemnitee is entitled to such indemnification and if a majority of the Trustees determine that the applicable standards of conduct necessary for indemnification appear to have been met. In addition, at least one of the following conditions must be met: (1) the indemnitee shall provide adequate security for his undertaking, (2) the Trust shall be insured against losses arising by reason of any lawful advances, or (3) a majority of a quorum of the Disinterested Non-Party Trustees, or if a majority vote of such quorum so directs, independent legal counsel in a written opinion, shall conclude, based on a review of readily available facts (as opposed to a full trial-type inquiry), that there is substantial reason to believe that the indemnitee ultimately will be found entitled to indemnification.
(d) The rights accruing to any indemnitee under these provisions shall not exclude any other right to which he or she may be lawfully entitled.
(e) Subject to any limitations provided by the Investment Company Act of 1940, as amended (the 1940 Act) and this Declaration, the Trust shall have the power and authority, solely out of the assets of the affected Series, to indemnify and provide for the advance payment of expenses to employees, agents and other Persons providing services to the Trust or serving in any capacity at the request of the Trust to the full extent as corporations organized under the Delaware General Corporation Law may indemnify or provide for the advance payment of expenses for such Persons provided that such indemnification has been approved by a majority of the Trustees.
Section 6 of each Investment Advisory Agreement with the Adviser provides as follows:
(a) The Trust hereby agrees to indemnify the Adviser and each of the Advisers partners, officers, employees, and agents (including any individual who serves at the Advisers request as director, officer, partner, trustee or the like of another corporation) and controlling persons (each such person being an Indemnitee) against any liabilities and expenses, including amounts paid in satisfaction of judgments, in compromise or as fines and penalties, and counsel fees (all as provided in accordance with applicable state law) reasonably incurred by such Indemnitee in connection with the defense or disposition of any action, suit or other proceeding, whether civil or criminal, before any court or administrative or investigative body in which he may be or may have been involved as a party or otherwise or with which he may be or may have been threatened, while acting in any capacity set forth above in this paragraph or thereafter by reason of his having acted in any such capacity, except with respect to any matter as to which he shall have been adjudicated not to have acted in good faith in the reasonable belief that his action was in the best interest of the Trust and furthermore, in the case of any criminal proceeding, so long as he had no reasonable cause to believe that the conduct was unlawful, provided, however, that (1) no Indemnitee shall be indemnified hereunder against any liability to the Trust or its shareholders or any expense of such Indemnitee arising by reason of (i) willful misfeasance, (ii) bad faith, (iii) gross negligence (iv) reckless disregard of the duties involved in the conduct of his position (the conduct referred to in such clauses (i) through (iv) being sometimes referred to herein as Disabling Conduct), (2) as to any matter disposed of by settlement or a compromise payment by such Indemnitee, pursuant to a consent decree or otherwise, no indemnification either for said payment or for any other expenses shall be provided unless there has been a determination that such settlement or compromise is in the best
interests of the Trust and that such Indemnitee appears to have acted in good faith in the reasonable belief that his action was in the best interests of the Trust and did not involve Disabling Conduct by such Indemnitee and (3) with respect to any action, suit or other proceeding voluntarily prosecuted by any Indemnitee as plaintiff, indemnification shall be mandatory only if the prosecution of such action, suit or other proceeding by such Indemnitee was authorized by a majority of the full Board of the Trust. Notwithstanding the foregoing, the Trust shall not be obligated to provide any such indemnification to the extent such provision would waive any right that the Trust cannot lawfully waive.
(b) The Trust shall make advance payments in connection with the expenses of defending any action with respect to which indemnification might be sought hereunder if the Trust receives a written affirmation of the Indemnitees good faith belief that the standard of conduct necessary for indemnification has been met and a written undertaking to reimburse the Trust unless it is subsequently determined that he is entitled to such indemnification and if the Trustees of the Trust determine that the facts then known to them would not preclude indemnification. In addition, at least one of the following conditions must be met: (1) the Indemnitee shall provide adequate security for his undertaking, (2) the Trust shall be insured against losses arising by reason of any lawful advances or, (3) a majority of a quorum of Trustees of the Trust who are neither interested persons of the Trust (as defined in Section 2(a)(19) of the 1940 Act) nor parties to the proceeding (Disinterested Non-Party Trustees) or an independent legal counsel in a written opinion, shall determine, based on a review of readily available facts (as opposed to a full trial-type inquiry), that there is reason to believe that the Indemnitee ultimately will be found entitled to indemnification.
(c) All determinations with respect to indemnification hereunder shall be made (1) by a final decision on the merits by a court or other body of competent jurisdiction before whom the proceeding was brought that such Indemnitee is not liable by reason of Disabling Conduct or, (2) in the absence of such a decision, by (i) a majority vote of a quorum of the Disinterested Non-Party Trustees of the Trust, or (ii) if such a quorum is not obtainable or even if obtainable, if a majority vote of such quorum so directs, independent legal counsel in a written opinion.
(d) Each Indemnitee shall, in the performance of its duties, be fully and completely justified and protected with regard to any act or any failure to act resulting from reliance in good faith upon the books of account or other records of the Trust, upon an opinion of counsel, or upon reports made to the Trust by any of the Trusts officers or employees or by any advisor, administrator, manager, distributor, selected dealer, accountant, appraiser or other expert or consultant selected with reasonable care by the Trustees, officers or employees of the Trust, regardless of whether such counsel or other person may also be a Trustee.
(e) The rights accruing to any Indemnitee under these provisions shall not exclude any other right to which he may be lawfully entitled.
Section 19 of the Underwriting Agreement with Highland Capital Funds Distributor, Inc. (the Distributor) provides as follows:
(a) The Funds agree to indemnify and hold harmless the Distributor and each of their directors and officers and each person, if any, who controls the Distributor within the meaning of Section 15 of the 1933 Act, against any loss, liability, claim, damages or expenses (including the reasonable cost of investigating or defending any alleged loss, liability, claim, damages or expense and reasonable counsel fees incurred in connection therewith) arising by reason of any person acquiring any Shares, based upon the grounds that a registration statement, prospectus, statement of additional information, shareholder reports or other information filed or made public a Fund (as from time to time amended) included an alleged untrue statement of a material fact or alleged omission of a material fact required to be stated or necessary in order to make the statements not misleading under the 1933 Act, the 1940 Act, or any other statute or the common law. However, the Fund does not agree to indemnify the Distributor or hold it harmless to the extent that the statement or omission was made in reliance upon, and in conformity with, information furnished to the Fund by or on behalf of the Distributor. In no case: (i) is the indemnity of a Fund in favor of the Distributor or any person indemnified to be deemed to protect the Distributor or any person against any liability to the Fund or its security holders to which the Distributor or such person would otherwise be subject by reason of willful misfeasance, bad faith or negligence in the performance of its duties or by
reason of its reckless disregard of its obligations and duties under this Agreement; or (ii) is a Fund to be liable under its indemnity agreement contained in this paragraph with respect to any claim made against the Distributor or any person indemnified unless the Distributor or person, as the case may be, shall have notified the particular Fund in writing of the claim promptly after the summons or other first written notification giving information of the nature of the claims shall have been served upon the Distributor or any such person (or after the Distributor or such person shall have received notice of service on any designated agent). However, failure to notify a Fund of any claim shall not relieve the Fund from any liability which it may have to any person against whom such action is brought otherwise than on account of its indemnity agreement contained in this paragraph. The Fund shall be entitled to participate at its own expense in the defense, or, if it so elects, to assume the defense of any litigation or proceeding brought to enforce any claims, and if the Fund elects to assume the defense, the defense shall be conducted by counsel chosen by the Fund. In the event the Fund elects to assume the defense of any litigation or proceeding and retain counsel, the Distributor, officers or directors or controlling person(s), and any other defendant(s) in the litigation or proceeding, shall bear the fees and expenses of any additional counsel retained by them. If the Fund does not elect to assume the defense of any litigation or proceeding, it will reimburse the Distributor, officers or directors or controlling person(s), or any other defendant(s) in the suit covered by the indemnification set forth in this Agreement for the reasonable fees and expenses of any counsel retained by them. The Fund agrees to notify the Distributor promptly of the commencement of any litigation or proceeding against it or any of its officers, directors or controlling person(s) in connection with the issuance or sale of any of the Shares.
(b) The Distributor also covenants and agrees that it will indemnify and hold harmless the Funds and each of their officers, trustees and each person, if any, who control a Fund within the meaning of Section 15 of the 1933 Act, against any loss, liability, damages, claims or expense (including the reasonable cost of investigating or defending any alleged loss, liability, damages, claim or expense and reasonable counsel fees incurred in connection therewith) arising by reason of: (i) any person acquiring any Shares, based upon the 1933 Act, the 1940 Act or any other statute or common law, alleging: (a) any wrongful act of the Distributor or any of its employees; or (b) that any sales literature, advertisements, information, statements or representations used or made by the Distributor or any of its affiliates or employees or that the registration statement, prospectus, or statement of additional information (as from time to time amended) included an alleged untrue statement of a material fact or an alleged omission of a material fact required to be stated or necessary in order to make the statements not misleading , insofar as the statement or omission was made in reliance upon, and in conformity with, information furnished to a Fund by or on behalf of the Distributor. In no case: (i) is the indemnity of the Distributor in favor of a Fund or any person indemnified to be deemed to protect the Fund or any person against any liability to which the Fund or such person would otherwise be subject by reason of willful misfeasance, bad faith or negligence in the performance of its duties or by reason of its reckless disregard of its obligations and duties under this Agreement; or (ii) is the Distributor to be liable under its indemnity agreement contained in this paragraph with respect to any claim made against a Fund or any person indemnified unless the Fund or person, as the case may be, shall have notified the Distributor in writing of the claim promptly after the summons or other first written notification giving information of the nature of the claim shall have been served upon the Fund or any such person (or after the Fund or such person shall have received notice of service on any designated agent). However, failure to notify the Distributor of any claim shall not relieve the Distributor from any liability which it may have to the Fund or any person against whom the action is brought otherwise than on account of its indemnity agreement contained in this paragraph. In the case of any notice to the Distributor it shall be entitled to participate, at its own expense, in the defense or, if it so elects, to assume the defense of any litigation or proceeding brought to enforce the claim, and if the Distributor elects to assume the defense, the defense shall be conducted by counsel chosen by it and satisfactory to the Fund, to its officers and to any controlling person(s) or any other defendant(s) in the suit covered by the indemnification set forth in this Agreement. In the event that the Distributor elects to assume the defense of any litigation or proceeding and retain counsel, the Fund or controlling person(s), and any other defendant(s) in the litigation or proceeding, shall bear the fees and expense of any additional counsel retained by them. If the Distributor does not elect to assume the defense of any litigation or proceeding, it will reimburse the Fund, officers or controlling person(s), or any other defendant(s) in the litigation or proceeding covered by the indemnification set forth in this Agreement, for the reasonable fees and expenses of any counsel retained by them. The Distributor agrees to notify a Fund promptly of the commencement of any litigation or proceeding against it, its officers, its directors or its controlling person(s) in connection with the Fund and sale of any of the Shares.
Section 12 of the Administration Agreement with HCMFA provides as follows:
(a) The Trust agrees to indemnify and hold harmless HCMFA and its affiliates from all taxes, charges, expenses, assessments, claims and liabilities (including without limitation reasonable attorneys fees and disbursements and liabilities arising under the Securities Laws and any state and foreign securities and blue sky laws) (collectively, Losses) arising directly or indirectly from any action or omission to act which HCMFA takes (i) at the request or on the direction of or in reliance on the advice of the Trust or (ii) upon Oral Instructions or Written Instructions; provided, however, neither HCMFA nor any of its affiliates, shall be indemnified against any liability (or any expenses incident to such liability) arising out of HCMFAs or its affiliates own willful misfeasance, bad faith, negligence or reckless disregard of its duties and obligations under this Agreement.
(b) Notwithstanding anything in this Agreement to the contrary, the Trust shall not be liable to HCMFA or its affiliates for any consequential, special or indirect losses or damages which HCMFA or its affiliates may incur or suffer as a consequence of this Agreement, whether or not the likelihood of such damages or losses was known by the Trust.
In addition, the Trust will maintain a trustees and officers liability insurance policy under which the Trust and its trustees and officers will be named insureds.
Item 31. | Business and Other Connections of the Investment Adviser and Investment Sub-Advisers |
(a) The description of the business of HCMFA, the investment adviser, is set forth under the caption Management of the Funds in the Prospectuses and under the caption Management in the SAI, each forming part of this Registration Statement. The information as to other businesses, if any, and the directors and officers of HCMFA is set forth in its Form ADV, as filed with the SEC through the Investment Adviser Registration Depository (IARD) on March 30, 2017 (CRD No. 149653) and as amended through the date hereof, and is incorporated herein by reference.
(b) Highland Capital Healthcare Advisors, L.P. (HCHA), Acis Capital Management, L.P., NexPoint Advisors, L.P., Highland Capital Management, L.P. (HCM), Granite Bay Advisors, L.P. and NexBank Securities, Inc., each with its principal place of business located at 200 Crescent Court, Suite 700, Dallas, Texas 75201, are registered investment advisers affiliated with HCMFA.
The following persons are executive officers of the general partner of HCHA, Highland Capital Healthcare Advisors GP, LLC:
(1) | James D. Dondero, President |
(2) | Mark Okada, Vice President |
(3) | Frank Waterhouse, Treasurer |
The following person is a non-executive officer of Acis Capital Management, L.P., Granite Bay Advisors, L.P. and HCM:
(1) | Thomas Surgent, Chief Compliance Officer |
The following person is a non-executive officer of NexPoint Advisors, L.P., HCMFA and HCHA:
(1) | Jason Post, Chief Compliance Officer |
The following persons are executive officers of the general partner of NexPoint Advisors, L.P. and NexPoint Advisors GP, LLC:
(1) | James Dondero, President |
(2) | Trey Parker, Executive Vice President |
(3) | Frank Waterhouse, Treasurer |
(4) | Dustin Norris, Secretary |
The following persons are executive officers of the general partner of HCM and Strand Advisors, Inc.:
(1) | James Dondero, President |
(2) | Mark Okada, Executive Vice President |
(3) | Scott Ellington, Secretary |
(4) | Frank Waterhouse, Treasurer |
(5) | Trey Parker, Assistant Secretary |
The following persons are executive officers of NexBank Securities, Inc.:
(1) | Craig Campbell, President |
The following persons are non-executive officers of NexBank Securities, Inc.:
(1) | David Holt, Chief Compliance Officer |
(2) | Brian Mitts, Financial and Operations Principal |
Item 32. | Principal Underwriter |
(a) HCFD serves as principal underwriter for the following investment companies registered under the Investment Company Act of 1940, as amended:
Highland Floating Rate Opportunities Fund
Highland Funds I (certain series)
Highland Global Allocation Fund II
Highland Funds II
NexPoint Real Estate Strategies Fund
NexPoint Capital, Inc.
