UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number 811-21756
First Trust Strategic High Income Fund
(Exact name of registrant as specified in charter)
120 East Liberty Drive, Suite 400
Wheaton, IL 60187
(Address of principal executive offices) (Zip code)
W. Scott Jardine, Esq.
First Trust Portfolios L.P.
120 East Liberty Drive, Suite 400
Wheaton, IL 60187
(Name and address of agent for service)
registrant's telephone number, including area code: 630-765-8000
Date of fiscal year end: October 31
Date of reporting period: October 31, 2009
Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549. The OMB has reviewed this collection of information under
the clearance requirements of 44 U.S.C. Section 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
FIRST TRUST STRATEGIC HIGH INCOME FUND
ANNUAL REPORT
FOR THE YEAR ENDED
OCTOBER 31, 2009
(FIRST TRUST LOGO)
BROOKFIELD
TABLE OF CONTENTS
FIRST TRUST STRATEGIC HIGH INCOME FUND (FHI)
ANNUAL REPORT
OCTOBER 31, 2009
Shareholder Letter........................................ 1
At A Glance............................................... 2
Portfolio Commentary...................................... 3
Portfolio of Investments.................................. 6
Statement of Assets and Liabilities....................... 12
Statement of Operations................................... 13
Statements of Changes in Net Assets....................... 14
Statement of Cash Flows................................... 15
Financial Highlights...................................... 16
Notes to Financial Statements............................. 17
Report of Independent Registered Public Accounting Firm... 25
Additional Information.................................... 26
Board of Trustees and Officers............................ 30
Privacy Policy............................................ 34
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements within the meaning of
the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934,
as amended. Forward-looking statements include statements regarding the goals,
beliefs, plans or current expectations of First Trust Advisors L.P. ("First
Trust" or the "Advisor") and/or Brookfield Investment Management Inc.
("Brookfield" or the "Sub-Advisor") and their respective representatives, taking
into account the information currently available to them. Forward-looking
statements include all statements that do not relate solely to current or
historical fact. For example, forward-looking statements include the use of
words such as "anticipate," "estimate," "intend," "expect," "believe," "plan,"
"may," "should," "would" or other words that convey uncertainty of future events
or outcomes.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause the actual results, performance or achievements of
First Trust Strategic High Income Fund (the "Fund") to be materially different
from any future results, performance or achievements expressed or implied by the
forward-looking statements. When evaluating the information included in this
report, you are cautioned not to place undue reliance on these forward-looking
statements, which reflect the judgment of the Advisor and/or Sub-Advisor and
their respective representatives only as of the date hereof. We undertake no
obligation to publicly revise or update these forward-looking statements to
reflect events and circumstances that arise after the date hereof.
PERFORMANCE AND RISK DISCLOSURE
There is no assurance that the Fund will achieve its investment objectives. The
Fund is subject to market risk, which is the possibility that the market values
of securities owned by the Fund will decline and that the value of the Fund
shares may therefore be less than what you paid for them. Accordingly, you can
lose money investing in the Fund. See "Risk Considerations" in the Notes to
Financial Statements for a discussion of other risks of investing in the Fund.
Performance data quoted represents past performance, which is no guarantee of
future results, and current performance may be lower or higher than the figures
shown. For the most recent month-end performance figures, please visit
http://www.ftportfolios.com or speak with your financial advisor. Investment
returns, net asset value and common share price will fluctuate and Fund shares,
when sold, may be worth more or less than their original cost.
HOW TO READ THIS REPORT
This report contains information that may help you evaluate your investment. It
includes details about the Fund and presents data and analysis that provide
insight into the Fund's performance and investment approach.
By reading the portfolio commentary by the portfolio management team of the
Fund, you may obtain an understanding of how the market environment affected the
Fund's performance. The statistical information that follows may help you
understand the Fund's performance compared to that of relevant market
benchmarks.
It is important to keep in mind that the opinions expressed by personnel of
Brookfield are just that: informed opinions. They should not be considered to be
promises or advice. The opinions, like the statistics, cover the period through
the date on the cover of this report. The risks of investing in the Fund are
spelled out in the prospectus, the statement of additional information, this
report and other regulatory filings.
SHAREHOLDER LETTER
FIRST TRUST STRATEGIC HIGH INCOME FUND (FHI)
ANNUAL REPORT
OCTOBER 31, 2009
Dear Shareholders:
2009 has been more positive for the U.S. and global markets, easing many of the
worries of both economists and investors about the recession that gripped us for
eighteen months. Many economists now believe that the recession that began in
December 2007 ended in March 2009. In fact, the Dow Jones Industrial Average's
total return from March 9, 2009, (the statistical end of the bear market) to
October 31, 2009, was 51.13%. Of course, no one can predict that this trend will
continue, but as we have seen better news across the financial markets the
economy has continued to rise.
First Trust Advisors L.P. ("First Trust") has always believed that in order to
be successful in reaching your financial goals, you should be invested for the
long term. A long-term investor understands that the market, from a historical
perspective, has always experienced ups and downs. But history has shown that
the patient investor is typically rewarded over the long term. We have always
believed that staying invested in quality products and having a long-term
perspective can help investors reach their financial goals.
The report you hold contains detailed information about your investment in First
Trust Strategic High Income Fund (the "Fund"). It contains a portfolio
commentary from the Fund's portfolio management team that provides a market
recap for the period, a performance analysis and a market and Fund outlook.
Additionally, the report provides the Fund's financial statements for the period
covered by the report. I encourage you to read this document and discuss it with
your financial advisor.
Since its inception, First Trust has been through many types of markets. We
remain committed to bringing you quality investment solutions regardless of the
inevitable volatility the market experiences. We offer a variety of products
that can fit many financial plans to help those investors seeking long-term
investment success. As well, we are committed to making available up-to-date
information about your investments so you and your financial advisor have
current information on your portfolio.
We continue to value our relationship with you, and we thank you for the
opportunity to assist you in achieving your financial goals.
Sincerely,
/s/ James A. Bowen
James A. Bowen
President of First Trust Strategic
High Income Fund
Page 1
FIRST TRUST STRATEGIC HIGH INCOME FUND
"AT A GLANCE"
AS OF OCTOBER 31, 2009 (UNAUDITED)
FUND STATISTICS
Symbol on New York Stock Exchange FHI
Common Share Price $ 2.63
Common Share Net Asset Value ("NAV") $ 2.92
Premium (Discount) to NAV (9.93)%
Net Assets Applicable to Common Shares $26,737,503
Current Monthly Distribution per Common Share (1) $ 0.025
Current Annualized Distribution per Common Share $ 0.300
Current Distribution Rate on Closing Common Share Price (2) 11.41%
Current Distribution Rate on NAV (2) 10.27%
COMMON SHARE PRICE & NAV (WEEKLY CLOSING PRICE)
(PERFORMANCE GRAPH)
Common Share Price NAV
------------------ ----
10/31/08 6.34 6.57
11/7/08 6.19 6.38
11/14/08 5.25 6.11
11/21/08 3.84 5.66
11/28/08 4.72 5.22
12/5/08 4.03 4.85
12/12/08 3.89 4.8
12/19/08 4.5 4.76
12/26/08 4.91 4.77
1/2/09 5.08 4.77
1/9/09 4.95 4.45
1/16/09 5.07 4.41
1/23/09 5.13 4.48
1/30/09 5.76 4.14
2/6/09 5.6 4.1
2/13/09 5.53 4.07
2/20/09 4.45 4.1
2/27/09 4.12 4.09
3/6/09 3.08 3.94
3/13/09 3.98 3.9
3/20/09 4.03 3.94
3/27/09 4.07 3.92
4/3/09 4.08 3.72
4/9/09 4.28 3.72
4/17/09 4.5 3.7
4/24/09 4.57 3.69
5/1/09 4.7 3.62
5/8/09 4.67 3.13
5/15/09 4.17 3.11
5/22/09 4.45 3.16
5/29/09 5.25 3.17
6/5/09 4.75 3.04
6/12/09 4.69 3.02
6/19/09 4.24 3.04
6/26/09 3.76 3.08
7/2/09 3.78 3.03
7/10/09 3.35 2.95
7/17/09 3.54 2.99
7/24/09 2.73 3
7/31/09 2.9 2.95
8/7/09 2.73 2.92
8/14/09 2.61 2.84
8/21/09 2.67 2.82
8/28/09 2.73 2.89
9/4/09 2.54 2.79
9/11/09 2.65 2.81
9/18/09 2.67 2.74
9/25/09 2.68 2.77
10/2/09 2.69 2.82
10/9/09 2.77 2.79
10/16/09 2.64 2.84
10/23/09 2.6 2.87
10/31/09 2.63 2.92
PERFORMANCE
Average Annual
Total Return
1 Year Ended Inception (7/26/2005)
10/31/2009 to 10/31/2009
------------ --------------------
Fund Performance
NAV (3) -42.52% -24.41%
Market Value (4) -46.35% -27.04%
Index Performance
Barclays Capital Ba U.S. High Yield Index 42.50% 6.31%
% OF TOTAL
ASSET CLASSIFICATION INVESTMENTS
-------------------- -----------
U.S. Government Agency
Mortgage-Backed Securities 34.9%
Corporate Bonds and Notes 31.6
Manufactured Housing Loans 13.7
Residential Mortgage-Backed Securities 6.9
Franchise Loans 6.0
Commercial Mortgage-Backed Securities 5.2
Collateralized Debt Obligations 1.5
Equity 0.2
-----
Total 100.0%
=====
% OF TOTAL
CREDIT QUALITY(5) INVESTMENTS
------------------ -----------
AAA 39.5%
A 0.8
BBB- 1.0
BB+ 0.1
BB 5.7
BB- 1.9
B+ 3.5
B 7.9
B- 6.4
CCC+ 6.0
CCC 4.6
CCC- 7.5
CC 7.6
C 3.2
D 4.3
-----
Total 100.0%
=====
(1) Most recent distribution paid or declared through 10/31/2009. Subject to
change in the future.
(2) Distribution rates are calculated by annualizing the most recent
distribution paid or declared through the report date and then dividing by
Common Share price or NAV, as applicable, as of 10/31/2009. Subject to
change in the future.
(3) Total return based on NAV is the combination of reinvested dividend
distributions and reinvested capital gain distributions, if any, at prices
obtained by the Dividend Reinvestment Plan and changes in NAV per share and
does not reflect sales load. Past performance is not indicative of future
results.
(4) Total return based on market value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan and changes in Common
Share price. Past performance is not indicative of future results.
(5) The credit quality information represented reflects the ratings assigned by
one or more nationally recognized statistical rating organizations
(NRSROs). For situations in which a security is rated by more than one
NRSRO and ratings are not equivalent, the ratings are averaged.
Page 2
PORTFOLIO COMMENTARY
SUB-ADVISOR
Brookfield Investment Management Inc. (formerly Hyperion Brookfield Asset
Management, Inc.), is an SEC-registered investment advisor specializing in core
fixed income, high yield, structured products (Mortgage-backed securities
("MBS") including Commercial MBS, Residential MBS and Asset-Backed Securities
("ABS")) as well as global Real Estate Investment Trusts and listed
infrastructure securities. Headquartered in New York, the firm has approximately
$24 billion of assets under management as of October 31, 2009. Brookfield
Investment Management is a subsidiary of Brookfield Asset Management Inc., a
global asset manager focused on property, power and other infrastructure assets
with approximately $90 billion of assets under management as of September 30,
2009.
On October 1, 2009, Hyperion Brookfield Asset Management, Inc. and Brookfield
Redding LLC, both subsidiaries of Brookfield Asset Management Inc., announced
the completion of their integration. The combined registered investment advisor
is now known as Brookfield Investment Management Inc. ("Brookfield").
PORTFOLIO MANAGEMENT TEAM
DANA E. ERIKSON, CFA,
MANAGING DIRECTOR
Mr. Erikson, Senior Portfolio Manager and the co-Head of the High Yield Team, is
responsible for Brookfield's corporate high yield and leveraged loan exposures,
the establishment of portfolio objectives and strategies. Mr. Erikson is a
member of the firm's Investment Committee. Mr. Erikson has over 20 years of
investment experience. Prior to joining Brookfield in September 2006, he was
with Evergreen Investments or one of its predecessor firms since 1996. He was a
senior portfolio manager and the Head of the High Yield team. Prior to that, he
was Head of High Yield Research. Prior to Evergreen, Mr. Erikson was Associate
Portfolio Manager for Prospect Street Investment Management Company.
Additionally, he was an Analyst with the Kellett Group and a Research Assistant
with Robert R. Nathan Associates. Mr. Erikson received a BA in economics from
Brown University and an MBA, with honors, from Northeastern University. He is a
member of the Boston Security Analysts Society.
ANTHONY BREAKS, CFA
DIRECTOR
Mr. Breaks is responsible for portfolio management of structured products and
for executing structured product financings for Brookfield and its partners. Mr.
Breaks joined Brookfield in 2005 from Brookfield Asset Management, Inc.
(formerly known as Brascan). At Brascan he was responsible for portfolio
investments and credit analysis for a reinsurance affiliate, execution and
management of a synthetic Collateralized Debt Obligation ("CDO"), and
development of insurance related investment products. Prior to joining Brascan
in 2002, Mr. Breaks was a Director at Liberty Hampshire and was responsible for
structuring, restructuring and executing several CDOs, as well as ongoing
monitoring and credit analysis for the CDO assets. Mr. Breaks began his career
at Merrill Lynch in 1998 where he worked in trading and structuring capacities
in CDOs, adjustable rate mortgages and medium-term notes. Mr. Breaks earned a BS
in Electrical Engineering from the Massachusetts Institute of Technology.
COMMENTARY
FIRST TRUST STRATEGIC HIGH INCOME FUND
The primary investment objective of the First Trust Strategic High Income Fund
("FHI" or the "Fund") is to seek a high level of current income. The Fund seeks
capital growth as a secondary objective. Effective September 1, 2009, the Fund
seeks to achieve its investment objectives by investing up to 100% of its
managed assets in below-investment grade debt securities (commonly referred to
as "high-yield" or "junk bonds"). Prior to September 1, 2009, the Fund pursued
its investment objectives by investing at least 80% of its managed assets in a
diversified portfolio of high income producing securities the Sub-Advisor
believes offer attractive yield and/or capital appreciation potential. There can
be no assurance that the Fund will achieve its investment objectives, and the
Fund may not be appropriate for all investors.
MARKET RECAP AND OUTLOOK
HIGH YIELD
The fiscal year ended October 31, 2009 was characterized by two markedly
different market environments. At the start of the fiscal year (November 1,
2008), high yield spreads were approximately 1,490 bps(1), reflecting the
market's severe aversion to risk and panic mentality in the midst of the credit
market crisis. High yield spreads continued to widen, reaching a high in mid
December 2008 of approximately 1,925 bps(1). Markets began to stabilize early in
the 2009 calendar year in response to massive government stimulus aimed at
avoiding a "Great Depression." With increasing confidence that a market bottom
had been reached, investors began to embrace risk and consequently, high yield
spreads tightened dramatically, closing the fiscal year at approximately 750
bps(1). The resulting market returns, as measured by the Barclays Capital Ba
U.S. High Yield Index, were impressive, with a 42.5% return for the 12 months
ended October 31, 2009.
----------
(1) JPMorgan High Yield Index
Page 3
PORTFOLIO COMMENTARY (CONTINUED)
An important contributor to renewed investor confidence was the re-opening of
the market for new high yield bond issuance. Investors were cognizant of the
fact that as access to capital improves, credit risk diminishes because
refinancing risk is minimized. This access to capital reduces the likelihood of
defaults, because companies have the ability to refinance maturing bonds. As of
September 30, 2009, 8.8% of the high yield market had defaulted in the prior 12
months, according to JPMorgan. While this level is high, it is worth noting that
it is still less than the prior credit cycle peak of 9.8% in January 2002 and
unchanged from July 2009. JPMorgan estimates that the default rate in 2009 will
be 9%, and that it will decline to 4% in 2010, reflecting the re-opening of the
new issue market(2). JPMorgan notes that Moody's estimates for 2010 are similar.
This reduction in risk may fuel a further narrowing of market spreads in the
months ahead. Despite the recent tightening, spreads remain wide as compared to
the typical mid-cycle levels of approximately 500 basis points.
Investors showed distinct preferences for certain industries during the Fund's
fiscal year, with large gains in the Broadcast, Financials and Wireless
Telecommunications sectors, which were up 98%, 96% and 66%, respectively, for
the year ended October 31, 2009(3). These industries were viewed as attractive
due to above market spreads, indicating above-average risk, or a revival of
investor confidence, particularly for Financials. Typically, the Financials
sector represents an insignificant portion of the high yield market. However,
automotive captive finance companies, such as Ford Motor Credit, as well as a
growing number of "fallen angel" bank and insurance companies, are now part of
this category. Underperforming sectors included Aerospace, Utility and Cable,
which were up 25%, 28% and 30%, respectively. These industries are considered
lower risk/lower growth, and therefore were not viewed as attractive as
investors sought out higher risk/higher beta holdings.
The supply and demand balance in the high yield market turned positive over the
period. The new issue market is now decidedly open and both top and mid-tier
issuers are able to access the capital markets. While additional supply would
typically be viewed as a negative, in the prevailing environment it was viewed
as a positive. Access to the debt markets reduced overall credit risk as issuers
had the prospect of refinancing maturing bonds again. Money continued to flow
into high yield mutual funds and most new issues were well over-subscribed and
traded to a premium in the after market. Issuance from CCC-rated companies began
to occur, reflecting investors' increased risk appetite.
We continue to hold a positive view of the high yield market, despite the record
returns and narrowing in yield spreads. While defaults may still rise modestly
over the remainder of the 2009 calendar year, we believe they are unlikely to
exceed typical cyclical peak levels of around 10%. Despite recent narrowing,
yield spreads remain wider than average at a time when investors are
increasingly anticipating economic growth in 2010. We are encouraged by the
re-opening of credit and equity markets and emphasize that access to capital
meaningfully reduces credit risk. We continue to believe that current yield
spreads more than adequately compensate investors for the likely risks that lie
ahead and investors may continue to benefit as markets return to normal.
COMMERCIAL MBS/RESIDENTIAL MBS
The unwinding of leverage that caused such a precipitous change in capital
markets over 2008 was addressed through a number of government programs designed
to add demand for MBS and ABS in the first half of the 2009 calendar year. These
included TALF (Term Asset-Backed Loan Facility) and PPIP (Public-Private
Investment Program). The U.S. Federal Reserve's buying plan for MBS and Treasury
notes kept mortgage rates in a target zone (less than 6%) over recent months.
However, intra-month increases in mortgage and Treasury rates called into
question the effectiveness of the program in targeting mortgage rates at higher
levels of interest rates. The U.S. government also implemented programs to curb
foreclosures and improve the affordability of existing mortgages, although we
believe these programs are likely to underperform market expectations.
These efforts by the government endeavor to relieve some of the decline in
housing prices, which we currently expect to bottom in 2010. Nevertheless, the
housing market may still decline 15% to 20% over the next 15 to 18 months before
reaching the low point as demand for new homes is likely to remain low, given
the weakness in employment and wages. The key signs of a bottom in the housing
sector will include an increase in home sales and significant declines in
existing home inventories. As the economy gradually improves and asset prices
stabilize, this will allow financial institutions to assess lending criteria and
encourage credit-worthy buyers to return to the market. In general, securitized
markets are pricing in conservative forward expectations for government
intervention, housing prices and defaults.
Market sentiment across the structured product investment market also continued
to improve as the 2009 calendar year unfolded. On the technical side, the PPIP
announcement in July has brought a strong leveraged bid into the Residential MBS
("RMBS") and Commercial MBS ("CMBS") markets. While this improved demand base is
largely focused on senior securities, there have also been improvements that
have affected subordinated securities. Recent updates to the Case-Shiller Home
Price Indices have been much stronger than anticipated. Though we believe
seasonal factors contribute strongly to these recent positive updates, there is
no dismissing an improvement in demand for housing at the much more affordable
prices. As well, recent legislative changes in the CMBS market have made loan
modifications and extensions more likely, which has improved the outlook for
more subordinated securities.
----------
(2) JPMorgan High Yield Market Monitor and JPMorgan Default Monitor, dated
September 30, 2009.
(3) JPMorgan High Yield Sub-Indices, Bloomberg.
Page 4
PORTFOLIO COMMENTARY (CONTINUED)
We still believe that the consumer outlook is weak. Unemployment and
underemployment remain high. As well, many of the jobs lost may have been
permanently lost. With the employment uncertainty and a substantial reduction in
wealth resulting from declines in home equity and declines in financial asset
values, we expect the savings rate to continue to increase and remain high. As a
result, the consumer is an unlikely source of economic stimulus. With a major
component of Gross Domestic Product likely to remain small, it is hard to
envision an economic recovery that is other than "U" shaped.
That said, we have reached a point where we believe the economy has stabilized
and we anticipate the government to "gradually" begin to reduce liquidity
support. While we anticipate interest rates will remain low in the near-term, we
also anticipate the government will begin to wind down its purchases of Treasury
notes and Agency MBS as we approach the extended TALF end-date (March 2010). The
impact of the reduced buying will likely result in wider Agency MBS yield
spreads -- as the current price levels supported by government buying have
crowded out most other investors. We believe the government will make some
changes to the structure of the Agency MBS market over the next two years.
PERFORMANCE ANALYSIS
For the 12 months ended October 31, 2009, the Fund's net asset value ("NAV")
total return(4) was -42.52%. The Fund traded from a discount to NAV of 3.50%
down to a discount to NAV of 9.93%, resulting in a market value total return(5)
of -46.35%. The Fund's exposure to loss-taking securities in the CMBS, RMBS and
ABS markets were the prime drivers of the negative NAV movement.
The total return for the Fund's benchmark, the Barclays Capital Ba U.S. High
Yield Index, was 42.50% for the twelve months ended October 31, 2009. While the
benchmark contains mostly corporate debt, the Fund's holdings during the period
were primarily structured finance and mortgage-related securities. As investor
risk appetite returned to the market during the second half of the fiscal year
ended October 31, 2009, corporate credit spreads tightened dramatically,
resulting in strong performance for the Fund's benchmark. Lower quality names
performed the best, as evidenced by the 53.50% return of the Barclays Capital
Caa U.S. High Yield Index.
