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: April 30, 2010
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
SEMI-ANNUAL REPORT
FOR THE SIX MONTHS ENDED
APRIL 30, 2010
(GRAPHIC)
(FIRST TRUST LOGO) BROOKFIELD
TABLE OF CONTENTS
FIRST TRUST STRATEGIC HIGH INCOME FUND (FHI)
SEMI-ANNUAL REPORT
APRIL 30, 2010
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
Additional Information .................................................... 24
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)
SEMI-ANNUAL REPORT
APRIL 30, 2010
Dear Shareholders:
I am pleased to present you with the semi-annual report for your investment in
First Trust Strategic High Income Fund (the "Fund").
First Trust Advisors L.P. ("First Trust") has always believed that staying
invested in quality products and having a long-term horizon can help investors
reach their financial goals. The past eighteen months have been challenging, but
successful investors understand that the success they have achieved is typically
because of their long-term investment perspective through all kinds of markets.
The report you hold contains detailed information about your investment; a
portfolio commentary from the Fund's management team that provides a recap of
the period; a performance analysis and a market and Fund outlook. Additionally,
you will find the Fund's financial statements for the six month period covered
by this report. I encourage you to read this document and discuss it with your
financial advisor.
First Trust offers a variety of products that can fit many financial plans to
help those investors who are seeking long-term financial success. You may want
to talk to your advisor about the other investments we offer that might fit your
financial plan.
At First Trust we continue to be committed to making available up-to-date
information about your investments so you and your financial advisor have
current information on your portfolio. We 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 APRIL 30, 2010 (UNAUDITED)
FUND STATISTICS
Symbol on New York Stock Exchange FHI
Common Share Price $ 3.32
Common Share Net Asset Value ("NAV") $ 3.52
Premium (Discount) to NAV (5.68)%
Net Assets Applicable to Common Shares $32,212,945
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) 9.04%
Current Distribution Rate on NAV (2) 8.52%
COMMON SHARE PRICE & NAV (WEEKLY CLOSING PRICE)
(PERFORMANCE GRAPH)
Common Share Price NAV
------------ ----- ----
4/30/09 4.66 3.7
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
10/30/09 2.63 2.92
11/6/09 2.6 2.89
11/13/09 2.61 2.96
11/20/09 2.73 3.02
11/27/09 2.78 3.16
12/4/09 2.84 3.15
12/11/09 2.87 3.16
12/18/09 2.91 3.19
12/24/09 2.9 3.18
12/31/09 2.93 3.18
1/8/10 2.89 3.2
1/15/10 3.03 3.37
1/22/10 3.05 3.37
1/29/10 3.1 3.4
2/5/10 3 3.38
2/12/10 3.02 3.35
2/19/10 3.04 3.38
2/26/10 3.07 3.4
3/5/10 3.08 3.34
3/12/10 3.11 3.38
3/19/10 3.17 3.4
3/26/10 3.2 3.41
4/1/10 3.29 3.39
4/9/10 3.26 3.42
4/16/10 3.25 3.49
4/23/10 3.27 3.5
4/30/10 3.32 3.52
PERFORMANCE
Average Annual
Total Return
6 Months Ended 1 Year Ended Inception (7/26/2005)
4/30/2010 4/30/2010 to 4/30/2010
-------------- ------------ ---------------------
Fund Performance (3)
NAV 26.63% 9.28% -18.22%
Market Value 32.60% -18.16% -20.00%
Index Performance
Barclays Capital Ba U.S. High Yield Index 10.33% 32.59% 7.84%
% OF TOTAL
ASSET CLASSIFICATION INVESTMENTS
-------------------- -----------
Corporate Bonds and Notes 59.8%
U.S. Government Agency
Mortgage-Backed Securities 20.7
Manufactured Housing Loans 7.9
Commercial Mortgage-Backed
Securities 6.3
Residential Mortgage-Backed
Securities 4.1
Franchise Loans 0.5
Senior Floating-Rate Notes 0.5
Collateralized Debt Obligations 0.1
Equity 0.1
-----
Total 100.0%
=====
% OF TOTAL
FIXED-INCOME
CREDIT QUALITY(4) INVESTMENTS
----------------- ------------
AAA 22.9%
A 0.5
BBB- 1.0
BB+ 2.3
BB 5.8
BB- 7.7
B+ 7.4
B 12.0
B- 14.4
CCC+ 10.0
CCC 3.6
CCC- 2.4
CC 1.3
C 6.0
D 2.7
-----
Total 100.0%
=====
(1) Most recent distribution paid or declared through 4/30/2010. 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 4/30/2010. Subject to
change in the future.
(3) Total return is based on the combination of reinvested dividend, capital
gain and return of capital distributions, if any, at prices obtained by the
Dividend Reinvestment Plan, and changes in NAV per share for net asset
value returns and changes in Common Share price for market value returns.
Total returns do not reflect sales load. Past performance is not indicative
of future results.
(4) 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.
Brookfield Investment Management Inc. ("Brookfield") 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 securities and listed infrastructure securities. Headquartered in New
York, the firm has approximately $24 billion of assets under management as of
March 31, 2010. Brookfield is a subsidiary of Brookfield Asset Management Inc.,
a global asset manager focused on property, power and other infrastructure
assets with approximately $100 billion of assets under management as of March
31, 2010.
PORTFOLIO MANAGEMENT TEAM
DANA E. ERIKSON, CFA,
MANAGING DIRECTOR
Mr. Erikson, Senior Portfolio Manager and the 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 has over
20 years of investment experience. Prior to joining Brookfield, 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 (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 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. 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"). 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 high yield market generated strong returns over the six months covered by
this report. Yield spreads on the broad market1 fell from 763 basis points at
October 31, 2009, to 555 basis points at April 30, 2010, as investor confidence
in the financial markets and the economy strengthened.
During the last six months, the high yield new issue market gradually opened as
capital markets were more accepting of risk. By the first quarter of 2010, the
high yield market was setting records for issuance, with more than $60 billion
of bonds issued during the three-month period. Many bonds came with security and
were used to refinance bank debt which was issued during 2006-2007 to finance
leveraged buyouts. One of the market's primary worries is the "mountain of
maturities" many companies face, between 2013-2015, as bonds and loans issued in
the 2006-2007 timeframe come due. While some commentators view this as a
significant risk to future returns, we view it as a "wall of worry" which may
fuel a further rally in high yield as companies successfully address these
concerns. We believe the record amount of new issuance is evidence that
corporate management teams and their equity sponsors are actively looking to
manage their capital structures. We view the market to be in a virtuous cycle
where new issuance, rather than pushing the market lower, serves to move it
higher because it inherently reduces overall credit risk by extending
maturities.
----------
(1) Performance numbers for the Merrill Lynch U.S. High Yield Master II Index,
H0A0 retrieved from Bloomberg
Page 3
PORTFOLIO COMMENTARY (CONTINUED)
The level of defaults peaked in late 2009 and fell dramatically over the period
to April 30, 2010. The widely watched 12-month default rate ended the 2009
calendar year at 12.7%(2) and dropped more than half to 4.04% by the end of
April(3). Many strategists reduced their forecast default rate for 2010, and we
expect it to be around 2% for the 2010 calendar year, representing continued
improvement in credit quality.
Investor appetite for risk remained robust during the last six months, with
bonds rated CCC returning 18.9% compared with the overall market, which was up
11.6%. Surprisingly, upper-tier BB issues rose 10.4%, which may reflect good
performance in the fallen Financials sector, many of which retain BB ratings.