SEI serves as principal underwriter for the following investment companies under the Investment Company Act of 1940, as amended:
SEI Daily Income Trust | RiverPark Funds Trust | |
SEI Tax Exempt Trust | Adviser Managed Trust Fund | |
SEI Institutional Managed Trust | New Covenant Funds | |
SEI Institutional International Trust | Cambria ETF Trust | |
The Advisors Inner Circle Fund | Highland Funds I (certain series) | |
The Advisors Inner Circle Fund II | KraneShares Trust | |
Bishop Street Funds | LocalShares Investment Trust | |
SEI Asset Allocation Trust | SEI Insurance Products Trust | |
SEI Institutional Investments Trust | KP Funds | |
City National Rochdale Funds (f/k/a CNI Charter Funds) | The Advisors Inner Circle Fund III | |
Causeway Capital Management Trust | J.P. Morgan Exchange-Traded Fund Trust | |
ProShares Trust | SEI Catholic Values Trust | |
Community Capital Trust (f/k/a Community Reinvestment Act | SEI Hedge Fund SPC | |
Qualified Investment Fund) | SEI Energy Debt Fund | |
TD Asset Management USA Funds | Winton Diversified Opportunities Fund | |
SEI Structured Credit Fund, LP | Gallery Trust | |
Global X Funds | RiverPark Floating Rate CMBS Fund (f/k/a RiverPark | |
ProShares Trust II | Commercial Real Estate Fund) | |
Exchange Traded Concepts Trust (f/k/a FaithShares Trust) | Schroder Series Trust | |
Schwab Strategic Trust | Schroder Global Series Trust |
SEI provides numerous financial services to investment managers, pension plan sponsors and bank trust departments. These services include portfolio evaluation, performance measurement and consulting services and automated execution, clearing and settlement of securities transactions.
(b) HCFDs main business address is 200 Crescent Court, Suite 700, Dallas, Texas 75201. The following is a list of the managers and officers of HCFD:
Name and Principal Business Address* |
Positions and Offices with Underwriter |
Positions and Offices with Registrant | ||
Brad Ross David Klos Eric Holt |
President Financial and Operations Principal Chief Compliance Officer |
President and Principal Executive Officer None None |
SEIs main business address is One Freedom Valley Drive, Oaks, Pennsylvania 19456. The following is a list of the directors and officers of SEI:
Name and Principal Business Address* |
Positions and Offices with Underwriter |
Positions and Offices with Registrant |
||
William Doran | Director | None | ||
Paul Klauder | Director | None | ||
Wayne Withrow | Director | None | ||
Kevin Barr | Director, President and Chief Executive Officer | None | ||
Maxine Chou | Chief Financial Officer, Chief Operations Officer & Treasurer | None | ||
Karen LaTourette | Chief Compliance Officer, Anti-Money Laundering Officer & Assistant Secretary | None | ||
John Munch | General Counsel & Secretary | None | ||
Mark Held | Senior Vice President | None | ||
John Coary | Vice President & Assistant Secretary | None | ||
Lori White | Vice President & Assistant Secretary | None | ||
Judith Hirx | Vice President | None | ||
Jason McGhin | Vice President | None | ||
Gary Michael Reese | Vice President | None | ||
Robert Silvestri | Vice President | None |
(c) Not applicable.
Item 33. | Location of Accounts and Records |
(1) | Boston Financial Data Services Inc., 2000 Crown Colony Drive Quincy, Massachusetts 02169-09534 (records relating to its function as transfer agent). |
(2) | Highland Capital Funds Distributor, Inc., 200 Crescent Court, Suite 700, Dallas, Texas 75201 (records relating to its function as distributor). |
(3) | State Street Bank and Trust Company, One Lincoln Street Boston, Massachusetts 02111 (records relating to its function as custodian, administrator and sub-administrator). |
(4) | Highland Capital Management Fund Advisors, L.P., 200 Crescent Court, Suite 700, Dallas, Texas 75201 (records relating to its function as adviser and as administrator). |
(5) | SEI Investments Distribution Co., One Freedom Valley Drive, Oaks, Pennsylvania 19456 (records relating to its function as distributor). |
(6) | SEI Investments Global Fund Services, One Freedom Valley Drive, Oaks, Pennsylvania 19456 (records relating to its function as administrator). |
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended (the Securities Act), and the Investment Company Act of 1940, as amended (the 1940 Act), Registrant certifies that it meets all of the requirements for effectiveness of this Registration Statement under Rule 485(b) under the Securities Act and has duly caused this Post-Effective Amendment No. 84 under the Securities Act and Amendment No. 87 under the 1940 Act to be signed on its behalf by the undersigned, duly authorized, in the City of Dallas, State of Texas on this 26 th day of October, 2017.
By: |
/s/ J. Bradley Ross |
|
J. Bradley Ross President and Principal Executive Officer |
Pursuant to the requirements of the Securities Act of 1933, this Post-Effective Amendment No. 83 to Registrants Registration Statement on Form N-1A has been signed below by the following persons in the capacities and on the dates indicated.
Signature |
Title |
Date |
||
/s/ Ethan Powell* Ethan Powell |
Trustee | October 26, 2017 | ||
/s/ Timothy K. Hui* Timothy K. Hui |
Trustee | October 26, 2017 | ||
/s/ Dr. Bob Froehlich* Dr. Bob Froehlich |
Trustee | October 26, 2017 | ||
/s/ John Honis* John Honis |
Trustee | October 26, 2017 | ||
/s/ Bryan A. Ward* Bryan A. Ward |
Trustee | October 26, 2017 | ||
/s/ Frank Waterhouse Frank Waterhouse |
Treasurer, Principal Financial Officer and Principal Accounting Officer | October 26, 2017 |
* By: |
/s/ J. Bradley Ross |
|
J. Bradley Ross | ||
Attorney in Fact* |
October 26, 2017 |
* | Pursuant to Power of Attorney dated January 28, 2016 incorporated herein by reference to Post-Effective Amendment No. 72 to the Registrants Registration Statement on Form N-1A, File No. 333-132400, filed on May 12, 2016. |
Exhibit Index
Exhibit No. |
||||||
(d) | (2) | Management Fee Waiver Agreement dated October 26, 2017 between HCMFA and the Registrant on behalf of Long/Short Equity Fund | ||||
(d) | (6) | Amended and Restated Investment Advisory Agreement dated June 5, 2017 between HCMFA and the Registrant on behalf of Merger Arbitrage Fund | ||||
(h) | (1) | (iv) | Revised Exhibit A to Administration Services Agreement dated June 5, 2017 between HCMFA and the Registrant | |||
(h) | (5) | (ii) | Notice to Master Sub-Administration Agreement dated September 1, 2017 between State Street and HCMFA | |||
(h) | (8) | Expense Limitation and Recoupment Agreement dated October 26, 2017 between HCMFA and the Registrant on behalf of Senior Loan ETF | ||||
(h) | (9) | Expense Limitation and Recoupment Agreement dated October 26, 2017 between HCMFA and the Registrant on behalf of Opportunistic Credit Fund | ||||
(h) | (10) | Expense Limitation and Recoupment Agreement dated October 26, 2017 between HCMFA and the Registrant on behalf of Merger Arbitrage Fund | ||||
(h) | (11) | (ii) | Amendment to the Master Administration Agreement dated June 5, 2017 between State Street and the series of the Registrant listed on Schedule A | |||
(j) | (1) | Consent of Ropes & Gray LLP | ||||
(j) | (2) | Consent of Independent Registered Public Accounting Firm | ||||
(p) | (2) | Code of Ethics of HCMFA |
Exhibit (d)(2)
October 26, 2017
LETTER AGREEMENT
Highland Funds I (the Trust)
200 Crescent Court, Suite 700
Dallas, Texas 75201
Re: Management Fee Waiver Agreement
Ladies and Gentlemen:
This Letter Agreement documents an undertaking by Highland Capital Management Fund Advisors, L.P. (the Adviser) to waive the management fees of Highland Long/Short Equity Fund (the Fund), a series of the Trust. This Letter Agreement shall terminate (i) in the event the Investment Advisory Agreement between the Trust and the Adviser terminates with respect to the Fund, (ii) at the sole discretion of the Funds Board of Trustees on 30 days prior written notice to the Adviser or (iii) upon mutual agreement between the Adviser and the Funds Board of Trustees.
Effective November 1, 2017 and until at least October 31, 2018, the Adviser hereby undertakes to waive 1.25% of the Funds management fees for each class of the Fund.
This Letter Agreement shall be governed by, and construed in accordance with, the laws of the State of Delaware without giving effect to the conflict of laws principles thereof; provided that nothing herein shall be construed to preempt, or to be inconsistent with, any federal law, regulation or rule, including the Investment Company Act of 1940, as amended, and the Investment Advisers Act of 1940, as amended, and any rules and regulations promulgated thereunder.
Sincerely,
Highland Capital Management Fund Advisors, L.P. | ||||
By: |
/s/ Frank Waterhouse |
|||
Name: | Frank Waterhouse | |||
Title: | Treasurer | |||
ACKNOWLEDGED AND ACCEPTED | ||||
Highland Funds I | ||||
By: |
/s/ Frank Waterhouse |
|||
Name: | Frank Waterhouse | |||
Title: | Treasurer, Principal Accounting Officer and Principal Financial Officer |
Exhibit (d)(6)
AMENDED AND RESTATED INVESTMENT ADVISORY AGREEMENT
This Amended and Restated Investment Advisory Agreement (the Agreement ) made June 5, 2017, by and between Highland Capital Management Fund Advisors, L.P., a Delaware limited partnership (the Adviser ), and Highland Funds I, a Delaware statutory trust (the Trust ), on behalf of its series, Highland Merger Arbitrage Fund (the Fund ).
WHEREAS, the Trust is engaged in business as an open-end management investment company and is registered as such under the Investment Company Act of 1940, as amended (the 1940 Act ); and
WHEREAS, the Adviser is engaged principally in the business of rendering investment management services and is registered as an investment adviser under the Investment Advisers Act of 1940, as amended; and
WHEREAS, the Trust has retained the Adviser to provide investment management services pursuant to an Investment Advisory Agreement dated May 12, 2016 (the Original Agreement);
NOW, THEREFORE, WITNESSETH: That it is hereby agreed between the parties hereto that the Original Agreement is hereby amended and restated pursuant to Section 9(b) thereof as of the date written above as follows:
SECTION 1. Appointment of Adviser .
The Trust hereby appoints the Adviser to act as manager and investment adviser to the Fund for the period and on the terms herein set forth. The Adviser accepts such appointment and agrees to render the services herein set forth, for the compensation herein provided.
SECTION 2. Duties of Adviser .
The Adviser, at its own expense, shall furnish the following services and facilities to the Fund:
(a) Investment Program . The Adviser shall (i) furnish continuously an investment program for the Fund, (ii) determine (subject to the overall supervision and review of the Trusts Board of Trustees) the investments to be purchased, held, sold or exchanged by the Fund and the portion, if any, of the assets of the Fund to be held uninvested, (iii) make changes in the investments of the Fund and (iv) vote, exercise consents and exercise all other rights pertaining to such investments. The Adviser also shall manage, supervise and conduct the other affairs and business of the Fund and matters incidental thereto , subject always to the control of the Trusts Board of Trustees, and to the provisions of the organizational documents of the Trust, the Registration Statement of the Trust with respect to the Fund and its shares of beneficial interest ( Shares ), including the Funds Prospectus(es) and Statement of Additional Information, and the 1940 Act, in each case as from time to time amended and in effect. Subject to the foregoing, the Adviser shall have the authority to engage, terminate and replace one or more sub-advisers in connection with the portfolio management of the Fund, which sub-advisers may be affiliates of the Adviser; provided, however, that the Adviser shall remain responsible to the Trust with respect to its duties and obligations on behalf of the Fund set forth in this Agreement. The Adviser agrees to furnish advice and recommendations to the Fund and the Board with respect to the selection and continued employment of any sub-adviser(s) to provide investment advisory services for the portion(s) of the Funds portfolio specified by the Adviser and on terms and conditions, including but not limited to the compensation payable to any such sub-adviser(s), approved in the manner provided by applicable law.
(b) Portfolio Transactions . The Adviser shall place all orders for the purchase and sale of portfolio securities for the account of the Fund with brokers or dealers selected by the Adviser, although the Fund will pay the actual brokerage commissions on portfolio transactions in accordance with Section 3(d) .
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In placing portfolio transactions for the Fund, it is recognized that the Adviser will give primary consideration to securing the most favorable price and efficient execution. Consistent with this policy, the Adviser may, to the extent permitted by Section 28(e) of the Securities Exchange Act of 1934, consider the financial responsibility, research and investment information and other services provided by brokers or dealers who may effect or be a party to any such transaction or other transactions to which other clients of the Adviser may be a party. It is understood that neither the Fund nor the Adviser has adopted a formula for allocation of the Funds investment transaction business. It is also understood that it is desirable for the Fund that the Adviser have access to supplemental investment and market research and security and economic analysis provided by brokers who may execute brokerage transactions at a higher cost to the Fund than would otherwise result when allocating brokerage transactions to other brokers on the basis of seeking the most favorable price and efficient execution. Therefore, the Adviser is authorized to place orders for the purchase and sale of securities for the Fund with such brokers, subject to review by the Trusts Board of Trustees from time to time with respect to the extent and continuation of this practice. It is understood that the services provided by such brokers may be useful or beneficial to the Adviser in connection with its services to other clients.
On occasions when the Adviser deems the purchase or sale of a security to be in the best interest of the Fund as well as other clients, the Adviser, to the extent permitted by applicable laws and regulations, may, but shall be under no obligation to, aggregate the securities to be so sold or purchased in order to obtain the most favorable price or lower brokerage commissions and efficient execution. In such event, allocation of the securities so purchased or sold, as well as the expenses incurred in the transaction, will be made by the Adviser in the manner it considers to be the most equitable and consistent with its fiduciary obligations to the Fund and to such other clients.
SECTION 3. Allocation of Expenses .