FUND REPOSITIONING
Upon taking over management of FHI at the start of the third quarter in 2009, we
began a process of repositioning the Fund to better meet the Fund's objectives
of high current income and, secondly, capital growth. The first step was to
increase the Fund's exposure to RMBS to above 25% and remove the Fund from its
temporary defensive posture positioning. This allowed more flexibility to add
high yielding corporate bonds as we sold structured products. Emboldened by an
appreciating equity and corporate market, investors took another look at
structured products. As a result, in some cases we thought the market was
willing to pay more for certain bonds and we took the opportunity to sell. As we
sold structured products, we added to corporate bonds, primarily below
investment grade.
One of our goals has been to reduce exposure to lower quality bonds, while still
maximizing the value of the individual holdings. Many of these bonds may not be
paying a coupon or face the potential of a full principal loss. Deal structures
commonly make individual securities in the structure highly sensitive to losses
in the supporting asset pool. In the case of Collateralized Loan Obligations
("CLO"), the securities held by the Fund may stop paying coupons for years while
more senior classes are repaid. If loan losses continue, the payments may never
return. We are particularly focused on selling these types of securities as we
believe they have little promise of capital appreciation and are not secure
sources of cash flow to be used for payment of dividends.
At the end of the fiscal year, the Fund's portfolio had increased exposure to
corporate bonds (to approximately 32%). Our goal is to continue to build a
diversified portfolio of high yield corporate bonds as the "core" portfolio that
generates cash flow to support an attractive dividend. We anticipate adding to
the Fund's corporate exposure as we opportunistically sell poorer performing
structured product holdings. As discussed above, our outlook for the high yield
corporate market remains positive, and we expect that the near-term opportunity
to generate high income for the Fund will come from that sector.
----------
(4) Total return based on NAV is the combination of reinvested dividend
distributions and reinvested capital gain distributions, if any, at prices
obtained by the Dividend Reinvestment Plan and changes in NAV per share and
does not reflect sales load. Past performance is not indicative of future
results.
(5) Total return based on market value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan and changes in Common
Share price. Past performance is not indicative of future results.
Page 5
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a)
OCTOBER 31, 2009
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
----------- --------------------------------------------------- ------ ---------- -----------
ASSET-BACKED SECURITIES - 34.7%
ACE Securities Corp., Home Equity Loan Trust
$ 149,772 Series 2003-OP1, Class B ....................... 6.00% 12/25/33 $ 44,759
Atherton Franchisee Loan Funding
316,846 Series 1999-A, Class A2 (b) .................... 7.23% 03/15/21 274,635
Bombardier Capital Mortgage Securitization Corp.
324,455 Series 1999-B, Class A1B ....................... 6.61% 09/15/10 199,699
830,691 Series 1999-B, Class A3 ........................ 7.18% 12/15/15 543,475
Conseco Finance Securitizations Corp.
3,280,650 Series 2000-6, Class M1 ........................ 7.72% 09/01/31 944,835
EMAC Owner Trust, LLC
1,140,497 Series 1998-1, Class A3 (b) .................... 6.63% 01/15/25 684,298
Falcon Franchise Loan Trust
4,905,000 Series 2000-1, Class E (b) (k) ................. 6.50% 04/05/16 98,100
4,231,000 Series 2003-1, Class E (c) (k) ................. 6.00% 01/05/25 42,310
FFCA Secured Lending Corp.
5,000,000 Series 1999-2, Class B1 (c) (j) ................ 8.27% 05/18/26 500,735
FMAC Loan Receivables Trust
635,856 Series 1997-B, Class A (b) ..................... 6.85% 09/15/19 508,685
Green Tree Financial Corp.
298,543 Series 1997-4, Class B1 ........................ 7.23% 02/15/29 32,359
935,547 Series 1998-4, Class M1 ........................ 6.83% 04/01/30 432,342
3,000,000 Series 1998-8, Class M1 ........................ 6.98% 09/01/30 1,508,921
5,202,224 Series 1999-3, Class M1 ........................ 6.96% 02/01/31 691,954
GSAMP Trust
440,199 Series 2004-AR2, Class B4 (c) .................. 5.00% 08/25/34 1,668
982,050 Series 2006-S3, Class A2 (j) ................... 5.77% 05/25/36 64,716
860,281 Series 2006-S5, Class A1 (d) ................... 0.33% 09/25/36 13,091
Halyard Multi Asset CBO I, Ltd.
1,668,248 Series 1A, Class B (c) (d) ..................... 0.67% 03/24/10 50,047
Independence lll CDO, Ltd.
5,000,000 Series 3A, Class C1 (c) (d) .................... 2.78% 10/03/37 50
Indymac Residential Asset Backed Trust
1,539,869 Series 2005-B, Class M10 (d) ................... 3.74% 08/25/35 6,412
Long Beach Mortgage Loan Trust
1,926,529 Series 2006-A, Class A2 ........................ 5.55% 05/25/36 105,959
Longhorn CDO, Ltd.
2,974,086 Series 1, Class C (c) (d) ...................... 6.71% 05/10/12 29,741
Merit Securities Corp.
1,198,570 Series 13, Class B1 (c) ........................ 7.96% 12/28/33 11,810
2,602,000 Series 13, Class M2 ............................ 7.96% 12/28/33 458,939
Park Place Securities, Inc.
2,421,646 Series 2004-WCW1, Class M8 (d) ................. 3.74% 09/25/34 66,734
1,301,976 Series 2004-WCW2, Class M10 (c) (d) ............ 2.99% 10/25/34 21,347
410,437 Series 2005-WCW3, Class M11 (c) (d) ............ 2.74% 08/25/35 1,716
Rosedale CLO, Ltd.
3,500,000 Series I-A, Class II (c) ....................... (e) 07/24/21 35,000
Signature 5, Ltd.
1,200,001 Series 5A, Class C (c) ......................... 12.56% 10/27/12 239,004
Soundview Home Equity Loan Trust
149,220 Series 2007-OPT3, Class M10 (c) (d) ............ 2.74% 08/25/37 282
See Notes to Financial Statements
Page 6
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
OCTOBER 31, 2009
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
----------- --------------------------------------------------- ------ ---------- -----------
ASSET-BACKED SECURITIES - (CONTINUED)
Structured Asset Securities Corp.
$ 1,602,073 Series 2006-GEL1, Class A1 (d) ................. 0.38% 11/25/35 $ 1,562,021
Summit CBO I, Ltd.
4,705,734 Series 1A, Class B (c) (d) (j) ................. 2.17% 05/23/11 94,115
-----------
TOTAL ASSET-BACKED SECURITIES
(Cost $14,536,023) 9,269,759
-----------
COLLATERALIZED MORTGAGE OBLIGATIONS - 2.0%
Bear Stearns Alt-A Trust
1,760,541 Series 2006-8, Class 2A2 ....................... 5.29% 08/25/46 99,304
Countrywide Alternative Loan Trust
3,221,775 Series 2005-56, Class M4 (d) ................... 1.16% 11/25/35 159,059
Deutsche Alt-A Securities, Inc. Mortgage Loan Trust
3,691,244 Series 2007-OA4, Class M10 (d) ................. 3.24% 08/25/47 49,610
HarborView Mortgage Loan Trust
3,841,395 Series 2005-9, Class B10 (d) ................... 2.00% 06/20/35 214,657
-----------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS
(Cost $1,717,590) 522,630
-----------
COMMERCIAL MORTGAGE-BACKED SECURITIES - 6.8%
Banc of America Commercial Mortgage Inc.
1,171,422 Series 2000-1, Class M (c) (k) ................. 6.00% 11/15/31 12
Banc of America Large Loan, Inc.
2,000,000 Series 2005-MIB1, Class L (c) (d) .............. 3.25% 03/15/22 167,381
Bear Stearns Commercial Mortgage Securities
1,776,400 Series 2000-WF1, Class K (k) ................... 6.50% 02/15/32 390,559
GE Capital Commercial Mortgage Corp.
700,000 Series 2000-1, Class G (c) ..................... 6.13% 01/15/33 249,103
GS Mortgage Securities Corp. II
6,885,655 Series 1998-C1, Class H (c) .................... 6.00% 10/18/30 383,896
LB-UBS Commercial Mortgage Trust
3,025,000 Series 2001-C7, Class Q (c) .................... 5.87% 11/15/33 151,395
2,083,703 Series 2001-C7, Class S (c) .................... 5.87% 11/15/33 14,815
Morgan Stanley Capital I, Inc.
968,400 Series 1999-WF1, Class M (c) ................... 5.91% 11/15/31 266,978
2,787,919 Series 2003-IQ5, Class O (c) (j) ............... 5.24% 04/15/38 198,702
-----------
TOTAL COMMERCIAL MORTGAGE-BACKED SECURITIES
(Cost $11,538,411) 1,822,841
-----------
CORPORATE BONDS AND NOTES - 41.5%
AUTO COMPONENTS - 1.8%
1,500,000 Lexington Precision Corp., Units (f) (g) .......... (e) 08/01/10 482,400
-----------
COMMERCIAL SERVICES & SUPPLIES - 4.6%
400,000 ARAMARK Corp. ..................................... 8.50% 02/01/15 406,000
400,000 Iron Mountain, Inc. ............................... 8.75% 07/15/18 419,000
400,000 KAR Holdings, Inc. ................................ 10.00% 05/01/15 412,000
-----------
1,237,000
-----------
See Notes to Financial Statements
Page 7
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
OCTOBER 31, 2009
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
----------- --------------------------------------------------- ------ ---------- -----------
CORPORATE BONDS AND NOTES - (CONTINUED)
CONTAINERS & PACKAGING - 1.6%
$ 400,000 Verso Paper Holdings LLC/ Verso Paper, Inc. (b) ... 11.50% 07/01/14 $ 428,000
-----------
DIVERSIFIED FINANCIALS - 1.4%
400,000 Ford Motor Credit Co., LLC ........................ 7.00% 10/01/13 379,768
-----------
DIVERSIFIED TELECOMMUNICATIONS - 4.1%
400,000 Frontier Communications Corp. ..................... 6.25% 01/15/13 397,000
400,000 PAETEC Holding Corp. .............................. 9.50% 07/15/15 368,000
400,000 Qwest Corp. ....................................... 6.88% 09/15/33 339,000
-----------
1,104,000
-----------
FOOD AND STAPLES RETAILING - 1.2%
400,000 Rite Aid Corp. .................................... 8.63% 03/01/15 330,000
-----------
HEALTH CARE PROVIDERS & SERVICES - 1.6%
400,000 HCA, Inc. ......................................... 9.25% 11/15/16 419,000
-----------
HOTELS, RESTAURANTS & LEISURE - 4.6%
Harrahs Operating Escrow
400,000 LLC/ Harrahs Escrow Corp. (b) .................. 11.25% 06/01/17 410,000
400,000 MGM MIRAGE (b) .................................... 10.38% 05/15/14 428,000
400,000 MTR Gaming Group, Inc. (b) ........................ 12.63% 07/15/14 394,000
-----------
1,232,000
-----------
HOUSEHOLD DURABLES - 1.5%
400,000 Jarden Corp. ...................................... 7.50% 05/01/17 396,000
-----------
IT CONSULTING & SERVICES - 1.6%
400,000 SunGard Data Systems, Inc. ........................ 10.25% 08/15/15 414,500
-----------
MACHINERY - 4.1%
400,000 CNH America LLC ................................... 7.25% 01/15/16 389,000
400,000 Mueller Water Products, Inc. ...................... 7.38% 06/01/17 348,000
400,000 Terex Corp. ....................................... 8.00% 11/15/17 369,000
-----------
1,106,000
-----------
MEDIA - 4.5%
400,000 AMC Entertainment, Inc. ........................... 8.75% 06/01/19 412,000
400,000 Lamar Media Corp. ................................. 6.63% 08/15/15 384,000
Mediacom Broadband
400,000 LLC/ Mediacom Broadband Corp. .................. 8.50% 10/15/15 406,000
-----------
1,202,000
-----------
METALS & MINING - 1.5%
400,000 Arch Western Finance LLC .......................... 6.75% 07/01/13 388,000
-----------
MULTILINE RETAIL - 1.3%
400,000 Neiman Marcus Group, Inc., PIK. ................... 9.00% 10/15/15 356,000
-----------
OIL, GAS & CONSUMABLE FUELS - 4.5%
400,000 Chesapeake Energy Corp. ........................... 6.88% 01/15/16 388,000
400,000 El Paso Corp. ..................................... 6.88% 06/15/14 400,186
400,000 Hercules Offshore LLC (b) ......................... 10.50% 10/15/17 401,000
-----------
1,189,186
-----------
See Notes to Financial Statements
Page 8
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
OCTOBER 31, 2009
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
----------- --------------------------------------------------- ------ ---------- -----------
CORPORATE BONDS AND NOTES - (CONTINUED)
SPECIALTY RETAIL - 1.6%
400,000 Limited Brands, Inc. (b) .......................... 8.50% 06/15/19 422,000
-----------
TOTAL CORPORATE BONDS AND NOTES
(Cost $11,671,682) ................................ 11,085,854
-----------
U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITIES - 45.8%
3,875,000 FannieMae, December (h) ........................... 5.50% 30 yr. TBA 4,063,302
2,250,000 FannieMae, December (h) ........................... 6.00% 30 yr. TBA 2,381,837
FannieMae-ACES
6,074,692 Series 1998-M7, Class N, IO (d) ................ 0.45% 05/25/36 93,692
3,875,000 Government National Mortgage
Association, January (h) ....................... 5.00% 30 yr. TBA 4,004,599
Government National Mortgage Association
23,024,517 Series 2003-59, Class XA, IO (d) ............... 2.06% 06/16/34 1,700,441
-----------
TOTAL U.S. GOVERNMENT AGENCY MORTGAGE-BACKED
SECURITIES
(Cost $12,106,992) ................................ 12,243,871
-----------
STRUCTURED NOTES - 0.3%
Bacchus Ltd.
1,225,000 Series 2006-1I, Subordinated Bond (c) .......... (e) 01/20/19 12,250
InCaps Funding II Ltd./InCaps Funding II Corp.
2,000,000 Subordinated Note (c) .......................... (e) 01/15/34 80,000
3,750,000 Preferred Term Securities XXV, Ltd. (c) ........... (e) 06/22/37 375
-----------
TOTAL STRUCTURED NOTES
(Cost $527,449) ................................... 92,625
-----------
SHARES DESCRIPTION VALUE
----------- ------------------------------------------------------------------------- -----------
PREFERRED SECURITIES - 0.3%
1,450 Ajax Two Ltd., Series 2A (c) (e) ........................................ 14,500
2,000 Ajax Two Ltd., Series 2X (c) (e) ........................................ 20,000
2,000 Soloso CDO, Ltd., Series 2005-1 (c) (e) ................................. 20,000
3,000 White Marlin CDO, Ltd., Series AI (c) (e) (f) ........................... 30,000
-----------
TOTAL PREFERRED SECURITIES
(Cost $703,411) ......................................................... 84,500
-----------
TOTAL INVESTMENTS - 131.4%
(Cost $52,801,558) (i) .................................................. 35,122,080
NET OTHER ASSETS AND LIABILITIES - (31.4%) (8,384,577)
-----------
NET ASSETS - 100.0% ..................................................... $26,737,503
===========
See Notes to Financial Statements
Page 9
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
OCTOBER 31, 2009
(a) All percentages shown in the Portfolio of Investments are based on net
assets.
(b) This security, sold within the terms of a private placement memorandum, is
exempt from registration under Rule 144A under the Securities Act of 1933,
as amended (the "1933 Act"), and may be resold in transactions exempt from
registration, normally to qualified institutional buyers. Pursuant to
procedures adopted by the Fund's Board of Trustees, this security has been
determined to be liquid by Brookfield Investment Management Inc., the
Fund's investment sub-advisor. Although instability in the markets has
resulted in periods of increased overall market illiquidity, liquidity for
each security is determined based on security-specific factors and
assumptions, which require subjective judgment. At October 31, 2009,
securities noted as such amounted to $4,048,718 or 15.1% of net assets.
(c) This security, sold within the terms of a private placement memorandum, is
exempt from registration under Rule 144A under the 1933 Act and may be
resold in transactions exempt from registration, normally to qualified
institutional buyers (see Note 2C - Restricted Securities in the Notes to
Financial Statements).
(d) Floating rate security. The interest rate shown reflects the rate in effect
at October 31, 2009.
(e) Zero coupon investment.
(f) The issuer is in default. Income is not being accrued.
(g) Security is fair-valued in accordance with procedures adopted by the Fund's
Board of Trustees.
(h) Security purchased on a forward commitment basis.
(i) Aggregate cost for federal income tax purposes is $102,986,514. As of
October 31, 2009, the aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost was
$1,328,680 and the aggregate gross unrealized depreciation for all
securities in which there was an excess of tax cost over value was
$69,193,114.
(j) Security is receiving less than the stated coupon.
(k) Security missed its last interest payment.
ACES Alternative Credit Enhancement Securities
CBO Collateralized Bond Obligation
CDO Collateralized Debt Obligation
CLO Collateralized Loan Obligation
IO Interest Only Security
PIK Payment in Kind
TBA To be announced; maturity date has not yet been established. Upon
settlement and delivery of the mortgage pools, maturity dates will be
assigned.
See Notes to Financial Statements
Page 10
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
OCTOBER 31, 2009
VALUATION INPUTS
A summary of the inputs used to value the Fund's total investments as of October
31, 2009 is as follows (see Note 2A -Portfolio Valuation in the Notes to
Financial Statements):
LEVEL 2 LEVEL 3
TOTAL MARKET LEVEL 1 SIGNIFICANT SIGNIFICANT
VALUE AT QUOTED OBSERVABLE UNOBSERVABLE
10/31/2009 PRICES INPUTS INPUTS
------------ ------- ----------- ------------
Asset-Backed Securities ............................ $ 9,269,759 $-- $ 7,621,504 $1,648,255
Collateralized Mortgage Obligations ................ 522,630 -- 522,630 --
Commercial Mortgage-Backed Securities .............. 1,822,841 -- 1,822,841 --
Corporate Bonds and Notes .......................... 11,085,854 -- 10,603,454 482,400
U.S. Government Agency Mortgage-Backed Securities .. 12,243,871 -- 12,243,871 --
Structured Notes ................................... 92,625 -- 375 92,250
Preferred Securities ............................... 84,500 -- -- 84,500
----------- --- ----------- ----------
TOTAL INVESTMENTS .................................. $35,122,080 $-- $32,814,675 $2,307,405
=========== === =========== ==========
The following table presents the Fund's investments measured at fair value on a
recurring basis using significant unobservable inputs (Level 3) for the period
presented.
NET
TRANSFERS REALIZED NET UNREALIZED NET BALANCE
INVESTMENTS AT FAIR VALUE USING BALANCE AS OF IN (OUT) GAINS APPRECIATION PURCHASES AS OF
SIGNIFICANT UNOBSERVABLE INPUTS (LEVEL 3) OCTOBER 31, 2008 OF LEVEL 3 (LOSSES) (DEPRECIATION) (SALES) OCTOBER 31, 2009
----------------------------------------- ---------------- ---------- ------------ -------------- ----------- ----------------
Asset-Backed Securities ................. $16,796,792 $(242,720) $(25,445,153) $ 15,438,774 $(4,899,438) $1,648,255
Collateralized Mortgage Obligations ..... 1,618,521 (423,327) (120,986) (1,057,936) (16,272) --
Commercial Mortgage-Backed Securities ... 639,123 (14,815) -- (624,308) -- --
Corporate Bonds and Notes ............... 1,305,000 -- -- (822,600) -- 482,400
Structured Notes ........................ 1,296,250 -- (942,619) (77,631) (183,750) 92,250
Preferred Securities .................... 1,389,000 -- (4,046,818) 5,038,518 (2,296,200) 84,500
----------- --------- ------------ ------------ ----------- ----------
Total Investments ....................... $23,044,686 $(680,862) $(30,555,576) $ 17,894,817 $(7,395,660) $2,307,405
=========== ========= ============ ============ =========== ==========
Net unrealized appreciation from Level 3 investments held as of October 31, 2009
was $7,504,992 and is included in the "Net change in unrealized appreciation
(depreciation) on investments" on the Statement of Operations.
See Notes to Financial Statements
Page 11
FIRST TRUST STRATEGIC HIGH INCOME FUND
STATEMENT OF ASSETS AND LIABILITIES
OCTOBER 31, 2009
ASSETS:
Investments, at value
Cost ($52,801,558) ................................................. $ 35,122,080
Cash .................................................................. 2,540,646
Prepaid expenses ...................................................... 6,036
Receivables:
Interest ........................................................... 753,232
Investment securities sold ......................................... 25,137
------------
Total Assets .................................................... 38,447,131
------------
LIABILITIES:
Payables:
Investment securities purchased .................................... 11,588,794
Audit and tax fees ................................................. 51,033
Printing fees ...................................................... 26,129
Investment advisory fees ........................................... 19,860
Administrative fees ................................................ 8,333
Legal fees ......................................................... 3,898
Trustees' fees and expenses ........................................ 3,459
Transfer agent fees ................................................ 2,851
Custodian fees ..................................................... 1,753
Accrued expenses and other liabilities ............................. 3,518
------------
Total Liabilities ............................................... 11,709,628
------------
NET ASSETS ............................................................ $ 26,737,503
============
NET ASSETS CONSIST OF:
Paid-in capital ....................................................... $127,981,197
Par value ............................................................. 91,506
Accumulated net investment income (loss) .............................. (1,518,220)
Net unrealized appreciation (depreciation) on investments ............. (17,679,478)
Accumulated net realized gain (loss) on investments ................... (82,137,502)
------------
NET ASSETS ............................................................ $ 26,737,503
============
NET ASSET VALUE, per Common Share (par value $0.01 per Common Share) .. $ 2.92
============
Number of Common Shares outstanding (unlimited number of Common Shares
has been authorized) ............................................... 9,150,594
============
See Notes to Financial Statements
Page 12
FIRST TRUST STRATEGIC HIGH INCOME FUND
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED OCTOBER 31, 2009
INVESTMENT INCOME:
Interest .............................................................. $ 10,399,214
------------
Total investment income ......................................... 10,399,214
------------
EXPENSES:
Investment advisory fees .............................................. 308,473
Administrative fees ................................................... 99,997
Printing fees ......................................................... 71,844
Legal fees ............................................................ 66,240
Audit and tax fees .................................................... 46,535
Trustees' fees and expenses ........................................... 39,712
Transfer agent fees ................................................... 34,465
Interest and fees on loan ............................................. 20,222
Custodian fees ........................................................ 9,737
Excise tax expense .................................................... (176,081)(a)
Other ................................................................. 83,313
------------
Total expenses .................................................. 604,457
------------
NET INVESTMENT INCOME ................................................. 9,794,757
------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain (loss) on investments ............................ (78,709,995)
Net change in unrealized appreciation (depreciation) on
investments ..................................................... 45,535,716
------------
NET REALIZED AND UNREALIZED GAIN (LOSS) ............................... (33,174,279)
------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS ....... $(23,379,522)
============
----------
(a) Refund of prior year excise tax payment/expense.