Bonds of companies in the Financial Services and Real Estate industries
performed well, as they recovered from poor performance in 2008. The Automotive
sector also outperformed as companies restructured and investors grew more
confident that the worst was over for the industry. The Technology sector
outperformed, as many companies in the industry began to recover in line with
the general economic recovery.
Industries which underperformed were generally considered to be defensive in
nature, including Telecommunications, Healthcare and Utilities. In 2008, these
sectors had been preferred amid a weaker environment. In general, performance of
an industry reflected the average credit quality of that industry; with
outperforming industries being lower quality and/or more beaten down in the 2008
downturn, and the underperforming industries representing more defensive, better
quality issues. (Source: Factset, Merrill Lynch.)
Supply/demand remained positive as 2010 commenced despite a record supply of new
issues. Credit Suisse estimates $1.2 billion of money flowed into the market
during the first quarter of 2010, an extension of the $22.9 billion that flowed
in during 2009(4). The steady flow of money into high yield retail mutual funds
put pressure on managers to deploy it quickly, which gave a boost to the new
issue calendar.
We continue to maintain our positive view of the high yield market despite the
hefty returns over the past 12 months. While yield spreads have narrowed nearer
to the long-term average, lower defaults, improving credit conditions, and the
gradual removal of the maturity mountain should protect investors from a market
correction. We believe we are on the right side of the credit cycle for
corporate credit and anticipate the yield advantage of high yield will prove
attractive in a low-yield world.
We believe that, on balance, the U.S. economy will surprise on the upside,
eventually overcoming residual investor fears of continued stagnation. We are
encouraged by the record pace of credit refinancing, and are beginning to see
signs of renewed IPO activity, both of which will serve to reduce credit risk
going forward.
In our opinion, confidence may receive a second boost should we see a return of
merger and acquisition ("M&A") activity in 2010 after a two-year hiatus. M&A
tends to be good for high yield investors on two fronts; first, it gives
companies a venue for selling assets and using cash to pay debt; and second,
bond investors benefit from a change-of-control put in the event their debtor is
taken over.
COMMERCIAL MBS/RESIDENTIAL MBS
Structured product securities, including MBS and CMBS, rallied over the first
quarter of 2010. Investors continued to add risk, with equities ending the
quarter higher and most fixed-income sectors experiencing price increases.
Nevertheless, volatility remains a risk amid government intervention and the
uncertain resolution of troubled real estate assets. Importantly, looking ahead,
overall loss projections for structured product securities for 2010 are improved
compared to 2009.
From a macro-economic perspective, the massive U.S. federal stimulus over the
past 12 months produced a number of measurable positive results. A steep yield
curve and renewed access to capital markets substantially improved profitability
of large U.S. banks in 2009, and further signs of strengthening economic
indicators suggested the U.S. economic recovery is sustainable.
The ongoing resolution of troubled assets over the coming 12 months will play an
important role in the economic recovery and investor sentiment. A level of
uncertainty continues to surround the commercial real estate sector, while the
residential housing market will be influenced by the significant shadow
inventory of unsold homes, as well as the continued impact of government policy
on loan servicing. From a consumer perspective, the rate of improvements in the
job market will be critical as well as straightforward credit provisions for
consumers, which currently remain limited.
We believe delinquency levels are likely to continue to increase in 2010, most
notably for employment-sensitive sectors, including prime MBS, CMBS, auto ABS
and credit card ABS. Additional government regulation is also anticipated as the
new issue securitization markets redevelop. Additional regulation is likely to
affect lending standards, which can either be a positive or a negative, largely
depending on the extent of the regulation.
----------
(2) JMerrill Lynch, "Situation Room: High Yield in 2010: Year Ahead Outlook,"
December 28, 2009, p. 4
(3) JP Morgan, High Yield Market Monitor, April 1, 2010, p. 14
(4) Credit Suisse, "Leveraged Finance Strategy Update," April 6, 2010, p. 10
Page 4
PORTFOLIO COMMENTARY (CONTINUED)
Non-Agency MBS and CMBS were among one of a few issuance markets where less than
a handful of deals were issued in 2009. In early 2010, the new issue market
across MBS sectors returned to activity, bringing the first CMBS conduit
securitization and the first prime RMBS securitization. While investors watched
for the impact of the end of government programs, such as TALF (Term
Asset-Backed Loan Facility), designed to aid liquidity in the securitized
markets, and the Agency MBS purchase program, designed to retain liquidity for
Agency MBS, there was little adverse impact noted as these programs closed.
We anticipate that the yield curve will remain steep over 2010 and that new
supply of issues will remain low. As such, we believe that markets with more
excess yield will benefit. Once excess yield has been compressed,
differentiation among collateral, structure and servicer will provide a great
source of relative value.
PERFORMANCE ANALYSIS
For the six months ended April 30, 2010, the Fund's net asset value ("NAV")
increased by 20.5%, resulting in an NAV total return of 26.63%. For the period,
the Fund traded from a discount to NAV of 9.93% to a discount to NAV of 5.68%,
resulting in a market value total return5 of 32.60%. The Fund benefitted from
increased exposure to corporate bonds during the period. The bonds of Qwest
Communications, Paetec Holdings and United Rentals all contributed strongly to
performance as each benefitted from increasing investor confidence in economic
recovery, and in the ability of each company to manage its balance sheet. The
Fund also benefitted from the recovery in the structured products market.
Signature 5 Class C, a Collateralized Loan Obligation ("CLO") note that has been
deferring coupons and ACLB 1999-2 D, a subordinate franchise-backed note, were
both sold at significant gains to where they were valued at the start of the six
months covered by this report. In the case of Signature 5, buyers were
dramatically more willing to price in the future deferred cash flows. This was
the case for many of the Fund's structured products holdings. As more
traditional sectors rallied, investors were more willing to accept complexity
and reductions in liquidity for a chance to invest in an asset class that still
offers high returns.
Detractors of performance included select structured products holdings such as
MESC 13 M2, an asset-backed security secured by manufactured housing and ACLB
1998-2 B, a franchise-backed security, both of which traded poorly in the
secondary market.
The total return for the Fund's benchmark, the Barclays Capital Ba U.S. High
Yield Index, was 10.33% for the six months ended April 30, 2010. While the
benchmark contains mostly corporate debt, the Fund had significant exposure to
structured finance and mortgage-related securities during the period. As
investor risk appetite continued to return to the market during the period
covered by this report, corporate credit spreads tightened dramatically
resulting in strong performance by the Fund's benchmark. Lower quality names
performed the best, as evidenced by the 15.45% 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 appreciation. 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 distressed 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 CLOs, 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 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 period, the Fund's portfolio had increased exposure to
corporate bonds (to approximately 60%). We are now within the target range for
corporate exposure for the Fund. While we will continue to attempt to reduce
exposure to structured product holding, we will look to invest the sale proceeds
across the fixed-income markets where we find value and income stability.
----------
(5) Total return is based on the combination of reinvested dividend, capital
gain and return of capital distributions, if any, at prices obtained by the
Dividend Reinvestment Plan and changes in NAV per share for net asset value
returns and changes in Common Share price for market value returns. Total
returns do not reflect sales load. Past performance is not indicative of
future results.
Page 5
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a)
APRIL 30, 2010 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
------------- ---------------------------------------------------------- ------ --------- -------------
ASSET-BACKED SECURITIES - 14.1%
Atherton Franchisee Loan Funding
$ 209,456 Series 1999-A, Class A2 (b) ........................... 7.23% 03/15/21 $ 188,758
Bombardier Capital Mortgage Securitization Corp.
