Filed Pursuant to Rule 497 (c)
under the Securities Act of 1933, As Amended
File No. 333-217581
PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED MARCH 6, 2018)
FIRST TRUST MLP AND ENERGY INCOME FUND
UP TO 4,600,000 COMMON SHARES
First Trust MLP and Energy Income Fund (the "Fund") has entered into a
sales agreement (the "sales agreement") with JonesTrading Institutional Services
LLC ("JonesTrading") relating to the Fund's common shares of beneficial
interest, par value $0.01 per share, offered by this prospectus supplement and
the accompanying prospectus ("Common Shares"). In accordance with the terms of
the sales agreement, the Fund may offer and sell up to 4,600,000 Common Shares
from time to time through JonesTrading as our agent for the offer and sale of
the Common Shares. As of February 15, 2018, the Fund has sold in this offering
an aggregate of 914,321 Common Shares, representing net proceeds to the Fund of
$13,790,654, after payment of commissions of $139,626 in the aggregate.
The Fund is a non-diversified, closed-end management investment company
which commenced investment operations in November 2012. The Fund's investment
objective is to seek a high level of total return with an emphasis on current
distributions paid to common shareholders.
The Common Shares offered in this prospectus supplement will be, subject
to notice of issuance, listed on the New York Stock Exchange ("NYSE") under the
trading or "ticker" symbol "FEI." The net asset value of the Fund's common
shares on February 15, 2018 was $14.10 and the last sale price of the common
shares on the NYSE on such date was $14.69.
Sales of the Common Shares, if any, under this prospectus supplement and
the accompanying prospectus may be made in negotiated transactions or
transactions that are deemed to be "at the market" as defined in Rule 415 under
the Securities Act of 1933, as amended (the "1933 Act"), including sales made
directly on the New York Stock Exchange or sales made to or through a market
maker other than on an exchange.
JonesTrading will be entitled to compensation of up to 200 basis points of
the gross sales price per share for any Common Shares sold under the sales
agreement, with the exact amount of such compensation to be mutually agreed upon
by the Fund and JonesTrading from time to time. In connection with the sale of
the Common Shares on our behalf, JonesTrading may be deemed to be an
"underwriter" within the meaning of the 1933 Act and the compensation of
JonesTrading may be deemed to be underwriting commissions or discounts.
INVESTING IN OUR SECURITIES INVOLVES CERTAIN RISKS. YOU COULD LOSE SOME OR
ALL OF YOUR INVESTMENT. SEE "RISKS" BEGINNING ON PAGE S-8 OF THIS PROSPECTUS
SUPPLEMENT AND PAGE 46 OF THE ACCOMPANYING PROSPECTUS. YOU SHOULD CONSIDER
CAREFULLY THESE RISKS TOGETHER WITH ALL OF THE OTHER INFORMATION CONTAINED IN
THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS BEFORE MAKING A
DECISION TO PURCHASE OUR SECURITIES.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS SUPPLEMENT OR THE ACCOMPANYING PROSPECTUS IS TRUTHFUL OR COMPLETE.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
JonesTrading
[PICTURE OMITTED]
Prospectus Supplement dated March 8, 2018
This prospectus supplement, together with the accompanying prospectus and
the SAI (as defined below), sets forth concisely the information that you should
know before investing. You should read the prospectus supplement and
accompanying prospectus, which contains important information about the Fund,
before deciding whether to invest in the Common Shares, and retain these
documents for future reference. The Statement of Additional Information (the
"SAI"), dated March 6, 2018, containing additional information about the Fund,
has been filed with the Securities and Exchange Commission (the "SEC") and is
incorporated by reference in its entirety into this prospectus supplement and
the accompanying prospectus. This prospectus supplement, the accompanying
prospectus and the SAI are part of a "shelf" registration statement on Form N-2
(the "Registration Statement") that the Fund filed with the SEC. This prospectus
supplement describes the specific details regarding this offering, including the
method of distribution. If information in this prospectus supplement is
inconsistent with the accompanying prospectus or the SAI, you should rely on
this prospectus supplement. You may request a free copy of the SAI, the table of
contents of which is on page 80 of the prospectus, annual and semi-annual
reports to shareholders, and other information about the Fund, and make
shareholder inquiries by calling (800) 988-5891, by writing to the Fund or from
the Fund's or the Advisor's website (https://www.ftportfolios.com). Please note
that the information contained in the Fund's or the Advisor's website, whether
currently posted or posted in the future, is not part of the prospectus or the
documents incorporated by reference in this prospectus supplement and the
accompanying prospectus. You also may obtain a copy of the SAI (and other
information regarding the Fund) from the SEC's website (https://www.sec.gov).
THE FUND'S SECURITIES DO NOT REPRESENT A DEPOSIT OR OBLIGATION OF, AND ARE
NOT GUARANTEED OR ENDORSED BY, ANY BANK OR OTHER INSURED DEPOSITORY INSTITUTION
AND ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE
FEDERAL RESERVE BOARD OR ANY OTHER GOVERNMENT AGENCY.
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus supplement, the accompanying prospectus and the SAI,
including documents incorporated by reference herein and therein, contain
"forward-looking statements." Forward-looking statements can be identified by
the words "may," "will," "intend," "expect," "estimate," "continue," "plan,"
"anticipate," and similar terms and the negative of such terms. By their nature,
all forward-looking statements involve risks and uncertainties, and actual
results could differ materially from those contemplated by the forward-looking
statements. Several factors that could materially affect the Fund's actual
results are the performance of the portfolio of securities held by the Fund, the
timing and amount of distributions and dividends from the publicly traded master
limited partnerships (MLPs) and MLP-related entities in which the Fund invests,
the conditions in the U.S. and international financial, energy, energy utilities
and other markets, the price at which the Fund's common shares trade in the
public markets and other factors discussed in this prospectus supplement, the
accompanying prospectus and the SAI, and in the Fund's periodic filings with the
SEC.