See Notes to Financial Statements
Page 13
FIRST TRUST STRATEGIC HIGH INCOME FUND
STATEMENTS OF CHANGES IN NET ASSETS
YEAR YEAR
ENDED ENDED
10/31/2009 10/31/2008
------------ ------------
OPERATIONS:
Net investment income (loss) ............................................... $ 9,794,757 $ 18,458,401
Net realized gain (loss) ................................................... (78,709,995) (54,237,722)
Net change in unrealized appreciation (depreciation) ....................... 45,535,716 (24,267,712)
------------ ------------
Net increase (decrease) in net assets resulting from operations ............ (23,379,522) (60,047,033)
------------ ------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income ...................................................... -- (7,286,555)
Return of capital .......................................................... (9,752,238) (9,998,690)
------------ ------------
Total distributions to shareholders ........................................ (9,752,238) (17,285,245)
------------ ------------
CAPITAL TRANSACTIONS:
Proceeds from Common Shares reinvested ..................................... 488,089 568,471
------------ ------------
Net increase (decrease) in net assets resulting from capital transactions .. 488,089 568,471
------------ ------------
Total increase (decrease) in net assets .................................... (32,643,671) (76,763,807)
NET ASSETS:
Beginning of period ........................................................ 59,381,174 136,144,981
------------ ------------
End of period .............................................................. $ 26,737,503 $ 59,381,174
============ ============
Accumulated net investment income (loss) at end of period .................. $ (1,518,220) $ 8,503,569
============ ============
CAPITAL TRANSACTIONS WERE AS FOLLOWS:
Common Shares at beginning of period ....................................... 9,035,801 8,983,394
Common Shares issued as reinvestment under the Dividend Reinvestment Plan .. 114,793 52,407
------------ ------------
Common Shares at end of period ............................................. 9,150,594 9,035,801
============ ============
See Notes to Financial Statements
Page 14
FIRST TRUST STRATEGIC HIGH INCOME FUND
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED OCTOBER 31, 2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net increase (decrease) in net assets resulting from operations ............ $(23,379,522)
Adjustments to reconcile net increase (decrease) in net assets resulting
from operations to net cash provided by operating activities:
Purchases of investments ................................................ (54,365,044)
Sales, paydowns and maturities of investments ........................... 45,780,587
Net amortization/accretion of premiums/discounts on investments ......... (1,618,284)
Net realized gain/loss on investments ................................... 78,709,995
Net change in unrealized appreciation/depreciation on investments ....... (45,535,716)
CHANGES IN ASSETS AND LIABILITIES:
Decrease in interest receivable ......................................... 97,900
Decrease in receivable for investment securities sold ................... 5,597,411
Decrease in prepaid expenses ............................................ 2,115
Increase in payable for investment securities purchased ................. 11,588,794
Decrease in interest and fees due on loan ............................... (87,966)
Decrease in investment advisory fees payable ............................ (48,339)
Decrease in audit and tax fees payable .................................. (12,217)
Decrease in legal fees payable .......................................... (8,706)
Increase in printing fees payable ....................................... 2,618
Decrease in transfer agent fees payable ................................. (3,197)
Increase in administrative fees payable ................................. 1
Decrease in custodian fees payable ...................................... (555)
Increase in Trustees' fees and expenses payable ......................... 530
Decrease in accrued expenses and other liabilities ...................... (2,021)
------------
CASH PROVIDED BY OPERATING ACTIVITIES ...................................... $ 16,718,384
------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Common Shares reinvested .................................. 488,089
Return of capital distributions ......................................... (9,752,238)
Repayment of loan ....................................................... (15,000,000)
------------
CASH USED BY FINANCING ACTIVITIES .......................................... (24,264,149)
------------
Decrease in cash ........................................................... (7,545,765)
Cash at beginning of period ................................................ 10,086,411
------------
CASH AT END OF PERIOD ...................................................... $ 2,540,646
============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest and fees .......................... $ 108,188
============
See Notes to Financial Statements
Page 15
FIRST TRUST STRATEGIC HIGH INCOME FUND
FINANCIAL HIGHLIGHTS
FOR A COMMON SHARE OUTSTANDING THROUGHOUT EACH YEAR
YEAR YEAR YEAR YEAR PERIOD
ENDED ENDED ENDED ENDED ENDED
10/31/2009(h) 10/31/2008 10/31/2007 10/31/2006 10/31/2005 (a)
------------- ---------- ---------- ---------- --------------
Net asset value, beginning of period ............. $ 6.57 $ 15.16 $ 19.82 $ 19.13 $ 19.10(b)
------- ------- -------- -------- --------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income ............................ 1.07 2.05 2.17 2.08 0.39
Net realized and unrealized gain (loss) .......... (3.64) (8.72) (4.84) 0.76 (0.17)
------- ------- -------- -------- --------
Total from investment operations ................. (2.57) (6.67) (2.67) 2.84 0.22
------- ------- -------- -------- --------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income ............................ -- (0.81) (1.97) (2.15) (0.15)
Net realized gain ................................ -- -- (0.02) -- --
------- ------- -------- -------- --------
Return of capital ................................ (1.08) (1.11) -- -- --
------- ------- -------- -------- --------
Total distributions .............................. (1.08) (1.92) (1.99) (2.15) (0.15)
------- ------- -------- -------- --------
Common Shares offering costs charged to
paid-in capital ............................... -- -- -- -- (0.04)
------- ------- -------- -------- --------
Net asset value, end of period ................... $ 2.92 $ 6.57 $ 15.16 $ 19.82 $ 19.13
======= ======= ======== ======== ========
Market value, end of period ...................... $ 2.63 $ 6.34 $ 14.19 $ 21.19 $ 18.79
======= ======= ======== ======== ========
Total return based on net asset value (c) (d) . .. (42.52)% (47.16)% (14.65)% 15.73% 1.03%
======= ======= ======== ======== ========
Total return based on market value (d) (e) ....... (46.35)% (45.56)% (25.30)% 26.16% (5.28)%
======= ======= ======== ======== ========
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) ............. $26,738 $59,381 $136,145 $176,375 $168,413
Ratio of total expenses to average net assets .... 1.78% 4.32% 3.70% 1.20% 1.33%(f)
Ratio of total expenses to average net assets
excluding interest expense and fees ........... 1.72% 2.21% 1.68% 1.20% 1.33%(f)
Ratio of net investment income to average
net assets .................................... 28.82% 19.21% 11.78% 10.84% 7.82%(f)
Portfolio turnover rate .......................... 127%(i) 4% 19% 78% 19%
INDEBTEDNESS:
Loan outstanding (in 000's) ...................... N/A $15,000 $ 61,200 N/A N/A
Asset coverage per $1,000 of indebtedness (g) .... N/A $ 4,959 $ 3,225 N/A N/A
----------
(a) Initial seed date of July 19, 2005. The Fund commenced operations on July
26, 2005.
(b) Net of sales load of $0.90 per share on initial offering.
(c) Total return based on net asset value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan and changes in net
asset value per share and does not reflect sales load.
(d) Total return is not annualized for periods less than one year.
(e) Total return based on market value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan and changes in Common
Share price.
(f) Annualized.
(g) Calculated by subtracting the Fund's total liabilities (not including the
loan outstanding) from the Fund's total assets, and dividing by the
outstanding loan balance in 000's.
(h) On June 29, 2009, the Fund's Board of Trustees approved an interim
sub-advisory agreement with Hyperion Brookfield Asset Management, Inc.
("Brookfield"), and on October 14, 2009, the Board of Trustees voted to
approve Brookfield as investment sub-advisor.
(i) In the fiscal year ended October 31, 2009, the Fund's portfolio turnover
rate reflects mortgage pool forward commitments as purchases and sales.
This caused the reported portfolio turnover rate to be higher than in
previous fiscal years. The turnover rate may vary greatly from year to year
as well as within a year.
N/A Not Applicable.
See Notes to Financial Statements
Page 16
NOTES TO FINANCIAL STATEMENTS
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009
1. FUND DESCRIPTION
First Trust Strategic High Income Fund (the "Fund") is a diversified, closed-end
management investment company organized as a Massachusetts business trust on
April 15, 2005 and is registered with the Securities and Exchange Commission
("SEC") under the Investment Company Act of 1940, as amended (the "1940 Act").
The Fund trades under the ticker symbol FHI on the New York Stock Exchange
("NYSE").
The Fund's primary investment objective is to seek a high level of current
income. The Fund seeks capital growth as a secondary objective. The Fund seeks
to achieve its investment objectives by investing up to 100% of its managed
assets in below-investment grade debt securities (commonly referred to as
"high-yield" or "junk bonds"). Managed assets means the value of the securities
and other investments the Fund holds plus cash or other assets, including
interest accrued but not yet received minus liabilities other than the principal
amount of borrowings. There can be no assurance that the Fund will achieve its
investment objectives. The Fund may not be appropriate for all investors.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts and disclosures in
the financial statements. Actual results could differ from those estimates.
A. PORTFOLIO VALUATION:
The net asset value ("NAV") of the Common Shares of the Fund is determined daily
as of the close of regular trading on the NYSE, normally 4:00 p.m. Eastern time,
on each day the NYSE is open for trading. Domestic debt securities and foreign
securities are priced using data reflecting the earlier closing of the principal
markets for those securities. The NAV per Common Share is calculated by dividing
the value of all assets of the Fund (including accrued interest and dividends),
less all liabilities (including accrued expenses, dividends declared but unpaid
and any borrowings of the Fund) by the total number of Common Shares
outstanding.
The Fund's investments are valued daily at market value or, in the absence of
market value with respect to any portfolio securities, at fair value according
to procedures adopted by the Fund's Board of Trustees. Securities for which
market quotations are readily available are valued at market value, which is
currently determined using the last reported sale price on the business day as
of which such value is being determined or, if no sales are reported on such day
(as in the case of some securities traded over-the-counter), the last reported
bid price, except that certain U.S. Government securities are valued at the mean
between the last reported bid and asked prices. The Fund values mortgage-backed
securities and other debt securities not traded in an organized market on the
basis of valuations provided by dealers who make markets in such securities or
by independent pricing services approved by the Board of Trustees which use
information with respect to transactions in such securities, quotations from
dealers, market transactions for comparable securities, various relationships
between securities and yield to maturity in determining value. In the Fund's
financial statements, the Statement of Assets and Liabilities includes
investments with a value of $2,307,405 (6.6% of total investments) as of October
31, 2009 whose values have been determined based on prices supplied by dealers
and investments with a value of $32,814,675 (93.4% of total investments) whose
values have been determined based on prices supplied by independent pricing
services. A ready market does not exist for some of these investments. As such,
these values may differ from the values that would have been used had a ready
market for these investments existed, and the differences could be material.
Debt securities having a remaining maturity of less than sixty days when
purchased are valued at cost adjusted for amortization of premiums and accretion
of discounts.
In the event that market quotations are not readily available, the pricing
service or dealer does not provide a valuation for a particular asset, or the
valuations are deemed unreliable, the Fund's Board of Trustees has designated
First Trust Advisors L.P. ("First Trust") to use a fair value method to value
the Fund's securities and other investments. Additionally, if events occur after
the close of the principal markets for particular securities (e.g., domestic
debt and foreign securities), but before the Fund values its assets, that could
materially affect NAV, First Trust may use a fair value method to value the
Fund's securities and other investments. As a general principle, the fair value
of a security is the amount which the Fund might reasonably expect to receive
for the security upon its current sale. A variety of factors may be considered
in determining the fair value of such securities including 1) the fundamental
business data relating to the issuer; 2) an evaluation of the forces which
influence the market in which these securities are purchased and sold; 3) type
of holding; 4) financial statements of the issuer; 5) cost at date of purchase;
6) credit quality and cash flow of the issuer based on external analysis; 7)
information as to any transactions in or offers for the holding; 8) price and
extent of public trading in similar securities of the issuer/borrower, or
comparable companies; and 9) other relevant factors. The use of fair value
pricing by the Fund is governed by valuation procedures adopted by the Fund's
Board of Trustees, and in accordance with the provisions of the 1940 Act. When
fair value pricing of securities is employed, the prices of securities used by
the Fund to calculate its NAV may differ from market quotations or official
closing prices. In light of the judgment involved in fair valuations, there can
be no assurance that a fair value assigned to a particular security will be the
amount which the Fund might be able to receive upon its current sale.
Page 17
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009
The Fund invests a significant portion of its assets in below-investment grade
debt securities, including mortgage-backed securities, asset-backed securities,
corporate bonds and collateralized debt obligations. The value and related
income of these securities is sensitive to changes in economic conditions,
including delinquencies and/or defaults. Instability in the markets for
fixed-income securities, particularly mortgage-backed and asset-backed
securities, has resulted in increased volatility and periods of illiquidity that
have adversely impacted the valuation of certain securities held by the Fund.
The Fund is subject to fair value accounting standards that define fair value,
establish the framework for measuring fair value and provide a three-level
hierarchy for fair valuation based upon the inputs to the valuation as of the
measurement date. The three levels of the fair value hierarchy are as follows:
- Level 1 - Level 1 inputs are quoted prices in active markets for
identical securities. An active market is a market in which
transactions for the security occur with sufficient frequency and
volume to provide pricing information on an ongoing basis.
- Level 2 - Level 2 inputs are observable inputs, either directly or
indirectly, and include the following:
- Quoted prices for similar securities in active markets.
- Quoted prices for identical or similar securities in markets that
are non-active. A non-active market is a market where there are
few transactions for the security, the prices are not current, or
price quotations vary substantially either over time or among
market makers, or in which little information is released
publicly.
- Inputs other than quoted prices that are observable for the
security (for example, interest rates and yield curves observable
at commonly quoted intervals, volatilities, prepayment speeds,
loss severities, credit risks, and default rates).
- Inputs that are derived principally from or corroborated by
observable market data by correlation or other means.
- Level 3 - Level 3 inputs are unobservable inputs. Unobservable inputs
reflect the reporting entity's own assumptions about the assumptions
that market participants would use in pricing the security.
The inputs or methodology used for valuing securities are not necessarily an
indication of the risk associated with investing in those securities. A summary
of the inputs used to value the Fund's investments as of October 31, 2009, is
included with the Fund's Portfolio of Investments.
B. SECURITIES TRANSACTIONS AND INVESTMENT INCOME:
Securities transactions are recorded as of the trade date. Realized gains and
losses from securities transactions are recorded on the identified cost basis.
Dividend income is recorded on the ex-dividend date. Interest income is recorded
on the accrual basis. Amortization of premiums and accretion of discounts are
recorded using the effective interest method.
The Fund invests in certain lower credit quality securitized assets that have
contractual cash flows (for example, asset-backed securities, collateralized
mortgage obligations and commercial mortgage-backed securities). For these
securities, if there is a change in the estimated cash flows, based on an
evaluation of current information, then the estimated yield is adjusted on a
prospective basis over the remaining life of the security. Additionally, if the
evaluation of current information indicates a permanent impairment of the
security, the cost basis of the security is written down and a loss is
recognized. Investment income is recorded net of foreign taxes withheld where
recovery of such taxes is uncertain. Debt obligations may be placed on
non-accrual status, and related interest income may be reduced by ceasing
current accruals and amortization/accretion and writing off interest receivables
when the collection of all or a portion of interest has become doubtful based on
consistently applied procedures. A debt obligation is removed from non-accrual
status when the issuer resumes interest payments or when collectibility of
interest is reasonably assured.
The Fund may purchase and sell securities on a "when-issued", "delayed delivery"
or "forward commitment" basis, with settlement to occur at a later date. The
price of the underlying securities and the date when the securities will be
delivered and paid for are fixed at the time the transaction is negotiated. The
value of the security so purchased is subject to market fluctuations during this
period. Purchasing securities on this basis involves a risk that the market
value at the time of delivery may be lower than the agreed upon purchase price
resulting in an unrealized loss. The Fund maintains liquid assets with a current
value at least equal to the amount of the when-issued, delayed delivery or
forward purchase commitments until payment is made. At October 31, 2009, the
Fund had $10,417,642 of when-issued, delayed delivery or forward purchase
commitments with a value of $10,449,738.
C. RESTRICTED SECURITIES:
The Fund invests in restricted securities, which are securities that may not be
offered for public sale without first being registered under the 1933 Act. Prior
to registration, restricted securities may only be resold in transactions exempt
from registration under Rule 144A under the 1933 Act, normally to qualified
institutional buyers. As of October 31, 2009, the Fund held restricted
securities as shown in the following table that Brookfield Investment Management
Inc. ("Brookfield" or the "Sub-Advisor") has deemed illiquid pursuant to
Page 18
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009
procedures adopted by the Fund's Board of Trustees. Although instability in the
markets has resulted in periods of increased overall market illiquidity,
liquidity for each security is determined based on security-specific factors and
assumptions, which require subjective judgment. The Fund does not have the right
to demand that such securities be registered. These securities are valued
according to the valuation procedures as stated in the Portfolio Valuation
footnote (Note 2A) and are not expressed as a discount to the carrying value of
a comparable unrestricted security. There are no unrestricted securities with
the same maturity dates and yields for these issuers.
% OF
ACQUISITION PRINCIPAL CARRYING NET
SECURITY DATE VALUE/SHARES PRICE COST VALUE ASSETS
-------- ----------- ------------ ------ ----------- ---------- ------
Ajax Two Ltd., Series 2A 11/30/05 1,450 $10.00 $ 534,349 $ 14,500 0.05%
Ajax Two Ltd., Series 2X 11/30/05 2,000 10.00 169,062 20,000 0.07
Bacchus Ltd.
Series 2006-1I, Subordinated Bond, Zero Coupon, 01/20/19 05/15/07 $1,225,000 1.00 -- 12,250 0.05
Banc of America Commercial Mortgage, Inc.
Series 2000-1, Class M, 6.00%, 11/15/31 08/22/05 $1,171,422 0.00 -- 12 0.00
Banc of America Large Loan, Inc.
Series 2005-MIB1, Class L, 3.25%, 03/15/22 08/26/06 $2,000,000 8.37 2,014,547 167,381 0.63
Falcon Franchise Loan Trust
Series 2003-1, Class E, 6.00%, 01/05/25 08/09/05 $4,231,000 1.00 -- 42,310 0.16
FFCA Secured Lending Corp.
Series 1999-2, Class B1, 8.27%, 05/18/26 05/18/05 $5,000,000 10.01 3,202,878 500,735 1.87
GE Capital Commercial Mortgage Corp.
Series 2000-1, Class G, 6.13%, 01/15/33 06/27/07 $ 700,000 35.59 690,019 249,103 0.93
GS Mortgage Securities Corp. II
Series 1998-C1, Class H, 6.00%, 10/18/30 08/02/05 $6,885,655 5.58 3,996,855 383,896 1.44
GSAMP Trust
Series 2004-AR2, Class B4, 5.00%, 08/25/34 08/17/05 $ 440,199 0.38 -- 1,668 0.01
Halyard Multi Asset CBO I, Ltd.
Series 1A, Class B, 0.67%, 03/24/10 03/26/06 $1,668,248 3.00 198,950 50,047 0.19
InCaps Funding II Ltd./InCaps Funding II Corp.
Subordinated Note, Zero Coupon, 01/15/34 05/01/07 $2,000,000 4.00 527,449 80,000 0.30
Independence III CDO, Ltd.
Series 3A, Class C1, 2.78%, 10/03/37 12/27/06 $5,000,000 0.00 -- 50 0.00
LB-UBS Commercial Mortgage Trust
Series 2001-C7, Class Q, 5.87%, 11/15/33 09/19/05 $3,025,000 5.00 2,696,046 151,395 0.57
Series 2001-C7, Class S, 5.87%, 11/15/33 09/29/05 $2,083,703 0.71 602,412 14,815 0.06
Longhorn CDO, Ltd.
Series 1, Class C, 6.71%, 05/10/12 03/24/06 $2,974,086 1.00 46,102 29,741 0.11
Merit Securities Corp.
Series 13, Class B1, 7.96%, 12/28/33 02/20/07 $1,198,570 0.99 28.800 11,810 0.04
Morgan Stanley Capital I, Inc.
Series 1999-WF1, Class M, 5.91%, 11/15/31 08/03/05 $ 968,400 27.57 680,886 266,978 1.00
Series 2003-IQ5, Class O, 5.24%, 04/15/38 10/19/06 $2,787,919 7.13 150,508 198,702 0.74
Park Place Securities, Inc.
Series 2004-WCW2, Class M10, 2.99%, 10/25/34 03/24/06 $1,301,976 1.64 98,107 21,347 0.08
Series 2005-WCW3, Class M11, 2.74%, 08/25/35 12/26/07 $ 410,437 0.42 -- 1,716 0.01
Preferred Term Securities XXV, Ltd.,
Zero Coupon, 06/22/37 03/22/07 $3,750,000 0.00 -- 375 0.00
Rosedale CLO, Ltd.