316,834 Series 1999-B, Class A1B .............................. 6.61% 09/15/10 188,410
811,180 Series 1999-B, Class A3 ............................... 7.18% 12/15/15 512,480
Conseco Finance Securitizations Corp.
3,039,905 Series 2000-6, Class M1 ............................... 7.72% 09/01/31 1,029,593
Falcon Franchise Loan Trust
4,905,000 Series 2000-1, Class E (b) (c) ........................ 6.50% 04/05/16 12,262
4,231,000 Series 2003-1, Class E (c) (d) ........................ 6.00% 01/05/25 10,577
Green Tree Financial Corp.
258,614 Series 1997-4, Class B1 ............................... 7.23% 02/15/29 26,203
903,008 Series 1998-4, Class M1 ............................... 6.83% 04/01/30 456,009
4,622,414 Series 1999-3, Class M1 ............................... 6.96% 02/01/31 882,276
GSAMP Trust
440,199 Series 2004-AR2, Class B4 (d) ......................... 5.00% 08/25/34 13,781
976,588 Series 2006-S3, Class A2 (e) .......................... 5.77% 05/25/36 71,958
854,581 Series 2006-S5, Class A1 (f) .......................... 0.35% 09/25/36 28,083
Independence III CDO, Ltd.
5,000,000 Series 3A, Class C1 (c) (d) (f) ....................... 2.79% 10/03/37 50
Indymac Residential Asset Backed Trust
366,731 Series 2005-B, Class M10 (f) .......................... 3.76% 08/25/35 1,040
Long Beach Mortgage Loan Trust
1,920,999 Series 2006-A, Class A2 ............................... 5.55% 05/25/36 128,244
Merit Securities Corp.
544,840 Series 13, Class B1 (d) ............................... 7.95% 12/28/33 3,213
Park Place Securities, Inc.
1,856,435 Series 2004-WCW1, Class M8 (f) ........................ 3.76% 09/25/34 29,317
1,301,976 Series 2004-WCW2, Class M10 (d) (f) ................... 3.01% 10/25/34 53,027
Structured Asset Securities Corp.
850,879 Series 2006-GEL1, Class A1 (b) (f) .................... 0.40% 11/25/35 847,374
Summit CBO I, Ltd.
4,159,437 Series 1A, Class B (d) (f) ............................ 1.49% 05/23/11 41,594
-------------
TOTAL ASSET-BACKED SECURITIES
(Cost $3,882,778) ........................................ 4,524,249
-------------
COLLATERALIZED MORTGAGE OBLIGATIONS - 1.4%
Bear Stearns Alt-A Trust
604,830 Series 2006-8, Class 2A2 .............................. 5.09% 08/25/46 15,157
Countrywide Alternative Loan Trust
3,142,911 Series 2005-56, Class M4 (f) .......................... 1.18% 11/25/35 44,454
Deutsche Alt-A Securities, Inc. Mortgage Loan Trust
3,691,244 Series 2007-OA4, Class M10 (f) ........................ 3.26% 08/25/47 50,681
HarborView Mortgage Loan Trust
3,777,718 Series 2005-9, Class B10 (f) .......................... 2.01% 06/20/35 338,130
-------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS
(Cost $1,535,825) ........................................ 448,422
-------------
See Notes to Financial Statements
Page 6
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
APRIL 30, 2010 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
------------- ---------------------------------------------------------- ------ --------- -------------
COMMERCIAL MORTGAGE-BACKED SECURITIES - 7.7%
$ 688,031 Banc of America Commercial Mortgage Inc.
Series 2000-1, Class M (d) (e) ........................ 6.00% 11/15/31 $ 7
Banc of America Large Loan, Inc.
2,000,000 Series 2005-MIB1, Class L (d) (e) (f) ................. 3.25% 03/15/22 301,427
Bear Stearns Commercial Mortgage Securities
1,776,400 Series 2000-WF1, Class K (c) .......................... 6.50% 02/15/32 439,328
GE Capital Commercial Mortgage Corp.
700,000 Series 2000-1, Class G (d) ............................ 6.13% 01/15/33 346,436
GS Mortgage Securities Corp. II
6,789,251 Series 1998-C1, Class H (d) (e) ....................... 6.00% 10/18/30 399,490
LB-UBS Commercial Mortgage Trust
3,025,000 Series 2001-C7, Class Q (d) ........................... 5.87% 11/15/33 151,352
2,071,442 Series 2001-C7, Class S (d) (e) ....................... 5.87% 11/15/33 14,894
Morgan Stanley Capital I, Inc.
968,400 Series 1999-WF1, Class M (d) .......................... 5.91% 11/15/31 621,579
2,787,919 Series 2003-IQ5, Class O (d) .......................... 5.24% 04/15/38 198,484
-------------
TOTAL COMMERCIAL MORTGAGE-BACKED SECURITIES
(Cost $11,574,782) ....................................... 2,472,997
-------------
CORPORATE BONDS AND NOTES - 73.2%
AEROSPACE & DEFENSE - 2.8%
425,000 BE Aerospace, Inc. ....................................... 8.50% 07/01/18 455,813
425,000 Bombardier, Inc. (b) ..................................... 7.75% 03/15/20 453,688
-------------
909,501
-------------
AUTO COMPONENTS - 1.3%
400,000 TRW Automotive, Inc. (b) ................................. 7.25% 03/15/17 405,000
-------------
AUTOMOBILES - 1.2%
400,000 Ford Motor Co. ........................................... 6.50% 08/01/18 382,000
-------------
CHEMICALS - 2.2%
305,000 Hexion Finance Escrow LLC/Hexion Escrow
Corp. (b) ............................................. 8.88% 02/01/18 301,569
400,000 Westlake Chemical Corp. .................................. 6.63% 01/15/16 402,000
-------------
703,569
-------------
COMMERCIAL SERVICES & SUPPLIES - 5.4%
425,000 ACCO Brands Corp. (b) .................................... 10.63% 03/15/15 472,812
425,000 Deluxe Corp. ............................................. 7.38% 06/01/15 434,031
400,000 Iron Mountain, Inc. ...................................... 8.75% 07/15/18 424,500
400,000 KAR Holdings, Inc. ....................................... 10.00% 05/01/15 426,000
-------------
1,757,343
-------------
CONTAINERS & PACKAGING - 1.6%
90,000 Berry Plastics Corp. (b) ................................. 9.50% 05/15/18 89,663
400,000 Owens-Illinois, Inc. ..................................... 7.80% 05/15/18 423,000
-------------
512,663
-------------
DISTRIBUTORS - 1.6%
500,000 C&S Group Enterprises LLC (b) ............................ 8.38% 05/01/17 506,250
-------------
See Notes to Financial Statements
Page 7
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
APRIL 30, 2010 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
------------- ---------------------------------------------------------- ------ --------- -------------
CORPORATE BONDS AND NOTES - (CONTINUED)
DIVERSIFIED TELECOMMUNICATION SERVICES - 7.7%
$ 425,000 Cincinnati Bell, Inc ..................................... 8.75% 03/15/18 $ 432,437
400,000 Citizens Communications .................................. 7.13% 03/15/19 388,000
400,000 Global Crossing Ltd. (b) ................................. 12.00% 09/15/15 451,000
400,000 PAETEC Holding Corp ...................................... 9.50% 07/15/15 409,500
400,000 Qwest Corp. .............................................. 6.88% 09/15/33 386,000
425,000 Windstream Corp .......................................... 7.00% 03/15/19 402,688
-------------
2,469,625
-------------
ELECTRICAL EQUIPMENT - 0.8%
245,000 Coleman Cable, Inc. (b) .................................. 9.00% 02/15/18 251,431
-------------
ENERGY EQUIPMENT & SERVICES - 3.9%
425,000 Edgen Murray Corp. (b) ................................... 12.25% 01/15/15 420,750
400,000 Hercules Offshore LLC (b) ................................ 10.50% 10/15/17 414,000
400,000 McJunkin Red Man Corp. (b) ............................... 9.50% 12/15/16 418,500
-------------
1,253,250
-------------
FOOD & STAPLES RETAILING - 2.4%
400,000 ARAMARK Corp ............................................. 8.50% 02/01/15 412,500
400,000 Rite Aid Corp ............................................ 8.63% 03/01/15 357,000
-------------
769,500
-------------
FOOD PRODUCTS - 1.4%
425,000 B&G Foods, Inc. .......................................... 7.63% 01/15/18 437,750