The Fund assumes and shall pay all expenses for all other Fund operations and activities and shall reimburse the Adviser for any such expenses incurred by the Adviser. Unless the Prospectus or Statement of Additional Information of the Fund provides otherwise, the expenses to be borne by the Fund shall include, without limitation:
(a) | all expenses of organizing the Fund; |
(b) | the charges and expenses of any registrar, stock transfer or dividend disbursing agent, shareholder servicing agent, custodian or depository appointed by the Fund for the safekeeping of its cash, portfolio securities and other property, including the costs of servicing shareholder investment accounts, and bookkeeping, accounting and pricing services provided to the Fund (other than those utilized by the Adviser in providing the services described in Section 2 ); |
(c) | the charges and expenses of bookkeeping, accounting and auditors; |
(d) | brokerage commissions and other costs incurred in connection with transactions in the portfolio securities of the Fund, including any portion of such commissions attributable to brokerage and research services as defined in Section 28(e) of the Securities Exchange Act of 1934; |
(e) | taxes, including issuance and transfer taxes, and trust registration, filing or other fees payable by the Fund to federal, state or other governmental agencies; |
2
(f) | expenses, including the cost of printing certificates, relating to the issuance of Shares of the Fund; |
(g) | expenses involved in registering and maintaining registrations of the Fund and of its Shares with the Securities and Exchange Commission ( SEC ) and various states and other jurisdictions, including reimbursement of actual expenses incurred by the Adviser or others in performing such functions for the Fund, and including compensation of persons who are employees of the Adviser, in proportion to the relative time spent on such matters; |
(h) | expenses of shareholders and trustees meetings, including meetings of committees, and of preparing, printing and mailing proxy statements, quarterly reports, if any, semi-annual reports, annual reports and other communications to existing shareholders; |
(i) | expenses of preparing and printing prospectuses and marketing materials; |
(j) | compensation and expenses of trustees who are not affiliated with the Adviser; |
(k) | charges and expenses of legal counsel in connection with matters relating to the Fund, including, without limitation, legal services rendered in connection with the Funds trust and financial structure and relations with its shareholders, issuance of Shares of the Fund and registration and qualification of Shares under federal, state and other laws; |
(l) | the cost and expense of maintaining the books and records of the Fund, including general ledger accounting; |
(m) | insurance premiums on fidelity, errors and omissions and other coverages, including the expense of obtaining and maintaining a fidelity bond as required by Section 17(g) of the 1940 Act which may also cover the Adviser; |
(n) | expenses incurred in obtaining and maintaining any surety bond or similar coverage with respect to securities of the Fund; |
(o) | interest payable on Fund borrowings; |
(p) | such other non-recurring expenses of the Fund as may arise, including expenses of actions, suits or proceedings to which the Trust on behalf of the Fund is a party and expenses resulting from the legal obligation that the Trust on behalf of the Fund may have to provide indemnity with respect thereto; |
(q) | expenses and fees reasonably incidental to any of the foregoing specifically identified expenses; and |
(r) | all other expenses permitted by the Prospectus(es) and Statement of Additional Information of the Fund as being paid by the Fund |
SECTION 4. Advisory Fee .
In return for the services and facilities to be provided to the Fund by the Adviser as provided in Section 2 hereof, the Fund will pay the Adviser a monthly fee, computed and accrued daily, based on an annual rate of 1.20% of the Funds Average Daily Managed Assets, so long as the Adviser has not waived all or a portion of such compensation. Average Daily Managed Assets of the Trust shall mean the average daily value of the total assets of the Trust, less all accrued liabilities of the Trust (other than the aggregate amount of any outstanding borrowings constituting financial leverage). The Adviser may waive a portion
3
of its fees. If this Agreement becomes effective subsequent to the first day of a month or shall terminate before the last day of a month, compensation for such month shall be computed in a manner consistent with the calculation of the fees payable on a monthly basis. Subject to the provisions of Section 5 below, the accrued fees will be payable monthly as promptly as possible after the end of each month during which this Agreement is in effect.
SECTION 5. Reimbursements .
The parties agree that they may negotiate from time to time for the Adviser to reimburse certain costs and expenses of the Fund. If such an agreement is in effect, the determination of whether reimbursement for such costs and expenses is due the Fund from the Adviser will be made on an accrual basis once monthly, and if it is so determined that such reimbursement is due, the accrued amount of such reimbursement that is due shall serve as an offset to the investment advisory fee payable monthly by the Fund to the Adviser pursuant to Section 4 hereof, and the amount to be paid by the Adviser to the Fund as soon as is practicable at the end of a fiscal year of the Fund shall be equal to the difference between the aggregate reimbursement due the Fund from the Adviser for that fiscal year and the aggregate offsets made by the Fund against the aggregate investment advisory fees payable to the Adviser pursuant to Section 4 hereof for that fiscal year by virtue of such aggregate reimbursement. The foregoing limitation on reimbursement of costs and expenses shall exclude distribution and service fees, brokerage commissions, short sale dividend expense, taxes, deferred organization expenses and extraordinary expenses (as determined by the Board of the Trustees of the Fund in the exercise of its business judgment).
SECTION 6. Indemnification .
(a) The Trust hereby agrees to indemnify the Adviser and each of the Advisers partners, officers, employees, and agents (including any individual who serves at the Advisers request as director, officer, partner, trustee or the like of another corporation) and controlling persons (each such person being an Indemnitee ) against any liabilities and expenses, including amounts paid in satisfaction of judgments, in compromise or as fines and penalties, and counsel fees (all as provided in accordance with applicable state law) reasonably incurred by such Indemnitee in connection with the defense or disposition of any action, suit or other proceeding, whether civil or criminal, before any court or administrative or investigative body in which he may be or may have been involved as a party or otherwise or with which he may be or may have been threatened, while acting in any capacity set forth above in this paragraph or thereafter by reason of his having acted in any such capacity, except with respect to any matter as to which he shall have been adjudicated not to have acted in good faith in the reasonable belief that his action was in the best interest of the Trust and furthermore, in the case of any criminal proceeding, so long as he had no reasonable cause to believe that the conduct was unlawful, provided, however , that (1) no Indemnitee shall be indemnified hereunder against any liability to the Trust or its shareholders or any expense of such Indemnitee arising by reason of (i) willful misfeasance, (ii) bad faith, (iii) gross negligence (iv) reckless disregard of the duties involved in the conduct of his position (the conduct referred to in such clauses (i) through (iv) being sometimes referred to herein as Disabling Conduct ), (2) as to any matter disposed of by settlement or a compromise payment by such Indemnitee, pursuant to a consent decree or otherwise, no indemnification either for said payment or for any other expenses shall be provided unless there has been a determination that such settlement or compromise is in the best interests of the Trust and that such Indemnitee appears to have acted in good faith in the reasonable belief that his action was in the best interests of the Trust and did not involve Disabling Conduct by such Indemnitee and (3) with respect to any action, suit or other proceeding voluntarily prosecuted by any Indemnitee as plaintiff, indemnification shall be mandatory only if the prosecution of such action, suit or other proceeding by such Indemnitee was authorized by a majority of the full Board of the Trust. Notwithstanding the foregoing, the Trust shall not be obligated to provide any such indemnification to the extent such provision would waive any right that the Trust cannot lawfully waive.
4
(b) The Trust shall make advance payments in connection with the expenses of defending any action with respect to which indemnification might be sought hereunder if the Trust receives a written affirmation of the Indemnitees good faith belief that the standard of conduct necessary for indemnification has been met and a written undertaking to reimburse the Trust unless it is subsequently determined that he is entitled to such indemnification and if the Trustees of the Trust determine that the facts then known to them would not preclude indemnification. In addition, at least one of the following conditions must be met: (1) the Indemnitee shall provide adequate security for his undertaking, (2) the Trust shall be insured against losses arising by reason of any lawful advances, (3) a majority of a quorum of Trustees of the Trust who are neither interested persons of the Trust (as defined in Section 2(a)(19) of the 1940 Act) nor parties to the proceeding ( Disinterested Non-Party Trustees ) or an independent legal counsel in a written opinion, shall determine, based on a review of readily available facts (as opposed to a full trial-type inquiry), that there is reason to believe that the Indemnitee ultimately will be found entitled to indemnification.
(c) All determinations with respect to indemnification hereunder shall be made (1) by a final decision on the merits by a court or other body of competent jurisdiction before whom the proceeding was brought that such Indemnitee is not liable by reason of Disabling Conduct or, (2) in the absence of such a decision, by (i) a majority vote of a quorum of the Disinterested Non-Party Trustees of the Trust, or (ii) if such a quorum is not obtainable or even if obtainable, if a majority vote of such quorum so directs, independent legal counsel in a written opinion.
(d) Each Indemnitee shall, in the performance of its duties, be fully and completely justified and protected with regard to any act or any failure to act resulting from reliance in good faith upon the books of account or other records of the Trust, upon an opinion of counsel, or upon reports made to the Trust by any of the Trusts officers or employees or by any advisor, administrator, manager, distributor, selected dealer, accountant, appraiser or other expert or consultant selected with reasonable care by the Trustees, officers or employees of the Trust, regardless of whether such counsel or other person may also be a Trustee.
(e) The rights accruing to any Indemnitee under these provisions shall not exclude any other right to which he may be lawfully entitled.
SECTION 7. Relations with Fund .
Subject to and in accordance with the organizational documents of the Adviser and the Trust, as well as their policies and procedures and codes of ethics, it is understood that Trustees, officers, agents and shareholders of the Fund are or may be interested in the Adviser (or any successor thereof) as directors, officers or otherwise, that partners, officers and agents of the Adviser (or any successor thereof) are or may be interested in the Fund as Trustees, officers, agents, shareholders or otherwise, and that the Adviser (or any such successor thereof) is or may be interested in the Fund as a shareholder or otherwise.
SECTION 8. Liability of Adviser .
The Adviser shall not be liable to the Fund for any error of judgment or mistake of law or for any loss suffered by the Fund in connection with the matters to which this Agreement relates; provided, however , that no provision of this Agreement shall be deemed to protect the Adviser against any liability to the Fund or its shareholders to which it might otherwise be subject by reason of any Disabling Conduct nor shall any provision hereof be deemed to protect any trustee or officer of the Fund against any such liability to which he might otherwise be subject by reason of any Disabling Conduct.
5
SECTION 9. Duration and Termination of this Agreement .
(a) Duration . This Agreement shall become effective on the date first set forth above, such date being the date on which this Agreement has been executed following the approval of the Trusts Board of Trustees, including approval by a vote of a majority of the Trustees who are not interested persons (as defined in the 1940 Act) of the Adviser or the Fund, cast in person at a meeting called for the purpose of voting on such approval. Unless terminated as herein provided, this Agreement shall continue in full force and effect, subject to paragraph 9(c) , so long as such continuance is approved at least annually (a) by either the Trusts Board of Trustees or by a vote of a majority of the outstanding voting securities (as defined in the 1940 Act) of the Fund and (b) in either event, by the vote of a majority of the Trustees of the Fund who are not parties to this Agreement or interested persons (as defined in the 1940 Act) of any such party, cast in person at a meeting called for the purpose of voting on such approval.
(b) Amendment . No provision of this Agreement may be amended, waived, discharged or terminated orally, but only by an instrument in writing signed by the party against which enforcement of the amendment, waiver, discharge or termination is sought. Any amendment of this Agreement shall be subject to the 1940 Act including the interpretation thereof that amendments that do not increase the compensation of the Adviser or otherwise fundamentally alter the relationship of the Trust with the Adviser do not require shareholder approval if approved by the requisite majority of the Trusts Trustees who are not interested persons (as defined in the 1940 Act) of the Trust.
(c) Termination . This Agreement may be terminated at any time, without payment of any penalty, by vote of the Trusts Board of Trustees, or by a vote of a majority of the outstanding voting securities (as defined in the 1940 Act) of the Fund, or by the Adviser, in each case on not more than 60 days nor less than 30 days prior written notice to the other party.
(d) Automatic Termination . This Agreement shall automatically and immediately terminate in the event of its assignment (as defined in the 1940 Act).
SECTION 10. Services Not Exclusive .
The services of the Adviser to the Fund hereunder are not to be deemed exclusive, and the Adviser (and its affiliates) shall be free to render similar services to others so long as its services hereunder are not impaired thereby; provided, however , that the Adviser will undertake no activities that in its reasonable good faith judgment, will adversely affect the performance of its obligations under this Agreement. In addition, the parties may enter into other agreements pursuant to which the Adviser provides administrative or other, non-investment advisory services to the Fund, and the Adviser may be compensated for such other services.
SECTION 11. Notices .
Notices under this Agreement shall be in writing and shall be addressed, and delivered or mailed postage prepaid, to the other party at such address as such other party may designate from time to time for the receipt of such notices. Until further notice to the other party, the address of each party to this Agreement for this purpose shall be 300 Crescent Court, Suite 700, Dallas, Texas 75201.
SECTION 12. Governing Law; Severability; Counterparts .
This Agreement shall be construed in accordance with the laws of the State of Delaware, and the applicable provisions of the 1940 Act. To the extent that applicable law of the State of Delaware, or any of the provisions herein, conflict with applicable provisions of the 1940 Act, the latter shall control. If any provision of this Agreement shall be held or made invalid by a court decision, statute, rule or otherwise, the remainder of this Agreement shall not be affected thereby. This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original, but such counterparts shall, together, constitute only one instrument.
6
SECTION 13. Use of the Name Highland.
The Adviser has consented to the use by the Trust of the name or identifying word Highland in the name of the Trust. Such consent is conditioned upon the employment of the Adviser as the investment adviser to the Trust. The name or identifying word Highland may be used from time to time in other connections and for other purposes by the Adviser and any of its affiliates. The Adviser may require the Trust to cease using Highland in the name of the Trust if the Trust ceases to employ, for any reason, the Adviser, any successor thereto or any affiliate thereof as investment adviser of the Trust.
SECTION 14. Miscellaneous .
The Adviser agrees to advise the Fund of any change of its membership (which shall mean its general partner) within a reasonable time after such change. If the Adviser enters into a definitive agreement that would result in a change of control (within the meaning of the 1940 Act) of the Adviser, it agrees to give the Fund the lesser of 60 days written notice and such notice as is reasonably practicable before consummating the transaction.
Where the effect of a requirement of the 1940 Act reflected in or contemplated by any provisions of this Agreement is altered by a rule, regulation or order of the SEC, whether of special or general application, such provision shall be deemed to incorporate the effect of such rule, regulation or order.
[Signature Page Follows]
7
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first set forth above.
HIGHLAND CAPITAL MANAGEMENT FUND ADVISORS, L.P. | ||
By: Strand Advisors XVI, Inc., its general partner | ||
By: |
/s/ Frank Waterhouse |
|
Name: | Frank Waterhouse | |
Title: | Treasurer | |
HIGHLAND FUNDS I, on behalf of its series, Highland Merger Arbitrage Fund | ||
By: |
/s/ Dustin Norris |
|
Name: |
Dustin Norris | |
Title: |
Assistant Secretary |
8
Exhibit (h)(1)(iv)
Highland Funds I
200 Crescent Court, Suite 700
Dallas, Texas 75201
June 5, 2017
Highland Capital Management Fund Advisors, L.P.
300 Crescent Court, Suite 700
Dallas, Texas 75201
Re: | Notice of Termination |
Reference is made to that certain Administration Services Agreement, dated as of December 4, 2006, as amended (the Agreement ), by and between Highland Capital Management Fund Advisors, L.P., a Delaware limited partnership (the Highland ) and Highland Funds I, a Delaware statutory trust (the Trust ), on behalf of its series Highland Merger Arbitrage Fund (the Fund ).