Series I-A, Class II, Zero Coupon, 07/24/21 01/12/07 $3,500,000 1.00 157,850 35,000 0.13
Signature 5, Ltd.
Series 5A, Class C, 12.56%, 10/27/12 05/21/07 $1,200,001 19.92 1,198,308 239,004 0.89
Soloso CDO, Ltd., Series 2005-1 11/30/05 2,000 10.00 -- 20,000 0.07
Soundview Home Equity Loan Trust
Series 2007-OPT3, Class M10, 2.74%, 08/25/37 06/21/07 $ 149,220 0.19 -- 282 0.00
Summit CBO I, Ltd
Series 1A, Class B, 2.17%, 05/23/11 08/03/05 $4,705,734 2.00 656,148 94,115 0.35
White Marlin CDO, Ltd., Series AI 06/01/07 3,000 10.00 -- 30,000 0.11
----------- ---------- ----
$17,649,276 $2,637,232 9.86%
=========== ========== ====
Page 19
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009
D. INTEREST ONLY SECURITIES:
An interest only security ("IO Security") is the interest only portion of a
mortgage-backed security ("MBS") that receives some or all of the interest
portion of the underlying MBS and little or no principal. A reference principal
value called a notional value is used to calculate the amount of interest due to
the IO Security. IO Securities are sold at a deep discount to their notional
principal amount. Generally speaking, when interest rates are falling and
prepayment rates are increasing, the value of an IO Security will fall.
Conversely, when interest rates are rising and prepayment rates are decreasing,
generally the value of an IO Security will rise. These investments are
identified on the Portfolio of Investments.
E. TBA SALE COMMITMENTS:
The Fund may enter into to be announced or TBA sale commitments, such as dollar
roll agreements, to hedge its portfolio position or to sell mortgage-backed
securities it owns under delayed delivery arrangements. Proceeds from TBA sale
commitments are not received until the contractual settlement date. During the
time a TBA sale commitment is outstanding, equivalent deliverable securities, or
an offsetting TBA purchase commitment deliverable on or before the sale
commitment date, are held as "cover" for the transaction. Unsettled TBA sale
commitments are valued at approximately the current value of the underlying
securities. The contract is "marked-to market" daily and the change in the value
is recorded by the Fund as an unrealized gain or loss. If the TBA sale
commitment is closed through the acquisition of an offsetting purchase
commitment, the Fund realizes a gain or loss from the sale of the securities
based upon the unit price established at the date the Fund entered the
commitment.
F. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS:
The Fund will distribute to holders of its Common Shares monthly dividends of
all or a portion of its net income after the payment of interest and dividends
in connection with leverage, if any. Distributions will automatically be
reinvested into additional Common Shares pursuant to the Fund's Dividend
Reinvestment Plan unless cash distributions are elected by the shareholder.
Distributions from income and capital gains are determined in accordance with
income tax regulations, which may differ from accounting principles generally
accepted in the United States of America. These differences are primarily due to
differing treatments of income and losses on various investment securities held
by the Fund, timing differences and differing characterization of distributions
made by the Fund. Permanent differences incurred during the fiscal year ended
October 31, 2009, resulting in book and tax accounting differences, have been
reclassified at year end to reflect a decrease in accumulated net investment
income (loss) of $19,816,546, an increase in accumulated net realized gain
(loss) on investments of $33,870,574 and a decrease to paid-in capital of
$14,054,028. Net assets were not affected by this reclassification.
The tax character of distributions paid during the fiscal year ended October 31,
2009 and October 31, 2008 was as follows:
Distributions paid from:
2009 2008
------------- -----------
Ordinary Income ................................. $ -- $ 7,286,555
Return of Capital ............................... 9,752,238 9,998,690
As of October 31, 2009, the components of
distributable earnings on a tax basis were as
follows:
Undistributed Ordinary Income ................... $ --
Net Unrealized Appreciation (Depreciation) ...... (67,864,434)
Accumulated Capital and Other Losses ............ (33,470,766)
G. INCOME TAXES:
The Fund intends to continue to qualify as a regulated investment company by
complying with the requirements under Subchapter M of the Internal Revenue Code
of 1986, as amended, which includes distributing substantially all of its net
investment income and net realized gains to shareholders. Accordingly, no
provision has been made for federal or state income taxes.
The Fund intends to utilize provisions of the federal income tax laws, which
allows it to carry realized capital losses forward for eight years following the
year of the loss and offset such loss against any future realized capital gains.
The Fund is subject to certain limitations under U.S. tax rules on the use of
capital loss carryforwards and net unrealized built-in losses. These limitations
apply when there has been a 50% change in ownership. At October 31, 2009, the
Fund had a capital loss carry forward for federal income tax purposes of
$32,586,032, with $2,534,309, $15,350,612 and $14,701,111 expiring 2015, 2016
and 2017, respectively.
Page 20
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009
The Fund is subject to accounting standards that establish a minimum threshold
for recognizing, and a system for measuring, the benefits of a tax position
taken or expected to be taken in a tax return. Taxable years ending 2009, 2008,
2007 and 2006 remain open to federal and state audit. As of October 31, 2009,
management has evaluated the application of these standards to the Fund, and has
determined that no provision for income tax is required in the Fund's financial
statements for uncertain tax provisions.
H. EXPENSES:
The Fund pays all expenses directly related to its operations.
3. INVESTMENT ADVISORY FEE, AFFILIATED TRANSACTIONS AND OTHER FEE ARRANGEMENTS
First Trust is a limited partnership with one limited partner, Grace Partners of
DuPage L.P., and one general partner, The Charger Corporation. First Trust
serves as investment advisor to the Fund pursuant to an Investment Management
Agreement. First Trust is responsible for the ongoing monitoring of the Fund's
investment portfolio, managing the Fund's business affairs and providing certain
administrative services necessary for the management of the Fund. For these
investment management services, First Trust is entitled to a monthly fee
calculated at an annual rate of 0.90% of the Fund's Managed Assets (the value of
the securities and other investments the Fund holds plus cash or other assets,
including interest accrued but not yet received minus accrued liabilities other
than the principal amount of any borrowings).
Prior to June 29, 2009, Valhalla Capital Partners, LLC ("Valhalla") served as
the Fund's sub-advisor and managed the Fund's portfolio subject to First Trust's
supervision. On May 1, 2009, Valhalla submitted its notice of resignation as
sub-advisor to the Fund effective June 30, 2009. First Trust Portfolios L.P., an
affiliate of First Trust, owns a minority interest in Valhalla. Effective June
29, 2009, the Board of Trustees appointed Brookfield as sub-advisor pursuant to
an interim sub-advisory agreement pending shareholder approval of a new
investment sub-advisory agreement with Brookfield. Effective October 14, 2009,
the shareholders voted to approve the new investment agreement with Brookfield.
The Sub-Advisor receives a portfolio management fee at an annual rate of 0.45%
of Managed Assets that is paid by First Trust from its investment advisory fee.
PNC Global Investment Servicing (U.S.) Inc., an indirect, majority-owned
subsidiary of The PNC Financial Services Group, Inc., serves as the Fund's
Administrator, Fund Accountant and Transfer Agent in accordance with certain fee
arrangements. PFPC Trust Company, also an indirect, majority-owned subsidiary of
The PNC Financial Services Group, Inc., serves as the Fund's Custodian in
accordance with certain fee arrangements.
Each Trustee who is not an officer or employee of First Trust, any sub-advisor
or any of their affiliates ("Independent Trustees") is paid an annual retainer
of $10,000 per trust for the first 14 trusts of the First Trust Fund Complex and
an annual retainer of $7,500 per trust for each subsequent trust in the First
Trust Fund Complex. The annual retainer is allocated equally among each of the
trusts. No additional meeting fees are paid in connection with board or
committee meetings.
Additionally, the Lead Independent Trustee is paid $10,000 annually, the
Chairman of the Audit Committee is paid $5,000 annually, and each of the
Chairmen of the Nominating and Governance Committee and the Valuation Committee
are paid $2,500 annually to serve in such capacities, with such compensation
paid by the trusts in the First Trust Fund Complex and divided among those
trusts. Trustees are also reimbursed by the trusts in the First Trust Fund
Complex for travel and out-of-pocket expenses in connection with all meetings.
The Lead Independent Trustee and each Committee chairman will serve two-year
terms ending December 31, 2009, before rotating to serve as a chairman of
another committee or as Lead Independent Trustee. The officers and "Interested"
Trustee received no compensation from the Fund for serving in such capacities.
4. PURCHASES AND SALES OF SECURITIES
The cost of purchases of U.S. Government securities and non-U.S. Government
securities, excluding short-term investments, for the year ended October 31,
2009 were $41,442,925 and $12,922,119, respectively. The proceeds from sales and
paydowns of U.S. Government securities and non-U.S. Government securities,
excluding short-term investments, for the year ended October 31, 2009 were
$34,519,817 and $11,260,770, respectively.
5. REVOLVING LOAN AGREEMENT
The Fund's Revolving Credit and Security Agreement with Liberty Street Funding
Corp., as conduit lender, and The Bank of Nova Scotia, as secondary lender,
expired on November 12, 2008. This facility provided for a revolving credit
facility to be used as leverage for the Fund. The credit facility provided for a
secured line of credit for the Fund, where Fund assets were pledged against
advances made to the Fund. Under the requirements of the 1940 Act, the Fund,
immediately after any such borrowings, must have an "asset coverage" of at least
300% (33-1/3% of the Fund's total assets after borrowings). In addition, the
Fund agreed to pay facility commitment fees on the unutilized line of credit,
which are included in "Interest and fees on outstanding loan" on the Statement
of Operations. The total
Page 21
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009
commitment under the Revolving Credit and Security Agreement was $87,000,000.
For the period November 1, 2008 through the termination date of November 7,
2008, the average amount outstanding was $12,333,333; the high and low annual
interest rates were 3.49% and 3.49%, respectively, and the weighted average
interest rate was 3.49%.
6. INDEMNIFICATION
The Fund has a variety of indemnification obligations under contracts with its
service providers. The Fund's maximum exposure under these arrangements is
unknown. However, the Fund has not had prior claims or losses pursuant to these
contracts and expects the risk of loss to be remote.
7. LITIGATION
Two class action lawsuits were filed in the United States District Court for the
Northern District of Illinois on behalf of purchasers of shares of First Trust
Strategic High Income Fund, First Trust Strategic High Income Fund II and First
Trust Strategic High Income Fund III. These lawsuits, Gosselin vs. First Trust
Advisors L.P., et al. (filed September 12, 2008) and Evans vs. First Trust
Advisors L.P., et al. (filed September 19, 2008), were consolidated into one
class action complaint, Gosselin vs. First Trust Advisors L.P. et al. (filed
April 30, 2009), that names the following entities as defendants: First Trust
Advisors L.P., First Trust Portfolios L.P., and the three closed-end funds (the
"Funds") named above. The consolidated complaint also names certain officers of
the Funds as defendants. The plaintiffs purport to bring the action on behalf of
a putative class consisting of all persons or entities who acquired shares of
the Funds between July 26, 2005 and July 7, 2008 inclusive.
The plaintiffs assert, among other things, that the registration statements and
prospectuses for the Funds failed to disclose that (a) the Funds lacked
effective controls and hedges to minimize the risk of loss from mortgage
delinquencies, (b) the Funds lacked effective internal controls, (c) the extent
of the Funds' liquidity risk was omitted, and (d) the extent of the Funds' risk
exposure to mortgage-backed assets was misstated. On July 29, 2009, the
defendants filed a motion to dismiss the consolidated complaint. On December 17,
2009, the court denied the defendants' motion to dismiss. The defendants believe
the lawsuit is without merit and intend to contest it vigorously.
8. RISK CONSIDERATIONS
Risks are inherent in all investing. The following summarizes some of the risks
that should be considered for the Fund. For additional information about the
risks associated with investing in the Fund, please see the Fund's prospectus
and statement of additional information, as well as other Fund regulatory
filings.
INVESTMENT AND MARKET RISK: An investment in the Fund's Common Shares is subject
to investment risk, including the possible loss of the entire principal
invested. An investment in Common Shares represents an indirect investment in
the securities owned by the Fund. The value of these securities, like other
market investments, may move up or down, sometimes rapidly and unpredictably.
Common Shares at any point in time may be worth less than the original
investment, even after taking into account the reinvestment of Fund dividends
and distributions. Security prices can fluctuate for several reasons including
the general condition of the securities markets, or when political or economic
events affecting the issuers occur. When the Advisor or Sub-Advisor determines
that it is temporarily unable to follow the Fund's investment strategy or that
it is impractical to do so (such as when a market disruption event has occurred
and trading in the securities is extremely limited or absent), the Fund may take
temporary defensive positions.
The Fund's performance was adversely impacted by the weakness in the credit
markets and broad stock market that occurred beginning in late 2008, and may
continue to be adversely affected if the weakness in the credit or stock markets
continue. In response to the financial crises affecting the banking system and
financial markets, the U.S. and foreign governments have intervened to an
unprecedented degree in the financial and credit markets. Among other things,
U.S. Government regulators have encouraged, and in some cases structured and
provided financial assistance for, banks, securities firms, insurers and other
financial companies. Additional intervention programs have been adopted and
proposed which may have a further impact on the financial and credit markets.
Many of the recently enacted or proposed government measures are far-reaching
and without historical precedent. Furthermore, the U.S. Government has stated
its willingness to implement additional measures as it may see fit to address
changes in market conditions. There can be no assurance that any or all of these
measures will succeed in stabilizing and providing liquidity to the U.S.
financial markets.
RESIDENTIAL MORTGAGE-BACKED SECURITIES CONCENTRATION RISK: Prior to October 14,
2009, the Fund was required to invest at least 25% of its total Managed Assets
in residential mortgage-backed securities under normal market conditions.
Effective October 14, 2009, shareholders of the Fund voted to remove the
concentration policy in residential mortgage-backed securities. The Fund may
deviate from its investment strategies, including its concentration policy, when
engaging in temporary defensive positions. A fund concentrated in a single
industry is likely to present more risks than a fund that is broadly diversified
over several industries. Mortgage-backed securities may have less potential for
capital appreciation than comparable fixed-income securities, due to the
likelihood of increased prepayments of mortgages as interest rates decline. If
the Fund buys mortgage-backed securities at a premium, mortgage foreclosures and
prepayments of principal by mortgagors (which usually may be made at any time
without penalty) may result in some loss of the Fund's principal
Page 22
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009
investment to the extent of the premium paid. Alternatively, in a rising
interest rate environment, the value of mortgage-backed securities may be
adversely affected when payments on underlying mortgages do not occur as
anticipated, resulting in the extension of the security's effective maturity and
the related increase in interest rate sensitivity of a longer-term instrument.
The value of mortgage-backed securities may also change due to shifts in the
market's perception of issuers and regulatory or tax changes adversely affecting
the markets as a whole. In addition, mortgage-backed securities are subject to
the credit risk associated with the performance of the underlying mortgage
properties. In certain instances, third-party guarantees or other forms of
credit support can reduce the credit risk. The Fund may also invest in
mortgage-backed securities which are interest only ("IO") securities and
principal only ("PO") securities. Generally speaking, when interest rates are
falling and prepayment rates are increasing, the value of a PO security will
rise and the value of an IO security will fall. Conversely, when interest rates
are rising and prepayment rates are decreasing, generally the value of a PO
security will fall and the value of an IO security will rise. In addition to the
foregoing, residential mortgage-backed securities are subject to additional
risks, including: (i) the United States residential mortgage market has recently
encountered various difficulties and changed economic conditions. In addition,
recently, residential property values in various states have declined or
remained stable, after extended periods of appreciation. A continued decline or
an extended flattening in those values may result in additional increases in
delinquencies and losses on residential mortgage loans generally; (ii) if a
residential mortgage obligation is secured by a junior lien it will be
subordinate to the rights of the mortgagees or beneficiaries under the related
senior mortgages or deeds of trust; and (iii) depending on the length of a
residential mortgage obligation underlying a residential mortgage-backed
security, unscheduled or early payments of principal and interest may shorten
the security's effective maturity and the prevailing interest rates may be
higher or lower than the current yield of the Fund's portfolio at the time the
Fund receives the payments for reinvestment.
VALUE INVESTING RISK: The Fund focuses its investments on securities that the
Sub-Advisor believes are undervalued or inexpensive relative to other
investments. Such securities are subject to the risk of misestimating certain
fundamental factors. Disciplined adherence to a "value" investment mandate
during periods in which that style is "out of favor" can result in significant
underperformance relative to overall market indices and other managed investment
vehicles that pursue growth style investments and/or flexible style mandates.
BELOW-INVESTMENT GRADE SECURITIES RISK: The Fund invests in below-investment
grade securities. The market values for high-yield securities tend to be very
volatile, and these securities are less liquid than investment grade debt
securities. For these reasons, an investment in the Fund is subject to the
following specific risks: (a) increased price sensitivity to changing interest
rates and to a deteriorating economic environment; (b) greater risk of loss due
to default or declining credit quality; (c) adverse issuer specific events are
more likely to render the issuer unable to make interest and/or principal
payments; and (d) a negative perception of the high-yield market may depress the
price and liquidity of high-yield securities.
DISTRESSED SECURITIES RISK: The Fund may invest in securities issued by
companies in a bankruptcy reorganization proceeding, subject to some other form
of a public or private debt restructuring or otherwise in default or in
significant risk of default in the payment of interest or repayment of principal
or trading at prices substantially below other below-investment grade debt
securities of companies in similar industries. Distressed securities frequently
do not produce income while they are outstanding. The Fund may be required to
incur certain extraordinary expenses in order to protect and recover its
investment. Therefore, to the extent the Fund seeks capital appreciation through
investment in distressed securities, its ability to achieve current income may
be diminished.
ECONOMIC CONDITIONS RISK: Adverse changes in economic conditions are more likely
to lead to a weakened capacity of a high-yield issuer to make principal payments
and interest payments than an investment grade issuer. An economic downturn
could severely affect the ability of highly leveraged issuers to service their
debt obligations or to repay their obligations upon maturity. Under adverse
market or economic conditions, the secondary market for high-yield securities
could contract further, independent of any specific adverse changes in the
condition of a particular issuer and these securities may become illiquid. As a
result, the Fund could find it more difficult to sell these securities or may be
able to sell the securities only at prices lower than if such securities were
widely traded.
FIXED-INCOME SECURITIES RISK: Debt securities, including high yield securities,
are subject to certain risks, including: (i) issuer risk, which is the risk that
the value of fixed-income securities may decline for a number of reasons which
directly relate to the issuer, such as management performance, financial
leverage and reduced demand for the issuer's goods and services or, in the case
of asset-backed issuers, a decline in the value and/or cash flows of the
underlying assets; (ii) reinvestment risk, which is the risk that income from
the Fund's portfolio will decline if the Fund invests the proceeds from matured,
traded or called bonds at market interest rates that are below the Fund
portfolio's current earnings rate; (iii) prepayment risk, which is the risk that
during periods of declining interest rates, the issuer of a security may
exercise its option to prepay principal earlier than scheduled, forcing the Fund
to reinvest in lower yielding securities; and (iv) credit risk, which is the
risk that a security in the Fund's portfolio will decline in price or the issuer
fails to make interest payments when due because the issuer of the security
experiences a decline in its financial status.
Page 23
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009
INTEREST RATE RISK: The Fund is also subject to interest rate risk. Interest
rate risk is the risk that fixed-income securities will decline in value because
of changes in market interest rates. Investments in debt securities with
long-term maturities may experience significant price declines if long-term
interest rates increase.
LEVERAGE RISK: The use of leverage results in additional risks and can magnify
the effect of any losses. The funds borrowed pursuant to a leverage borrowing
program constitute a substantial lien and burden by reason of their prior claim
against the income of the Fund and against the net assets of the Fund in
liquidation. The rights of lenders to receive payments of interest on and
repayments of principal on any borrowings made by the Fund under a leverage
borrowing program are senior to the rights of holders of Common Shares with
respect to the payment of dividends or upon liquidation. If the Fund is not in
compliance with certain credit facility provisions, the Fund may not be
permitted to declare dividends or other distributions or purchase Common Shares.
9. SUBSEQUENT EVENTS
Management has evaluated the impact of all subsequent events on the Fund through
December 28, 2009, the date the financial statements were issued, and has
determined that there were subsequent events as follows:
On October 20, 2009, the Fund declared a dividend of $0.0250 per share to common
shareholders of record November 4, 2009, payable November 16, 2009.
On November 20, 2009, the Fund declared a dividend of $0.0250 per share to
common shareholders of record December 3, 2009, payable December 11, 2009.
On December 21, 2009, the Fund declared a dividend of $0.025 per share to common
shareholders of record January 6, 2010, payable January 15, 2010.
Page 24
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF FIRST TRUST STRATEGIC HIGH INCOME
FUND:
We have audited the accompanying statement of assets and liabilities of First
Trust Strategic High Income Fund (the "Fund"), including the portfolio of
investments, as of October 31, 2009, and the related statements of operations
and cash flows for the year then ended, the statements of changes in net assets
for each of the two years in the period then ended, and the financial highlights
for the periods presented. These financial statements and financial highlights
are the responsibility of the Fund's management. Our responsibility is to
express an opinion on these financial statements and financial highlights based
on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements and financial highlights are free of material misstatement.
The Fund is not required to have, nor were we engaged to perform, an audit of
its internal control over financial reporting. Our audits included consideration
of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of October 31, 2009 by correspondence with the Fund's
custodian. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of First
Trust Strategic High Income Fund as of October 31, 2009, the results of its
operations and its cash flows for the year then ended, the changes in its net
assets for each of the two years in the period then ended, and the financial
highlights for the periods presented, in conformity with accounting principles
generally accepted in the United States of America.
(DELOITTE & TOUCHE LLP)
Chicago, Illinois
December 28, 2009
Page 25
ADDITIONAL INFORMATION
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009 (UNAUDITED)
DIVIDEND REINVESTMENT PLAN
If your Common Shares are registered directly with the Fund or if you hold your
Common Shares with a brokerage firm that participates in the Fund's Dividend
Reinvestment Plan (the "Plan"), unless you elect, by written notice to the Fund,
to receive cash distributions, all dividends, including any capital gain
distributions, on your Common Shares will be automatically reinvested by PNC
Global Investment Servicing (U.S.) Inc. (the "Plan Agent"), in additional Common
Shares under the Plan. If you elect to receive cash distributions, you will
receive all distributions in cash paid by check mailed directly to you by the
Plan Agent, as dividend paying agent.