-------------
GAS UTILITIES - 0.6%
175,000 Niska Gas Storage US LLC/Niska Gas
Storage Canada ULC (b) ................................ 8.88% 03/15/18 183,750
-------------
HEALTH CARE PROVIDERS & SERVICES - 1.3%
400,000 HCA, Inc ................................................. 9.25% 11/15/16 433,500
-------------
HOTELS, RESTAURANTS & LEISURE - 5.2%
400,000 AMC Entertainment, Inc. .................................. 8.75% 06/01/19 426,000
400,000 Harrah's Operating Co., Inc. ............................. 11.25% 06/01/17 438,000
425,000 MGM MIRAGE ............................................... 5.88% 02/27/14 377,187
400,000 MTR Gaming Group, Inc. ................................... 12.63% 07/15/14 422,000
-------------
1,663,187
-------------
HOUSEHOLD DURABLES - 1.3%
400,000 Jarden Corp .............................................. 7.50% 05/01/17 411,000
-------------
INDEPENDENT POWER PRODUCERS & ENERGY TRADERS - 2.6%
425,000 Dynegy Holdings, Inc. .................................... 7.75% 06/01/19 342,125
425,000 Edison Mission Energy .................................... 7.00% 05/15/17 311,844
225,000 Texas Competitive Electric Holdings Co., LLC,
Series A .............................................. 10.25% 11/01/15 169,875
-------------
823,844
-------------
IT SERVICES - 1.1%
400,000 First Data Corp. ......................................... 9.88% 09/24/15 368,000
-------------
See Notes to Financial Statements
Page 8
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
APRIL 30, 2010 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
------------- ---------------------------------------------------------- ------ --------- -------------
CORPORATE BONDS AND NOTES- (CONTINUED)
MACHINERY - 5.6%
$ 400,000 CNH America LLC .......................................... 7.25% 01/15/16 $ 419,000
400,000 Mueller Water Products, Inc. ............................ 7.38% 06/01/17 366,000
225,000 RBS Global, Inc./Rexnord LLC (b) ......................... 8.50% 05/01/18 226,688
400,000 Terex Corp. .............................................. 8.00% 11/15/17 392,000
400,000 Trimas Corp. (b) ......................................... 9.75% 12/15/17 414,500
-------------
1,818,188
-------------
MEDIA - 2.7%
425,000 CCO Holdings LLC/CCO Holdings Capital Corp. (b) .......... 8.13% 04/30/20 436,688
425,000 Mediacom LLC/Mediacom Capital Corp. (b) .................. 9.13% 08/15/19 439,875
-------------
876,563
-------------
METALS & MINING - 2.4%
155,000 AK Steel Corp. ........................................... 7.63% 05/15/20 160,425
600,000 United States Steel Corp. ................................ 7.00% 02/01/18 613,500
-------------
773,925
-------------
MULTILINE RETAIL - 1.3%
400,000 Neiman Marcus Group, Inc. ................................ 10.38% 10/15/15 423,500
-------------
OIL, GAS & CONSUMABLE FUELS - 5.8%
425,000 Arch Coal, Inc. (b) ...................................... 8.75% 08/01/16 454,750
400,000 Chesapeake Energy Corp. .................................. 6.88% 01/15/16 401,000
425,000 Crosstex Energy LP/Crosstex Energy Finance Corp. (b) ..... 8.88% 02/15/18 444,125
120,000 Linn Energy LLC/Linn Energy Finance Corp. (b) ............ 8.63% 04/15/20 125,100
425,000 Pioneer Natural Resources Co. ............................ 6.65% 03/15/17 439,765
-------------
1,864,740
-------------
PAPER & FOREST PRODUCTS - 3.3%
215,000 Appleton Papers, Inc. (b) ................................ 10.50% 06/15/15 219,300
185,000 Georgia-Pacific LLC ...................................... 7.25% 06/01/28 188,700
215,000 Georgia-Pacific LLC ...................................... 7.38% 12/01/25 216,613
400,000 Verso Paper Holdings LLC/Verso Paper, Inc. (b) ........... 11.50% 07/01/14 447,000
-------------
1,071,613
-------------
ROAD & RAIL - 1.4%
425,000 Avis Budget Car Rental LLC/Avis Budget
Finance, Inc. (b) ..................................... 9.63% 03/15/18 461,125
-------------
SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT - 0.8%
250,000 Freescale Semiconductor, Inc. (b) ........................ 9.25% 04/15/18 261,250
-------------
SPECIALTY RETAIL - 0.1%
40,000 Limited Brands, Inc. ..................................... 7.00% 05/01/20 41,000
-------------
TEXTILES, APPAREL & LUXURY GOODS - 2.7%
400,000 Easton-Bell Sports, Inc. (b) ............................ 9.75% 12/01/16 428,000
425,000 Levi Strauss & Co. ....................................... 9.75% 01/15/15 448,906
-------------
876,906
-------------
See Notes to Financial Statements
Page 9
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
APRIL 30, 2010 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
------------- ---------------------------------------------------------- ------ --------- -------------
CORPORATE BONDS AND NOTES - (CONTINUED)
TRADING COMPANIES & DISTRIBUTORS - 2.7%
$ 425,000 RSC Equipment Rental, Inc./RSC
Holdings III LLC (b) .................................. 10.25% 11/15/19 $ 445,188
400,000 United Rentals North America, Inc. ....................... 9.25% 12/15/19 430,000
-------------
875,188
-------------
TOTAL CORPORATE BONDS AND NOTES
(Cost $22,667,195) ....................................... 23,585,161
-------------
U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITIES- 25.3%
3,875,000 FannieMae, June (g) ...................................... 5.50% 30 yr. TBA 4,077,229
FannieMae-ACES
5,760,968 Series 1998-M7, Class N, IO (f) ....................... 0.43% 05/25/36 69,463
3,875,000 Government National Mortgage
Association, June (g) ................................. 5.00% 30 yr. TBA 4,016,104
-------------
TOTAL U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITIES
(Cost $8,195,004) ........................................ 8,162,796
-------------
SENIOR FLOATING-RATE NOTES - 0.6%
ENERGY EQUIPMENT & SERVICES - 0.6%
225,000 Texas Competitive Electric Holdings Co., LLC
Tranche B2 (f) ........................................ 3.80% 10/10/14 184,247
-------------
TOTAL SENIOR FLOATING-RATE NOTES
(Cost $185,906) .......................................... 184,247
-------------
STRUCTURED NOTES - 0.0%
3,750,000 Preferred Term Securities XXV, Ltd. (d) .................. (h) 06/22/37 375
-------------
TOTAL STRUCTURED NOTES
(Cost $0) ............................................... 375
-------------
SHARES DESCRIPTION VALUE
------------- ------------------------------------------------------------------------------- -------------
PREFERRED SECURITIES - 0.1%
2,000 Soloso CDO, Ltd., Series 2005-1 (d) (h) ....................................... 20,000
3,000 White Marlin CDO, Ltd., Series AI (d) (h) (i) ................................. 15,000
-------------
TOTAL PREFERRED SECURITIES
(Cost $0) ..................................................................... 35,000
-------------
TOTAL INVESTMENTS - 122.4%
(Cost $48,041,490) (j) ........................................................ 39,413,247
NET OTHER ASSETS AND LIABILITIES - (22.4%) ................................... (7,200,302)
-------------
NET ASSETS - 100.0% ........................................................... $ 32,212,945
=============
----------
(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
See Notes to Financial Statements
Page 10
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (A) - (CONTINUED)
APRIL 30, 2010 (UNAUDITED)
Investment Management Inc., the Fund's investment sub-advisor. Although
market instability can result 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
April 30, 2010, securities noted as such amounted to $10,220,396 or 31.7%
of net assets.