Pursuant to Section 15 of the Agreement, the Trust hereby provides Highland with written notice of the intention of the Board of Trustees of the Trust to terminate the Agreement on behalf of the Fund. Exhibit A to the Agreement shall be deleted and replaced in its entirety with Exhibit A attached hereto, effective as of the date set forth above.
By accepting and agreeing to this notice of termination, Highland hereby waives the provision of Section 15 of the Agreement that requires the Trust to provide such notice to Highland at least 60 days prior to the Trusts intended termination date.
[Signature Page Follows]
HIGHLAND FUNDS I, ON BEHALF OF ITS SERIES, HIGHLAND MERGER ARBITRAGE FUND | ||
By: |
/s/ Dustin Norris |
|
Name: | Dustin Norris | |
Title: | Assistant Secretary |
Accepted and Agreed, as of the date first written above | ||
HIGHLAND CAPITAL MANAGEMENT FUND ADVISORS, L.P. BY: STRAND ADVISORS XVI, INC., ITS GENERAL PARTNER |
||
By: |
/s/ Frank Waterhouse |
|
Name: | Frank Waterhouse | |
Title: | Treasurer |
EXHIBIT A
(revised June 5, 2017)
Portfolio | Administrative Fee | |||
Highland Long/Short Equity Fund |
0.20 | % | ||
Highland Long/Short Healthcare Fund |
0.20 | % | ||
Highland Floating Rate Opportunities |
0.20 | % |
Exhibit (h)(5)(ii)
September 1, 2017
State Street Bank and Trust Company
Channel Center, Mailstop CCB0502
1 Iron Street
Boston, MA 02210
Attention: Brett Fernquist, Managing Director
Re: H IGHLAND F LOATING R ATE O PPORTUNITIES F UND II (the Trust)
Ladies and Gentlemen:
Please be advised that the undersigned Trust has established a new series of shares to be known as H IGHLAND F LOATING R ATE O PPORTUNITIES F UND II.
In accordance with Section 18, the Additional Trusts provision, of the Master Sub-Administration Agreement dated as of January 7, 2013 by and among State Street Bank and Trust Company (the Sub-Administrator) and Highland Capital Management Fund Advisors, L.P. (f/k/a Pyxis Capital, L.P.) (the Administrator) (as amended, modified, or supplemented from time to time, the Agreement), by this letter the Administrator hereby requests that you act as Sub-Administrator for the new Trust under the terms of the Agreement. In connection with such request, the undersigned Trust hereby confirms to the Sub-Administrator, as of the date hereof, its representations and warranties set forth in Section 4(f) of the Agreement.
Please indicate your acceptance of the foregoing by executing two copies of this letter agreement, returning one to the Administrator and retaining one for your records.
Also, attached for your records is a revised copy of the Schedule A to the Agreement, which reflects the above-referenced changes.
Sincerely, | ||
HIGHLAND FLOATING RATE OPPORTUNITIES FUND II | ||
By: |
/s/ Dustin Norris |
|
Name: | Dustin Norris | |
Title: | Assistant Secretary, Duly Authorized |
Agreed and Accepted: | ||
STATE STREET BANK AND TRUST COMPANY | ||
By: |
/s/ Andrew Erickson |
|
Name: | Andrew Erickson | |
Title: | Executive Vice President, Duly Authorized | |
Effective Date: | September 6, 2017 |
MASTER SUB-ADMINISTRATION AGREEMENT
SCHEDULE A
Listing of Trusts and Funds
Highland Funds I
Highland Long/Short Equity Fund
Highland Long/Short Healthcare Fund
Highland Funds II
Highland Energy MLP Fund
Highland Floating Rate Opportunities Fund II
Exhibit (h)(8)
October 26, 2017
LETTER AGREEMENT
Highland Funds I (the Trust)
200 Crescent Court, Suite 700
Dallas, Texas 75201
Re: Expense Limitation and Recoupment Agreement
Ladies and Gentlemen:
This Letter Agreement documents (i) an undertaking by Highland Capital Management Fund Advisors, L.P. (the Adviser) to limit the total operating expenses of the Highland/iBoxx Senior Loan ETF (the Fund), a series of the Trust, and (ii) our agreement regarding the extent to which the Adviser will, under certain circumstances, receive payment from the Trust, on behalf of the Fund, as recoupment of certain amounts paid, waived or reimbursed by the Adviser to the Fund in fulfillment of the undertaking described above. This Letter Agreement shall terminate (i) in the event the Investment Advisory Agreement between the Trust and the Adviser terminates with respect to the Fund, (ii) at the sole discretion of the Funds Board of Trustees on 30 days prior written notice to the Adviser, or (iii) upon mutual agreement between the Adviser and the Funds Board of Trustees.
Effective November 1, 2017 and until at least October 31, 2018, the Adviser hereby undertakes to limit the total annual operating expenses (exclusive of taxes, brokerage commissions and other transaction costs, acquired fund fees and expenses, extraordinary expenses and dividend expense on short sales) of the Fund to 0.55% of average daily net assets attributable to any class of the Fund (the Expense Cap).
The Trust, on behalf of the Fund, hereby agrees that it will be obligated to pay the Adviser all amounts previously paid, waived or reimbursed by the Adviser with respect to the Fund pursuant to the Expense Cap, provided that the amount of such additional payment in any year, together with all other expenses of the Fund, in the aggregate, would not cause the Funds total annual operating expenses in any such year to exceed the amount of the Expense Cap or any other agreed upon expense limitation for that year, and provided further that no additional payments by the Trust will be made with respect to amounts paid, waived or reimbursed by the Adviser more than thirty-six (36) months after the date the Fund accrues a liability with respect to such amounts paid, waived or reimbursed by the Adviser. The Adviser may not recoup any amounts previously paid, waived or reimbursed hereunder before payment of the Funds operating expenses for the year in which the Adviser intends to recoup such amounts.
Any payments by the Trust under this Letter Agreement shall be in addition to all amounts otherwise payable to the Adviser as an advisory fee or any other fee for services to the Fund under the Investment Advisory Agreement or any other agreement with the Trust, as applicable.
This Letter Agreement shall be governed by, and construed in accordance with, the laws of the State of Delaware without giving effect to the conflict of laws principles thereof; provided that nothing herein shall be construed to preempt, or to be inconsistent with, any federal law, regulation or rule, including the Investment Company Act of 1940, as amended, and the Investment Advisers Act of 1940, as amended, and any rules and regulations promulgated thereunder.
Sincerely, | ||||
Highland Capital Management Fund Advisors, L.P. | ||||
By: |
/s/ Frank Waterhouse |
|||
Name: | Frank Waterhouse | |||
Title: | Treasurer |
ACKNOWLEDGED AND ACCEPTED | ||||
Highland Funds I | ||||
By: |
/s/ Frank Waterhouse |
|||
Name: | Frank Waterhouse | |||
Title: | Treasurer, Principal Accounting Officer and Principal Financial Officer |
Exhibit (h)(9)
October 26, 2017
LETTER AGREEMENT
Highland Funds I (the Trust)
200 Crescent Court, Suite 700
Dallas, Texas 75201
Re: Expense Limitation and Recoupment Agreement
Ladies and Gentlemen:
This Letter Agreement documents (i) an undertaking by Highland Capital Management Fund Advisors, L.P. (the Adviser) to limit the total operating expenses of the Highland Opportunistic Credit Fund (the Fund), a series of the Trust, and (ii) our agreement regarding the extent to which the Adviser will, under certain circumstances, receive payment from the Trust, on behalf of the Fund, as recoupment of certain amounts paid, waived or reimbursed by the Adviser to the Fund in fulfillment of the undertaking described above. This Letter Agreement shall terminate (i) in the event the Investment Advisory Agreement between the Trust and the Adviser terminates with respect to the Fund, (ii) at the sole discretion of the Funds Board of Trustees on 30 days prior written notice to the Adviser, or (iii) upon mutual agreement between the Adviser and the Funds Board of Trustees.
Effective November 1, 2017 and until at least October 31, 2018, the Adviser hereby undertakes to limit the total annual operating expenses (exclusive of fees paid by the Fund pursuant to its distribution plan under Rule 12b-1 under the Investment Company Act of 1940, taxes, brokerage commissions and other transaction costs, interest payments, acquired fund fees and expenses, extraordinary expenses and dividend expense on short sales) of the Fund to 0.90% of average daily net assets attributable to any class of the Fund (the Expense Cap).
The Trust, on behalf of the Fund, hereby agrees that it will be obligated to pay the Adviser all amounts previously paid, waived or reimbursed by the Adviser with respect to the Fund pursuant to the Expense Cap, provided that the amount of such additional payment in any year, together with all other expenses of the Fund, in the aggregate, would not cause the Funds total annual operating expenses in any such year to exceed the amount of the Expense Cap or any other agreed upon expense limitation for that year, and provided further that no additional payments by the Trust will be made with respect to amounts paid, waived or reimbursed by the Adviser more than thirty-six (36) months after the date the Fund accrues a liability with respect to such amounts paid, waived or reimbursed by the Adviser. The Adviser may not recoup any amounts previously paid, waived or reimbursed hereunder before payment of the Funds operating expenses for the year in which the Adviser intends to recoup such amounts.
Any payments by the Trust under this Letter Agreement shall be in addition to all amounts otherwise payable to the Adviser as an advisory fee or any other fee for services to the Fund under the Investment Advisory Agreement or any other agreement with the Trust, as applicable.
This Letter Agreement shall be governed by, and construed in accordance with, the laws of the State of Delaware without giving effect to the conflict of laws principles thereof; provided that nothing herein shall be construed to preempt, or to be inconsistent with, any federal law, regulation or rule, including the Investment Company Act of 1940, as amended, and the Investment Advisers Act of 1940, as amended, and any rules and regulations promulgated thereunder.
Sincerely, | ||||
Highland Capital Management Fund Advisors, L.P. | ||||
By: |
/s/ Frank Waterhouse |
|||
Name: | Frank Waterhouse | |||
Title: | Treasurer | |||
ACKNOWLEDGED AND ACCEPTED | ||||
Highland Funds I | ||||
By: |
/s/ Frank Waterhouse |
|||
Name: | Frank Waterhouse | |||
Title: | Treasurer, Principal Accounting Officer and Principal Financial Officer |
Exhibit (h)(10)
October 26, 2017
LETTER AGREEMENT
Highland Funds I (the Trust)
200 Crescent Court, Suite 700
Dallas, Texas 75201
Re: Expense Limitation and Recoupment Agreement
Ladies and Gentlemen:
This Letter Agreement documents (i) an undertaking by Highland Capital Management Fund Advisors, L.P. (the Adviser) to limit the total operating expenses of the Highland Merger Arbitrage Fund (the Fund), a series of the Trust, and (ii) our agreement regarding the extent to which the Adviser will, under certain circumstances, receive payment from the Trust, on behalf of the Fund, as recoupment of certain amounts paid, waived or reimbursed by the Adviser to the Fund in fulfillment of the undertaking described above. This Letter Agreement shall terminate (i) in the event the Investment Advisory Agreement between the Trust and the Adviser terminates with respect to the Fund, (ii) at the sole discretion of the Funds Board of Trustees on 30 days prior written notice to the Adviser, or (iii) upon mutual agreement between the Adviser and the Funds Board of Trustees.
Effective November 1, 2017 and until at least October 31, 2018, the Adviser hereby undertakes to limit the total annual operating expenses (exclusive of fees paid by the Fund pursuant to its distribution plan under Rule 12b-1 under the Investment Company Act of 1940, taxes, brokerage commissions and other transaction costs, interest payments, acquired fund fees and expenses, extraordinary expenses and dividend expense on short sales) of the Fund to 1.50% of average daily net assets attributable to any class of the Fund (the Expense Cap).
The Trust, on behalf of the Fund, hereby agrees that it will be obligated to pay the Adviser all amounts previously paid, waived or reimbursed by the Adviser with respect to the Fund pursuant to the Expense Cap, provided that the amount of such additional payment in any year, together with all other expenses of the Fund, in the aggregate, would not cause the Funds total annual operating expenses in any such year to exceed the amount of the Expense Cap or any other agreed upon expense limitation for that year, and provided further that no additional payments by the Trust will be made with respect to amounts paid, waived or reimbursed by the Adviser more than thirty-six (36) months after the date the Fund accrues a liability with respect to such amounts paid, waived or reimbursed by the Adviser. The Adviser may not recoup any amounts previously paid, waived or reimbursed hereunder before payment of the Funds operating expenses for the year in which the Adviser intends to recoup such amounts.
Any payments by the Trust under this Letter Agreement shall be in addition to all amounts otherwise payable to the Adviser as an advisory fee or any other fee for services to the Fund under the Investment Advisory Agreement or any other agreement with the Trust, as applicable.
This Letter Agreement shall be governed by, and construed in accordance with, the laws of the State of Delaware without giving effect to the conflict of laws principles thereof; provided that nothing herein shall be construed to preempt, or to be inconsistent with, any federal law, regulation or rule, including the Investment Company Act of 1940, as amended, and the Investment Advisers Act of 1940, as amended, and any rules and regulations promulgated thereunder.
Sincerely, | ||||
Highland Capital Management Fund Advisors, L.P. | ||||
By: |
/s/ Frank Waterhouse |
|||
Name: | Frank Waterhouse | |||
Title: | Treasurer | |||
ACKNOWLEDGED AND ACCEPTED | ||||
Highland Funds I | ||||
By: |
/s/ Frank Waterhouse |
|||
Name: | Frank Waterhouse | |||
Title: | Treasurer, Principal Accounting Officer and Principal Financial Officer |
Exhibit (h)(11)(ii)
June 5, 2017
State Street Bank and Trust Company
Channel Center, Mailstop CCB0502
1 Iron Street
Boston, MA 02210
Attention: Thomas P. Barry, Vice President
Re: | H IGHLAND F UNDS I (the Trust) |
Ladies and Gentlemen:
In accordance with Section 1, the Appointment of Administrator provision, of the Master Administration Agreement dated as of January 7, 2013 by and among State Street Bank and Trust Company (State Street) and the Trust (as amended, modified, or supplemented from time to time, the Agreement), the undersigned Trust hereby requests that State Street act as Administrator for the H IGHLAND M ERGER A RBITRAGE F UND (the Fund) under the terms of the Agreement. In connection with such request, the undersigned Trust hereby confirms to State Street, as of the date hereof, its representations and warranties set forth in Section 4 of the Agreement.
Schedule A to the Agreement shall be deleted and replaced in its entirety with Schedule A attached hereto, effective as of the date set forth below.
Please indicate your acceptance of the foregoing by executing two copies of this letter agreement, returning one to the Trust and retaining one for your records.