If you decide to participate in the Plan, the number of Common Shares you will
receive will be determined as follows:
1) If Common Shares are trading at or above NAV at the time of valuation, the
Fund will issue new shares at a price equal to the greater of (i) NAV per
Common Share on that date or (ii) 95% of the market price on that date.
2) If Common Shares are trading below NAV at the time of valuation, the Plan
Agent will receive the dividend or distribution in cash and will purchase
Common Shares in the open market, on the NYSE or elsewhere, for the
participants' accounts. It is possible that the market price for the Common
Shares may increase before the Plan Agent has completed its purchases.
Therefore, the average purchase price per share paid by the Plan Agent may
exceed the market price at the time of valuation, resulting in the purchase
of fewer shares than if the dividend or distribution had been paid in
Common Shares issued by the Fund. The Plan Agent will use all dividends and
distributions received in cash to purchase Common Shares in the open market
within 30 days of the valuation date except where temporary curtailment or
suspension of purchases is necessary to comply with federal securities
laws. Interest will not be paid on any uninvested cash payments.
You may elect to opt-out of or withdraw from the Plan at any time by giving
written notice to the Plan Agent, or by telephone at (800) 334-1710, in
accordance with such reasonable requirements as the Plan Agent and Fund may
agree upon. If you withdraw or the Plan is terminated, you will receive a
certificate for each whole share in your account under the Plan and you will
receive a cash payment for any fraction of a share in your account. If you wish,
the Plan Agent will sell your shares and send you the proceeds, minus brokerage
commissions.
The Plan Agent maintains all Common Shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. Common Shares in your account will be held by the
Plan Agent in non-certificated form. The Plan Agent will forward to each
participant any proxy solicitation material and will vote any shares so held
only in accordance with proxies returned to the Fund. Any proxy you receive will
include all Common Shares you have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or distributions
in Common Shares. However, all participants will pay a pro rata share of
brokerage commissions incurred by the Plan Agent when it makes open market
purchases.
Automatically reinvesting dividends and distributions does not mean that you do
not have to pay income taxes due upon receiving dividends and distributions.
Capital gains and income are realized, although cash is not received by you.
Consult your financial advisor for more information.
If you hold your Common Shares with a brokerage firm that does not participate
in the Plan, you will not be able to participate in the Plan and any dividend
reinvestment may be effected on different terms than those described above.
The Fund reserves the right to amend or terminate the Plan if in the judgment of
the Board of Trustees the change is warranted. There is no direct service charge
to participants in the Plan; however, the Fund reserves the right to amend the
Plan to include a service charge payable by the participants. Additional
information about the Plan may be obtained by writing PNC Global Investment
Servicing (U.S.) Inc., 301 Bellevue Parkway, Wilmington, Delaware 19809.
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that the Fund uses to determine how
to vote proxies and information on how the Fund voted proxies relating to
portfolio securities during the most recent 12 month period ended June 30 is
available (1) without charge, upon request, by calling (800) 988-5891; (2) on
the Fund's website located at http://www.ftportfolios.com; and (3) on the
Securities and Exchange Commission's website at http://www.sec.gov.
Page 26
ADDITIONAL INFORMATION - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009 (UNAUDITED)
PORTFOLIO HOLDINGS
The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission ("SEC") for the first and third quarters of each fiscal
year on Form N-Q. The Fund's Forms N-Q are available (1) by calling (800)
988-5891; (2) on the Fund's website located at http://www.ftportfolios.com; (3)
on the SEC's website at http://www.sec.gov; and (4) for review and copying at
the SEC's Public Reference Room ("PRR") in Washington, DC. Information regarding
the operation of the PRR may be obtained by calling (800) SEC-0330.
NYSE CERTIFICATION INFORMATION
In accordance with Section 303A-12 of the New York Stock Exchange ("NYSE")
Listed Company Manual, the Fund's President has certified to the NYSE that, as
of June 16, 2009, he was not aware of any violation by the Fund of NYSE
corporate governance listing standards. In addition, the Fund's reports to the
SEC on Forms N-CSR, N-CSRS and N-Q contain certifications by the Fund's
principal executive officer and principal financial officer that relate to the
Fund's public disclosure in such reports and are required by Rule 30a-2 under
the 1940 Act.
SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
The Joint Annual Meeting of Shareholders of the Common Shares of Macquarie/First
Trust Global Infrastructure/Utilities Dividend & Income Fund, Energy Income and
Growth Fund, First Trust Enhanced Equity Income Fund, First Trust/Aberdeen
Global Opportunity Income Fund, First Trust/FIDAC Mortgage Income Fund, First
Trust Strategic High Income Fund, First Trust Strategic High Income Fund II,
First Trust Tax-Advantaged Preferred Income Fund, First Trust Specialty Finance
and Financial Opportunities Fund and First Trust Active Dividend Income Fund was
held on April 16, 2009. At the Annual Meeting, Independent Trustees Richard E.
Erickson and Thomas R. Kadlec were elected by the holders of Common Shares of
the Fund as Class II Trustees for three-year terms expiring at the Fund's annual
meeting of shareholders in 2012. The number of votes cast in favor of Dr.
Erickson was 8,030,619, the number of votes against was 256,146 and the number
of abstentions was 770,254. The number of votes cast in favor of Mr. Kadlec was
8,026,260, the number of votes against was 260,505 and the number of abstentions
was 770,254. James A. Bowen, Robert F. Keith and Niel B. Nielson are the current
and continuing Trustees.
At a Special Meeting of Shareholders of the Fund held on October 14, 2009,
shareholders voted to approve a new investment sub-advisory agreement with
Brookfield replacing the Funds' prior sub-advisor, Valhalla, effective June 29,
2009. At a special meeting of the Board of Trustees of the Fund, the Board
approved an interim sub-advisory agreement among the Funds, First Trust and
Brookfield, whereby Brookfield would serve as the Fund's sub-advisor for a
maximum period of 150 days, subject to shareholder approval. The new
sub-advisory agreement, approved by shareholders on October 14, 2009, is
substantially similar to the Fund's previous sub-advisory agreements with
Valhalla, except that Brookfield receives a sub-advisory fee of 0.45% which is
five basis points higher than the prior sub-advisory fee of 0.40%. The number of
votes cast in favor of the new sub-advisory agreement was 4,210,294, the number
of votes against was 199,108, and the number of abstentions was 308,428.
Also at the Special Meeting of Shareholders of the Fund held on October 14,
2009, shareholders of the Fund approved a change in the Fund's industry
concentration policy so that the Fund may not purchase any security if, as a
result of the purchase, 25% or more of the Fund's total assets (taken at current
value) would be invested in the securities of borrowers and other issuers having
their principal business activities in the same industry; provided that this
limitation shall not apply with respect to obligations issued or guaranteed by
the U.S. government or by its agencies or instrumentalities. Previously, the
Fund's industry concentration policy provided that the Fund would invest at
least 25% of its assets in residential mortgage-backed securities under normal
market conditions. The number of votes cast in favor of the change in industry
concentration policy was 4,257,356, the number of votes against was 166,426, the
number of abstentions was 294,048.
TAX INFORMATION
Of the ordinary income (including short-term capital gain) distributions made by
the Fund during the year ended October 31, 2009, none qualify for the corporate
dividends received deduction available to corporate shareholders or as qualified
dividend income.
CHANGE IN INVESTMENT POLICY
On June 29, 2009, the Board of Trustees of the Fund approved a change in
investment policy so that the Fund may invest up to 100% of its managed assets
in below-investment grade debt securities (commonly referred to as "high-yield"
or "junk bonds"). This investment policy is non-fundamental and therefore may be
changed by approval of the Board of Trustees without shareholder approval. The
investment policy was effective on or about September 1, 2009. Previously, the
Fund pursued its investment objectives by investing at least 80% of its managed
assets in a diversified portfolio of high income producing securities that the
investment Sub-Advisor believe offer attractive yield and capital appreciation
potential. High income producing securities in which the Fund invests consist of
below-investment grade debt securities (high-yield or junk bonds) and investment
grade securities which offer yields comparable to below-investment grade
securities.
Page 27
ADDITIONAL INFORMATION - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009 (UNAUDITED)
SUB-ADVISORY AGREEMENTS
BOARD CONSIDERATIONS REGARDING APPROVAL OF INTERIM SUB-ADVISORY AGREEMENT AND
NEW SUB-ADVISORY AGREEMENT WITH BROOKFIELD INVESTMENT MANAGEMENT INC. FOR FIRST
TRUST STRATEGIC HIGH INCOME FUND, FIRST TRUST STRATEGIC HIGH INCOME FUND II AND
FIRST TRUST STRATEGIC HIGH INCOME FUND III
The Board of Trustees of First Trust Strategic High Income Fund ("FHI"), First
Trust Strategic High Income Fund II ("FHY") and First Trust Strategic High
Income Fund III ("FHO") (each, a "Fund" and collectively, the "Funds"),
including a majority of the Independent Trustees, approved an Interim
Sub-Advisory Agreement and a New Sub-Advisory Agreement (collectively, the
"Agreements") among each Fund, First Trust Advisors L.P. (the "Advisor") and
Hyperion Brookfield Asset Management, Inc. (now known as Brookfield Investment
Management Inc.) ("Brookfield") at a meeting held on June 29, 2009 (the
"Meeting"). The Board determined that the terms of the Agreements are fair and
reasonable and in the best interests of each Fund.
On May 1, 2009, Valhalla Capital Partners, LLC ("Valhalla") notified the Funds
and the Advisor of its resignation as sub-advisor to each Fund, effective June
30, 2009 (the "Resignation"). The Advisor immediately notified the Board and
thereafter conducted a review of potential sub-advisors to replace Valhalla. The
Board considered that pursuant to the Investment Company Act of 1940, as amended
("1940 Act"), any sub-advisory agreement with a replacement sub-advisor would
require shareholder approval prior to such sub-advisor assuming its duties. In
light of the short amount of time available to the Funds and the Advisor to find
a suitable replacement for Valhalla and to obtain shareholder approval of a new
sub-advisory agreement, the Advisor proposed and the Board approved the
termination of the sub-advisory agreement with Valhalla for each Fund (the
"Valhalla Sub-Advisory Agreements") at the Meeting. The termination of the
Valhalla Sub-Advisory Agreements allowed each Fund to rely on Rule 15a-4 under
the 1940 Act to enter into an interim sub-advisory agreement with a successor
sub-advisor without first obtaining shareholder approval during the period while
shareholder approval of a new sub-advisory agreement was sought.
Between the time the Funds and the Advisor received notice of the Resignation
and the Meeting, the Advisor reviewed potential sub-advisors for consideration
as the successor sub-advisor and determined to recommend that Brookfield serve
as the new sub-advisor for the Funds. Prior to the Meeting, Brookfield provided
to the Board written responses to questions posed by independent legal counsel
on behalf of the Independent Trustees. At the Meeting, representatives from
Brookfield, including the prospective portfolio managers for the Funds, made a
presentation to the Board and responded to questions. In their presentation, the
Brookfield representatives reviewed the process they followed in transitioning
as investment advisor to another group of similar closed-end funds, and
discussed the changes they proposed for the Funds' investment policies and to
the Funds' portfolios. The Board then discussed the presentation and the
materials provided. The Independent Trustees then met separately with their
independent legal counsel to discuss the information provided by Brookfield and
the Advisor. Based on their consideration of all the information received, the
Trustees appointed Brookfield as the interim sub-advisor to each Fund, pursuant
to the Interim Sub-Advisory Agreements, effective June 29, 2009. Also at the
Meeting, the Board approved the New Sub-Advisory Agreements and determined to
recommend them to shareholders of each Fund for their approval.
To reach its determinations as to the Agreements, the Board considered its
duties under the 1940 Act, as well as under the general principles of state law
in reviewing and approving advisory contracts; the requirements of the 1940 Act
in such matters; the fiduciary duty of investment advisors with respect to
advisory agreements and compensation; the standards used by courts in
determining whether investment company boards have fulfilled their duties; and
the factors to be considered by the Board in voting on such agreements. In its
evaluation of the Agreements, the Board considered a report from Brookfield
responding to a request for information from counsel to the Independent
Trustees. The report, among other things, outlined the services to be provided
by Brookfield, including the relevant personnel responsible for these services
and their experience; the proposed sub-advisory fee for each Fund as compared to
fees charged to other clients of Brookfield; the potential for economies of
scale, if any; financial data on Brookfield; any fall out benefits to
Brookfield; and information on Brookfield's compliance program. The Board
applied its business judgment to determine whether the proposed arrangements
between the Funds, the Advisor and Brookfield are reasonable business
arrangements from the Funds' perspective as well as from the perspective of
shareholders.
In reviewing the Agreements, the Board considered the nature, quality and extent
of services to be provided by Brookfield under the Agreements. The Board
considered Brookfield's investment style and the backgrounds of the investment
personnel who would be responsible for the day-to-day management of each Fund.
The Board reviewed performance information provided by Brookfield for a
composite of high yield accounts managed by Brookfield. The Board also discussed
with the prospective portfolio managers the approach they planned to take in
transitioning the Funds' portfolios. In light of the information presented and
the considerations made, the Board concluded that the nature, quality and extent
of services to be provided to the Funds by Brookfield under the Agreements are
expected to be satisfactory.
Page 28
ADDITIONAL INFORMATION - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009 (UNAUDITED)
The Board considered the sub-advisory fees to be paid under the Agreements. The
Board noted that, as required by Rule 15a-4, the sub-advisory fee under each
Interim Sub-Advisory Agreement would be the same as the fee paid under the
Valhalla Sub-Advisory Agreements. However, the Board considered that the
sub-advisory fee proposed under each New Sub-Advisory Agreement (the "New
Sub-Advisory Fee") would be five basis points higher than the fee paid under the
Valhalla Sub-Advisory Agreements. The Board considered that the New Sub-Advisory
Fee was negotiated at arm's length between the Advisor and Brookfield, an
unaffiliated third party, and noted that the fees to be paid to Brookfield would
be paid by the Advisor from its advisory fee. The Board also considered the
advisory fees charged by Brookfield to other exchange-traded closed-end funds
managed by Brookfield with similar investment objectives as the Funds. The Board
noted that the advisory fees charged by Brookfield to these comparable funds
were higher than the New Sub-Advisory Fee. On the basis of all the information
provided, the Board concluded that the sub-advisory fees to be paid under the
Agreements were reasonable and appropriate in light of the nature, quality and
extent of services expected to be provided by Brookfield under the Agreements.
The Board considered the information provided by Brookfield on the estimated
profitability of the New Sub-Advisory Agreements to Brookfield, noting that the
estimated profitability did not seem unreasonable in light of the nature,
quality and extent of services expected to be provided by Brookfield under the
New Sub-Advisory Agreements. The Board noted that the overall management fee
structure reflects an appropriate level of sharing of any economies of scale.
The Board noted that Brookfield currently does not intend to utilize soft
dollars in connection with its management of the Funds' portfolios, and did not
anticipate any fall-out benefits from its relationship with the Funds. The
Advisor stated that there may be additional opportunities for the Advisor to
work with Brookfield going forward.
Based on all of the information considered and the conclusions reached, the
Board, including a majority of the Independent Trustees, determined that the
terms of the Agreements are fair and reasonable and that the approval of the
Agreements is in the best interests of each Fund. No single factor was
determinative in the Board's analysis.
Page 29
BOARD OF TRUSTEES AND OFFICERS
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009 (UNAUDITED)
Information pertaining to the Trustees and Officers of the Fund is set forth
below.
NUMBER OF
PORTFOLIOS IN OTHER
NAME, ADDRESS, THE FIRST TRUST TRUSTEESHIPS OR
DATE OF BIRTH AND TERM OF OFFICE AND PRINCIPAL OCCUPATIONS FUND COMPLEX DIRECTORSHIPS
POSITION WITH THE FUND LENGTH OF SERVICE(1) DURING PAST 5 YEARS OVERSEEN BY TRUSTEE HELD BY TRUSTEE
----------------------------- ------------------------ -------------------------- ------------------- ----------------------
INDEPENDENT TRUSTEES
Richard E. Erickson, Trustee - Three Year Term Physician; President, 61 None
c/o First Trust Advisors L.P. - Since Fund Wheaton Orthopedics;
120 E. Liberty Drive, Inception Co-owner and Co-Director
Suite 400 (January 1996 to May
Wheaton, IL 60187 2007), Sports Med Center
D.OB.: 04/51 for Fitness; Limited
Partner, Gundersen Real
Estate Partnership;
Limited Partner,
Sportsmed LLC
Thomas R. Kadlec, Trustee - Three Year Term Senior Vice President and 61 Director of ADM
c/o First Trust Advisors L.P. - Since Fund Chief Financial Officer Investor Services,
120 E. Liberty Drive, Inception (May 2007 to Present), Inc. and ADM Investor
Suite 400 Vice President and Chief Services International
Wheaton, IL 60187 Financial Officer (1990 to
D.O.B.: 11/57 May 2007), ADM
Investor Services, Inc.
(Futures Commission
Merchant)
Robert F. Keith, Trustee - Three Year Term President (2003 to 61 None
c/o First Trust Advisors L.P. - Since June 2006 Present), Hibs Enterprises
120 E. Liberty Drive, (Financial and
Suite 400 Management Consulting)
Wheaton, IL 60187
D.O.B.: 11/56
----------
1 Currently, Robert F. Keith is serving as a trustee until the Fund's 2011
annual meeting of shareholders. Richard E. Erickson and Thomas R. Kadlec
are each serving as trustees until the Fund's 2012 annual meeting of
shareholders. James A. Bowen and Niel B. Nielson are each serving as
trustees until the Fund's 2010 annual meeting. Officers of the Fund have an
indefinite term.
Page 30
BOARD OF TRUSTEES AND OFFICERS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009 (UNAUDITED)
NUMBER OF
PORTFOLIOS IN OTHER
NAME, ADDRESS, THE FIRST TRUST TRUSTEESHIPS OR
DATE OF BIRTH AND TERM OF OFFICE AND PRINCIPAL OCCUPATIONS FUND COMPLEX DIRECTORSHIPS
POSITION WITH THE FUND LENGTH OF SERVICE(1) DURING PAST 5 YEARS OVERSEEN BY TRUSTEE HELD BY TRUSTEE
----------------------------- ------------------------ -------------------------- ------------------- ----------------------
INDEPENDENT TRUSTEES (CONTINUED)
Niel B. Nielson, Trustee - Three Year Term President (June 2002 to 61 Director of Covenant
c/o First Trust Advisors L.P. - Since Fund Present), Covenant Transport Inc.
120 E. Liberty Drive, Inception College
Suite 400
Wheaton, IL 60187
D.O.B.: 03/54
INTERESTED TRUSTEE
James A. Bowen(2), Trustee, - Three Year Trustee President, First Trust 61 Trustee of Wheaton
President, Chairman of the Term and Indefinite Advisors L.P. and First College
Board and CEO Officer Term Trust Portfolios L.P.;
120 E. Liberty Drive, - Since Fund Chairman of the Board of
Suite 400 Inception Directors, BondWave LLC
Wheaton, IL 60187 (Software Development
D.O.B.: 09/55 Company/Investment
Advisor) and Stonebridge
Advisors LLC (Investment
Advisor)
NAME, ADDRESS, POSITION AND OFFICES TERM OF OFFICE AND PRINCIPAL OCCUPATIONS
AND DATE OF BIRTH WITH FUND LENGTH OF SERVICE DURING PAST 5 YEARS
----------------------------- ----------------------- -------------------------- --------------------------------------------
OFFICERS WHO ARE NOT TRUSTEES(3)
Mark R. Bradley Treasurer, Controller, - Indefinite Term Chief Financial Officer, First Trust
120 E. Liberty Drive, Chief Financial Officer - Since Fund Advisors L.P. and First Trust Portfolios
Suite 400 and Chief Accounting Inception L.P.; Chief Financial Officer, BondWave LLC
Wheaton, IL 60187 Officer (Software Development Company/Investment
D.O.B.: 11/57 Advisor) and Stonebridge Advisors LLC
(Investment Advisor)
----------
(1) Currently, Robert F. Keith is serving as a trustee until the Fund's 2011
annual meeting of shareholders. Richard E. Erickson and Thomas R. Kadlec
are each serving as trustees until the Fund's 2012 annual meeting of
shareholders. James A. Bowen and Niel B. Nielson are each serving as
trustees until the Fund's 2010 annual meeting. Officers of the Fund have an
indefinite term.
(2) Mr. Bowen is deemed an "interested person" of the Fund due to his position
as President of First Trust Advisors L.P., investment advisor of the Fund.
(3) The term "officer" means the president, vice president, secretary,
treasurer, controller or any other officer who performs a policy making
function.
Page 31
BOARD OF TRUSTEES AND OFFICERS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009 (UNAUDITED)
NAME, ADDRESS, POSITION AND OFFICES TERM OF OFFICE AND PRINCIPAL OCCUPATIONS
AND DATE OF BIRTH WITH FUND LENGTH OF SERVICE DURING PAST 5 YEARS
----------------------------- ----------------------- -------------------------- --------------------------------------------
OFFICERS WHO ARE NOT TRUSTEES(3) (CONTINUED)
Erin E. Chapman Assistant Secretary - Indefinite Term Assistant General Counsel (October 2007 to
120 E. Liberty Drive, - Since June 2009 Present), Associate Counsel (March 2006 to
Suite 400 October 2007), First Trust Advisors L.P. and
Wheaton, IL 60187 First Trust Portfolios L.P.; Associate
D.O.B.: 08/76 Attorney (November 2003 to March 2006),
Doyle & Bolotin, Ltd.