(c) Security missed its last interest payment.
(d) 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).
(e) Security is receiving less than the stated coupon.
(f) Floating rate security. The interest rate shown reflects the rate in effect
at April 30, 2010.
(g) Security purchased on a forward commitment basis.
(h) Zero coupon investment.
(i) The issuer is in default. Income is not being accrued.
(j) Aggregate cost for financial reporting purposes, which approximates the
aggregate cost for federal income tax purposes. As of April 30, 2010, the
aggregate gross unrealized appreciation for all securities in which there
was an excess of value over tax cost was $2,165,334 and the aggregate gross
unrealized depreciation for all securities in which there was an excess of
tax cost over value was $10,793,577.
ACES Alternative Credit Enhancement Securities
CBO Collateralized Bond Obligation
CDO Collateralized Debt Obligation
IO Interest Only Security
TBA To be announced; maturity date has not yet been established. Upon
settlement and delivery of the mortgage pools, maturity dates will be
assigned.
VALUATION INPUTS
A summary of the inputs used to value the Fund's total investments as of April
30, 2010 is as follows (see Note 2A - Portfolio Valuation in the Notes to
Financial Statements):
LEVEL 2
TOTAL LEVEL 1 SIGNIFICANT LEVEL 3
VALUE AT QUOTED OBSERVABLE UNOBSERVABLE
4/30/2010 PRICES INPUTS INPUTS
----------- ------- ----------- ------------
Asset-Backed Securities ................. $ 4,524,249 $-- $ 4,459,816 $64,433
Collateralized Mortgage Obligations ..... 448,422 -- 448,422 --
Commercial Mortgage-Backed Securities ... 2,472,997 -- 2,472,997 --
Corporate Bonds and Notes ............... 23,585,161 -- 23,585,161 --
U.S. Government Agency Mortgage-Backed
Securities ........................... 8,162,796 -- 8,162,796 --
Senior Floating-Rate Notes .............. 184,247 -- 184,247 --
Structured Notes ........................ 375 -- 375 --
Preferred Securities .................... 35,000 -- -- 35,000
----------- --- ----------- -------
TOTAL INVESTMENTS $39,413,247 $-- $39,313,814 $99,433
=========== === =========== =======
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 CHANGE IN
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, 2009 OF LEVEL 3 (LOSSES) (DEPRECIATION) (SALES) APRIL 30, 2010
----------------------------------------- ---------------- ---------- ----------- -------------- ----------- --------------
Asset-Backed Securities ................. $1,648,255 $(128,244) $ (671,914) $ 565,424 $(1,349,088) $64,433
Corporate Bonds and Notes ............... 482,400 -- (225,000) 717,600 (975,000) --
Structured Notes ........................ 92,250 -- 58,535 315,059 (465,844) --
Preferred Securities .................... 84,500 -- (306,657) 464,157 (207,000) 35,000
---------- --------- ----------- ---------- ----------- -------
Total Investments ....................... $2,307,405 $(128,244) $(1,145,036) $2,062,240 $(2,996,932) $99,433
========== ========= =========== ========== =========== =======
Net change in unrealized appreciation/depreciation from Level 3 investments held
as of April 30, 2010 was $429,851 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
APRIL 30, 2010 (UNAUDITED)
ASSETS:
Investments, at value
Cost ($48,041,490) ................................................. $ 39,413,247
Cash .................................................................. 503,149
Prepaid expenses ...................................................... 19,586
Receivables:
Investment securities sold ......................................... 8,155,964
Interest ........................................................... 793,610
------------
Total Assets .................................................... 48,885,556
------------
LIABILITIES:
Payables:
Investment securities purchased .................................... 16,584,982
Audit and tax fees ................................................. 29,425
Investment advisory fees ........................................... 23,429
Printing fees ...................................................... 13,669
Administrative fees ................................................ 8,333
Transfer agent fees ................................................ 4,089
Trustees' fees and expenses ........................................ 2,291
Legal fees ......................................................... 2,290
Custodian fees ..................................................... 669
Other liabilities ..................................................... 3,434
------------
Total Liabilities ............................................... 16,672,611
------------
NET ASSETS ............................................................ $ 32,212,945
============
NET ASSETS CONSIST OF:
Paid-in capital ....................................................... $127,981,197
Par value ............................................................. 91,506
Accumulated net investment income (loss) .............................. (1,123,783)
Accumulated net realized gain (loss) on investments ................... (86,107,732)
Net unrealized appreciation (depreciation) on investments ............. (8,628,243)
------------
NET ASSETS ............................................................ $ 32,212,945
============
NET ASSET VALUE, per Common Share (par value $0.01 per Common Share) .. $ 3.52
============
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 SIX MONTHS ENDED APRIL 30, 2010 (UNAUDITED)
INVESTMENT INCOME:
Interest ................................................................ $ 2,179,687
-----------
Total investment income ........................................... 2,179,687
-----------
EXPENSES:
Investment advisory fees ................................................ 133,797
Legal fees .............................................................. 79,250
Administrative fees ..................................................... 49,999
Printing fees ........................................................... 48,035
Audit and tax fees ...................................................... 25,260
Trustees' fees and expenses ............................................. 18,598
Transfer agent fees ..................................................... 18,000
Custodian fees .......................................................... 4,755
Other ................................................................... 34,967
-----------
Total expenses .................................................... 412,661
-----------
NET INVESTMENT INCOME ................................................... 1,767,026
-----------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain (loss) on investments .............................. (3,970,230)
Net change in unrealized appreciation (depreciation) of investments .. 9,051,235
-----------
NET REALIZED AND UNREALIZED GAIN (LOSS) ................................. 5,081,005
-----------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS ......... $ 6,848,031
===========
See Notes to Financial Statements
Page 13
FIRST TRUST STRATEGIC HIGH INCOME FUND
STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS
ENDED YEAR
4/30/2010 ENDED
(UNAUDITED) 10/31/2009
----------- ------------
OPERATIONS:
Net investment income (loss) ............................................... $ 1,767,026 $ 9,794,757
Net realized gain (loss) ................................................... (3,970,230) (78,709,995)
Net change in unrealized appreciation (depreciation) ....................... 9,051,235 45,535,716
----------- ------------
Net increase (decrease) in net assets resulting from operations ............ 6,848,031 (23,379,522)
----------- ------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income ...................................................... (1,372,589) --
Return of capital .......................................................... -- (9,752,238)
----------- ------------
Total distributions to shareholders ........................................ (1,372,589) (9,752,238)
----------- ------------
CAPITAL TRANSACTIONS:
Proceeds from Common Shares reinvested ..................................... -- 488,089
----------- ------------
Net increase (decrease) in net assets resulting from capital transactions .. -- 488,089