Although the Fund believes that the expectations expressed in these
forward-looking statements are reasonable, actual results could differ
materially from those expressed or implied in the forward-looking statements.
The Fund's future financial condition and results of operations, as well as any
forward-looking statements, are subject to change and are subject to inherent
risks and uncertainties, such as those disclosed in the "Risks" sections of this
prospectus supplement and the accompanying prospectus. You are cautioned not to
place undue reliance on these forward-looking statements. All forward-looking
statements contained or incorporated by reference in this prospectus supplement
or the accompanying prospectus are made as of the date of this prospectus
supplement or the accompanying prospectus, as the case may be. Except for the
Fund's ongoing obligations under the federal securities laws, the Fund does not
intend, and the Fund undertakes no obligation, to update any forward-looking
statement. The forward-looking statements contained in this prospectus
supplement, the accompanying prospectus and the SAI are excluded from the safe
harbor protection provided by Section 27A of the 1933 Act.
Currently known risk factors that could cause actual results to differ
materially from the Fund's expectations include, but are not limited to, the
factors described in the "Risks" sections of this prospectus supplement and the
accompanying prospectus. The Fund urges you to review carefully those sections
for a more detailed discussion of the risks of an investment in the Fund's
securities.
- ii -
TABLE OF CONTENTS
PROSPECTUS SUPPLEMENT
PROSPECTUS SUPPLEMENT SUMMARY............................................... S-1
CAPITALIZATION.............................................................. S-4
SUMMARY OF FUND EXPENSES.................................................... S-5
MARKET AND NET ASSET VALUE INFORMATION...................................... S-7
USE OF PROCEEDS............................................................. S-8
RISKS....................................................................... S-8
PLAN OF DISTRIBUTION........................................................ S-8
LEGAL MATTERS............................................................... S-9
EXPERTS..................................................................... S-9
AVAILABLE INFORMATION....................................................... S-9
PROSPECTUS
PROSPECTUS SUMMARY........................................................... 1
SUMMARY OF FUND EXPENSES..................................................... 31
FINANCIAL HIGHLIGHTS......................................................... 33
MARKET AND NET ASSET VALUE INFORMATION....................................... 34
THE FUND..................................................................... 35
USE OF PROCEEDS.............................................................. 35
THE FUND'S INVESTMENTS....................................................... 35
LEVERAGE PROGRAM............................................................. 43
RISKS........................................................................ 46
MANAGEMENT OF THE FUND....................................................... 65
NET ASSET VALUE.............................................................. 67
DISTRIBUTIONS................................................................ 68
DIVIDEND REINVESTMENT PLAN................................................... 69
PLAN OF DISTRIBUTION......................................................... 69
DESCRIPTION OF SHARES........................................................ 71
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST AND BY-LAWS................... 73
STRUCTURE OF THE FUND; COMMON SHARE REPURCHASES AND CHANGE IN
FUND STRUCTURE............................................................... 74
TAX MATTERS.................................................................. 75
CUSTODIAN, ADMINISTRATOR, FUND ACCOUNTANT AND TRANSFER AGENT................. 79
LEGAL OPINIONS............................................................... 79
TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION................ 80
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR INCORPORATED BY
REFERENCE IN THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS IN
MAKING YOUR INVESTMENT DECISION. THE FUND HAS NOT AUTHORIZED ANY PERSON TO
PROVIDE YOU WITH DIFFERENT OR INCONSISTENT INFORMATION. IF ANYONE PROVIDES YOU
WITH DIFFERENT OR INCONSISTENT INFORMATION, YOU SHOULD NOT RELY ON IT. THIS
PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS DO NOT CONSTITUTE AN OFFER
TO SELL OR SOLICITATION OF AN OFFER TO BUY ANY SECURITIES IN ANY JURISDICTION
WHERE THE OFFER OR SALE IS NOT PERMITTED. THE INFORMATION APPEARING IN THIS
PROSPECTUS SUPPLEMENT AND IN THE ACCOMPANYING PROSPECTUS IS ACCURATE ONLY AS OF
THE DATES ON THEIR COVERS OR THE DATES OF SUCH INFORMATION, AS APPLICABLE. THE
FUND'S BUSINESS, FINANCIAL CONDITION AND PROSPECTS MAY HAVE CHANGED SINCE SUCH
DATES.
- iii -
PROSPECTUS SUPPLEMENT SUMMARY
The following summary contains basic information about the Fund and its
securities. It is not complete and may not contain all of the information you
may want to consider. You should review the more detailed information contained
in this prospectus supplement and in the accompanying prospectus and in the SAI,
especially the information set forth under the heading "Risks" beginning on page
S-8 of this prospectus supplement and page 46 of the accompanying prospectus.
THE FUND ............. First Trust MLP and Energy Income Fund is a
non-diversified, closed-end management investment
company. The Fund's investment objective is to seek a
high level of total return with an emphasis on current
distributions paid to common shareholders. The Fund
seeks to provide its common shareholders with a vehicle
to invest in a portfolio of cash-generating securities,
with a focus on investing in publicly traded master
limited partnerships ("MLPs"), MLP-related entities (as
defined below) and other companies in the energy sector
and energy utility industries (each as defined below)
that are weighted towards non-cyclical, fee-for-service
revenues. The Fund considers investments in "MLP-related
entities" to include investments that offer economic
exposure to publicly traded MLPs and private investments
that have MLP characteristics, but are not publicly
traded. The Fund considers investments in the "energy
sector" to include companies that derive a majority of
their revenues or operating income from transporting,
processing, storing, distributing, marketing, exploring,
developing, managing or producing natural gas, natural
gas liquids (including propane), crude oil, refined
petroleum products, coal or electricity, or from
supplying energy-related products and services, or any
such other companies within the energy sector as
classified under the Global Industry Classification
Standards developed by MSCI, Inc. and Standard & Poor's
("GICS"). The Fund considers investments in "energy
utility" to include companies that derive a majority of
their revenues or operating income from providing
products, services or equipment for the generation,
transmission, distribution or sale of electricity or gas
and such other companies within the electric, gas,
independent power and renewable electricity producers
and multi-utilities industries as classified under GICS.