Sincerely, HIGHLAND FUNDS I on behalf of: HIGHLAND MERGER ARBITRAGE FUND |
||
By: |
/s/ Dustin Norris |
|
Name: | Dustin Norris | |
Title: | Assistant Secretary, Duly Authorized |
Agreed and Accepted: | ||
STATE STREET BANK AND TRUST COMPANY | ||
By: | /s/ Andrew Erickson | |
Name: | Andrew Erickson | |
Title: | Executive Vice President, Duly Authorized |
Effective Date: | June 5, 2017 |
MASTER ADMINISTRATION AGREEMENT
SCHEDULE A
Listing of Trusts and Funds
Highland Funds I
Highland Opportunistic Credit Fund
Highland Merger Arbitrage Fund
Highland Funds II
Highland Fixed Income Fund
Highland Global Allocation Fund
Highland Premier Growth Equity Fund
Highland Small-Cap Equity Fund
Highland Tax-Exempt Fund
Highland Total Return Fund
Highland-First Foundation Income Fund
Exhibit (j)(1)
CONSENT OF COUNSEL
We hereby consent to the use of our name and the references to our firm under the caption Legal Counsel included in or made a part of Post-Effective Amendment No. 84 to the Registration Statement of Highland Funds I. (File No. 333-132400), on Form N-1A under the Securities Act of 1933, as amended.
/s/ Ropes & Gray LLP |
Ropes & Gray LLP |
Boston, MA |
October 26, 2017 |
Exhibit (j)(2)
Consent of Independent Registered Public Accounting Firm
The Board of Trustees and Shareholders
Highland Funds I and Highland/iBoxx Senior Loan ETF:
We consent to the use of our reports, dated August 29, 2017, with respect to the financial statements of Highland Long/Short Equity Fund, Highland Long/Short Healthcare Fund, Highland Merger Arbitrage Fund, Highland Opportunistic Credit Fund and Highland/iBoxx Senior Loan ETF, incorporated herein by reference, and to the references to our firm under the headings FINANCIAL HIGHLIGHTS in the prospectus and INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM and FINANCIAL STATEMENTS in the statement of additional information.
/s/ KPMG LLP
Boston, Massachusetts
October 26, 2017
Exhibit (p)(2)
CODE OF ETHICS POLICY
Purpose and Scope
The purpose of the Code of Ethics Policy (the Policy) is to implement a policy of strict compliance with the highest standards of ethical business conduct and the provisions of applicable federal securities laws, including rules and regulations promulgated by the SEC. This Policy provides guidance to all Company personnel regarding ethical business principles. The Policy designed to ensure compliance with legal requirements and the Companys standard of business conduct. Employees shall read and understand the Policy and uphold the standards outlined herein in their day-to-day activities at the Company.
General Policy
This Policy does not address every possible situation that may arise. Consequently, every Employee is responsible for exercising good judgment, applying ethical principles, and bringing violations or potential violations of this Policy to the attention of the Chief Compliance Officer. Any questions regarding the Companys policies and procedures should be referred to the Compliance Department. This Policy shall apply to each Employee of the Company. The Policy covers the following topics:
(i) | Insider Trading |
(ii) | Personal Trading Policy |
(iii) | Outside Business Activities and Private Securities Transactions |
(iv) | Business Gifts and Entertainment |
(v) | Political Contributions |
The Company will distribute this Code of Ethics, and any amendments, to each Employee, and each Employee will be required to sign either electronically or in writing an acknowledgement, indicating that they have received a copy of the Code of Ethics and will comply with its provisions. Acknowledgements required under the Code of Ethics may be submitted in written or electronic format containing substantially the same information included on the form.
Standards of Conduct
Compliance with Governing Laws, Regulations and Procedures
The Company and its Employees shall comply with all applicable federal and state laws and regulations.
(i) | Employees shall comply with all procedures and guidelines established by the Company to ensure compliance with applicable federal and state laws and regulations. No Employee shall knowingly participate in, assist, or condone any act of violation of any statute or regulation governing the Company or any act that would violate any provision of this Policy. |
(ii) | Employees shall have and maintain knowledge of and shall comply with the provisions of the Policy. |
(iii) | Employees having knowledge of violations of this Policy shall immediately report such violations to the Chief Compliance Officer. |
Individual Standards of Conduct
The following general principles guide the individual conduct of each Employee:
(i) | Employees will not take any action that will violate any applicable laws or regulations, including all federal securities laws. |
(ii) | Employees will adhere to the highest standards of ethical conduct. |
(iii) | Employees will maintain the confidentiality of all information obtained in the course of employment with the Company. |
(iv) | Employees will bring any issues reasonably believed to place the Company at risk to the attention of the Chief Compliance Officer. |
(v) | Employees will not abuse or misappropriate the Companys or any Clients assets or use them for personal gain. |
(vi) | Employees will disclose any activities that may create an actual or potential conflict of interest between the Employee, the Company and/or any Client. |
(vii) | Employees will deal fairly with Clients and other Employees and will not abuse the Employees position of trust and responsibility with Clients or take inappropriate advantage of his or her position with the Company. |
(viii) | Employees will comply with this Code of Ethics. |
Ethical Business Practices
It is the policy of the Company that any violation of applicable laws, regulations or this Policy shall be immediately reported to the Chief Compliance Officer. If an Employee, in good faith, raises an issue regarding a possible violation of law, regulation or Company policy or any suspected illegal or unethical behavior he or she will be protected from retaliation.
Falsification or Alteration of Records
Falsifying or altering records or reports, preparing records or reports that do not accurately or adequately reflect the underlying transactions or activities, or knowingly approving such conduct is prohibited. Examples of prohibited financial or accounting practices include:
(i) | Making false or inaccurate entries or statements in any Company or Client books, records, or reports that intentionally hide or misrepresent the true nature of a transaction or activity; |
(ii) | Manipulating books, records, or reports for personal gain; |
(iii) | Failing to maintain books and records that completely, accurately, and timely reflect all business transactions; |
(iv) | Maintaining any undisclosed or unrecorded Company or Client funds or assets; |
(v) | Using funds for a purpose other than the described purpose; and |
(vi) | Making a payment or approving a receipt with the understanding that the funds will be, or have been, used for a purpose other than what is described in the record of the transaction. |
Competition and Fair Dealing
The Company seeks to outperform its competition fairly and honestly. The Company seeks competitive advantages through superior performance, not through unethical or illegal business practices. Stealing proprietary information, possessing trade secret information obtained without the owners consent, or inducing such disclosures by past or present employees of other companies is prohibited. Each Employee should endeavor to respect the rights of and deal fairly with the Clients, vendors, service providers, suppliers, and competitors. No Employee should, in connection with any Company business, take unfair advantage of anyone through manipulation, concealment, abuse of privileged information, misrepresentation of material facts, or any other intentional unfair dealing practice. Employees should not falsely disparage or make unfair negative comments about its competitors or their products and services. Negative public statements concerning the conduct or performance of any former Employee of the Company should also be avoided.
Privacy of Personal Information
The Company will acquire and retain only personal information that is required for the effective operation of the business of the Company or that is required by law in the jurisdictions in which the Company operates. Access to such information will be restricted internally to those with a legitimate need to know. Employee communications transmitted by the Companys systems are not considered private.
Online Blogging and Communication with Media
Without the express advance approval of the Chief Compliance Officer or the Compliance Department, Employees are prohibited from posting their opinions regarding an investment, issuer, investment strategy, market conditions, government financial actions, and any and all other such opinions as may appear to impart a financial opinion on any corporate, personal, or financial blogging website.
Spreading of False Rumors
The Company prohibits Employees from spreading Rumors (as hereinafter defined) directly or indirectly regarding the financial condition of any company. For purposes of the Code of Ethics, a Rumor shall be defined to include any statement which, at the time of making, the Employee knew, or should have known, was false, misleading, or otherwise untrue or deceptive. This includes any statement in which the Employee omits a fact or set of facts, which if disclosed would change the nature of the statement, and which by being omitted results in the statement being false, misleading or otherwise untrue and deceptive. The Company prohibits the dissemination of Rumors verbally, electronically, or in writing.
Protection of Confidential Information
Information generated in the Company is a valuable Company asset. Protecting this information plays a vital role in the Companys continued growth and ability to compete. Such information includes among other things, technical information such as computer programs and databases, business information such as the Companys objectives and strategies, trade secrets, processes, analysis, charts, drawings, reports, sales, earnings, forecasts, relationships with Clients, marketing strategies, training materials, Employee compensation and records, and other information of a similar nature. Employees must maintain the confidentiality of the Companys proprietary and confidential information and must not use or disclose such information without the express consent of an officer of the Company or when legally mandated.
Confidentiality of Investor Information
As a registered investment adviser, we have particular responsibilities for safeguarding our investors information and the proprietary information of the Company. Employees should be mindful of this obligation when using the telephone, fax, electronic mail, and other electronic means of storing and transmitting information. Employees should not discuss confidential information in public areas, read confidential documents in public places, or leave or discard confidential documents where they can be retrieved by others.
Information concerning the identity of investors and their transactions and accounts is confidential. Such information may not be disclosed to persons within the Company
except as they may need to know it in order to fulfill their responsibilities to the Company. You may not disclose such information to anyone or any firm outside the Company unless (i) the outside firm requires the information in order to perform services for the Company and is bound to maintain its confidentiality; (ii) when the Client has consented or been given an opportunity to request that the information not be shared; (iii) as required by law; or (iv) as authorized by the Chief Compliance Officer. In addition, Regulation S-AM (Reg S-AM) prohibits a registered investment adviser from using information about an individual consumer that has been obtained from an affiliated entity for marketing purposes unless the information sharing practices have been disclosed and the consumer has not opted out. The Company should not use information about individuals that was obtained from affiliates for any marketing purposes and should not provide information about individuals to any of its affiliates for any marketing purposes.
Information regarding investor orders must not be used in any way to influence trades in personal accounts or in the accounts of other Clients. Intentionally trading ahead of a Clients order with the purpose of benefiting on the trade as a result of the Clients follow-on trade is known as frontrunning and is prohibited. Certain six-month short-swing transactions (e.g., a sale and a purchase, or a purchase and a sale, occurring within a six-month period) are also prohibited. If you reasonably believe improper trading in personal or Client accounts has occurred, you must report such conduct to the Chief Compliance Officer.
Additionally, Employees are prohibited from buying or selling an option while in possession of non-public information concerning a block transaction in the underlying stock, or buying or selling an underlying security while in possession of non-public information concerning a block transaction in an option covering that security (the inter-market front running), for an account in which the Company or such Employee has an interest or with respect to which the Company or such Employee exercises investment discretion. This prohibition extends to trading in stock index options and stock index futures while in possession of non-public information concerning a block transaction in a component stock of an index. A block transaction means a transaction involving 10,000 shares or more of an underlying security or options covering 10,000 shares or more of such security. In the case of a thinly traded security, fewer than 10,000 shares may constitute a block transaction.
Prohibition Against Insider Trading
General
The Company forbids any Employee from trading, either personally or on behalf of others, including registered investment companies, private investment funds and private accounts advised by the Company, on material non-public information or communicating material non-public information to others in violation of the law. This conduct is frequently referred to as insider trading. The Companys policy extends to activities within and outside each persons duties at the Company.
The term insider trading is not defined in the federal securities laws, but generally is used to refer to the use of material non-public information to trade in securities (whether or not one is an insider) or to communications of material non-public information to others.
While the law concerning insider trading is not static, it is generally understood that the law prohibits:
(i) | Trading by an insider while in possession of material non-public information; |
(ii) | Trading by a non-insider while in possession of material non-public information, where the information either was disclosed to the non-insider in violation of an insiders duty to keep it confidential or was misappropriated; or |
(iii) | Communicating material non-public information to others. |
Insider Trading
The elements of insider trading and the penalties for such unlawful conduct are discussed below. If Employees have any questions, they should consult the Chief Compliance Officer.
Who is an Insider?
The concept of who is an insider is broad. It includes generally officers, directors and Employees of a company. In addition, a person can become a temporary insider if he or she enters into a special confidential relationship in the conduct of a companys affairs and, as a result, is given access to information solely for the companys purposes. A temporary insider can include, among others, a companys attorneys, accountants, consultants, bank lending officers, and certain Employees of such organizations. In addition, although it is unlikely to occur in the normal conduct of its business, the Company or an Employee could become a temporary insider of a company it advises or for which it performs other services. According to the U.S. Supreme Court, the company must expect an outsider to keep the disclosed non-public information confidential and the relationship must at least imply such a duty before the outsider will be considered an insider.
What is Material Information?
Trading on inside information is not a basis for liability unless the information is material. Material information is defined generally as information for which there is a substantial likelihood that a reasonable investor would consider it important in making his or her investment decisions, or information that is reasonably certain to have a substantial effect on the price of a Companys securities. Information that should be considered material includes, but is not limited to, dividend changes, earnings estimates, changes in previously released earnings estimates, significant merger or acquisition proposals or
agreements, major litigation problems, antitrust charges, labor disputes, pending large commercial or government contracts, major new products or services, significant shifts in operating or financial circumstances (such as major write-offs and strikes at major plants) and extraordinary management developments (such as key personnel changes).
What is Non-Public Information?
Information is non-public until it has been effectively communicated to the market place. One must be able to point to some fact to show that the information is generally public. For example, information found in a report filed with the SEC, or appearing in Dow Jones, Reuters Economic Services, The Wall Street Journal or other publications of general circulation would be considered public.
Penalties for Insider Trading
Penalties for trading on or communicating material non-public information are severe, both for individuals involved in such unlawful conduct and their employers. A person can be subject to some or all of the penalties below even if he or she does not personally benefit from the violation. Penalties include:
(i) | civil injunctions; |
(ii) | disgorgement of profits; |
(iii) | jail sentences; |
(iv) | fines for the person who committed the violation of up to three times the profit gained or loss avoided, whether or not the person actually benefited; and |
(v) | fines for the employer or other controlling person of up to the greater of $1,000,000 or three times the amount of the profit gained or loss avoided. |
In addition, violations can be expected to result in serious sanctions by the Company, detailed in the Sanction Provisions section in this Policy, potentially including dismissal of the person(s) involved.
Procedures to Detect and Prevent Insider Trading
The following procedures have been established to aid Employees in avoiding insider trading, and to aid the Company in preventing, detecting and imposing sanctions against individuals for insider trading. Each Employee must follow these procedures or risk serious sanctions, including dismissal, substantial personal liability and criminal penalties.
Identifying Inside Information
Before trading for yourself or others, including any Client Account, in the securities of a Company about which you may have potential inside information, ask yourself the following questions:
(i) | Is the information material? Is this information that an investor would consider important in making his or her investment decisions? Is this information that would substantially affect the market price of the securities if disclosed? |
(ii) | Is the information non-public? To whom has this information been provided? Has the information been effectively communicated to the marketplace by appearing in publications of general circulation? Is the information already available to a significant number of other traders in the market? |
If after consideration of the foregoing you believe that the information is material and non-public, or if you have questions as to whether the information is material and non-public, you should take the following steps:
(i) | Report the matter immediately to the Chief Compliance Officer. |
(ii) | Do not purchase or sell the securities on behalf of yourself or others, including any Client Account. |
(iii) | Do not communicate the information within or outside of the Company other than to the Chief Compliance Officer. |
Client Account Trading
In connection with Company investments, certain Employees may gain access to material, non-public information relating to the applicable borrower or issuer. In such cases, the applicable borrower or issuer will be placed on the Companys Restricted List discussed below. In addition, in connection with investments, the Company will often enter into a confidentiality agreement relating to information that it may receive. It is the Companys general policy that all companies who are the subject of a confidentiality agreement will be placed on the Companys Restricted List.