----------- ------------
Total increase (decrease) in net assets .................................... 5,475,442 (32,643,671)
NET ASSETS:
Beginning of period ........................................................ 26,737,503 59,381,174
----------- ------------
End of period .............................................................. $32,212,945 $ 26,737,503
=========== ============
Accumulated net investment income (loss) at end of period .................. $(1,123,783) $ (1,518,220)
=========== ============
CAPITAL TRANSACTIONS WERE AS FOLLOWS:
Common Shares at beginning of period ....................................... 9,150,594 9,035,801
Common Shares issued as reinvestment under the Dividend Reinvestment Plan .. -- 114,793
----------- ------------
Common Shares at end of period ............................................. 9,150,594 9,150,594
=========== ============
See Notes to Financial Statements
Page 14
FIRST TRUST STRATEGIC HIGH INCOME FUND
STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED APRIL 30, 2010 (UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net increase (decrease) in net assets resulting from operations ........... $ 6,848,031
Adjustments to reconcile net increase (decrease) in net assets resulting
from operations to net cash provided by operating activities:
Purchases of investments ............................................... (79,335,582)
Sales, maturities and paydowns of investments .......................... 79,416,131
Net amortization/accretion of premiums/discount on investments ......... 709,289
Net realized gain/loss on investments .................................. 3,970,230
Net change in unrealized appreciation/depreciation on investments ...... (9,051,235)
CHANGES IN ASSETS AND LIABILITIES:
Increase in interest receivable ........................................ (40,378)
Increase in receivable for investment securities sold .................. (8,130,827)
Increase in prepaid expenses ........................................... (13,550)
Increase in payable for investment securities purchased ................ 4,996,188
Increase in investment advisory fees payable ........................... 3,569
Decrease in audit and tax fees payable ................................. (21,608)
Decrease in legal fees payable ......................................... (1,608)
Decrease in printing fees payable ...................................... (12,460)
Increase in transfer agent fees payable ................................ 1,238
Decrease in custodian fees payable ..................................... (1,084)
Decrease in Trustees' fees and expenses payable ........................ (1,168)
Decrease in other liabilities .......................................... (84)
------------
CASH USED BY OPERATING ACTIVITIES ......................................... $ (664,908)
-----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Distributions to Common Shareholders from net investment income ........ (1,372,589)
------------
CASH USED BY FINANCING ACTIVITIES ......................................... (1,372,589)
-----------
Decrease in cash .......................................................... (2,037,497)
Cash at beginning of period ............................................... 2,540,646
-----------
CASH AT END OF PERIOD ..................................................... $ 503,149
===========
See Notes to Financial Statements
Page 15
FIRST TRUST STRATEGIC HIGH INCOME FUND
FINANCIAL HIGHLIGHTS
FOR A COMMON SHARE OUTSTANDING THROUGHOUT EACH PERIOD
SIX MONTHS
ENDED YEAR YEAR YEAR YEAR PERIOD
4/30/2010 ENDED ENDED ENDED ENDED ENDED
(UNAUDITED) 10/31/2009(a) 10/31/2008 10/31/2007 10/31/2006 10/31/2005(b)
----------- ------------- ---------- ---------- ---------- -------------
Net asset value, beginning of period ............ $ 2.92 $ 6.57 $ 15.16 $ 19.82 $ 19.13 $ 19.10(c)
------- ------- ------- -------- -------- ---------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income ........................... 0.19 1.07 2.05 2.17 2.08 0.39
Net realized and unrealized gain (loss) ......... 0.56 (3.64) (8.72) (4.84) 0.76 (0.17)
------- ------- ------- -------- -------- ---------
Total from investment operations ................ 0.75 (2.57) (6.67) (2.67) 2.84 0.22
------- ------- ------- -------- -------- ---------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income ........................... (0.15) -- (0.81) (1.97) (2.15) (0.15)
Net realized gain ............................... -- -- -- (0.02) -- --
Return of capital ............................... -- (1.08) (1.11) -- -- --
------- ------- ------- -------- -------- ---------
Total distributions ............................. (0.15) (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 .................. $ 3.52 $ 2.92 $ 6.57 $ 15.16 $ 19.82 $ 19.13
======= ======= ======= ======== ======== =========
Market value, end of period ..................... $ 3.32 $ 2.63 $ 6.34 $ 14.19 $ 21.19 $ 18.79
======= ======= ======= ======== ======== =========
TOTAL RETURN BASED ON NET ASSET VALUE (d) ....... 26.63% (42.52)% (47.16)% (14.65)% 15.73% 1.03%
======= ======= ======= ======== ======== =========
TOTAL RETURN BASED ON MARKET VALUE (d) .......... 32.60% (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) ............ $32,213 $26,738 $59,381 $136,145 $176,375 $ 168,413
Ratio of total expenses to average net assets ... 2.78%(e) 1.78% 4.32% 3.70% 1.20% 1.33%(e)
Ratio of total expenses to average net assets
excluding interest expense and fees .......... 2.78%(e) 1.72% 2.21% 1.68% 1.20% 1.33%(e)
Ratio of net investment income to average
net assets ................................... 11.89%(e) 28.82% 19.21% 11.78% 10.84% 7.82%(e)
Portfolio turnover rate ......................... 207%(f) 127%(f) 4% 19% 78% 19%
INDEBTEDNESS:
Loan outstanding (in 000's) ..................... N/A N/A $15,000 $ 61,200 N/A N/A
Asset coverage per $1,000 of indebtedness (g) ... N/A N/A $ 4,959 $ 3,225 N/A N/A
----------
(a) On June 29, 2009, the Fund's Board of Trustees approved an interim
sub-advisory agreement with Brookfield Investment Management Inc. (formerly
known as Hyperion Brookfield Asset Management, Inc.) ("Brookfield"), and on
October 14, 2009, the Shareholders voted to approve Brookfield as
investment sub-advisor.
(b) Initial seed date of July 19, 2005. The Fund commenced operations on July
26, 2005.
(c) Net of sales load of $0.90 per share on initial offering.
(d) Total return is based on the combination of reinvested dividend, capital
gain and return of capital distributions, if any, at prices obtained by the
Dividend Reinvestment Plan, and changes in net asset value per share for
net asset value returns and changes in Common Share price for market value
returns. Total returns do not reflect sales load and are not annualized for
periods less than one year.
(e) Annualized.
(f) In the six months ended April 30, 2010 and 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.
(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.
N/A Not Applicable.
See Notes to Financial Statements
Page 16
NOTES TO FINANCIAL STATEMENTS
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2010 (UNAUDITED)
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 $99,433 (0.3% of total investments) as of April 30,
2010 whose values have been determined based on prices supplied by dealers and
investments with a value of $39,313,814 (99.7% 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
APRIL 30, 2010 (UNAUDITED)
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 April 30, 2010, 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.
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. 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 April 30, 2010, the Fund
had when-issued, delayed delivery or forward purchase commitments with a cost of
$8,077,105 and a value of $8,093,333.
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 April 30, 2010, 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
APRIL 30, 2010 (UNAUDITED)
procedures adopted by the Fund's Board of Trustees. Although market instability
can result 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
-------- ----------- ------------ ------ ----------- ---------- ------
Banc of America Commercial Mortgage, Inc.