The Fund commenced operations upon completion of its
initial public offering of common shares in November
2012, raising approximately $866 million in equity after
the payment of offering expenses. As of February 15,
2018, the Fund had 46,779,490 common shares outstanding
and net assets applicable to common shares of
approximately $660 million.
THE OFFERING ......... The Fund, First Trust Advisors L.P. ("First Trust
Advisors" or the "Advisor") and Energy Income Partners,
LLC ("Energy Income Partners" or the "Sub-Advisor")
entered into a sales agreement with JonesTrading
relating to the Common Shares offered by this prospectus
supplement and the accompanying prospectus. In
accordance with the terms of the sales agreement, the
Fund may offer and sell up to 4,600,000 Common Shares
from time to time through JonesTrading as the Fund's
agent for the offer and sale of the Common Shares. As of
February 15, 2018, the Fund has sold in this offering an
aggregate of 914,321 Common Shares, representing net
proceeds to the Fund of $13,790,654, after payment of
commissions of $139,626 in the aggregate.
The Fund's common shares are listed on the NYSE under
the symbol "FEI." As of February 15, 2018, the last
reported sale price for the common shares was $14.69 and
the net asset value per share of the common shares was
$14.10.
S-1
Sales of the Common Shares, if any, under this
prospectus supplement and the accompanying prospectus
may be made in negotiated transactions or transactions
that are deemed to be "at the market" as defined in Rule
415 under the 1933 Act, including sales made directly on
the NYSE or sales made to or through a market maker
other than on an exchange. The Common Shares may not be
sold through agents, underwriters or dealers without
delivery or deemed delivery of a prospectus and a
prospectus supplement describing the method and terms of
the offering of our securities. Under the Investment
Company Act of 1940, as amended (the "1940 Act"), the
Fund may not sell any Common Shares at a price below the
current net asset value of such Common Shares, exclusive
of any distributing commission or discount, except with
the consent of a majority of its common shareholders, or
under certain other circumstances.
INVESTMENT ADVISOR
AND SUB-ADVISOR ...... First Trust Advisors is the Fund's investment adviser,
responsible for supervising the Fund's Sub-Advisor,
monitoring the Fund's investment portfolio, managing the
Fund's business affairs and providing certain clerical
and bookkeeping and other administrative services. The
Advisor, in consultation with the Sub-Advisor, is also
responsible for determining the
Fund's overall investment strategy and overseeing its
implementation. Energy Income Partners is the Fund's
sub-adviser and is primarily responsible for the
day-to-day supervision and investment strategy of, and
making investment decisions for, the Fund.
First Trust Advisors, a registered investment adviser,
is an Illinois limited partnership formed in 1991. First
Trust Advisors serves as investment adviser or portfolio
supervisor to investment portfolios with approximately
$124.8 billion in assets which it managed or supervised
as of January 31, 2018.
Energy Income Partners is a Delaware limited liability
company and a registered investment adviser, which
provides professional asset management services in the
area of energy-related MLPs and other high-payout
securities in the energy infrastructure sector. Founded
in 2003, Energy Income Partners serves as investment
adviser to investment portfolios with approximately $6.6
billion of assets as of January 31, 2018.
Pursuant to the investment management agreement between
First Trust Advisors and the Fund, the Fund pays an
annual management fee for the services and facilities
provided by First Trust Advisors, payable on a monthly
basis, equal to 1.00% of the Fund's Managed Assets. For
purposes of calculation of the management fee, the
Fund's "Managed Assets" means the average daily gross
asset value of the Fund (which includes assets
attributable to the Fund's preferred shares of
beneficial interest ("Preferred Shares"), if any, and
the principal amount of any borrowings), minus the sum
of the Fund's accrued and unpaid dividends on any
outstanding Preferred Shares and accrued liabilities
(other than the principal amount of any borrowings of
money incurred or of commercial paper or notes issued by
the Fund).
The Sub-Advisor receives a portfolio management fee
equal to 0.50% of the Fund's Managed Assets. The
Sub-Advisor's fee is paid by the Advisor out of the
Advisor's management fee. See "Management of the Fund"
on page 65 of the accompanying prospectus.
FINANCIAL LEVERAGE ... The Fund has entered into a credit facility agreement
with The Bank of Nova Scotia that has a maximum
commitment amount of $270,000,000 (the "Credit
S-2
Facility"). As of January 31, 2018, the principal amount
of borrowings under the Credit Facility was
$243,500,000, representing approximately 26% of the
Fund's Managed Assets. The borrowing rate under the
Credit Facility is equal to 1-month LIBOR plus 0.85%. In
addition, under the Credit Facility, the Fund pays a
commitment fee of 0.25% on the undrawn amount of the
Credit Facility when the utilization is below 75% of the
maximum commitment amount. The average amount
outstanding for the year ended October 31, 2017 was
$236,831,507, with a weighted average interest rate of
1.84%. The total annual interest and fee rate as of
January 31, 2018 was 2.42%. Based upon the terms of the
Credit Facility as of January 31, 2018, assuming that
the Fund's leverage costs remain as described above (at
an assumed average annual cost of 2.42%) and leverage as
a percentage of the Fund's Managed Assets remains at
26%, the annual return that the Fund's portfolio must
experience (net of expenses) in order to cover its
leverage costs would be 0.64%.