James M. Dykas Assistant Treasurer - Indefinite Term Senior Vice President (April 2007 to
120 E. Liberty Drive, - Since Fund Present), Vice President (January 2005 to
Suite 400 Inception April 2007), First Trust Advisors L.P. and
Wheaton, IL 60187 First Trust Portfolios L.P.; Executive
D.O.B.: 01/66 Director (December 2002 to January 2005),
Vice President (December 2000 to December
2002), Van Kampen Asset Management and
Morgan Stanley Investment Management
Christopher Fallow Assistant Vice President - Indefinite Term Assistant Vice President (August 2006 to
120 E. Liberty Drive, - Since Fund Present), Associate (January 2005 to August
Suite 400 Inception 2006), First Trust Advisors L.P. and First
Wheaton, IL 60187 Trust Portfolios L.P.; Municipal Bond Trader
D.O.B.: 04/79 (July 2001 to January 2005), BondWave LLC
(Software Development Company/Investment
Advisor)
W. Scott Jardine Secretary and Chief - Indefinite Term General Counsel, First Trust Advisors L.P.
120 E. Liberty Drive, Compliance Officer - Since Fund and First Trust Portfolios L.P.; Secretary,
Suite 400 Inception BondWave LLC (Software Development
Wheaton, IL 60187 Company/Investment Advisor) and Stonebridge
D.O.B.: 05/60 Advisors LLC (Investment Advisor)
Daniel J. Lindquist Vice President - Indefinite Term Senior Vice President (September 2005 to
120 E. Liberty Drive, - Since Fund Present), Vice President (April 2004 to
Suite 400 Inception September 2005), First Trust Advisors L.P.
Wheaton, IL 60187 and First Trust Portfolios L.P.
D.O.B.: 02/70
----------
(3) The term "officer" means the president, vice president, secretary,
treasurer, controller or any other officer who performs a policy making
function.
Page 32
BOARD OF TRUSTEES AND OFFICERS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009 (UNAUDITED)
NAME, ADDRESS, POSITION AND OFFICES TERM OF OFFICE AND PRINCIPAL OCCUPATIONS
AND DATE OF BIRTH WITH FUND LENGTH OF SERVICE DURING PAST 5 YEARS
----------------------------- ----------------------- -------------------------- --------------------------------------------
OFFICERS WHO ARE NOT TRUSTEES(3)
Coleen D. Lynch Assistant Vice President - Indefinite Term Assistant Vice President (January 2008 to
120 E. Liberty Drive, - Since July 2008 Present), First Trust Advisors L.P. and
Suite 400 First Trust Portfolios L.P.; Vice President
Wheaton, IL 60187 (May 1998 to January 2008), Van Kampen Asset
D.O.B.: 07/58 Management and Morgan Stanley Investment
Management
Kristi A. Maher Assistant Secretary - Indefinite Term Deputy General Counsel (May 2007 to
120 E. Liberty Drive, and Deputy Chief - Assistant Secretary Present), Assistant General Counsel (March
Suite 400 Compliance Officer since Fund 2004 to May 2007), First Trust Advisors L.P.
Wheaton, IL 60187 Inception and First Trust Portfolios L.P.
D.O.B.: 12/66 - Deputy Chief
Compliance Officer
since November 2009
-----------------
(3) The term "officer" means the president, vice president, secretary,
treasurer, controller or any other officer who performs a policy making
function.
Page 33
PRIVACY POLICY
FIRST TRUST STRATEGIC HIGH INCOME FUND
OCTOBER 31, 2009 (UNAUDITED)
PRIVACY POLICY
The open-end and closed-end funds advised by First Trust Advisors L.P. (each a
"Fund") consider your privacy an important priority in maintaining our
relationship. We are committed to protecting the security and confidentiality of
your personal information.
SOURCES OF INFORMATION
We may collect nonpublic personal information about you from the following
sources:
- Information we receive from you or your broker-dealer, investment
adviser or financial representative through interviews, applications,
agreements or other forms;
- Information about your transactions with us, our affiliates or others;
- Information we receive from your inquiries by mail, e-mail or
telephone; and
- Information we collect on our website through the use of "cookies."
For example, we may identify the pages on our website that your
browser requests or visits.
INFORMATION COLLECTED
The type of data we collect may include your name, address, social security
number, age, financial status, assets, income, tax information, retirement and
estate plan information, transaction history, account balance, payment history,
investment objectives, marital status, family relationships and other personal
information.
DISCLOSURE OF INFORMATION
We do not disclose any nonpublic personal information about our customers or
former customers to anyone, except as permitted by law. The permitted uses
include the disclosure of such information to unaffiliated companies for the
following reasons:
- In order to provide you with products and services and to effect
transactions that you request or authorize, we may disclose your
personal information as described above to unaffiliated financial
service providers and other companies that perform administrative or
other services on our behalf, such as transfer agents, custodians and
trustees, or that assist us in the distribution of investor materials
such as trustees, banks, financial representatives and printers.
- We may release information we have about you if you direct us to do
so, if we are compelled by law to do so, or in other legally limited
circumstances (for example to protect your account from fraud).
In addition, in order to alert you to our other financial products and services,
we may share your personal information with affiliates of the Fund. Please note,
however, that the California Financial Information Privacy Act contains an "opt
out" mechanism that California consumers may use to prevent us from sharing
nonpublic personal information with affiliates.
CONFIDENTIALITY AND SECURITY
With regard to our internal security procedures, the Fund restricts access to
your nonpublic personal information to those individuals who need to know that
information to provide products or services to you. We maintain physical,
electronic and procedural safeguards to protect your nonpublic personal
information.
POLICY UPDATES AND INQUIRIES
As required by federal law, we will notify you of our privacy policy annually.
We reserve the right to modify this policy at any time; however, if we do change
it, we will tell you promptly.
For questions about our policy, or for additional copies of this notice, please
contact us at (800) 621-1675.
Page 34
This Page Left Blank Intentionally.
This Page Left Blank Intentionally.
(FIRST TRUST LOGO)
INVESTMENT ADVISOR
First Trust Advisors L.P.
120 E. Liberty Drive, Suite 400
Wheaton, IL 60187
INVESTMENT SUB-ADVISOR
Brookfield Investment Management Inc.
3 World Financial Center
200 Vesey Street, 10th Floor
New York, NY 10281
ADMINISTRATOR,
FUND ACCOUNTANT &
TRANSFER AGENT
PNC Global Investment Servicing (U.S.) Inc.
301 Bellevue Parkway
Wilmington, DE 19809
CUSTODIAN
PFPC Trust Company
8800 Tinicum Boulevard
Philadelphia, PA 19153
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
111 S. Wacker Drive
Chicago, IL 60606
LEGAL COUNSEL
Chapman and Cutler LLP
111 W. Monroe Street
Chicago, IL 60603
ITEM 2. CODE OF ETHICS.
(a) The registrant, as of the end of the period covered by this report,
has adopted a code of ethics that applies to the registrant's
principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar
functions, regardless of whether these individuals are employed by
the registrant or a third party.
(c) During the period covered by this report, the code of ethics that
applies to the registrant's principal executive officer, principal
financial officer, principal accounting officer or controller, or
persons performing similar functions, regardless of whether these
individuals are employed by the registrant or a third party, and
that relates to any element of the code of ethics description was
amended to name W. Scott Jardine as the Compliance Coordinator for
the implementation and administration of the aforementioned code.
The amended code of ethics is provided as an exhibit pursuant to
Item 12(a)(1).
(d) The registrant has not granted any waivers, including an implicit
waiver, from a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial
officer, principal accounting officer or controller, or persons
performing similar functions, regardless of whether these
individuals are employed by the registrant or a third party, that
relates to one or more of the items set forth in paragraph (b) of
this item's instructions.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
As of the end of the period covered by the report, the Registrant's board of
trustees has determined that Thomas R. Kadlec and Robert F. Keith are qualified
to serve as audit committee financial experts serving on its audit committee and
that each of them is "independent," as defined by Item 3 of Form N-CSR.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
(a) AUDIT FEES (REGISTRANT) -- The aggregate fees billed for each of the
last two fiscal years for professional services rendered by the
principal accountant for the audit of the registrant's annual
financial statements or services that are normally provided by the
accountant in connection with statutory and regulatory filings or
engagements for those fiscal years were $53,500 for the fiscal year
ended October 31, 2008 and $45,800 for the fiscal year ended October
31, 2009.
(b) AUDIT-RELATED FEES (REGISTRANT) -- The aggregate fees billed in each
of the last two fiscal years for assurance and related services by
the principal accountant that are reasonably related to the
performance of the audit of the registrant's financial statements
and are not reported under paragraph (a) of this Item were $6,868
for the fiscal year ended October 31, 2008 and $0 for the fiscal
year ended October 31, 2009. These fees were for additional audit
work.
AUDIT-RELATED FEES (INVESTMENT ADVISOR) -- The aggregate fees billed
in each of the last two fiscal years for assurance and related
services by the principal accountant that are reasonably related to
the performance of the audit of the registrant's financial
statements and are not reported under paragraph (a) of this Item
were $6,868 for the fiscal year ended October 31, 2008 and $0 for
the fiscal year ended October 31, 2009. These fees were for
additional audit work.
(c) TAX FEES (REGISTRANT) -- The aggregate fees billed in each of the
last two fiscal years for professional services rendered by the
principal accountant for tax compliance, tax advice, and tax
planning were $5,000 for the fiscal year ended October 31, 2008 and
$5,200 for the fiscal year ended October 31, 2009. These fees were
for tax return preparation.
TAX FEES (INVESTMENT ADVISOR) -- The aggregate fees billed in each
of the last two fiscal years for professional services rendered by
the principal accountant for tax compliance, tax advice, and tax
planning were $0 for the fiscal year ended October 31, 2008 and $0
for the fiscal year ended October 31, 2009.
(d) ALL OTHER FEES (REGISTRANT) -- The aggregate fees billed in each of
the last two fiscal years for products and services provided by the
principal accountant to the Registrant, other than the services
reported in paragraphs (a) through (c) of this Item were $0 for the
fiscal year ended October 31, 2008 and $0 for the fiscal year ended
October 31, 2009.
ALL OTHER FEES (INVESTMENT ADVISER) The aggregate fees billed in
each of the last two fiscal years for products and services provided
by the principal accountant to the Registrant, other than the
services reported in paragraphs (a) through (c) of this Item were $0
for the fiscal year ended October 31, 2008 and $0 for the fiscal
year ended October 31, 2009.
(e)(1) Disclose the audit committee's pre-approval policies and procedures
described in paragraph (c)(7) of Rule 2-01 of Regulation S-X.
Pursuant to its charter and its Audit and Non-Audit Services Pre-Approval
Policy, the Audit Committee (the "COMMITTEE") is responsible for the
pre-approval of all audit services and permitted non-audit services (including
the fees and terms thereof) to be performed for the registrant by its
independent auditors. The Chairman of the Committee is authorized to give such
pre-approvals on behalf of the Committee up to $25,000 and report any such
pre-approval to the full Committee.
The Committee is also responsible for the pre-approval of the independent
auditor's engagements for non-audit services with the registrant's adviser (not
including a sub-adviser whose role is primarily portfolio management and is
sub-contracted or overseen by another investment adviser) and any entity
controlling, controlled by or under common control with the investment adviser
that provides ongoing services to the registrant, if the engagement relates
directly to the operations and financial reporting of the registrant, subject to
the DE MINIMIS exceptions for non-audit services described in Rule 2-01 of
Regulation S-X. If the independent auditor has provided non-audit services to
the registrant's adviser (other than any sub-adviser whose role is primarily
portfolio management and is sub-contracted with or overseen by another
investment adviser) and any entity controlling, controlled by or
under common control with the investment adviser that provides ongoing services
to the registrant that were not pre-approved pursuant to its policies, the
Committee will consider whether the provision of such non-audit services is
compatible with the auditor's independence.
(e)(2) The percentage of services described in each of paragraphs (b)
through (d) for the Registrant and the Registrant's investment
adviser of this Item that were approved by the audit committee
pursuant to the pre-approval exceptions included in paragraph
(c)(7)(i)(c) or paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X
are as follows:
(b) 0%
(c) 0%
(d) 0%
(f) The percentage of hours expended on the principal accountant's
engagement to audit the registrant's financial statements for the
most recent fiscal year that were attributed to work performed by
persons other than the principal accountant's full-time, permanent
employees was less than fifty percent.
(g) The aggregate non-audit fees billed by the registrant's accountant
for services rendered to the registrant, and rendered to the
registrant's investment adviser (not including any sub-adviser whose
role is primarily portfolio management and is subcontracted with or
overseen by another investment adviser), and any entity controlling,
controlled by, or under common control with the adviser that
provides ongoing services to the registrant for the Registrant's
fiscal year ended October 31, 2008, were $5,000 for the Registrant
and $12,143 for the Registrant's investment adviser and for the
Registrant's fiscal year ended October 31, 2009 were $5,200 the
Registrant and $36,000 for the Registrant's investment adviser.
(h) The registrant's audit committee of the board of directors has
considered whether the provision of non-audit services that were
rendered to the registrant's investment adviser (not including any
sub-adviser whose role is primarily portfolio management and is
subcontracted with or overseen by another investment adviser), and
any entity controlling, controlled by, or under common control with
the investment adviser that provides ongoing services to the
registrant that were not pre-approved pursuant to paragraph
(c)(7)(ii) of Rule 2-01 of Regulation S-X is compatible with
maintaining the principal accountant's independence.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
(a) The Registrant has a separately designated audit committee consisting of
all the independent directors of the Registrant. The members of the audit
committee are: Thomas R. Kadlec, Niel B. Nielson, Richard E. Erickson and
Robert F. Keith.
ITEM 6. INVESTMENTS.
(a) Schedule of Investments in securities of unaffiliated issuers as of the
close of the reporting period is included as part of the report to
shareholders filed under Item 1 of this form.
(b) Not applicable.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
The Proxy Voting Policies are attached herewith.
PROXY VOTING POLICIES AND PROCEDURES
BROOKFIELD INVESTMENT MANAGEMENT INC.
PORTFOLIO PROXY VOTING POLICIES AND PROCEDURES
NOVEMBER 2009
The Portfolio Proxy Voting Policies and Procedures (the "Policies and
Procedures") set forth the proxy voting policies, procedures and guidelines to
be followed by Brookfield Investment Management Inc. and its subsidiaries
(collectively, "BIM") in voting portfolio proxies relating to securities that
are held in the portfolios of the investment companies or other clients
("Clients") for which BIM has been delegated such proxy voting authority.
A. PROXY VOTING COMMITTEE
BIM's internal proxy voting committee (the "Committee") is responsible for
overseeing the proxy voting process and ensuring that BIM meets its regulatory
and corporate governance obligations in voting of portfolio proxies.
The Committee shall oversee the proxy voting agent's compliance with these
Policies and Procedures, including any deviations by the proxy voting agent from
the proxy voting guidelines ("Guidelines") provided in Appendix I attached
hereto.
B. ADMINISTRATION AND VOTING OF PORTFOLIO PROXIES
1. FIDUCIARY DUTY AND OBJECTIVE
As an investment adviser that has been granted the authority to vote on
portfolio proxies, BIM owes a fiduciary duty to its Clients to monitor corporate
events and to vote portfolio proxies consistent with the best interests of its
Clients. In this regard, BIM seeks to ensure that all votes are free from
unwarranted and inappropriate influences. Accordingly, BIM generally votes
portfolio proxies in a uniform manner for its Clients and in accordance with
these Policies and Procedures and the Guidelines. In meeting its fiduciary duty,
BIM generally view proxy voting as a way to enhance the value of the company's
stock held by the Clients. Similarly, when voting on matters for which the
Guidelines dictate a vote be decided on a case-by-case basis, BIM's primary
consideration is the economic interests its Clients.
2. PROXY VOTING AGENT
BIM may retain an independent third party proxy voting agent to assist BIM in
its proxy voting responsibilities in accordance with these Policies and
Procedures and in particular, with the Guidelines. As discussed above, the
Committee is responsible for monitoring the proxy voting agent.
In general, BIM may consider the proxy voting agent's research and analysis as
part of BIM's own review of a proxy proposal in which the Guidelines recommend
that the vote be considered on a case-by-case basis. BIM bears ultimate
responsibility for how portfolio proxies are voted. Unless instructed otherwise
by BIM, the proxy voting agent, when retained, will vote each portfolio proxy in
accordance with the Guidelines. The proxy voting agent also will assist BIM in
maintaining records of BIM's portfolio proxy votes, including the appropriate
records necessary for registered investment companies to meet their regulatory
obligations regarding the annual filing of proxy voting records on Form N-PX
with the Securities and Exchange Commission ("SEC").
3. MATERIAL CONFLICTS OF INTEREST
BIM votes portfolio proxies without regard to any other business relationship
between BIM and the company to which the portfolio proxy relates. To this end,
BIM must identify material conflicts of interest that may arise between a Client
and BIM, such as the following relationships:
o BIM provides significant investment advisory or other services to
a portfolio company or its affiliates (the "Company") whose
management is soliciting proxies or BIM is seeking to provide such
services;
o BIM serves as an investment adviser to the pension or other
investment account of the Company or BIM is seeking to serve in
that capacity; or
o BIM and the Company have a lending or other financial-related
relationship.
In each of these situations, voting against the Company management's
recommendation may cause BIM a loss of revenue or other benefit.
BIM generally seeks to avoid such material conflicts of interest by maintaining
separate investment decision-making and proxy voting decision-making processes.
To further minimize possible conflicts of interest, BIM and the Committee employ
the following procedures, as long as BIM determines that the course of action is
consistent with the best interests of the Clients:
o If the proposal that gives rise to a material conflict is
specifically addressed in the Guidelines, BIM will vote the
portfolio proxy in accordance with the Guidelines, provided that
the Guidelines do not provide discretion to BIM on how to vote on
the matter (i.e., case-by-case); or
o If the proposal that gives rise to a potential conflict is not
specifically addressed in the Guidelines and the Guidelines do not
provide voting discretion to BIM, BIM will vote in accordance with
its proxy voting agent's general recommended guidelines on the
proposal provided that BIM has reasonably determined there is no
conflict of interest on the part of the proxy voting agent; or
o If neither of the previous two procedures provides an appropriate
voting recommendation, BIM may retain an independent fiduciary for
advice on how to vote the proposal or the Committee may direct BIM
to abstain from voting because voting on the particular proposal
is impracticable and/or is outweighed by the cost of voting.
4. CERTAIN FOREIGN SECURITIES
Portfolio proxies relating to foreign securities held by Clients are subject to
these Policies and Procedures. In certain foreign jurisdictions, however, the
voting of portfolio proxies can result in additional restrictions that have an
economic impact to the security, such as "share-blocking." If BIM votes on the
portfolio proxy, share-blocking may prevent BIM from selling the shares of the
foreign security for a period of time. In determining whether to vote portfolio
proxies subject to such restrictions, BIM, in consultation with the Committee,
considers whether the vote, either in itself or together with the votes of other
shareholders, is expected to affect the value of the security that outweighs the
cost of voting. If BIM votes on a portfolio proxy and during the "share-blocking
period," BIM would like to sell the affected foreign security, BIM, in
consultation with the Committee, will attempt to recall the shares (as allowable
within the market time-frame and practices).
C. FUND BOARD REPORTING AND RECORDKEEPING
BIM will prepare periodic reports for submission to the Boards of Directors of
its affiliated funds (the "Helios Funds") describing:
o any issues arising under these Policies and Procedures since the
last report to the Helios Funds' Boards of Directors and the
resolution of such issues, including but not limited to,
information about conflicts of interest not addressed in the
Policies and Procedures; and
o any proxy votes taken by BIM on behalf of the Helios Funds since
the last report to the Helios Funds' Boards of Directors that
deviated from these Policies and Procedures, with reasons for any
such deviations.
In addition, no less frequently than annually, BIM will provide the Boards of
Directors of the Helios Funds with a written report of any recommended changes
based upon BIM's experience under these Policies and Procedures, evolving
industry practices and developments in the applicable laws or regulations.
BIM will maintain all records that are required under, and in accordance with,
the Investment Company Act of 1940, as amended, and the Investment Advisers Act
of 1940, which include, but not limited to:
o these Policies and Procedures, as amended from time to time;
o records of votes cast with respect to portfolio proxies,
reflecting the information required to be included in Form N-PX;
o records of written client requests for proxy voting information
and any written responses of BIM to such requests; and
o any written materials prepared by BIM that were material to making
a decision in how to vote, or that memorialized the basis for the
decision.
D. AMENDMENTS TO THESE PROCEDURES
The Committee shall periodically review and update these Policies and Procedures
as necessary. Any amendments to these Procedures and Policies (including the
Guidelines) shall be provided to the Board of Directors of BIM and to the Boards
of Directors of the Helios Funds for review and approval.
E. PROXY VOTING GUIDELINES
Guidelines are attached as Appendix A.
U.S. Proxy Voting Guidelines Concise Summary
(Digest of Selected Key Guidelines)
January 15, 2009
1. Operational Items:
AUDITOR RATIFICATION
Vote FOR proposals to ratify auditors, unless any of the following apply:
- An auditor has a financial interest in or association with the
company, and is therefore not independent;
- There is reason to believe that the independent auditor has rendered
an opinion which is neither accurate nor indicative of the company's
financial position;
- Poor accounting practices are identified that rise to a serious level
of concern, such as: fraud; misapplication of GAAP; and material
weaknesses identified in Section 404 disclosures; or
- Fees for non-audit services ("Other" fees) are excessive.
Non-audit fees are excessive if:
- Non-audit ("other") fees exceed audit fees + audit-related fees + tax
compliance/preparation fees
Vote CASE-BY-CASE on shareholder proposals asking companies to prohibit or limit
their auditors from engaging in non-audit services.
Vote CASE-BY-CASE on shareholder proposals asking for audit firm rotation,
taking into account:
- The tenure of the audit firm;
- The length of rotation specified in the proposal;
- Any significant audit-related issues at the company;
- The number of Audit Committee meetings held each year;
- The number of financial experts serving on the committee; and
- Whether the company has a periodic renewal process where the auditor
is evaluated for both audit quality and competitive price.
2. Board of Directors:
VOTING ON DIRECTOR(1) NOMINEES IN UNCONTESTED ELECTIONS
Vote on director nominees should be determined on a CASE-BY-CASE basis.