Series 2000-1, Class M, 6.00%, 11/15/31 08/22/05 $ 688,031 $ 0.00* $ -- $ 7 0.00%**
Banc of America Large Loan, Inc.
Series 2005-MIB1, Class L, 3.25%, 03/15/22 08/26/06 $2,000,000 15.07 2,032,264 301,427 0.94
Falcon Franchise Loan Trust
Series 2003-1, Class E, 6.00%, 01/05/25 08/09/05 $4,231,000 0.25 -- 10,577 0.03
GE Capital Commercial Mortgage Corp.
Series 2000-1, Class G, 6.13%, 01/15/33 06/27/07 $ 700,000 49.49 692,282 346,436 1.07
GS Mortgage Securities Corp. II
Series 1998-C1, Class H, 6.00%, 10/18/30 08/02/05 $6,789,251 5.88 4,010,443 399,490 1.24
GSAMP Trust
Series 2004-AR2, Class B4, 5.00%, 08/25/34 08/17/05 $ 440,199 3.13 -- 13,781 0.04
Independence III CDO, Ltd.
Series 3A, Class C1, 2.79%, 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 2,742,235 151,352 0.47
Series 2001-C7, Class S, 5.87%, 11/15/33 09/29/05 $2,071,442 0.72 610,827 14,894 0.05
Merit Securities Corp.
Series 13, Class B1, 7.95%, 12/28/33 02/20/07 $ 544,840 0.59 -- 3,213 0.01
Morgan Stanley Capital I, Inc.
Series 1999-WF1, Class M, 5.91%, 11/15/31 08/03/05 $ 968,400 64.19 694,797 621,579 1.93
Series 2003-IQ5, Class O, 5.24%, 04/15/38 10/19/06 $2,787,919 7.12 78,720 198,484 0.62
Park Place Securities, Inc.
Series 2004-WCW2, Class M10, 3.01%, 10/25/34 03/24/06 $1,301,976 4.07 88,011 53,027 0.16
Preferred Term Securities XXV, Ltd.
Zero Coupon, 06/22/37 03/22/07 $3,750,000 0.00* -- 375 0.00**
Soloso CDO, Ltd., Series 2005-1 11/30/05 2,000 10.00 -- 20,000 0.06
Summit CBO I, Ltd
Series 1A, Class B, 1.49%, 05/23/11 08/03/05 $4,159,437 1.00 41,205 41,594 0.13
White Marlin CDO, Ltd., Series AI 06/01/07 3,000 5.00 -- 15,000 0.05
----------- ---------- ----
$10,990,784 $2,191,286 6.80%
=========== ========== ====
* Amount is less than $0.01.
** Amount is less than 0.01%.
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 ("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.
Page 19
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2010 (UNAUDITED)
F. COLLATERALIZED DEBT OBLIGATIONS:
A collateralized debt obligation ("CDO") is an asset-backed security whose
underlying collateral is typically a portfolio of bonds or bank loans. Where the
underlying collateral is a portfolio of bonds, a CDO is referred to as a
collateralized bond obligation ("CBO"). Where the underlying collateral is a
portfolio of bank loans, a CDO is referred to as a collateralized loan
obligation ("CLO"). Investors in CDOs bear the credit risk of the underlying
collateral. Multiple tranches of securities are issued by the CDO, offering
investors various maturity and credit risk characteristics. Tranches are
categorized as senior, mezzanine, and subordinated/equity, according to their
degree of risk. If there are defaults or the CDO's collateral otherwise
underperforms, scheduled payments to senior tranches take precedence over those
of mezzanine tranches, and scheduled payments to mezzanine tranches take
precedence over those to subordinated/equity tranches. CDOs, similar to other
asset-backed securities, are subject to prepayment risk.
G. 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. The character of distributions for tax reporting purposes will
depend on the Fund's investment experience during the remainder of its fiscal
year, however, based on information for the fiscal year through April 30, 2010,
it is likely that the Fund's distributions will include a return of capital
component for the fiscal year ending on October 31, 2010.
The tax character of distributions paid during the fiscal year ended October 31,
2009 was as follows:
Distributions paid from:
Ordinary Income ........................... $ --
Return of Capital ......................... 9,752,238
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)
H. 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
allow 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 on October
31, 2015, 2016 and 2017, respectively.
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 April 30, 2010,
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.
I. EXPENSES:
The Fund pays all expenses directly related to its operations.
J. ACCOUNTING PRONOUNCEMENT:
In January 2010, the Financial Accounting Standards Board ("FASB") issued
Accounting Standards Update ("ASU") No. 2010-06 "Improving Disclosures about
Fair Value Measurements." ASU 2010-06 amends FASB Accounting Standards
Codification Topic 820, Fair Value Measurements and Disclosures, to require
additional disclosures regarding fair value measurements. Certain disclosures
Page 20
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2010 (UNAUDITED)
required by ASU No. 2010-06 are effective for interim and annual reporting
periods beginning after December 15, 2009, and other required disclosures are
effective for fiscal years beginning after December 15, 2010, and for interim
periods within those fiscal years. Management is currently evaluating the impact
ASU No. 2010-06 will have on the Fund's financial statement disclosures.
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).
Brookfield serves as the Fund's sub-advisor and manages the Fund's portfolio
subject to First Trust's supervision. 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, wholly-owned
subsidiary of The PNC Financial Services Group, Inc. ("PNC"), 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 PNC, serves as the Fund's Custodian in accordance with certain fee
arrangements.
On February 2, 2010, PNC entered into a Stock Purchase Agreement (the "Stock
Purchase Agreement") with The Bank of New York Mellon Corporation ("BNY
Mellon"). Upon the terms and subject to the conditions set forth in the Stock
Purchase Agreement, which has been approved by the board of directors of each
company, PNC will sell to BNY Mellon (the "Stock Sale") 100% of the issued and
outstanding shares of PNC Global Investment Servicing Inc. The Stock Sale
includes PNC Global Investment Servicing (U.S.) Inc. and PFPC Trust Company and
is expected to close in the third quarter of 2010.
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, 2011, 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 six months ended April 30,
2010 were $60,475,791 and $18,859,791, respectively. The proceeds from sales and
paydowns of U.S. Government securities and non-U.S. Government securities,
excluding short-term investments, for the six months ended April 30, 2010 were
$68,570,885 and $10,845,246, respectively.
5. 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.
6. 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,
Page 21
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2010 (UNAUDITED)
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.
7. 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.
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 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.
Page 22
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2010 (UNAUDITED)
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.
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.
8. SUBSEQUENT EVENTS
Management has evaluated the impact of all subsequent events to the Fund through
the date the financial statements were issued, and has determined that there
were subsequent events as follows:
On April 20, 2010, the Fund declared a dividend of $0.0250 per share to Common
Shareholders of record on May 5, 2010, payable May 17, 2010.
On May 20, 2010, the Fund declared a dividend of $0.0250 per share to Common
Shareholders of record on June 10, 2010, payable June 15, 2010.
On June 21, 2010, the Fund declared a dividend of $0.0250 per share to Common
Shareholders of record on July 6, 2010, payable July 15, 2010.
Page 23
ADDITIONAL INFORMATION
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2010 (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 24
ADDITIONAL INFORMATION - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2010 (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.