The following table is designed to illustrate the effect
of leverage on common share total return after the
assumed issuance and sale of the 4,600,000 Common Shares
contemplated by this prospectus supplement and the
accompanying prospectus, assuming investment portfolio
total returns (comprised of income and changes in the
value of securities held in the Fund's portfolio) of
(10%), (5%), 0%, 5% and 10%. These assumed investment
portfolio returns are hypothetical figures and are not
necessarily indicative of the investment portfolio
returns experienced or expected to be experienced by the
Fund. See "Risks--Leverage Risk," beginning on page 59
of the accompanying prospectus. The table further
assumes leverage representing 26% of the Fund's Managed
Assets, net of expenses, and the Fund's annual leverage
interest and fee rate of 2.42% as of January 31, 2018.
Prior approval from the Credit Facility lender will be
required for borrowings above $270,000,000 under the
Credit Facility. There is no assurance that such
approval will be obtained.
Assumed Portfolio Total Return
(Net of Expenses)................. -10% -5% 0% 5% 10%
Common Share Total Return......... -14.36% -7.61% -0.85% 5.91% 12.66%
USE OF PROCEEDS ...... Unless otherwise specified in this prospectus
supplement, the Fund currently intends to use net
proceeds from the sale of the Common Shares in
accordance with its investment objective and policies,
or to use such proceeds for other general corporate
purposes. See "Use of Proceeds."
DISTRIBUTIONS ........ The Fund has paid distributions to common shareholders
every month since the commencement of its distribution
program. Payment of future distributions is subject to
approval by the Fund's Board of Trustees ("Board of
Trustees"), as well as meeting the covenants of any
senior debt and the asset coverage requirements of the
1940 Act, including covenants contained in the Credit
Facility. The Fund's most recent monthly distribution
for the month ending February 28, 2018 was paid on
February 15, 2018 in the amount of $0.1183 per share.
The Fund's next monthly distribution to common
shareholders will be for the month ending March 31, 2018
to shareholders of record as of March 2, 2018.
S-3
CAPITALIZATION
The Fund may offer and sell up to 4,600,000 Common Shares from time to time
through JonesTrading as the Fund's agent under this prospectus supplement and
the accompanying prospectus. As of February 15, 2018, the Fund has sold in this
offering an aggregate of 914,321 Common Shares, representing net proceeds to the
Fund of $13,790,654, after payment of commissions of $139,626 in the aggregate.
There is no guarantee that there will be any additional sales of the Common
Shares pursuant to this prospectus supplement and the accompanying prospectus.
The table below assumes that the Fund will sell the remaining 3,685,679 Common
Shares offered pursuant to this prospectus supplement, at a price of $14.69 per
share (the last reported sale price per share of our Common Shares on the NYSE
on February 15, 2018). Actual sales of the Common Shares under this prospectus
supplement and the accompanying prospectus may be greater or less than $14.69
per share, depending on the market price of the Common Shares at the time of any
such sale. To the extent that the market price per share of the Fund's common
shares on any given day is less than the net asset value per share on such day,
the Fund will instruct JonesTrading not to make any sales on such day.
The following table sets forth our capitalization at October 31, 2017:
o on a historical basis; and
o on a pro forma as adjusted basis to reflect (1) the assumed sale of
3,685,679 additional Common Shares at $14.69 per share (the last
reported sale price for the Common Shares on the NYSE on February 15,
2018), in an offering under this prospectus supplement and the
accompanying prospectus, after deducting the assumed commission of
$541,426 (representing an estimated commission paid to JonesTrading of
1.00% of the gross sales price per share in connection with sales of
common shares effected by JonesTrading in this offering) and
additional offering expenses payable by the Fund of $133,750, (2) the
issuance of an aggregate of 80,965 common shares issued pursuant to
the Fund's Dividend Reinvestment Plan since October 31, 2017, (3) the
issuance of an aggregate of 60,855 common shares sold through the "at
the market" offering since October 31, 2017, and (4) borrowing of
$8,000,000 since October 31, 2017 and an assumed additional borrowing
of $11,522,933 under the Fund's credit facility.
ACTUAL AS ADJUSTED
---------------------- ----------------------
BORROWINGS $ 235,500,000 $ 255,022,933
---------------------- ----------------------
SHAREHOLDERS' EQUITY
Common Shares, $0.01 par value per share, unlimited
shares authorized, 46,637,670 shares outstanding
(actual) and
50,465,169 shares outstanding (as adjusted) 630,724,516 686,214,087
Accumulated net investment income (loss) (32,486,567) (32,486,567)
Accumulated net realized gain (loss) on investments (17,359,875) (17,359,875)
Net unrealized appreciation (depreciation) on investments
and foreign currency translation 91,494,753 91,494,753
---------------------- ----------------------
Net assets applicable to common shareholders 672,372,827 727,862,398
---------------------- ----------------------
TOTAL CAPITALIZATION $ 907,872,827 $ 982,885,331
====================== ======================
S-4
SUMMARY OF FUND EXPENSES
The following table and example contains information about the costs and
expenses that common shareholders will bear directly or indirectly. In
accordance with SEC requirements, the table below shows the Fund's expenses,
including leverage costs, as a percentage of the Fund's net assets as of October
31, 2017, as adjusted. As of January 31, 2018, the Fund had $243,500,000 of
leverage outstanding pursuant to its credit facility. Such leverage represents
26% of Managed Assets as of January 31, 2018.