Prior to a confidentiality agreement being executed and an issuer being placed on the internal Company restricted list, an email should be circulated by the investment professional or his/her designee to an internal restricted list, which comprises members of investments, notifying his/her intention to become restricted in an issuer. This notification will provide members of the firm time to opine or reject the execution of the confidentiality agreement. After a period of 24 hours has passed and if there are no objections received, the issuer will be placed on the Companys restricted list. Each proposed confidentiality agreement shall be emailed to the Companys Legal department for review, prior to execution.
Restricting Access to Material Non-Public Information
Information in your possession that you identify as material and non-public may not be communicated to anyone, including any person within the Company other than those persons who need to know such information in order to perform their job responsibilities at the Company. In addition, care should be taken to keep the information secure. For example, memos, reports, correspondence or files containing the information should be restricted.
Resolving Insider Trading Issues
If, after consideration of the provisions of this Code of Ethics, you have questions as to whether information is material or non-public, the propriety of any action, or about the foregoing procedures, please contact the Legal/Compliance Department to discuss your questions before trading or communicating the information to anyone.
Restricted Lists
Prior to voluntarily receiving any private-side or otherwise non-public information regarding any issuer (regardless of whether it is currently owned by the Company or any Client Account, but particularly if the Company is analyzing or recommending securities for Client transactions) in any form (oral, written, electronic, etc.) or in any manner (by conversation, by accessing private-side information on intralinks/syndtrak/debt domain, by fax, by e-mail, by confidentiality agreement, etc.), Employees should email [ ]@hcmlp.com requesting permission for the issuer to become restricted. This email is intended to put all relevant parties on notice of the potential restriction. Please include in your email the issuer name and whether or not the issuer has public securities. Also please indicate the anticipated length of the restriction (Note: for confidentiality agreements, this period is assumed to be the term of the agreement, absent CCO approval of a shorter period). Each analyst is responsible for notifying the Compliance Department immediately when the name of an issuer he or she monitors changes.
After receipt of the email notification, recipients of the restricted list request are generally provided 24 hours to object to the request to become restricted. If an objection is received, the relevant portfolio managers and other Employees should discuss the matter with Compliance to determine whether we will proceed with receiving the private information and become restricted.
Notwithstanding anything in this policy to the contrary, if an Employee of the Company receives or otherwise is in possession of material, non-public information with respect to an issuer, there is no applicable waiting period and the Employee receiving the information must immediately notify the Compliance Department
via [ ]@hcmlp.com to immediately add the issuer to the Restricted List . Specific instances where an issuer must immediately be added to the Companys Restricted List include, but are not limited to, the following:
| In the event Highland has a representative or observer on the Board of Directors of an issuer, the employee appointed or the portfolio manager responsible for the issuer must also immediately submit a Restricted List request for such issuer. |
| In the event any Highland personnel becomes aware that any Highland portfolio company in respect of which Highland has a board designee or observer rights is (i) entering into or has entered into a confidentiality or non-disclosure agreement with respect to an M&A transaction, the counterparties (e.g., the acquiring, merging or target company) should be immediately placed on the Restricted List; or (ii) presenting any other transaction to the board of such portfolio company for approval, then the facts and circumstances regarding such transaction shall be immediately communicated to the CCO for a determination as to whether the Company needs to add one or more parties to the transaction to the Companys Restricted List. |
Any questions regarding whether we are in possession of material non-public information or whether we need to add an issuer to the Restricted List must be brought to the immediate attention of the CCO for a determination. The CCO may, but is not required to, consult legal counsel for further guidance in making such a determination.
Exceptions to this policy can only be granted with express Compliance Approval upon a showing that none of the information in the possession of the Company constitutes material non-public information. The Compliance Department also has discretion to place an issuer on the Restricted List even though no Employee has or is expected to receive any material, non-public information about the issuer. Such action may be taken for the purpose of avoiding any appearance of the misuse of material, non-public information. When an issuer is placed on the Restricted List, all Employees are prohibited from personal trading in securities of those issuers. In addition, no trades in Client Accounts may be made in securities of an issuer on the Restricted List until the Compliance Department makes a determination as provided below.
In the event that the Company desires to engage in a securities transaction relating to an issuer that is listed on the Restricted List, the Chief Compliance Officer will consider all relevant factors, which may include: (i) whether the proposed transaction involves a security, (ii) the circumstances surrounding the placement of such issuer on the Restricted List, (iii) the extent to which any Employee may have material, non-public information, (iv) whether the counterparty to the transaction has access to the same information, and (v) whether the counterparty is entering into customary big-boy/non-reliance representations. The Chief Compliance Officer will then determine whether such factors prevent the Company from engaging in such security transaction. All such determinations
will be made on a case-by-case basis and may be made in conjunction with advice from internal and/or external legal counsel. The Legal/Compliance Department may condition its determination on the Portfolio Manager providing a certification affirming that, as of such trade date, he or she does not possess any material, non-public information relating to such issuer. In addition, in certain circumstances the Chief Compliance Officer may authorize one or more groups to trade while the firm is in possession of material nonpublic information, subject to appropriate ethical walls determined by the Chief Compliance Officer following consultation with any internal and/or external legal counsel that the Chief Compliance Officer may deem appropriate, being imposed that insulate the authorized groups from the information otherwise in possession of the firm.
All confidentiality or non-disclosure agreements must be reviewed by a member of the Companys legal department prior to execution.
There are two processes to remove an issuer from the Restricted List:
| Process A: Restricted List Expiration |
| Five days prior to the issuers expiration date a computer generated email reminder will be sent to the Portfolio Managers listed on the Restricted List as well as to the Compliance Department. |
| The issuer will be removed from the Restricted List upon the expiration date if the Portfolio Managers affirmatively indicate to the Compliance Department that the issuer should be removed. |
| Process B: Removal Prior to Expiration |
| For removals that are prior to the Restricted List expiration date, send an email to the Compliance Department confirming the basis for why we no longer have material non-public information. |
| Compliance will only remove a particular issuer from the Restricted List with Chief Compliance Officer approval following review of the relevant facts and circumstances, as described above. |
The only persons who are authorized to remove issuers from the Restricted List are members of the Compliance Department .
Personal Trading Policy
Policy Overview
The purpose of this policy regarding employee personal trading is to ensure that employees personal trading activity complies with applicable laws and regulations, and is
carried out in a manner consistent with Company policy. The Company has an obligation to monitor employee personal trading to ensure that all trades meet the requirements set forth in this policy and that all personal trading transactions must avoid even the appearance of a conflict of interest. (For additional information regarding the Personal Trading Policy, including the list of approved brokerage firms, please see Employee Trading Policy ).
General Principles
The following general principles should guide the individual trading activities of Employees:
1. | Employees may only trade Reportable Securities during the permitted trading windows discussed under Blackout Periods for Reportable Securities below, provided that up to 40 ETF trades may be completed each year at any time and, provided further that the Chief Compliance Officer may permit additional trades on a case-by-case basis. |
2. | Employees may not trade in the securities of an issuer in which any portfolio or fund managed by the Company has an interest in any part of the capital structure, (other than securities of issuers with respect to which the Company may be deemed to have an interest solely as a result of such securities being held in a retail client that is managed by a third party sub-advisor). Notwithstanding the foregoing, the Chief Compliance Officer may approve exceptions to this limitation upon showing of need such as (in the case of a sale by an employee where the Company is long the security in an account) or a showing of alignment of interests (such as where the employee wishes to buy a security that the company is long) provided that the investment does not violate any legal, regulatory, or contractual restriction. Issuers held by Company-advised ETFs which track an underlying index are excluded for this purpose and may be traded by employees assuming all other factors are met. |
3. | Executions of Employee account orders are subject to completion of Client orders (See, Restrictions on Personal Trading Activity below). |
4. | The Company reserves the right to cancel any Employees transaction. If a transaction is canceled, the Employee will bear the risk of loss and the Company (or a designated charity) will retain any profit associated with such cancellation. |
5. | Any breach of this policy may result in disciplinary action, up to and including termination of employment (See, Sanction Provisions for a detailed list of sanctions relating to violations of the Companys Code of Ethics Policy). |
Pre-Clearance Required for Reportable Securities: PTS
Employees are required to pre-clear all acquisitions or dispositions of Reportable Securities. Pre-clearance approval is good for the day on which it is obtained. Receiving pre-clearance approval for a specific trade does not oblige the employee to place the trade. Limit orders expiring at the end of a trading day are permissible; good until canceled orders are not.
Pre-Clearance Procedures
To monitor, record, and report the personal trading activities of Employees, the Company uses the Financial Tracking Personal Trading System (PTS). Each Employee is provided a username and password to the online PTS. Pre-clearance must be obtained by submitting a pre-clearance request using the PTS. PTS will generate an approval or denial of the pre-clearance. PTS maintains a record of all pre-clearance requests submitted and their approval status, which can be viewed by both Compliance and Employees. The Chief Compliance Officer monitors all transactions made by all Employees in order to ascertain any pattern of conduct which may evidence conflicts or potential conflicts with the principles and objectives of this Policy.
Employees requiring pre-clearance of personal securities transactions while out of the office can email [ ]@highlandcapital.com .
Transaction activity in proprietary accounts of the Company and its affiliates does not require preclearance pursuant to these policies.
Advance trade clearance in no way waives or absolves any Employees of the obligation to abide by the provisions, principles and objectives of this Policy.
Reportable Securities
For the purpose of this Code of Ethics, Reportable Securities are exchange traded funds (ETFs), closed-end funds, notes and financial derivatives, and, except as provided below, all public or private securities. However, ETFs and options on ETFs are not required to be pre-cleared.
The following instruments are not considered Reportable Securities: shares issued by open-end funds (mutual funds), other than funds advised by the Company or its affiliates , direct obligations of the Government of the United States, municipal securities, annuities, currencies and commodities, commercial paper, banker acceptances, and bank certificates of deposit.
Restrictions on Personal Trading Activity
Excessive trading by employees is discouraged and will be documented by Compliance and any issues identified will be presented to Senior Management.
Under no circumstances may any Employee effect a transaction in his or her personal account or in another Employees account while either in possession of material non-public information (MNPI) regarding the financial instrument and/or issuer that is the subject of the transaction, or with knowledge that a Client account is engaging, or likely to engage on the same day, in a similar transaction in the same instrument. Employees may reference the Companys Restricted List for a complete list of issuers the Company has access to MNPI. If an employee holds a position that is subsequently placed on the Restricted List, employees are prevented from closing out the position until the issuer is removed from the list.
Employees are also restricted from trading issuers where the Company has filed under Section 13D (Company owns more than 5%) or Section 16A (Company owns more than 10%). Compliance will maintain a complete list of restricted issuers under this rule.
Employees are prohibited from trading in any firm holding, excluding ETFs, that is in conflict with the Companys position. Conflicting positions misalign employee interests with investor interests. For example, employees are not allowed to go long in a security if the Company is currently short in an account nor shall they short a security if the company is currently long the security in an account.
All employees are prohibited from violating any rule, regulation, or law while trading in their personal accounts. Highland employees are expected to live up not only to the letter of the law but also to the ideals of the Company.
Blackout Periods for Reportable Securities
Without the prior approval of the Chief Compliance Officer or his designee, no employee may directly or indirectly acquire or dispose of a beneficial ownership interest in a Reportable Security other than during the first 7 calendar days of February, May, August, November and during the seven calendar days commencing on December 15 th and ending on December 21 st each year. No Employee may directly or indirectly acquire or dispose of a beneficial ownership in a Reportable Security, with the exceptions of ETFs, when the Company has a pending transaction for an asset of the same issuer or its wholly owned affiliate. In the event the Chief Compliance Officer permits an employee trading a firm holding, such employee trade may not be effected until the seventh calendar day after the Companys most recent transaction in the assets of that issuer. For example, if the Company purchases any part of IBMs capital structure on Calendar Day 1 (loans, bonds, or equity), on Calendar Day 6 an employee may not trade in IBM but on Calendar Day 7 the Employee may enter such a trade if the Company did not enter a trade in IBM on Calendar Day 6 and has no open orders on Calendar Day 7.
Employees will not be restricted from (i) exercising a call/put option position or otherwise covering an option position in their personal trading accounts prior to expiration as long as the original option position was approved through PTS, (ii) toggling elections within the Companys 401(k) plan, or (iii) investing in Funds managed by the Company or its affiliates (subject to applicable investor eligibility restrictions).
Front Running
All Employees are prohibited from front running. The SEC states front-running occurs when a person trades in advance of his or her client in order to take advantage of changes in the market price of a security that will be caused by that clients trade. The Company generally does not permit Employees to trade within seven days before a Client Account, unless subject to approval from the Chief Compliance Officer. If the seventh day falls on a weekend or holiday, the preceding business day is used.
Highland Retail Fund Trading
Employees are not allowed to trade for short term profits in any of the Retail Funds managed or sub-advised by the Company. Preclearance will be reviewed by the Chief Compliance Officer and will be subject to the same restrictions held on all other securities.
Pre-Clearance Required for Participation in IPOs
No Employee shall acquire any beneficial ownership in any securities in an initial public offering (as defined in Rule 204A-1 promulgated under the Advisers Act), for his or her account, without the prior approval of the Chief Compliance Officer who has been provided with full details of the proposed transaction.
Pre-Clearance Required for Private or Limited Offerings
No Employee shall acquire beneficial ownership of any securities in a limited offering (as defined in Rule 204A-1 promulgated under the Advisers Act) without the prior written approval of the Chief Compliance Officer who has been provided with full details of the proposed transaction.
Pre-Clearance Required for Personal Loans Collateralized by Securities
Prior to arranging a personal loan with a financial institution, which will be collateralized by securities, an Employee must obtain the approval of the Chief Compliance Officer. If the loan is approved, the Employee must supply the Chief Compliance Officer with an email containing the following information:
(i) | The date of the transaction, the title and the number of securities involved in the transaction, the principal amount of each security, and a description of any other interest involved; |
(ii) | The nature of the transaction (i.e., purchase, sale or any other type of acquisition or disposition); |
(iii) | The price at which the transaction was effected; and |
(iv) | The name of the broker, dealer or bank with or through whom the transaction was effected. |
Hardship Exemption
Employees may request to trade outside of permitted windows or amounts under the hardship exemption. This exemption includes, without limitation, transferring assets to a new account, raising cash for taxes due, raising cash for unanticipated personal, family or medical expenses, raising cash for a large investment, incurring losses or gains in excess of 20% on an investment, or court ordered liquidation. These and other claims under the hardship exemption will be reviewed at the discretion of the Chief Compliance Officer.