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/Aberdeen Emerging Opportunity Fund, First Trust Strategic High
Income Fund III, First Trust Specialty Finance and Financial Opportunities Fund
and First Trust Active Dividend Income Fund was held on April 14, 2010. At the
Annual Meeting, Trustees James A. Bowen and Niel B. Nielson were elected by the
Common Shareholders of the First Trust Strategic High Income Fund as Class III
Trustees for a three-year term expiring at the Fund's annual meeting of
shareholders in 2013. The number of votes cast in favor of Mr. Bowen was
7,749,760, the number of votes against was 232,451 and the number of abstentions
was 1,168,383. The number of votes cast in favor of Mr. Nielson was 7,596,212,
the number of votes against was 385,999 and the number of abstentions was
1,168,383. Richard E. Erickson, Thomas R. Kadlec and Robert F. Keith are the
other current and continuing Trustees.
ADVISORY AGREEMENT
BOARD CONSIDERATIONS REGARDING APPROVAL OF INVESTMENT MANAGEMENT AGREEMENT
The Board of Trustees of First Trust Strategic High Income Fund (the "Fund"),
including the Independent Trustees, unanimously approved the continuation of the
Investment Management Agreement (the "Agreement") between the Fund and First
Trust Advisors L.P. (the "Advisor") at a meeting held on March 21-22, 2010. The
Board determined that the terms of the Agreement are fair and reasonable and
that the Agreement continues to be in the best interests of the Fund.
To reach this determination, the Board considered its duties under the
Investment Company Act of 1940, as amended (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. To assist the Board in its evaluation of the Agreement, the
Independent Trustees received a report from the Advisor in advance of the Board
meeting responding to a request for information from counsel to the Independent
Trustees. The report, among other things, outlined the services provided by the
Advisor (including the relevant personnel responsible for these services and
their experience) and the new sub-advisor for the Fund; the advisory and
sub-advisory fees for the Fund as compared to fees charged to other clients of
the Advisor and as compared to fees charged by investment advisors to comparable
funds; expenses of the Fund as compared to expense ratios of comparable funds;
the nature of expenses incurred in providing services to the Fund and the
potential for economies of scale, if any; financial data on the Advisor; any
fall out benefits to the Advisor; and information on the Advisor's compliance
program. The Independent Trustees also met separately with their independent
legal counsel to discuss the information provided by the Advisor. The Board
applied its business judgment to determine whether the arrangement between the
Fund and the Advisor is a reasonable business arrangement from the Fund's
perspective as well as from the perspective of shareholders.
The Board considered the nature, quality and extent of services provided by the
Advisor under the Agreement. The Board considered the Advisor's statements
regarding the incremental benefits associated with the Fund's
advisor/sub-advisor management structure. The Board considered that the Advisor
is responsible for the overall management and administration of the Fund,
including the oversight of the sub-advisor. The Board considered the efforts of
the Advisor in finding a suitable sub-advisor for the Fund after receiving a
notice of resignation from the prior sub-advisor. The Board noted the compliance
program that had been developed by the Advisor and considered that the
compliance program includes policies and procedures for monitoring the
sub-advisor's compliance with the 1940 Act and the Fund's investment objectives
and policies. The Board also noted the enhancements made by the Advisor to the
compliance program in 2009. The Board noted that shareholders had approved a
sub-advisory agreement with Brookfield Investment Management Inc. at a special
meeting held on October 14, 2009, and that the new sub-advisor had begun serving
as such on June 29, 2009. In light of the information presented and the
considerations made, the Board concluded that the nature, quality and extent of
services provided to the Fund by the Advisor under the Agreement have been and
are expected to remain satisfactory and that the Fund has been managed
consistent with its investment objectives and policies.
Page 25
ADDITIONAL INFORMATION - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2010 (UNAUDITED)
The Board considered the advisory fees paid under the Agreement. The Board
considered the advisory fees charged by the Advisor to similar funds and other
non-fund clients, and noted that the Advisor does not provide advisory services
to clients with investment objectives and policies similar to the Fund's, other
than to two other closed end funds for which the fee rate is identical. In
addition, the Board received data prepared by Lipper Inc. ("Lipper"), an
independent source, showing the management fees and expense ratios of the Fund
as compared to the management fees and expense ratios of a combined peer group
selected by Lipper and the Advisor. The Board discussed with representatives of
the Advisor the limitations in creating a relevant peer group for the Fund,
including that (i) the peer funds may use different types of leverage which have
different costs associated with them; (ii) most peer funds do not employ an
advisor/sub-advisor management structure; (iii) the peer funds may not have the
same fiscal year as the Fund, which may cause the expense data used by Lipper to
be measured over different time periods; and (iv) many of the peer funds are
larger than the Fund. The Board reviewed the Lipper materials, but based on its
discussions with the Advisor, the Board determined that the Lipper data was of
limited value for purposes of its consideration of the renewal of the Agreement.
The Board also considered performance information for the Fund, noting that the
performance information included the Fund's quarterly performance report, which
is part of the process that the Board has established for monitoring the Fund's
performance on an ongoing basis, and had been enhanced to assess portfolio risk
as well. The Board determined that this process continues to be effective for
reviewing the Fund's performance. In addition to the Board's ongoing review of
performance, the Board also received data prepared by Lipper comparing the
Fund's performance to the combined peer group selected by Lipper and the
Advisor, as well as to a larger group and to a benchmark. The Board reviewed the
Lipper materials, but for similar reasons to those described above, the Board
determined that the performance data provided by Lipper was of limited value.
The Board also considered the change in sub-advisor, changes in investment
strategies and changes made to the Fund's portfolio. In addition, the Board
considered the market price and net asset value performance of the Fund since
inception, and compared the Fund's premium/discount to the average and median
premium/discount of the combined peer group, noting that the Fund's
premium/discount was generally indicative of the asset class and market events.
On the basis of all the information provided on the fees, expenses and
performance of the Fund, the Board concluded that the advisory fees were
reasonable and appropriate in light of the nature, quality and extent of
services provided by the Advisor under the Agreement.
The Board noted that the Advisor has continued to invest in personnel and
infrastructure and considered whether fee levels reflect any economies of scale
for the benefit of shareholders. The Board concluded that the advisory fee
reflects an appropriate level of sharing of any economies of scale at current
asset levels. The Board also considered the costs of the services provided and
profits realized by the Advisor from serving as investment manager to the Fund
for the twelve months ended December 31, 2009, as set forth in the materials
provided to the Board, noting that the Advisor incurred a loss in providing
services to the Fund in 2009. In addition, the Board considered and discussed
any ancillary benefits derived by the Advisor from its relationship with the
Fund and noted that the typical fall out benefits to the Advisor such as soft
dollars are not present. The Board concluded that any other fall out benefits
received by the Advisor or its affiliates would appear to be limited. The Board
also considered information regarding a private lawsuit involving the Advisor
and the Fund alleging misleading disclosure in the Fund's registration
statement. The Board noted the Advisor's representation that the lawsuit would
not impact the Advisor's ability to perform under the Agreement.
Based on all of the information considered and the conclusions reached, the
Board, including the Independent Trustees, determined that the terms of the
Agreement continue to be fair and reasonable and that the continuation of the
Agreement is in the best interests of the Fund. No single factor was
determinative in the Board's analysis.
Page 26
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.
Not applicable.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
Not applicable.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Not applicable.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
Not applicable.
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.
Not applicable.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
There has been no change, as of the date of this filing, in any of the
portfolios managers identified in response to paragraph (a)(1) of this Item in
the Registrant's most recently filed annual report on Form N-CSR.
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) Not applicable.
(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 June 24, 2010
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 June 24, 2010
By (Signature and Title)* /s/ Mark R. Bradley
----------------------------------------------------
Mark R. Bradley, Treasurer, Controller, Chief
Financial Officer and Chief Accounting Officer
(principal financial officer)
Date June 24, 2010
* Print the name and title of each signing officer under his or her
signature.