SHAREHOLDER TRANSACTION EXPENSES:
Sales Load (as a percentage of offering price).........................1.00% (1)
Offering Expenses Borne by the Fund
(as a percentage of offering price) (2).............................0.02%
Dividend Reinvestment Plan Fees........................................None (3)
PERCENTAGE OF NET ASSETS
ATTRIBUTABLE TO COMMON SHARES AT OCTOBER 31, 2017
(ASSUMES 26% LEVERAGE IS OUTSTANDING)
-------------------------------------------------
ANNUAL EXPENSES:
Management Fees (4)........................................................................... 1.35%
Interest and Fees on Leverage (5)............................................................. 0.85%
Other Expenses (exclusive of current and deferred income tax expense (benefit)) (6)........... 0.14%
--------
Annual Expenses (exclusive of current and deferred income tax expense (benefit)) (6).......... 2.34%
Current Income Tax Expense (benefit).......................................................... 1.08%
Deferred Income Tax Expense (benefit)......................................................... (0.01)%
--------
Total Annual Expenses (including current and deferred income tax expense (benefit))........... 3.41%
========
--------------------------------------------------------------------------------
(1) Represents the estimated commission with respect to the Common Shares being
sold in this offering, which the Fund will pay to JonesTrading in connection
with sales of Common Shares effected by JonesTrading in this offering. While
JonesTrading is entitled to a commission of up to 2.0% of the gross sales
price for Common Shares sold, with the exact amount to be agreed upon by the
parties, the Fund has assumed, for purposes of this offering, that
JonesTrading will receive a commission of 1% of such gross sales price. This
is the only sales load to be paid in connection with this offering. There is
no guarantee that there will be any sales of Common Shares pursuant to this
prospectus supplement and the accompanying prospectus. Actual sales of
Common Shares under this prospectus supplement and the accompanying
prospectus, if any, may be less than as set forth in this table. In
addition, the price per share of any such sale may be greater or less than
the price set forth in this table, depending on the market price of the
Common Shares at the time of any such sale.
(2) The Fund will pay all offering costs other than the sales load.
(3) You will pay brokerage charges if you direct BNY Mellon Investment Servicing
(US) Inc., as agent for the Common Shareholders Dividend Reinvestment Plan,
to sell your Common Shares held in a dividend reinvestment account.
(4) Represents the aggregate fee payable to the Advisor (a portion of which is
paid by the Advisor to the Sub-Advisor).
(5) Interest and fees on leverage in the table reflect the cost to the Fund of
Borrowings, expressed as a percentage of the Fund's net assets as of October
31, 2017, based on interest rates in effect as of January 31, 2018. The
table assumes total Borrowings of $255,022,933, which reflects leverage in
an amount representing 26% of Managed Assets. The Borrowings bear interest
at a rate equal to 1-month LIBOR plus 0.85%.
(6) Current and deferred income tax expense (benefit) varies based on the Fund's
net investment income and realized and unrealized investment gain and
losses, which cannot be predicted. Accordingly, other expenses do not
include current or deferred income tax expense (benefit). The Fund's current
and deferred income tax expense (benefit) as a percentage of average net
assets by fiscal year from inception through October 31, 2017 has been as
follows:
Period November 27, 2012 (commencement of operations)
Through October 31, 2013 7.86%
Year Ended October 31, 2014 9.49%
Year Ended October 31, 2015 (12.40)%
Year Ended October 31, 2016 (1.99)%
Year Ended October 31, 2017 1.11%
S-5
The table set forth below presents the Fund's annual operating expenses as a
percentage of net assets attributable to Common Shares, excluding an estimate
of current and deferred income tax expense (benefit).
PERCENTAGE OF NET ASSETS
ATTRIBUTABLE TO COMMON SHARES AT OCTOBER 31, 2017
(ASSUMES 26% LEVERAGE IS OUTSTANDING)
ANNUAL EXPENSES:
Management Fees.......................................................................... 1.35%
Interest and Fees on Leverage............................................................ 0.85%
Other Expenses (exclusive of current and deferred income tax expense (benefit)).......... 0.14%
-------
Total Annual Expenses (exclusive of current and deferred income tax expense (benefit))... 2.34%
=======
The purpose of the tables above and the examples below is to help you
understand all fees and expenses that you, as a holder of Common Shares, would
bear directly or indirectly. The expenses shown in the tables under "Other
Expenses" and "Total Annual Expenses" are based on estimated amounts for the
Fund's 12 months of operations after October 31, 2017 unless otherwise indicated
and assumes that the Fund has not issued any additional common shares.
The following examples illustrate the expenses that you would pay on a $1,000
investment in Common Shares, assuming: (i) total annual expenses of 3.41% of net
assets attributable to Common Shares through year 10, including the Fund's
estimate of current and deferred income tax expense (benefit), (ii) a 5% annual
return and (iii) all distributions are reinvested at net asset value:(1)
1 YEAR 3 YEARS 5 YEARS 10 YEARS
$44 $114 $186 $376
The following examples illustrate the expenses that you would pay on a $1,000
investment in Common Shares, assuming: (i) total annual expenses of 2.34% of net
assets attributable to Common Shares through year 10, excluding the Fund's
estimate of current and deferred income tax expense (benefit), (ii) a 5% annual
return and (iii) all distributions are reinvested at net asset value:(1)
1 YEAR 3 YEARS 5 YEARS 10 YEARS
$34 $82 $134 $275
--------------------------------------------------------------------------------
(1) THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE EXPENSES.