Requests for hardship exemptions must be provided to the Chief Compliance Officer in writing. The Employee is not permitted to complete any transaction unless approval has been granted.
Any and all ambiguities relating to the administration of this policy will be determined and resolved by the Chief Compliance Officer in his sole discretion.
Monitoring and Review of Personal Securities Transactions
The Chief Compliance Officer or a designee will monitor and review all reports required under the Policy for compliance with Highlands policies regarding personal securities transactions and applicable SEC rules and regulations. The Chief Compliance Officer may also initiate inquiries of Employees regarding personal securities trading. Employees are required to cooperate with such inquiries and any monitoring or review procedures employed by the Company. Any transactions for any accounts of the Chief Compliance Officer will be reviewed and approved by a separate member of Compliance, internal legal counsel or other designated supervisory person. All Employees are required to comply with the reporting requirements outlined in the Code of Ethics.
Reporting Requirements for Employees
Every Employee shall annually disclose their personal brokerage and third party 401(k) accounts and holdings held within those accounts. It is the Companys policy that Employees must maintain their account with firm approved brokerage firms. Additionally, an employee may be asked to provide hard copy duplicate statements for their disclosed personal brokerage accounts.
Initial and Annual Holdings Disclosure
Every Employee must, no later than ten (10) days after becoming an Employee and after opening any additional brokerage accounts thereafter, submit a completed Securities/Futures Account Disclosure Form covering the accounts over which they have investment discretion. Employees are required to provide a copy of their most current brokerage statements (and the information must be current as of no more than 45 days prior to the reporting date), and transfer their account to one of the designated brokers approved by the Company. For the purpose of this Policy, an Employee account includes:
(i) | Any account owned by an Employee, any account owned/controlled by his or her family (including a spouse, minor child or other relative living in the same household); |
(ii) | Any account, contract, understanding or other arrangement in which the Employee has a beneficial or pecuniary interest (such as a corporation, partnership, or estate in which the Employee has an interest); and |
(iii) | Any account over which the Employee exercises discretionary trading control (such as an IRA, trust account or other custodian account). |
Every employee must submit a completed Non-Discretionary Account Certification (attached as Appendix F ) if any of their accounts include a trust or third-party managed account within ten days of opening a new account. Employees completing this form will certify that:
(i) | The employee cannot suggest purchases or sales of investments to the trustee or third-party discretionary manager; |
(ii) | The employee cannot direct purchases or sales of investments in any of the trusts or third-party managed accounts; and |
(iii) | The employee does not consult with the trustee or third-party discretionary manager as to the particular allocation of investments to be made in any of the trusts or third-party managed accounts. |
No later thirty (30) days after the end of each calendar year, each Employee must complete an Annual Holdings Certification reflecting account holdings as of year-end. Both the Securities/Futures Account Disclosure Form and the Annual Holdings Certification at a minimum must contain the following information:
(i) | The title and type, the exchange ticker symbol or CUSIP number, the interest rate and maturity date (if applicable), the number of shares and the principal amount (if applicable) of each reportable security and/or reportable fund in which the Employee had any direct or indirect beneficial ownership; |
(ii) | The name of any broker, dealer or bank with whom the Employee maintains an account in which any securities were held for the direct or indirect benefit of the Employee; and |
(iii) | The date the report is submitted by the Employee. |
Securities/Futures Account Disclosure Form, Non-Discretionary Account Certification and Annual Holdings Certifications are submitted to the Chief Compliance Officer using PTS.
Quarterly Certification of Transactions
Every Employee must, no later than thirty (30) days after the end of each calendar quarter, file a quarterly Certification of Transactions containing the following information with respect to any transaction during the quarter in a reportable security over which the Employees had any direct or indirect beneficial ownership:
(i) | The date of the transaction, the title and exchange ticker symbol or CUSIP number, the interest rate and maturity date (if applicable), the number of shares and the principal amount (if applicable) of each reportable security; |
(ii) | The nature of the transaction (i.e., purchase, sale or any other type of acquisition or disposition); |
(iii) | The price of the reportable security at which the transaction was effected; |
(iv) | The name of the broker, dealer or bank with or through whom the transaction was effected; |
(v) | The date the account was established; and |
(vi) | The date the report is submitted by the Employee. |
As part of the reporting requirements, every Employee must also, no later than thirty (30) days after the end of each calendar quarter, affirm that they have reported all Reportable Securities transactions during the period. Quarterly Certification of Transactions are submitted to the Chief Compliance Officer using PTS.
Annual Certification & Conflict of Interest Disclosure
Every Employee must, no later than 30 days following year end, or no less than annually, must complete the Annual Certification & Conflicts of Interest Disclosure. The Annual Certification & Conflicts of Interest Disclosure is submitted to the Chief Compliance Officer using PTS. The Chief Compliance Officer or his/her designee is responsible reviewing and following up on any issues identified as potential conflicts of interest on the questionnaires.
Sanction Provisions
The following details violations of the Policy and the related sanctions that may result from non-adherence to the Policy. Each violation may result in the corresponding sanction, but the Company is not limited by what is enumerated. Similarly, the Company may take disciplinary action with respect to certain violations not specifically mentioned herein. The Chief Compliance Officer has the discretion to additionally fine a violator and to call a violator before Senior Management. A violation of the Policy may result in, warnings or fines as well as additional disciplinary action up to and including termination. All penalty fines will be placed in a fund held by the Company that will be available for donations to charities approved by Senior Management.
The Company encourages any Employee who has or may have violated the Policy (or any securities law or regulation) to voluntarily bring the matter to the attention of the Chief Compliance Officer. To the extent that any such volunteered violation of the Policy is determined to have been unintentional, or to the extent that such voluntary disclosure prevented further violation of the Policy, the Chief Compliance Officer, after such consultation with Senior Management that the Chief Compliance Officer determines is necessary or advisable, shall take such factors into consideration in determining any sanction relating to such Employee actions.
Outside Business Activities and Private Transactions
All employees of Highland Capital Management, L.P. (the Company) are required to devote their full time and efforts to the business of the Company. In addition, no person may make use of his or her position as an employee, make use of information acquired during employment, or make personal investments in a manner that may create a conflict, or the appearance of a conflict, between the employees personal interests and the interests of the Company.
To assist in ensuring that such conflicts are avoided, an employee must obtain the approval of the Chief Compliance Officer prior to:
(i) | Serving as a director, officer, general partner or trustee of, or as a consultant to, any business, corporation or partnership, including family owned businesses and charitable, non-profit and political organizations. |
(ii) | Accepting a second job or part-time job of any kind or engaging in any other business outside of the Company. |
(iii) | Acting, or representing that the employee is acting, as agent for a firm in any investment banking matter or as a consultant or finder. |
(iv) | Forming or participating in any stockholders or creditors committee. |
(v) | Receiving compensation of any nature, directly or indirectly, from any person, firm, corporation, estate, trust or association, other than the Company, whether as a fee, commission, bonus or other consideration such as stock, options or warrants. |
Every employee is required to complete the required disclosure form via PTS and have the form approved by the Chief Compliance Officer prior to serving in any of the capacities or making any of the investments described heretofore.
The Chief Compliance Officer, in connection with approving any outside activities, may place such conditions on an approval as he deems necessary and appropriate to protect the interests of any Client. In addition, an employee must notify the Legal/Compliance Department if the employee is or believes that he or she may become a participant, either as a plaintiff, defendant or witness, in any litigation or arbitration.
Gifts and Entertainment Policy
General
The Company recognizes the value of fostering good working relationships with individuals and firms doing business or seeking to do business with the Company. To this end, subject to the guidelines below, Employees are permitted, on occasion, to accept unsolicited perishable gifts and invitations to attend entertainment events with current or prospective service providers and counterparties. When doing so, however, Employees should always act in the best interests of the Company and its Clients and should avoid any activity that might create an actual or perceived conflict of interest or impropriety in the course of the Companys business relationships. Employees should contact the Chief Compliance Officer to discuss any offered activity or gift that they feel creates such a conflict. The Company reserves the right to prohibit the acceptance or retention of a gift or offer of entertainment, regardless of value, as it may determine in its sole discretion. In addition, the Company may reimburse certain expenses or costs paid by Employees as determined on a case by case basis.
Prior to accepting entertainment from an existing or prospective firm service provider or counterparty, Employees must notify and obtain approval from their Team Leader. All entertainment having a market value in excess of $200.00 per occurrence/item must also be pre-approved by Compliance. No gifts regardless of market value, other than unsolicited perishable items, may be accepted by Employees. To obtain approval employees must submit a Gift and Event Approval Form using PTS.
To determine approval or denial of the pre-clearance requests, the Chief Compliance Officer or his designee will consider if the gift or entertainment is of significant value and whether accepting such the gift or entertainment would create a real or potential conflict of interest. Entertainment may include such events as meals, shows, concerts, theatre events, sporting events, certain accommodations or similar types of entertainment. Entertainment also includes in-town and out-of-town trips and seminars where the service provider or counterparty offers to pay for items such as lodging, airfare, meal and/or event expenses. No gift or entertainment may be accepted or given, however, regardless of value, that is intended to influencing, or has the likelihood of influences, any business decision or relationship of the Company.
Entertainment
Entertainment includes events such as meals, shows, concerts, theatre events, sporting events, or similar types of entertainment.
(i) | The applicable current or prospective service provider or counterparty must accompany Employees to all Entertainment. |
(ii) | Entertainment may be provided for Employees and their immediate family members. |
(iii) | Employees must pay for all air transportation, which may be reimbursed by the Company in its sole discretion. |
(iv) | Despite the actual dollar value, the cost of the entertainment should in all instances be reasonable under the circumstances. |
(v) | Employees may not request to attend particular entertainment events. |
Gifts
Gifts include all items received from a service provider or counterparty, as well as tickets to an event that is not attended by the grantor, which is prohibited.
(i) | Only unsolicited perishable gifts are permitted. Alcoholic beverages are not considered perishable for Compliance purposes. |
(ii) | If a non-perishable gift is received, the Employee must return the gift to the grantor or donate the gift to charity. If the Employee elects to donate the gift to charity: |
(a) | The gift must be forwarded to the Employees respective administrative assistant. |
(b) | The non-perishable item will be donated to a local charitable organization (e.g. Goodwill or the Salvation Army). |
(c) | Evidence of the donation must be submitted to Compliance. |
(d) | No charitable tax deduction can be taken by the Company or any Employee in connection with the donation. |
(iii) | Employees may not request or solicit gifts. |
(iv) | No gift of cash or cash equivalents may be accepted. |
(v) | Employees may not receive perishable gifts on more than two occasions annually from a specific service provider or counterparty. |
Employee Provided Gifts and Entertainment
Employees may occasionally give and expense business gifts to someone doing or seeking to do business with the Advisor.
(i) | The value of such gift should be limited to approximately $150.00. |
(ii) | Employees should limit entertainment and meal expenses to approximately $150.00 per attendee per event and approximately $400.00 per person per day, provided that seats at sporting events shall be permitted regardless of value. |
(iii) | Employees should not give a requested business gift or entertainment. |
Guiding Principles
The Company holds its Employees to high ethical standards and strictly prohibits any giving or receipt of things of value that are designed to improperly influence the recipient. Anti-bribery and anti-corruption statutes in the U.S. and the U.K. are broadly written, so Employees should consult with the CCO if there is even an appearance of impropriety associated with the giving or receipt of anything of value.
Business gifts and entertainment are complex topics involving strict rules and dollar limits as well as the need for good judgment. Before offering or accepting any Business Gift or Business Entertainment, it is essential that Employees are familiar with the rules, but it is equally essential that Employees exercise appropriate judgment in situations that, even if within the rules, could appear improper to an independent observer such as a regulator or member of the media.
Terms with Special Meanings
Business Entertainment.
Any meal, sporting event (whether as a spectator or participant), cultural event, or similar entertainment that an Employee and a Business Partner attend together and that one of the parties provided. Exception: Meals that are in connection with an approved training and education event or industry conference are not considered Business Entertainment.
Business Gift.
Anything of value that is given to, or accepted from, a Business Partner. It includes prizes (whether awarded by skill or chance) and any discount or rebate not generally available to the public.
Business Partner.
Any natural person who is:
(i) | A current or prospective Client, a consultant of same, or a vendor, supplier, or provider of any service to the Company. |
(ii) | An employee, agent, officer, or representative of any of the above. |
Government Official.
Any elected or appointed official at any level of government in any country (U.S. or non-U.S.), and any U.S. candidate for federal, state or local office. This includes any board members or personnel of a state or local retirement plan, sovereign wealth fund, or government-controlled enterprise. For purposes of this policy, the term Government Official also includes any individual who would be considered a foreign official under the Foreign Corrupt Practices Act (FCPA), including but not limited to, all officers and employees of a foreign government or any department, agency, or instrumentality thereof, as well as any board members or personnel of a state or local retirement plan, sovereign wealth fund, or government-controlled enterprise.
General Restrictions and Requirements
Prohibition Against Broker-Sponsored Entertainment.
The acceptance of any broker provided gifts, tickets or invitations to entertainment oriented events while acting as a representative of the Company is prohibited. This includes gifts of any kind as well as invitations ore tickets to any sporting events, plays, concerts, rounds of golf, charitable events, etc. If Employees elect to participate in any of these events with a broker, the Employee must consider their participation as a personal choice and they will be required to pay their own way.
Prohibition Against Giving or Receiving Cash or Cash Equivalents.
Employees must never give or accept cash or cash equivalents as a Business Gift. This includes items that can be redeemed for cash, such as checks and cash-redeemable gift cards. Gift cards or gift certificates that can be redeemed only for goods or services, and not for cash, are allowed.
Prohibition Against Solicitation of Business Gifts and Business Entertainment.
Employees must never solicit a Business Gift or Business Entertainment. If a Business Partner solicits either of these from an Employee, such request should politely be declined and reported to the CCO.
Prohibition Against Quid Pro Quo Arrangements.
Employees may never give or receive a Business Gift or Business Entertainment if there is any explicit quid-pro-quo arrangement, meaning that there is an understanding (either spoken or implicit) that the gift or entertainment is specifically linked to a certain business outcome.
Restrictions for Special Categories
Gifts and Entertainment Given to Union Officials.
Any gift or entertainment provided by Highland to a labor union or a union official in excess of $250 per fiscal year must be reported on Department of Labor Form LM-10 within 90 days following the end of the Companys fiscal year.
Gifts and Entertainment Given to ERISA Plan Fiduciaries.
The Company is prohibited from giving gifts or entertainment with an aggregate value exceeding $250 per year to any ERISA plan fiduciary.
Gifts and Entertainment Given to Government Officials.