Vote AGAINST or WITHHOLD(2) from individual directors who:
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(1) RiskMetrics' classification of directors can be found in U.S. PROXY VOTING
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- Attend less than 75 percent of the board and committee meetings
without a valid excuse, such as illness, service to the nation, work
on behalf of the company, or funeral obligations. If the company
provides meaningful public or private disclosure explaining the
director's absences, evaluate the information on a CASE-BY-CASE basis
taking into account the following factors:
- Degree to which absences were due to an unavoidable conflict;
- Pattern of absenteeism; and
- Other extraordinary circumstances underlying the director's
absence;
- Sit on more than six public company boards;
- Are CEOs of public companies who sit on the boards of more than two
public companies besides their own-- withhold only at their outside
boards.
Vote AGAINST or WITHHOLD from all nominees of the board of directors, (except
from new nominees, who should be considered on a CASE-BY-CASE basis) if:
- The company's proxy indicates that not all directors attended 75% of
the aggregate of their board and committee meetings, but fails to
provide the required disclosure of the names of the directors
involved. If this information cannot be obtained, vote
against/withhold from all incumbent directors;
- The company's poison pill has a dead-hand or modified dead-hand
feature. Vote against/withhold every year until this feature is
removed;
- The board adopts or renews a poison pill without shareholder approval,
does not commit to putting it to shareholder vote within 12 months of
adoption (or in the case of an newly public company, does not commit
to put the pill to a shareholder vote within 12 months following the
IPO), or reneges on a commitment to put the pill to a vote, and has
not yet received a withhold/against recommendation for this issue;
- The board failed to act on a shareholder proposal that received
approval by a majority of the shares outstanding the previous year (a
management proposal with other than a FOR recommendation by management
will not be considered as sufficient action taken);
- The board failed to act on a shareholder proposal that received
approval of the majority of shares cast for the previous two
consecutive years (a management proposal with other than a FOR
recommendation by management will not be considered as sufficient
action taken);
- The board failed to act on takeover offers where the majority of the
shareholders tendered their shares;
- At the previous board election, any director received more than 50
percent withhold/against votes of the shares cast and the company has
failed to address the underlying issue(s) that caused the high
withhold/against vote;
- The board is classified, and a continuing director responsible for a
problematic governance issue at the board/committee level that would
warrant a withhold/against vote recommendation is not up for election-
any or all appropriate nominees (except new) may be held accountable;
- The board lacks accountability and oversight, coupled with sustained
poor performance relative to peers. Sustained poor performance is
measured by one- and three-year total shareholder returns in the
bottom half of a company's four-digit GICS industry group (Russell
3000 companies only).
Vote AGAINST or WITHHOLD from Inside Directors and Affiliated Outside Directors
(per the Classification of Directors below) when:
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(2) In general, companies with a plurality vote standard use "Withhold" as the
valid opposition vote option in director elections; companies with a
majority vote standard use "Against". However, it will vary by company and
the proxy must be checked to determine the valid opposition vote for the
particular company.
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- The inside or affiliated outside director serves on any of the three
key committees: audit, compensation, or nominating;
- The company lacks an audit, compensation, or nominating committee so
that the full board functions as that committee;
- The company lacks a formal nominating committee, even if board attests
that the independent directors fulfill the functions of such a
committee;
- The full board is less than majority independent.
Vote AGAINST or WITHHOLD from the members of the Audit Committee if:
- The non-audit fees paid to the auditor are excessive;
- The company receives an adverse opinion on the company's financial
statements from its auditor; or
- There is persuasive evidence that the audit committee entered into an
inappropriate indemnification agreement with its auditor that limits
the ability of the company, or its shareholders, to pursue legitimate
legal recourse against the audit firm.
Vote CASE-by-CASE on members of the Audit Committee and/or the full board if
poor accounting practices, which rise to a level of serious concern are
indentified, such as: fraud; misapplication of GAAP; and material weaknesses
identified in Section 404 disclosures.
Examine the severity, breadth, chronological sequence and duration, as well as
the company's efforts at remediation or corrective actions in determining
whether negative vote recommendations are warranted against the members of the
Audit Committee who are responsible for the poor accounting practices, or the
entire board.
Vote AGAINST or WITHHOLD from the members of the Compensation Committee if:
- There is a negative correlation between the chief executive's pay and
company performance (see discussion under Equity Compensation Plans);
- The company reprices underwater options for stock, cash or other
consideration without prior shareholder approval, even if allowed in
their equity plan;
- The company fails to submit one-time transfers of stock options to a
shareholder vote;
- The company fails to fulfill the terms of a burn rate commitment they
made to shareholders;
- The company has backdated options (see "Options Backdating" policy);
The company has poor compensation practices (see "Poor Pay Practices" policy).
Poor pay practices may warrant withholding votes from the CEO and potentially
the entire board as well.
Vote AGAINST or WITHHOLD from directors, individually or the entire board, for
egregious actions or failure to replace management as appropriate.
INDEPENDENT CHAIR (SEPARATE CHAIR/CEO)
Generally vote FOR shareholder proposals requiring that the chairman's position
be filled by an independent director, unless the company satisfies ALL of the
following criteria:
The company maintains the following counterbalancing features:
- Designated lead director, elected by and from the independent board
members with clearly delineated and comprehensive duties. (The role
may alternatively reside with a presiding director, vice chairman, or
rotating lead director; however the director must serve a minimum of
one year in order to qualify as a lead director.) The duties should
include, but are not limited to, the following:
- presides at all meetings of the board at which the chairman is
not present, including executive sessions of the independent
directors;
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- serves as liaison between the chairman and the independent
directors;
- approves information sent to the board;
- approves meeting agendas for the board;
- approves meeting schedules to assure that there is sufficient
time for discussion of all agenda items;
- has the authority to call meetings of the independent directors;
- if requested by major shareholders, ensures that he is available
for consultation and direct communication;
- Two-thirds independent board;
- All independent key committees;
- Established governance guidelines;
- A company in the Russell 3000 universe must not have exhibited
sustained poor total shareholder return (TSR) performance, defined as
one- and three-year TSR in the bottom half of the company's four-digit
GICS industry group within the Russell 3000 only), unless there has
been a change in the Chairman/CEO position within that time;
- The company does not have any problematic governance or management
issues, examples of which include, but are not limited to:
- Egregious compensation practices;
- Multiple related-party transactions or other issues putting
director independence at risk;
- Corporate and/or management scandals;
- Excessive problematic corporate governance provisions; or
- Flagrant board or management actions with potential or realized
negative impact on shareholders.
MAJORITY VOTE SHAREHOLDER PROPOSALS
Generally vote FOR precatory and binding resolutions requesting that the board
change the company's bylaws to stipulate that directors need to be elected with
an affirmative majority of votes cast, provided it does not conflict with the
state law where the company is incorporated. Binding resolutions need to allow
for a carve-out for a plurality vote standard when there are more nominees than
board seats.
Companies are strongly encouraged to also adopt a post-election policy (also
know as a director resignation policy) that provides guidelines so that the
company will promptly address the situation of a holdover director.
PERFORMANCE/GOVERNANCE EVALUATION FOR DIRECTORS
Vote WITHHOLD/AGAINST on all director nominees if the board lacks accountability
and oversight, coupled with sustained poor performance relative to peers,
measured by one- and three-year total shareholder returns in the bottom half of
a company's four-digit GICS industry group (Russell 3000 companies only).
Evaluate board accountability and oversight at companies that demonstrate
sustained poor performance. Problematic provisions include but are not limited
to:
- a classified board structure;
- a supermajority vote requirement;
- majority vote standard for director elections with no carve out for
contested elections;
- the inability of shareholders to call special meetings;
- the inability of shareholders to act by written consent;
- a dual-class structure; and/or
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- a non-shareholder approved poison pill.
If a company exhibits sustained poor performance coupled with a lack of board
accountability and oversight, also take into consideration the company's
five-year total shareholder return and five-year operational metrics in the
evaluation.
3. Proxy Contests
VOTING FOR DIRECTOR NOMINEES IN CONTESTED ELECTIONS
Vote CASE-BY-CASE on the election of directors in contested elections,
considering the following factors:
- Long-term financial performance of the target company relative to its
industry;
- Management's track record;
- Background to the proxy contest;
- Qualifications of director nominees (both slates);
- Strategic plan of dissident slate and quality of critique against
management;
- Likelihood that the proposed goals and objectives can be achieved
(both slates);
- Stock ownership positions.
REIMBURSING PROXY SOLICITATION EXPENSES
Vote CASE-BY-CASE on proposals to reimburse proxy solicitation expenses. When
voting in conjunction with support of a dissident slate, vote FOR the
reimbursement of all appropriate proxy solicitation expenses associated with the
election.
Generally vote FOR shareholder proposals calling for the reimbursement of
reasonable costs incurred in connection with nominating one or more candidates
in a contested election where the following apply:
- The election of fewer than 50% of the directors to be elected is
contested in the election;
- One or more of the dissident's candidates is elected;
- Shareholders are not permitted to cumulate their votes for directors;
and
- The election occurred, and the expenses were incurred, after the
adoption of this bylaw.
4. Antitakeover Defenses and Voting Related Issues
ADVANCE NOTICE REQUIREMENTS FOR SHAREHOLDER PROPOSALS/NOMINATIONS
Vote CASE-BY-CASE on advance notice proposals, giving support to proposals that
allow shareholders to submit proposals/nominations reasonably close to the
meeting date and within the broadest window possible, recognizing the need to
allow sufficient notice for company, regulatory and shareholder review.
To be reasonable, the company's deadline for shareholder notice of a proposal/
nominations must not be more than 60 days prior to the meeting, with a submittal
window of at least 30 days prior to the deadline.
In general, support additional efforts by companies to ensure full disclosure in
regard to a proponent's economic and voting position in the company so long as
the informational requirements are reasonable and aimed at providing
shareholders with the necessary information to review such proposal.
POISON PILLS
Vote FOR shareholder proposals requesting that the company submit its poison
pill to a shareholder vote or redeem it UNLESS the company has: (1) A
shareholder approved poison pill in place; or (2) The company has
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adopted a policy concerning the adoption of a pill in the future specifying that
the board will only adopt a shareholder rights plan if either:
- Shareholders have approved the adoption of the plan; or
- The board, in exercising its fiduciary responsibilities, determines
that it is in the best interest of shareholders under the
circumstances to adopt a pill without the delay that would result from
seeking stockholder approval (i.e., the "fiduciary out" provision). A
poison pill adopted under this "fiduciary out" will be put to a
shareholder ratification vote within 12 months of adoption or expire.
If the pill is not approved by a majority of the votes cast on this
issue, the plan will immediately terminate.
Vote FOR shareholder proposals calling for poison pills to be put to a vote
within a time period of less than one year after adoption. If the company has no
non-shareholder approved poison pill in place and has adopted a policy with the
provisions outlined above, vote AGAINST the proposal. If these conditions are
not met, vote FOR the proposal, but with the caveat that a vote within 12 months
would be considered sufficient.
Vote CASE-by-CASE on management proposals on poison pill ratification, focusing
on the features of the shareholder rights plan. Rights plans should contain the
following attributes:
- No lower than a 20% trigger, flip-in or flip-over;
- A term of no more than three years;
- No dead-hand, slow-hand, no-hand or similar feature that limits the
ability of a future board to redeem the pill;
- Shareholder redemption feature (qualifying offer clause); if the board
refuses to redeem the pill 90 days after a qualifying offer is
announced, 10 percent of the shares may call a special meeting or seek
a written consent to vote on rescinding the pill.
In addition, the rationale for adopting the pill should be thoroughly explained
by the company. In examining the request for the pill, take into consideration
the company's existing governance structure, including: board independence,
existing takeover defenses, and any problematic governance concerns.
For management proposals to adopt a poison pill for the stated purpose of
preserving a company's net operating losses ("NOL pills"), the following factors
should be considered:
- the trigger (NOL pills generally have a trigger slightly below 5%);
- the value of the NOLs;
- the term;
- shareholder protection mechanisms (sunset provision, causing
expiration of the pill upon exhaustion or expiration of NOLs); and
- other factors that may be applicable.
In addition, vote WITHHOLD/AGAINST the entire board of directors, (except new
nominees, who should be considered on a CASE-by-CASE basis) if the board adopts
or renews a poison pill without shareholder approval, does not commit to putting
it to a shareholder vote within 12 months of adoption (or in the case of a newly
public company, does not commit to put the pill to a shareholder vote within 12
months following the IPO), or reneges on a commitment to put the pill to a vote,
and has not yet received a withhold recommendation for this issue.
5. Mergers and Corporate Restructurings
OVERALL APPROACH
For mergers and acquisitions, review and evaluate the merits and drawbacks of
the proposed transaction, balancing various and sometimes countervailing factors
including:
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- VALUATION - Is the value to be received by the target shareholders (or
paid by the acquirer) reasonable? While the fairness opinion may
provide an initial starting point for assessing valuation
reasonableness, emphasis is placed on the offer premium, market
reaction and strategic rationale.
- MARKET REACTION - How has the market responded to the proposed deal? A
negative market reaction should cause closer scrutiny of a deal.
- STRATEGIC RATIONALE - Does the deal make sense strategically? From
where is the value derived? Cost and revenue synergies should not be
overly aggressive or optimistic, but reasonably achievable. Management
should also have a favorable track record of successful integration of
historical acquisitions.
- NEGOTIATIONS AND PROCESS - Were the terms of the transaction
negotiated at arm's-length? Was the process fair and equitable? A fair
process helps to ensure the best price for shareholders. Significant
negotiation "wins" can also signify the deal makers' competency. The
comprehensiveness of the sales process (e.g., full auction, partial
auction, no auction) can also affect shareholder value.
- CONFLICTS OF INTEREST - Are insiders benefiting from the transaction
disproportionately and inappropriately as compared to non-insider
shareholders? As the result of potential conflicts, the directors and
officers of the company may be more likely to vote to approve a merger
than if they did not hold these interests. Consider whether these
interests may have influenced these directors and officers to support
or recommend the merger. The change-in-control figure presented in the
"RMG Transaction Summary" section of this report is an aggregate
figure that can in certain cases be a misleading indicator of the true
value transfer from shareholders to insiders. Where such figure
appears to be excessive, analyze the underlying assumptions to
determine whether a potential conflict exists.
- GOVERNANCE - Will the combined company have a better or worse
governance profile than the current governance profiles of the
respective parties to the transaction? If the governance profile is to
change for the worse, the burden is on the company to prove that other
issues (such as valuation) outweigh any deterioration in governance.
6. State of Incorporation
REINCORPORATION PROPOSALS
Evaluate management or shareholder proposals to change a company's state of
incorporation on a CASE-BY-CASE basis, giving consideration to both financial
and corporate governance concerns including the following:
- Reasons for reincorporation;
- Comparison of company's governance practices and provisions prior to
and following the reincorporation; and
- Comparison of corporation laws of original state and destination state
Vote FOR reincorporation when the economic factors outweigh any neutral or
negative governance changes.
7. Capital Structure
COMMON STOCK AUTHORIZATION
Vote CASE-BY-CASE on proposals to increase the number of shares of common stock
authorized for issuance. Take into account company-specific factors which
include, at a minimum, the following:
- Specific reasons/ rationale for the proposed increase;
- The dilutive impact of the request as determined through an allowable
cap generated by RiskMetrics' quantitative model;
- The board's governance structure and practices; and
- Risks to shareholders of not approving the request.
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Vote FOR proposals to approve increases beyond the allowable cap when a
company's shares are in danger of being delisted or if a company's ability to
continue to operate as a going concern is uncertain.
PREFERRED STOCK
Vote CASE-BY-CASE on proposals to increase the number of shares of preferred
stock authorized for issuance. Take into account company-specific factors which
include, at a minimum, the following:
- Specific reasons/ rationale for the proposed increase;
- The dilutive impact of the request as determined through an allowable
cap generated by RiskMetrics' quantitative model;
- The board's governance structure and practices; and
- Risks to shareholders of not approving the request.
Vote AGAINST proposals authorizing the creation of new classes of preferred
stock with unspecified voting, conversion, dividend distribution, and other
rights ("blank check" preferred stock).
Vote FOR proposals to create "declawed" blank check preferred stock (stock that
cannot be used as a takeover defense).
Vote FOR proposals to authorize preferred stock in cases where the company
specifies the voting, dividend, conversion, and other rights of such stock and
the terms of the preferred stock appear reasonable.
Vote AGAINST proposals to increase the number of blank check preferred stock
authorized for issuance when no shares have been issued or reserved for a
specific purpose.
8. Executive and Director Compensation
EQUITY COMPENSATION PLANS
Vote CASE-BY-CASE on equity-based compensation plans. Vote AGAINST the equity
plan if any of the following factors apply:
- The total cost of the company's equity plans is unreasonable;
- The plan expressly permits the repricing of stock options/stock
appreciation rights (SARs) without prior shareholder approval;
- The CEO is a participant in the proposed equity-based compensation
plan and there is a disconnect between CEO pay and the company's
performance where over 50 percent of the year-over-year increase is
attributed to equity awards;
- The company's three year burn rate exceeds the greater of 2% and the
mean plus one standard deviation of its industry group;
- The plan provides for the acceleration of vesting of equity awards
even though an actual change in control may not occur (e.g., upon
shareholder approval of a transaction or the announcement of a tender
offer); or
- The plan is a vehicle for poor pay practices.
POOR PAY PRACTICES
Vote AGAINST or WITHHOLD from compensation committee members, CEO, and
potentially the entire board, if the company has poor compensation practices.
Vote AGAINST equity plans if the plan is a vehicle for poor compensation
practices.
The following practices, while not exhaustive, are examples of poor compensation
practices that may warrant withhold vote recommendations:
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- Egregious employment contracts - Contracts containing multi-year
guarantees for salary increases, bonuses and equity compensation;
- Excessive perks/tax reimbursements:
- Overly generous perquisites, which may include, but are not
limited to the following: personal use of corporate aircraft,
personal security system maintenance and/or installation, car
allowances;
- Reimbursement of income taxes on executive perquisites or other
payments;
- Perquisites for former executives, such as car allowances,
personal use of corporate aircraft or other inappropriate
arrangements;
Abnormally large bonus payouts without justifiable performance linkage or
proper disclosure - Performance metrics that are changed, canceled or
replaced during the performance period without adequate explanation of the
action and the link to performance;
- Egregious pension/SERP (supplemental executive retirement plan)
payouts:
- Inclusion of additional years of service not worked that result
in significant payouts;
- Inclusion of performance-based equity awards in the pension
calculation;
- New CEO with overly generous new hire package:
- Excessive "make whole" provisions;
- Any of the poor pay practices listed in this policy;
- Excessive severance and/or change in control provisions:
- Inclusion of excessive change in control or severance payments,
especially those with a multiple in excess of 3X cash pay;
- Payments upon an executive's termination in connection with
performance failure;
- Change in control payouts without loss of job or substantial
diminution of job duties (single-triggered);
- New or materially amended employment or severance agreements that
provide for modified single triggers, under which an executive
may voluntarily leave for any reason and still receive the
change-in-control severance package;
- Liberal change in control definition in individual contracts or
equity plans which could result in payments to executives without
an actual change in control occurring;
- New or materially amended employment or severance agreements that
provide for an excise tax gross-up. Modified gross-ups would be
treated in the same manner as full gross-ups;
- Perquisites for former executives such as car allowances,
personal use of corporate aircraft or other inappropriate
arrangements;
- Dividends or dividend equivalents paid on unvested performance shares
or units;
- Poor disclosure practices:
- Unclear explanation of how the CEO is involved in the pay setting
process;
- Retrospective performance targets and methodology not discussed;
- Methodology for benchmarking practices and/or peer group not
disclosed and explained;
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- Internal Pay Disparity:
- Excessive differential between CEO total pay and that of next
highest paid named executive officer (NEO);
- Options backdating (covered in a separate policy);
- Other excessive compensation payouts or poor pay practices at the
company.
OTHER COMPENSATION PROPOSALS AND POLICIES
ADVISORY VOTE ON EXECUTIVE COMPENSATION (SAY-ON-PAY) MANAGEMENT PROPOSALS
Vote CASE-BY-CASE on management proposals for an advisory vote on executive
compensation. Vote AGAINST these resolutions in cases where boards have failed
to demonstrate good stewardship of investors' interests regarding executive
compensation practices.
For U.S. companies, consider the following factors in the context of each
company's specific circumstances and the board's disclosed rationale for its
practices:
RELATIVE CONSIDERATIONS:
- Assessment of performance metrics relative to business strategy, as
discussed and explained in the CD & A;
- Evaluation of peer groups used to set target pay or award
opportunities;
- Alignment of company performance and executive pay trends over time
(e.g., performance down: pay down);
- Assessment of disparity between total pay of the CEO and other Named
Executive Officers (NEOs).
DESIGN CONSIDERATIONS:
- Balance of fixed versus performance-driven pay;
- Assessment of excessive practices with respect to perks, severance
packages, supplemental executive pension plans, and burn rates.
COMMUNICATION CONSIDERATIONS:
- Evaluation of information and board rationale provided in CD&A about
how compensation is determined (e.g., why certain elements and pay
targets are used, and specific incentive plan goals, especially
retrospective goals);
- Assessment of board's responsiveness to investor input and engagement
on compensation issues (e.g., in responding to majority-supported
shareholder proposals on executive pay topics).
EMPLOYEE STOCK PURCHASE PLANS-- NON-QUALIFIED PLANS
Vote CASE-by-CASE on nonqualified employee stock purchase plans. Vote FOR
nonqualified employee stock purchase plans with all the following features:
- Broad-based participation (i.e., all employees of the company with the
exclusion of individuals with 5 percent or more of beneficial
ownership of the company);
- Limits on employee contribution, which may be a fixed dollar amount or
expressed as a percent of base salary;
- Company matching contribution up to 25 percent of employee's
contribution, which is effectively a discount of 20 percent from
market value;
- No discount on the stock price on the date of purchase since there is
a company matching contribution.
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Vote AGAINST nonqualified employee stock purchase plans when any of the plan
features do not meet the above criteria. If the company matching contribution
exceeds 25 percent of employee's contribution, evaluate the cost of the plan
against its allowable cap.