The example assumes that the estimated "Other Expenses (exclusive of current
and deferred income tax expense (benefit))" set forth in the Annual Expenses
table are accurate, that all dividends and distributions are reinvested at
net asset value and that the Fund is engaged in leverage of 26% of Managed
Assets, assuming interest and fees on leverage of 2.42% and a sales load of
1.00% in year 1. The interest and fees on leverage is expressed as an
interest rate and represents interest and fees payable on the Nova Scotia
Facility. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. Moreover,
the Fund's actual rate of return may be greater or less than the
hypothetical 5% return shown in the example.
S-6
MARKET AND NET ASSET VALUE INFORMATION
The Fund's currently outstanding common shares are, and the Common Shares
offered by this prospectus supplement and the accompanying prospectus, subject
to notice of issuance, will be, listed on the NYSE. The Fund's common shares
commenced trading on the NYSE on November 27, 2012.
The Fund's common shares have traded both at a premium and at a discount in
relation to net asset value. Shares of closed-end investment companies
frequently trade at a discount from net asset value. The Fund's issuance of the
Common Shares or additional common shares may have an adverse effect on prices
in the secondary market for the Fund's common shares by increasing the number of
common shares available, which may put downward pressure on the market price for
the Fund's common shares. See "Risks -- Market Discount From Net Asset Value,"
beginning on page 46 of the accompanying prospectus.
The following table sets forth for each of the periods indicated the high and
low closing market prices for common shares of the Fund on the NYSE, and the
corresponding net asset value per share and the premium or discount to net asset
value per share at which the Fund's common shares were trading. Net asset value
is determined daily as of the close of regular trading on the NYSE (normally
4:00 p.m. eastern time).
PREMIUM/(DISCOUNT)
MARKET PRICE(1) NET ASSET VALUE(2) TO NET ASSET VALUE(3)
QUARTER ENDED HIGH LOW HIGH LOW HIGH LOW
December 31, 2012...................... $20.65 $19.98 $19.11 $19.07 8.06% 4.77%
March 31, 2013......................... $21.05 $20.02 $20.18 $19.60 4.31% 2.14%
June 30, 2013.......................... $22.29 $19.35 $21.20 $20.04 5.14% (3.44)%
September 30, 2013..................... $21.08 $18.91 $20.79 $20.08 1.39% (5.83)%
December 31, 2013...................... $20.01 $18.30 $21.02 $20.25 (4.80)% (9.63)%
March 31, 2014......................... $19.98 $18.80 $20.58 $20.61 (2.92)% (8.78)%
June 30, 2014.......................... $21.63 $19.53 $23.32 $21.37 (7.25)% (8.61)%
September 30, 2014..................... $22.15 $20.49 $24.09 $22.29 (8.05)% (8.08)%
December 31, 2014...................... $22.12 $18.95 $23.93 $21.23 (7.56)% (10.74)%
March 31, 2015......................... $21.45 $19.43 $23.10 $21.58 (7.14)% (9.96)%
June 30, 2015.......................... $21.15 $18.21 $22.03 $20.47 (3.99)% (11.04)%
September 30, 2015..................... $18.44 $15.20 $20.46 $15.54 (9.87)% (2.19)%
December 31, 2015...................... $17.20 $10.89 $17.78 $12.74 (3.26)% (14.52)%
March 31, 2016......................... $13.78 $ 8.84 $14.17 $10.64 (2.75)% (16.92)%
June 30, 2016.......................... $15.87 $12.75 $15.67 $13.22 1.28% (3.56)%
September 30, 2016..................... $16.56 $15.17 $15.86 $15.55 4.41% (2.44)%
December 31, 2016...................... $17.27 $14.63 $15.53 $14.90 11.20% (1.81)%
March 31, 2017......................... $17.50 $15.92 $16.26 $15.68 7.63% 1.53%
June 30, 2017.......................... $16.64 $14.61 $15.92 $14.41 4.52% 1.39%
September 30, 2017..................... $15.96 $14.59 $15.36 $14.23 3.91% 2.53%
December 31, 2017...................... $15.65 $13.79 $14.63 $14.01 6.97% (1.57)%
--------------------------------------------------------------------------------
(1) Based on high and low closing market price for the respective quarter.
(2) Based on the net asset value calculated on the day of the high and low
closing market prices, as applicable, as of the close of regular trading
on the NYSE (normally 4:00 p.m. eastern time).
(3) Calculated based on the information presented.
The last reported sale price, net asset value per share and percentage
premium to net asset value per share of the common shares as of February 15,
2018 were $14.69, $14.10 and 4.18%, respectively. As of February 15, 2018, the
Fund had 46,779,490 common shares outstanding and net assets attributable to
common shares of approximately $660 million.
The following table provides information about the Fund's outstanding
securities as of January 31, 2018:
AMOUNT HELD BY
AMOUNT THE FUND OR FOR AMOUNT
TITLE OF CLASS AUTHORIZED ITS ACCOUNT OUTSTANDING
Common shares................. Unlimited 0 46,779,490
S-7
USE OF PROCEEDS
Unless otherwise specified in this prospectus supplement, the Fund currently
intends to use net proceeds from the sale of the Common Shares in accordance
with its investment objective and policies, or use such proceeds for other
general corporate purposes. Pending any such use, the proceeds may be invested
in cash, cash equivalents or other securities.
RISKS
Investing in the Common Shares involves risk, including the risk that you may
receive little or no return on your investment or even that you may lose part or
all of your investment. Therefore, before investing in the Common Shares you
should consider carefully the risk factors described in the accompanying
prospectus beginning on page 46. Such factors could affect actual results and
cause results to differ materially from those expressed or implied in any
forward-looking statements made by the Fund or on the Fund's behalf. Additional
risks and uncertainties not currently known to the Fund or that the Fund
currently views as immaterial may also affect the Fund's business operations.