Due to various restrictions on the giving of gifts and entertainment to elected and appointed officials at any level of government and in any country, as well as any United States candidate for federal, state, or local office, all Business Gifts and Business Entertainment to be given to such Government Officials must be pre-cleared.
The Foreign Corrupt Practices Act (FCPA) prohibits the direct or indirect giving of, or a promise to give, things of value in order to corruptly obtain a business benefit from an officer, employee, or other instrumentality of a foreign government. Companies that are owned, even partly, by a foreign government may be considered an instrumentality of that government. In particular, government investments in foreign financial institutions may make the FCPA applicable to those institutions. Individuals acting in an official capacity on behalf of a foreign government or a foreign political party may also be instrumentalities of a foreign government.
The FCPA includes provisions that may permit the giving of gifts and entertainment under certain circumstances, including certain gifts and entertainment that are lawful under the written laws and regulations of the recipients country, as well as bona-fide travel costs for certain legitimate business purposes. However, the availability of these exceptions is limited and is dependent on the relevant facts and circumstances.
Civil and criminal penalties for violating the FCPA can be severe. Employees must consult with the CCO, or designee, prior to providing any business gifts and/or entertainment to individuals that may be covered by the FCPA.
Political Contributions
General
Individuals may have important personal reasons for seeking public office, supporting candidates for public office, or making charitable contributions. However, such activities could pose compliance and business risks to an investment adviser because federal and state pay-to-play laws.
SEC Rule 206(4)-5 (the Pay-to-Play Rule) imposes restrictions on certain political contributions made by investment advisers that provide advisory services to a state or local government entity or to an investment pool in which a state or local governmental entity invests. An investment pool includes:
(i) | Any investment company registered under the Investment Company Act that is an investment option of a plan or program of a government entity; or |
(ii) | Any company that would be an investment company under section 3(a) of the Investment Company Act but for the exclusion provided from that definition by section 3(c)(1), section 3(c)(7) or section 3(c)(11) of the Investment Company Act. |
The Company currently provides advisory services to government entities and anticipates continuing to do so in the future and therefore will fall under the provisions of the Rule. Any questions regarding this rule should be directed to the Chief Compliance Officer.
Specifics of the Rule
There are three key elements of the Rule: (i) a two-year time-out from receiving compensation for providing advisory services to certain government entities after certain political contributions are made, (ii) a prohibition on soliciting contributions and payments, and (iii) a prohibition from paying third parties for soliciting government clients.
Two-Year Time Out
The Rule prohibits an Investment Adviser from receiving compensation from a government entity for two years after the Investment Adviser or any of its covered associates makes a political contribution to an official of the government entity. During the two-year time-out period, the Investment Adviser is only prohibited from receiving compensation from a government entity; the Investment Adviser can still provide advisory services to the government entity.
Any employee who makes a disqualifying contribution during the course of his or her employment without first clearing such contribution with Compliance may be held personally liable to the Company for any loss of fees or other damages incurred by the Company as a result of such noncompliance.
Employees Must Obtain Pre-Clearance Before Making Political Contributions
If an employee is considering making a political contribution to any state or local government entity, official, candidate, political party, or political action committee, the potential contributor must seek pre-clearance from the CCO.
Look-Back Provision
Under the Rule, when a person becomes a covered associate (including when an existing employee is transferred or promoted), the Investment Adviser must look back in time to that persons prior contributions to determine whether the time-out provisions of the Rule apply to the Investment Adviser. If the person is involved in soliciting clients, then the Investment Adviser is required to look back two years. If the person is not involved in soliciting clients, then the Investment Adviser is only required to look back six months. The look-back provision is prophylactic since it bars advisers from influencing the selection process by hiring persons who have made political contributions.
Soliciting Contributions and Payments
The Rule bars an Investment Adviser and its covered associates from soliciting or coordinating: (i) contributions to an official of a government entity to which the Investment Adviser is seeking to provide investment advisory services, or (ii) payments to a political party of a state or locality where the Investment Adviser is providing or seeking to provide investment advisory services to a government entity.
Prohibition on Third Party Solicitation
The Rule prohibits an Investment Adviser or any of its covered associates from paying any person to solicit a government entity unless such person is (i) a regulated person (i.e., a registered investment adviser or broker-dealer) that is subject to prohibitions against engaging in pay-to-play practices or (ii) one of the Investment Advisers employees, general partners, managing members, or executive officers (although contributions by these persons may trigger the two-year time out). This provision is a change from the initial proposal, which would have completely barred the use of solicitors.
The prohibition does not extend to non-affiliated persons providing legal, accounting or other professional services in connection with specific investment advisory business that are not being paid directly or indirectly for communicating with the government entity for the purpose of obtaining or retaining investment advisory business for the Investment Adviser.
Catch-all Provision
There is a catch-all provision in the Rule that prohibits acts done indirectly, which, if done directly, would violate the Rule. As a result, an Investment Adviser and its covered
associates are not permitted to funnel payments through third parties, including, for example, consultants, attorneys, family members, friends or companies affiliated with the adviser as a means to circumvent the Rule.
De Minimis Exception
The Rule has a de minimis exception for contributions to officials for whom the contributor can vote. The exception permits individual contributions up to $350 per official (per election) for whom the employee is entitled to vote. In addition, contributions that in the aggregate do not exceed $150 per election per official will not violate the Rule, even if the contributor is not entitled to vote for the official. These de minimis exceptions are available only for contributions by individual covered associates, not the Investment Adviser. Under both exceptions, primary and general elections are considered separate elections.
Returned Contributions Exception
The Rule contains an exception that will provide an Investment Adviser with a limited ability to cure the consequences of an inadvertent political contribution to an official for whom the covered associate making it is not entitled to vote. The exception is available for a limited number of contributions that, in the aggregate, do not exceed $350 to any one official, per election. The Investment Adviser must have discovered the offending contribution within four months of the date the contribution was made and, within 60 days after learning of the triggering contribution, the contributor must obtain the return of the contribution.
Exemptions
The SEC may exempt an Investment Adviser from the two-year time out requirement after an offending contribution is discovered when the exemption is necessary or appropriate in the public interest.
Whistleblower Policy
Purpose
This policy establishes procedures for the receipt, review, and retention of Reporting Person (defined below) complaints relating to the Advisers accounting, internal accounting controls, and auditing matters. The Adviser is committed to complying with all applicable accounting standards, accounting controls, and audit practices. While the Adviser does not encourage frivolous complaints, the Adviser does expect its officers, employees, and agents to report any irregularities and other suspected wrongdoing regarding questionable accounting or auditing matters. It is the Advisers policy that its employees may submit complaints of such information on a confidential and anonymous basis without fear of dismissal or retaliation of any kind. This policy applies only to reports concerning Accounting Violations (as defined in Part 3 below).
The Chief Compliance Officer is responsible for overseeing the receipt, investigation, resolution, and retention of all complaints submitted pursuant to this policy.
This policy was adopted in order to:
(i) | Cause violations to be disclosed before they can disrupt the business or operations of the Adviser, or lead to serious loss; |
(ii) | Promote a climate of accountability and full disclosure with respect to the Advisers accounting, internal controls, compliance matters, and Code of Ethics; and |
(iii) | Ensure that no individual feels at a disadvantage for raising legitimate concerns. |
This policy provides a means whereby individuals can safely raise, at a high level, serious concerns and disclose information that an individual believes in good faith relates to violations of the Compliance Manual, Code of Ethics, or law.
Reporting Persons Protected
This policy and the related procedures offer protection from retaliation against officers, employees, and agents who make any complaint with respect to perceived violations (referred to herein as a Reporting Person), provided the complaint is made in good faith. Good faith means that the Reporting Person has a reasonably held belief that the complaint made is true and has not been made either for personal gain or for any ulterior motive.
The Adviser will not discharge, demote, suspend, threaten, harass, or in any manner discriminate or otherwise retaliate against any Reporting Person in the terms or conditions of his employment with the Adviser based upon such Reporting Persons submitting in good faith any complaint regarding an Accounting Violation. Any acts of retaliation against a Reporting Person will be treated by the Adviser as a serious violation of Adviser policy and could result in dismissal.
Scope of Complaints
The Adviser encourages employees and officers (Inside Reporting Persons) as well as non-employees such as agents, consultants and investors (Outside Reporting Persons) to report irregularities and other suspected wrongdoings, including, without limitation, the following:
(i) | Fraud or deliberate error in the preparation, evaluation, review or audit of any financial statement of the Adviser; |
(ii) | Fraud or deliberate error in preparation and dissemination of any financial, marketing, informational, or other information or communication with regulators and/or the public; |
(iii) | Deficiencies in or noncompliance with the Advisers internal controls and procedures; |
(iv) | Misrepresentation or false statement to or by a senior officer of the Adviser regarding any matters in violation of state and/or federal securities laws; or |
(v) | Deviation from full and fair reporting of the Advisers financial condition. |
Confidentiality of Complaint
The Chief Compliance Officer will keep the identity of any Inside Reporting Person confidential and privileged under all circumstances to the fullest extent allowed by law, unless the Inside Reporting Person has authorized the Adviser to disclose his identity.
The Chief Compliance Officer will exercise reasonable care to keep the identity of any Outside Reporting Person confidential until it launches a formal investigation. Thereafter, the identity of the Outside Reporting Person may be kept confidential, unless confidentiality is incompatible with a fair investigation, there is an overriding reason for identifying or otherwise disclosing the identity of such person, or disclosure is required by law, such as where a governmental entity initiates an investigation of allegations contained in the complaint. Nothing in this Manual prohibits any Supervised Person from initiating communications directly with, or responding to any inquiry from, or providing testimony before, the SEC, FINRA, any other self-regulatory organization or any other state or federal regulatory authority, regarding a possible securities law violation.
Submitting Complaints
Inside Reporting Persons should submit complaints in accordance with the following procedures:
(i) | Complaints must be submitted in writing and mailed in a sealed envelope addressed as follows: The Chief Compliance Officer, Confidential To be Opened Only by the Chief Compliance Officer. |
(ii) | If they so desire, Inside Reporting Persons may request to discuss their complaint with the Chief Compliance Officer by indicating such desire and including their name and telephone number in the complaint. |
(iii) | Inside Reporting Persons may report violations on an anonymous basis. The Chief Compliance Officer urges any employee that is considering making an anonymous complaint to strongly consider that anonymous complaints are, by their nature, susceptible to abuse, less reliable, and more difficult to resolve. In addition, employees considering making an anonymous complaint should be aware that there are significant rights and protections available to them if they identify themselves when making a complaint, and that these rights and protections may be lost if they make the complaint on an anonymous basis. Therefore, the Adviser encourages employees to identify themselves when making reports of Accounting Violations. In responding to anonymous complaints, the Chief Compliance Officer will pay due regard to: |
(a) | The fairness to any individual named in the anonymous complaint; |
(b) | The seriousness of the issue raised; |
(c) | The credibility of the information or allegations in the complaint, with allegations that are speculative or that do not have a specific factual basis being likely to receive less credence; and |
(d) | The ability to ascertain the validity of the complaint and appropriately resolve the complaint without the assistance and cooperation of the person making the complaint. |
Outside Reporting Persons should submit complaints concerning violations in accordance with the following procedures:
(i) | Complaints may be submitted by e-mail or by a written letter in a sealed envelope addressed as follows: The Chief Compliance Officer, Confidential To be Opened Only by the Chief Compliance Officer. |
The Chief Compliance Officer recommends that Outside Reporting Persons use the sample Complaint Form attached to this policy when reporting Accounting Violations.
(ii) | Outside Reporting Persons are required to disclose their identity in any complaints submitted under this policy. Complaints submitted by non-employees on an anonymous basis may not be reviewed. |
Investigation of Complaints
(i) | Upon receipt of a complaint, the Chief Compliance Officer (or his designated representative) will confirm the complaint pertains to a violation. Investigations will be conducted as quickly as possible, taking into account the nature and complexity of the complaint and the issues raised therein. Any complaints submitted pursuant to this policy that do not relate to a violation will be returned to the Reporting Person, unless the Reporting Persons identity is unknown. |
(ii) | The Chief Compliance Officer may enlist employees of the Adviser and outside legal, accounting and other advisors, as appropriate, to conduct an investigation of a complaint. |
(iii) | The results of each investigation will be reported timely to the Chief Compliance Officer, which will then apprise the Chief Executive Officer, and prompt and appropriate remedial action will be taken as warranted in the judgment of the Chief Executive Officer or as otherwise directed by the Chief Compliance Officer. Any actions taken in response to a complaint will be reported to the Reporting Person to the extent allowed by law, unless the complaint was submitted on an anonymous basis. |
(iv) | An Inside Reporting Person who is not satisfied with the outcome of the initial investigation or the remedial action taken with respect thereto, if any, may submit directly to the Chief Compliance Officer for its review a written complaint with an explanation of why the investigation or remedial action was inadequate. An Inside Reporting Person may submit a revised complaint on an anonymous basis in his sole discretion. The Inside Reporting Person should forward the revised complaint to the attention of the Chief Compliance Officer in the same manner as set out above for the original complaint. |
(v) | The Chief Compliance Officer will review the Reporting Persons revised complaint, together with documentation of the initial investigation, and determine in its sole discretion if the revised complaint merits further investigation. The Chief Compliance Officer will conduct a subsequent investigation to the extent and in the manner it deems appropriate. The Chief Compliance Officer may enlist employees of the Adviser and outside legal, accounting and other advisors, as appropriate, to undertake the subsequent investigation. The Chief Compliance Officer or its designated representative will inform the Reporting Person of any remedial action taken in response to a Revised Complaint to the extent allowed by law, unless the complaint was submitted on an anonymous basis. |
Retention of Complaints
The Chief Compliance Officer will maintain all complaints received, tracking their receipt, investigation, and resolution. All complaints and reports will be maintained in accordance with the Advisers confidentiality and document retention policies.
Unsubstantiated Allegations
If a Reporting Person makes a complaint in good faith pursuant to this policy and any facts alleged therein are not confirmed by a subsequent investigation, no action will be taken against the Reporting Person. In submitting complaints, Reporting Persons should exercise due care to ensure the accuracy of the information reported. If, after an investigation, it is determined that a complaint is without substance or was made for malicious or frivolous reasons or otherwise submitted in bad faith, the Reporting Person could be subject to disciplinary action. Where alleged facts reported pursuant to this policy are found to be without merit or unsubstantiated: (i) the conclusions of the investigation will be made known to both the Reporting Person, unless the complaint was submitted on an anonymous basis, and, if appropriate, to the persons against whom any allegation was made in the complaint; and (ii) the allegations will be dismissed.
Reporting and Annual Review
The Chief Compliance Officer will submit periodic reports to the Chief Executive Officer of all complaints and any remedial actions taken in connection therewith. This policy will be reviewed annually by the Chief Compliance Officer, taking into account the effectiveness of this policy in promoting the reporting of Accounting Violations of the Adviser, but with a view to minimizing improper complaint submissions and investigations.