OPTION EXCHANGE PROGRAMS/REPRICING OPTIONS
Vote CASE-by-CASE on management proposals seeking approval to exchange/reprice
options, taking into consideration:
- Historic trading patterns--the stock price should not be so volatile
that the options are likely to be back "in-the-money" over the near
term;
- Rationale for the re-pricing--was the stock price decline beyond
management's control?
- Is this a value-for-value exchange?
- Are surrendered stock options added back to the plan reserve?
- Option vesting--does the new option vest immediately or is there a
black-out period?
- Term of the option--the term should remain the same as that of the
replaced option;
- Exercise price--should be set at fair market or a premium to market;
- Participants--executive officers and directors should be excluded.
If the surrendered options are added back to the equity plans for re-issuance,
then also take into consideration the company's total cost of equity plans and
its three-year average burn rate.
In addition to the above considerations, evaluate the intent, rationale, and
timing of the repricing proposal. The proposal should clearly articulate why the
board is choosing to conduct an exchange program at this point in time.
Repricing underwater options after a recent precipitous drop in the company's
stock price demonstrates poor timing. Repricing after a recent decline in stock
price triggers additional scrutiny and a potential AGAINST vote on the proposal.
At a minimum, the decline should not have happened within the past year. Also,
consider the terms of the surrendered options, such as the grant date, exercise
price and vesting schedule. Grant dates of surrendered options should be far
enough back (two to three years) so as not to suggest that repricings are being
done to take advantage of short-term downward price movements. Similarly, the
exercise price of surrendered options should be above the 52-week high for the
stock price.
Vote FOR shareholder proposals to put option repricings to a shareholder vote.
OTHER SHAREHOLDER PROPOSALS ON COMPENSATION
ADVISORY VOTE ON EXECUTIVE COMPENSATION (SAY-ON-PAY)
Generally, vote FOR shareholder proposals that call for non-binding shareholder
ratification of the compensation of the Named Executive Officers and the
accompanying narrative disclosure of material factors provided to understand the
Summary Compensation Table.
GOLDEN COFFINS/EXECUTIVE DEATH BENEFITS
Generally vote FOR proposals calling on companies to adopt a policy of obtaining
shareholder approval for any future agreements and corporate policies that could
oblige the company to make payments or awards following the death of a senior
executive in the form of unearned salary or bonuses, accelerated vesting or the
continuation in force of unvested equity grants, perquisites and other payments
or awards made in lieu of compensation. This would not apply to any benefit
programs or equity plan proposals for which the broad-based employee population
is eligible.
SHARE BUYBACK HOLDING PERIODS
Generally vote AGAINST shareholder proposals prohibiting executives from selling
shares of company stock during periods in which the company has announced that
it may or will be repurchasing shares of its stock. Vote FOR the proposal when
there is a pattern of abuse by executives exercising options or selling shares
during periods of share buybacks.
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STOCK OWNERSHIP OR HOLDING PERIOD GUIDELINES
Generally vote AGAINST shareholder proposals that mandate a minimum amount of
stock that directors must own in order to qualify as a director or to remain on
the board. While RMG favors stock ownership on the part of directors, the
company should determine the appropriate ownership requirement.
Vote on a CASE-BY-CASE on shareholder proposals asking companies to adopt
policies requiring Named Executive Officers to retain 75% of the shares acquired
through compensation plans while employed and/or for two years following the
termination of their employment, and to report to shareholders regarding this
policy. The following factors will be taken into account:
- Whether the company has any holding period, retention ratio, or
officer ownership requirements in place. These should consist of:
- Rigorous stock ownership guidelines, or
- A holding period requirement coupled with a significant long-term
ownership requirement, or
- A meaningful retention ratio,
- Actual officer stock ownership and the degree to which it meets or
exceeds the proponent's suggested holding period/retention ratio or
the company's own stock ownership or retention requirements.
- Problematic pay practices, current and past, which may promote a
short-term versus a long-term focus.
TAX GROSS-UP PROPOSALS
Generally vote FOR proposals asking companies to adopt a policy of not providing
tax gross-up payments to executives, except where gross-ups are provided
pursuant to a plan, policy, or arrangement applicable to management employees of
the company, such as a relocation or expatriate tax equalization policy.
9. Corporate Social Responsibility (CSR) Issues
OVERALL APPROACH
When evaluating social and environmental shareholder proposals, RMG considers
the following factors:
- Whether adoption of the proposal is likely to enhance or protect
shareholder value;
- Whether the information requested concerns business issues that relate
to a meaningful percentage of the company's business as measured by
sales, assets, and earnings;
- The degree to which the company's stated position on the issues raised
in the proposal could affect its reputation or sales, or leave it
vulnerable to a boycott or selective purchasing;
- Whether the issues presented are more appropriately/effectively dealt
with through governmental or company-specific action;
- Whether the company has already responded in some appropriate manner
to the request embodied in the proposal;
- Whether the company's analysis and voting recommendation to
shareholders are persuasive;
- What other companies have done in response to the issue addressed in
the proposal;
- Whether the proposal itself is well framed and the cost of preparing
the report is reasonable;
- Whether implementation of the proposal's request would achieve the
proposal's objectives;
- Whether the subject of the proposal is best left to the discretion of
the board;
- Whether the requested information is available to shareholders either
from the company or from a publicly available source; and
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- Whether providing this information would reveal proprietary or
confidential information that would place the company at a competitive
disadvantage.
GENETICALLY MODIFIED INGREDIENTS
Generally vote AGAINST proposals asking suppliers, genetic research companies,
restaurants and food retail companies to voluntarily label genetically
engineered (GE) ingredients in their products and/or eliminate GE ingredients.
The cost of labeling and/or phasing out the use of GE ingredients may not be
commensurate with the benefits to shareholders and is an issue better left to
regulators.
Vote CASE-BY-CASE on proposals asking for a report on the feasibility of
labeling products containing GE ingredients taking into account:
- The company's business and the proportion of it affected by the
resolution;
- The quality of the company's disclosure on GE product labeling,
related voluntary initiatives, and how this disclosure compares with
industry peer disclosure; and
- Company's current disclosure on the feasibility of GE product
labeling, including information on the related costs.
Generally vote AGAINST proposals seeking a report on the social, health, and
environmental effects of genetically modified organisms (GMOs). Studies of this
sort are better undertaken by regulators and the scientific community.
Generally vote AGAINST proposals to completely phase out GE ingredients from the
company's products or proposals asking for reports outlining the steps necessary
to eliminate GE ingredients from the company's products. Such resolutions
presuppose that there are proven health risks to GE ingredients (an issue better
left to regulators) that may outweigh the economic benefits derived from
biotechnology.
PHARMACEUTICAL PRICING, ACCESS TO MEDICINES, AND PRODUCT REIMPORTATION
Generally vote AGAINST proposals requesting that companies implement specific
price restraints on pharmaceutical products unless the company fails to adhere
to legislative guidelines or industry norms in its product pricing.
Vote CASE-BY-CASE on proposals requesting that the company report on their
product pricing policies or their access to medicine policies, considering:
- The nature of the company's business and the potential for
reputational and market risk exposure;
- The existing disclosure of relevant policies;
- Deviation from established industry norms;
- The company's existing, relevant initiatives to provide research
and/or products to disadvantaged consumers;
- Whether the proposal focuses on specific products or geographic
regions; and
- The potential cost and scope of the requested report.
Generally vote FOR proposals requesting that companies report on the financial
and legal impact of their prescription drug reimportation policies unless such
information is already publicly disclosed.
Generally vote AGAINST proposals requesting that companies adopt specific
policies to encourage or constrain prescription drug reimportation. Such matters
are more appropriately the province of legislative activity and may place the
company at a competitive disadvantage relative to its peers.
GENDER IDENTITY, SEXUAL ORIENTATION, AND DOMESTIC PARTNER BENEFITS
Generally vote FOR proposals seeking to amend a company's EEO statement or
diversity policies to prohibit discrimination based on sexual orientation and/or
gender identity, unless the change would result in excessive costs for the
company.
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Generally vote AGAINST proposals to extend company benefits to, or eliminate
benefits from domestic partners. Decisions regarding benefits should be left to
the discretion of the company.
CLIMATE CHANGE
Generally vote FOR resolutions requesting that a company disclose information on
the impact of climate change on the company's operations and investments
considering whether:
- The company already provides current, publicly-available information
on the impacts that climate change may have on the company as well as
associated company policies and procedures to address related risks
and/or opportunities;
- The company's level of disclosure is at least comparable to that of
industry peers; and
- There are no significant, controversies, fines, penalties, or
litigation associated with the company's environmental performance.
LOBBYING EXPENDITURES/INITIATIVES
Vote CASE-BY-CASE on proposals requesting information on a company's lobbying
initiatives, considering:
- Significant controversies, fines, or litigation surrounding a
company's public policy activities,
- The company's current level of disclosure on lobbying strategy, and
- The impact that the policy issue may have on the company's business
operations.
POLITICAL CONTRIBUTIONS AND TRADE ASSOCIATION SPENDING
Generally vote AGAINST proposals asking the company to affirm political
nonpartisanship in the workplace so long as:
- There are no recent, significant controversies, fines or litigation
regarding the company's political contributions or trade association
spending; and
- The company has procedures in place to ensure that employee
contributions to company-sponsored political action committees (PACs)
are strictly voluntary and prohibits coercion.
Vote AGAINST proposals to publish in newspapers and public media the company's
political contributions. Such publications could present significant cost to the
company without providing commensurate value to shareholders.
Vote CASE-BY-CASE on proposals to improve the disclosure of a company's
political contributions and trade association spending, considering:
- Recent significant controversy or litigation related to the company's
political contributions or governmental affairs; and
- The public availability of a company policy on political contributions
and trade association spending including information on the types of
organizations supported, the business rationale for supporting these
organizations, and the oversight and compliance procedures related to
such expenditures of corporate assets.
Vote AGAINST proposals barring the company from making political contributions.
Businesses are affected by legislation at the federal, state, and local level
and barring political contributions can put the company at a competitive
disadvantage.
Vote AGAINST proposals asking for a list of company executives, directors,
consultants, legal counsels, lobbyists, or investment bankers that have prior
government service and whether such service had a bearing on the business of the
company. Such a list would be burdensome to prepare without providing any
meaningful information to shareholders.
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LABOR AND HUMAN RIGHTS STANDARDS
Generally vote FOR proposals requesting a report on company or company supplier
labor and/or human rights standards and policies unless such information is
already publicly disclosed.
Vote CASE-BY-CASE on proposals to implement company or company supplier labor
and/or human rights standards and policies, considering:
- The degree to which existing relevant policies and practices are
disclosed;
- Whether or not existing relevant policies are consistent with
internationally recognized standards;
- Whether company facilities and those of its suppliers are monitored
and how;
- Company participation in fair labor organizations or other
internationally recognized human rights initiatives;
- Scope and nature of business conducted in markets known to have higher
risk of workplace labor/human rights abuse;
- Recent, significant company controversies, fines, or litigation
regarding human rights at the company or its suppliers;
- The scope of the request; and
- Deviation from industry sector peer company standards and practices.
SUSTAINABILITY REPORTING
Generally vote FOR proposals requesting the company to report on its policies,
initiatives, and oversight mechanisms related to social, economic, and
environmental sustainability, unless:
- The company already discloses similar information through existing
reports or policies such as an Environment, Health, and Safety (EHS)
report; a comprehensive Code of Corporate Conduct; and/or a Diversity
Report; or
- The company has formally committed to the implementation of a
reporting program based on Global Reporting Initiative (GRI)
guidelines or a similar standard within a specified time frame
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ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
(A)(1) IDENTIFICATION OF PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBERS AND
DESCRIPTION OF ROLE OF PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBERS
Information provided as of January 8, 2010.
Brookfield Investment Management Inc. ("Brookfield") (formerly Hyperion
Brookfield Asset Management, Inc.), serves as the Registrant's investment
sub-advisor and is an SEC-registered investment advisor specializing in core
fixed income, high yield, structured products (Mortgage-backed securities
("MBS") including Commercial MBS, Residential MBS and Asset-Backed Securities
("ABS")) as well as global Real Estate Investment Trusts and listed
infrastructure securities. Headquartered in New York, the firm has approximately
$24 billion of assets under management as of October 31, 2009. Brookfield
Investment Management is a subsidiary of Brookfield Asset Management Inc., a
global asset manager focused on property, power and other infrastructure assets
with approximately $90 billion of assets under management as of September 30,
2009. On October 1, 2009, Hyperion Brookfield Asset Management, Inc. and
Brookfield Redding LLC, both subsidiaries of Brookfield Asset Management Inc.,
announced the completion of their integration. The combined registered
investment advisor is now known as Brookfield Investment Management Inc.
("Brookfield"). Dana E. Erikson and Anthony Breaks are portfolio managers for
the Registrant.
DANA E. ERIKSON, CFA, MANAGING DIRECTOR
Mr. Erikson, Senior Portfolio Manager and the co-Head of the Brookfield
High Yield Team, is responsible for Brookfield's corporate high yield and
leveraged loan exposures, the establishment of portfolio objectives and
strategies. Mr. Erikson is a member of Brookfield's Investment Committee.
Mr. Erikson has over 21 years of investment experience. Prior to joining
Brookfield in September 2006, he was with Evergreen Investments or one of its
predecessor firms since 1996. He was a senior portfolio manager and the Head of
the High Yield team. Prior to that, he was the Head of High Yield Research.
Prior to Evergreen, Mr. Erikson was an Associate Portfolio Manager for Prospect
Street Investment Management Company. Additionally, he was an Analyst with the
Kellett Group and a Research Assistant with Robert R. Nathan Associates.
Mr. Erikson received a BA in Economics from Brown University and an MBA,
with honors, from Northeastern University. He is a member of the Boston Security
Analysts Society.
ANTHONY BREAKS, CFA, DIRECTOR
Mr. Breaks is responsible for portfolio management of structured products
and for executing structured product financings for Brookfield and its partners.
Mr. Breaks is also head of Brookfield's Short Term Investments and Financing
business.
Mr. Breaks joined Brookfield in September 2005 from Brookfield Asset
Management (formerly known as Brascan), where he worked since 2002. At Brascan
he was responsible for portfolio investments and credit analysis for a
reinsurance affiliate, execution and management of a synthetic CDO, and
development of insurance related investment products. Prior to joining Brascan,
Mr. Breaks was a Director at Liberty Hampshire since 2000 and was responsible
for structuring, restructuring and executing several CDOs, as well as ongoing
monitoring and credit analysis for the CDO assets. Mr. Breaks began his career
at Merrill Lynch where he worked in trading and structuring capacities in CDOs,
adjustable rate mortgages and medium-term notes.
Mr. Breaks earned a BS in Electrical Engineering from the Massachusetts
Institute of Technology.
(A)(2) OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBER
AND POTENTIAL CONFLICTS OF INTEREST
Information provided as of October 31, 2009.
# of Accounts Total Assets
Total Managed for for which
Name of Portfolio # of which Advisory Advisory Fee
Manager or Accounts Total Fee is Based on is Based on
Team Member Type of Accounts* Managed Assets Performance Performance
----------------- --------------------------------- -------- ------ --------------- ------------
1. Dana Erikson Registered Investment Companies: 11 $325M 0 $0
Other Pooled Investment Vehicles: 0 $ 0 0 $0
Other Accounts: 2 $100M 0 $0
2. Anthony Breaks Registered Investment Companies: 6 $299M 0 $0
Other Pooled Investment Vehicles: 0 $ 0 0 $0
Other Accounts: 5 $569M 0 $0
POTENTIAL CONFLICTS OF INTERESTS
Potential conflicts of interest may arise when a portfolio manager of the
Registrant has day-to-day management responsibilities with respect to one or
more other funds or other accounts, as is the case for the portfolio managers of
the Registrant.
These potential conflicts include:
ALLOCATION OF LIMITED TIME AND ATTENTION. A portfolio manager who is
responsible for managing multiple funds and/or accounts may devote unequal time
and attention to the management of those funds and/or accounts. As a result, the
portfolio manager may not be able to formulate as complete a strategy or
identify equally attractive investment opportunities for each of those accounts
as the case may be if he or she were to devote substantially more attention to
the management of a single fund. The effects of this potential conflict may be
more pronounced where funds and/or accounts overseen by a particular portfolio
manager have different investment strategies.
ALLOCATION OF LIMITED INVESTMENT OPPORTUNITIES. If a portfolio manager
identifies a limited investment opportunity that may be suitable for multiple
funds and/or accounts, the opportunity may be allocated among these several
funds or accounts, which may limit a fund's ability to take full advantage of
the investment opportunity.
PURSUIT OF DIFFERING STRATEGIES. At times, a portfolio manager may
determine that an investment opportunity may be appropriate for only some of the
funds and/or accounts for which he or she exercises investment responsibility,
or may decide that certain of the funds and/or accounts should take differing
positions with respect to a particular security. In these cases, the portfolio
manager may place separate transactions for one or more funds or accounts which
may affect the market price of the security or the execution of the transaction,
or both, to the detriment or benefit of one or more other funds and/or accounts.
VARIATION IN COMPENSATION. A conflict of interest may arise where the
financial or other benefits available to the portfolio manager differ among the
funds and/or accounts that he or she manages. If the structure of Brookfield's
management fee and/or the portfolio manager's compensation differs among funds
and/or accounts (such as where certain funds or accounts pay higher management
fees or performance-based management fees), the portfolio manager might be
motivated to help certain funds and/or accounts over others. The portfolio
manager might be motivated to favor funds and/or accounts in which he or she has
an interest or in which Brookfield and/or its affiliates have interests.
Similarly, the desire to maintain or raise assets under management or to enhance
the portfolio manager's performance record or to derive other rewards, financial
or otherwise, could influence the portfolio manager to lend preferential
treatment to those funds and/or accounts that could most significantly benefit
the portfolio manager.
RELATED BUSINESS OPPORTUNITIES. Brookfield or its affiliates may provide
more services (such as distribution or recordkeeping) for some types of funds or
accounts than for others. In such cases, a portfolio manager may benefit, either
directly or indirectly, by devoting disproportionate attention to the
management of fund and/or accounts that provide greater overall returns to the
investment manager and its affiliates.
Brookfield has adopted compliance policies and procedures that are designed
to address the various conflicts of interest that may arise for Brookfield and
the individuals that it employs. For example, Brookfield seeks to minimize the
effects of competing interests for the time and attention of portfolio managers
by assigning portfolio managers to manage funds and accounts that share a
similar investment style. Brookfield has also adopted trade allocation
procedures that are designed to facilitate the fair allocation of limited
investment opportunities among multiple funds and accounts. There is, however,
no guarantee that such policies and procedures will be able to detect and
prevent every situation in which an actual or potential conflict may appear.
(A)(3) COMPENSATION STRUCTURE OF PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBERS
PORTFOLIO MANAGER COMPENSATION
Information provided as of October 31, 2009.
The Registrant's portfolio managers are compensated by Brookfield. The
compensation structure of Brookfield's portfolio managers and other investment
professionals has three primary components: (1) a base salary, (2) an annual
cash bonus, and (3) if applicable, long-term stock-based compensation consisting
generally of restricted stock units of Brookfield's indirect parent company,
Brookfield Asset Management, Inc. The portfolio managers also receive certain
retirement, insurance and other benefits that are broadly available to all of
Brookfield's employees. Compensation of the portfolio managers is reviewed on an
annual basis by senior management.
Brookfield compensates its portfolio managers based primarily on the scale and
complexity of their portfolio responsibilities, the total return performance of
funds and accounts managed by the portfolio manager on an absolute basis and
versus appropriate peer groups of similar size and strategy, as well as the
management skills displayed in managing their subordinates and the teamwork
displayed in working with other members of the firm. Since the portfolio
managers are responsible for multiple funds and accounts, investment performance
is evaluated on an aggregate basis almost equally weighted among performance,
management and teamwork. Base compensation for Brookfield's portfolio managers
varies in line with the portfolio manager's seniority and position. The
compensation of portfolio managers with other job responsibilities (such as
acting as an executive officer of Brookfield and supervising various
departments) will include consideration of the scope of such responsibilities
and the portfolio manager's performance in meeting them. Brookfield seeks to
compensate portfolio managers commensurate with their responsibilities and
performance, and competitive with other firms within the investment management
industry. Salaries, bonuses and stock-based compensation are also influenced by
the operating performance of Brookfield and its indirect parent. While the
salaries of Brookfield's portfolio managers are comparatively fixed, cash
bonuses and stock-based compensation may fluctuate significantly from year to
year, based on changes in the portfolio manager's performance and other factors
as described herein.
(A)(4) DISCLOSURE OF SECURITIES OWNERSHIP
Information provided as of October 31, 2009.
Dollar Range of Fund
Name Shares Beneficially Owned
---- -------------------------
Dana Erikson $0
Anthony Breaks $0
(B) Not applicable.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR
229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)),
or this Item.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers,
or persons performing similar functions, have concluded that the
registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the
"1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date within
90 days of the filing date of the report that includes the disclosure
required by this paragraph, based on their evaluation of these
controls and procedures required by Rule 30a-3(b) under the 1940 Act
(17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the
Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or
240.15d-15(b)).
(b) There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act
(17 CFR 270.30a-3(d)) that occurred during the registrant's second
fiscal quarter of the period covered by this report that has
materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Code of ethics, or any amendment thereto, that is the subject of
disclosure required by Item 2 is attached hereto.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and
Section 906 of the Sarbanes- Oxley Act of 2002 are attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) First Trust Strategic High Income Fund
By (Signature and Title)* /s/ James A. Bowen
------------------------------------------------------
James A. Bowen, Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
Date December 23, 2009
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /s/ James A. Bowen
------------------------------------------------------
James A. Bowen, Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
Date December 23, 2009
By (Signature and Title)* /s/ Mark R. Bradley
------------------------------------------------------
Mark R. Bradley, Treasurer, Controller, Chief
Financial Officer and Chief Accounting Officer
(principal financial officer)
Date December 23, 2009
* Print the name and title of each signing officer under his or her
signature.