PLAN OF DISTRIBUTION
Under the sales agreement among the Fund, First Trust Advisors, Energy Income
Partners and JonesTrading, upon written instructions from the Fund, JonesTrading
will use its commercially reasonable efforts consistent with its sales and
trading practices to sell, as the Fund's agent, the Common Shares under the
terms and subject to the conditions set forth in the sales agreement.
JonesTrading's sales efforts will continue until the Fund instructs JonesTrading
to suspend sales. The Fund will instruct JonesTrading as to the amount of Common
Shares to be sold by JonesTrading. The Fund may instruct JonesTrading not to
sell Common Shares if the sales cannot be effected at or above the price
designated by the Fund in any instruction. The Fund or JonesTrading may suspend
the offering of Common Shares upon proper notice and subject to other
conditions.
JonesTrading will provide written confirmation to the Fund not later than the
opening of the trading day on the NYSE following the trading day on which Common
Shares are sold under the sales agreement. Each confirmation will include the
number of shares sold on the preceding day, the net proceeds to the Fund and the
compensation payable by the Fund to JonesTrading in connection with the sales.
The Fund will pay JonesTrading commissions for its services in acting as
agent in the sale of Common Shares. JonesTrading will be entitled to
compensation of up to 200 basis points of the gross sales price per share of any
Common Shares sold under the sales agreement, with the exact amount of such
compensation to be mutually agreed upon by the Fund and JonesTrading from time
to time. There is no guarantee that there will be any additional sales of the
Common Shares pursuant to this prospectus supplement and the accompanying
prospectus. Actual sales, if any, of the Common Shares under this prospectus
supplement and the accompanying prospectus may be greater or less than the price
set forth in this paragraph, depending on the market price of our Common Shares
at the time of any such sale. As of February 15, 2018, the Fund has sold in this
offering an aggregate of 914,321 Common Shares, representing net proceeds to the
Fund of $13,790,654, after payment of commissions of $139,626 in the aggregate.
Assuming 3,685,679 of the remaining Common Shares offered hereby are sold at a
market price of $14.69 per share (the last reported sale price for our Common
Shares on the NYSE on February 15, 2018), the Fund estimates that the total
expenses for the offering, excluding compensation payable to JonesTrading under
the terms of the sales agreement, would be approximately $133,750. This estimate
is inclusive of up to (i) $20,000 in reasonable fees and expenses of counsel for
JonesTrading in connection with the commencement of the "at the market"
offering, including the preparation and execution of the sales agreement, and
(ii) $10,000 in reasonable fees and expenses of counsel for JonesTrading in each
annual period following the date of the sales agreement, subject to
reimbursement by JonesTrading to the Fund to the extent aggregate proceeds of
the Common Shares sold under the sales agreement equal or exceed $25 million.
Settlement for sales of Common Shares will occur on the second trading day
following the date on which such sales are made, or on some other date that is
agreed upon by the Fund and JonesTrading in connection with a particular
transaction, in return for payment of the net proceeds to the Fund. There is no
arrangement for funds to be received in an escrow, trust or similar arrangement.
In connection with the sale of the Common Shares on our behalf, JonesTrading
may, and will with respect to sales effected in an "at the market" offering, be
deemed to be an "underwriter" within the meaning of the 1933 Act, and the
S-8
compensation of JonesTrading may be deemed to be underwriting commissions or
discounts. The Fund and the Advisor have agreed to provide indemnification and
contribution to JonesTrading against certain civil liabilities, including
liabilities under the 1933 Act.
The offering of the Common Shares pursuant to the sales agreement will
terminate upon the earlier of (1) the sale of all Common Shares subject the
sales agreement or (2) termination of the sales agreement. The sales agreement
may be terminated by the Fund in its sole discretion at any time by giving
notice to JonesTrading. In addition, JonesTrading may terminate the sales
agreement under the circumstances specified in the sales agreement and in its
sole discretion at any time following a period of 12 months from the date of the
sales agreement by giving notice to us.
The principal business address of JonesTrading is 757 Third Avenue, 23rd
Floor, New York, New York 10017.
LEGAL MATTERS
Certain legal matters in connection with the Common Shares will be passed
upon for the Fund by Chapman and Cutler LLP, Chicago, Illinois. Chapman and
Cutler LLP may rely as to certain matters of Massachusetts law on the opinion of
Morgan, Lewis & Bockius LLP.
EXPERTS
The financial statements and financial highlights in the accompanying SAI
have been audited by Deloitte & Touche LLP, an independent registered public
accounting firm, as stated in their report appearing herein and elsewhere in the
Registration Statement. Such financial statements and financial highlights are
included in reliance upon the report of such firm given upon their authority as
experts in accounting and auditing.
AVAILABLE INFORMATION
The Fund is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and the 1940 Act and is
required to file reports, including annual and semi-annual reports, proxy
statements and other information with the SEC. The Fund's most recent
shareholder report filed with the SEC is for the fiscal year ended October 31,
2017. These documents are available on the SEC's IDEA system and can be
inspected and copied for a fee at the SEC's public reference room, 100 F Street,
N.E., Room 1580, Washington, D.C. 20549. Additional information about the
operation of the public reference room facilities may be obtained by calling the
SEC at (202) 551-5850.
This prospectus supplement and the accompanying prospectus do not contain all
of the information in the Registration Statement, including amendments,
exhibits, and schedules. Statements in this prospectus supplement and the
accompanying prospectus about the contents of any contract or other document are
not necessarily complete and in each instance reference is made to the copy of
the contract or other document filed as an exhibit to the Registration
Statement, each such statement being qualified in all respects by this
reference.
Additional information about the Fund can be found in the Registration
Statement (including amendments, exhibits, and schedules). The SEC maintains a
web site (https://www.sec.gov) that contains the Registration Statement, other
documents incorporated by reference, and other information the Fund has filed
electronically with the SEC, including proxy statements and reports filed under
the Exchange Act.
S-9
BASE PROSPECTUS
FIRST TRUST MLP AND ENERGY INCOME FUND
UP TO 13,600,000 COMMON SHARES
--------------------------------------------------------------------------------
The Fund. First Trust MLP and Energy Income Fund (the "Fund") is a
non-diversified, closed-end management investment company which commenced
operations in November 2012.
Investment Objective. The Fund's investment objective is to seek a high level of
total return with an emphasis on current distributions paid to common
shareholders. There can be no assurance that the Fund will meet its investment
objective.
Investment Strategy. The Fund seeks to provide its common shareholders with a
vehicle to invest in a portfolio of cash- generating securities, with a focus on
investing in publicly traded master limited partnerships ("MLPs"), MLP-related
entities and other companies in the energy sector and energy utility industries.
Under normal market conditions, the Fund invests at least 85% of its Managed
Assets (as defined below) in equity and debt securities of MLPs, MLP-related
entities and other energy sector and energy utility companies that the Fund's
Sub-Advisor (as defined below) believes offer opportunities for growth and
income. The Fund considers investments in "MLP related entities" to include
investments that offer economic exposure to publicly traded MLPs and private
investments that have MLP characteristics, but are not publicly traded. To
generate additional income, the Fund may write (or sell) covered call options on
up to 35% of its Managed Assets. See "The Fund's Investments--Investment
Objective and Policies."
"Managed Assets" means the average daily gross asset value of the Fund (which
includes assets attributable to the Fund's preferred shares of beneficial
interest ("Preferred Shares"), if any, and the principal amount of any
borrowings), minus the sum of the Fund's accrued and unpaid dividends on any
outstanding Preferred Shares and accrued liabilities (other than the principal
amount of any borrowings of money incurred or of commercial paper or notes
issued by the Fund). For purposes of determining Managed Assets, the liquidation
preference of the Preferred Shares is not treated as a liability.
The Fund may offer, on an immediate, continuous or delayed basis, up to
13,600,000 of the Fund's common shares of beneficial interest (the "common
shares") in one or more offerings. The Fund may offer its common shares in
amounts, at prices and on terms set forth in a prospectus supplement to this
prospectus. See "Description of Shares" beginning on page 71. You should read
this prospectus and the related prospectus supplement carefully before you
decide to invest in any of the common shares.
The Fund may offer the common shares directly to one or more purchasers, through
agents that the Fund or the purchasers designate from time to time, or to or
through underwriters or dealers. The prospectus supplement relating to the
particular offering will identify any agents or underwriters involved in the
sale of the common shares, and will set forth any applicable purchase price,
fee, commission or discount arrangement between the Fund and such agents or
underwriters or among the underwriters or the basis upon which such amount may
be calculated. For more information about the manner in which the Fund may offer
the common shares, see "Plan of Distribution." The common shares may not be sold
through agents, underwriters or dealers without delivery of a prospectus
supplement.
The Fund's currently outstanding common shares are, and the common shares
offered in this prospectus will be, subject to notice of issuance, listed on the
New York Stock Exchange ("NYSE") under the trading or "ticker" symbol "FEI." The
net asset value of the Fund's common shares on February 15, 2018 was $14.10 per
common share, and the last sale price of the common shares on the NYSE on such
date was $14.69.
Investing in the Fund's common shares involves certain risks, including those
described in the "Risks" section beginning on page 46 of this prospectus. You
could lose some or all of your investment. Common shares of closed-end
investment companies, like the Fund, frequently trade at a discount from their
net asset value. If the Fund's common shares trade at a discount to net asset
value, the risk of loss may increase for purchasers in an offering under this
prospectus, especially for those investors who expect to sell their common
shares in a relatively short period after purchasing shares in such an offering.
See "Risks--Market Discount from Net Asset Value."
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
Tax Status. Due to the nature of the Fund's MLP investments, under current law,
the Fund is not eligible to elect to be treated as a "regulated investment
company" under the Internal Revenue Code of 1986, as amended, as is common for
most investment companies. Rather, the Fund has elected to be treated as a
regular corporation for federal income tax purposes and, as such, unlike most
investment companies, it is subject to corporate income tax to the extent the
Fund recognizes taxable income. See "Tax Matters."
Investment Advisor and Sub-Advisor. First Trust Advisors L.P. ("First Trust
Advisors" or the "Advisor") is the Fund's investment adviser and Energy Income
Partners, LLC ("Energy Income Partners" or the "Sub-Advisor") is the Fund's
sub-adviser. See "Management of the Fund" in this prospectus and "Investment
Advisor" and "Sub-Advisor" in the Fund's Statement of Additional Information
(the "SAI").
Distributions. The Fund intends to pay monthly distributions to common
shareholders out of legally available funds. Distributions, if any, are
determined by the Fund's Board of Trustees. There is no assurance the Fund will
continue to pay regular distributions or that it will do so at a particular
rate. See "Distributions" and "Tax Matters."
Leverage. The Fund is currently engaged in and expects to continue to engage in
the use of leverage to make additional investments to seek to enhance the level
of its current distributions. The Fund may utilize leverage through borrowings
and/or through the issuance of commercial paper or notes in an amount up to
33-1/3% of its total assets or may issue Preferred Shares in an amount up to 50%
of its total assets. As of October 31, 2017, the Fund utilized leverage through
the use of borrowings under a credit facility representing approximately 25.94%
of Managed Assets. The cost associated with any issuance and use of leverage is
borne by the holders of the Fund's common shares. Through the use of leverage,
the Fund seeks to obtain a higher return for common shareholders than if the
Fund did not use leverage. The use of leverage is a speculative technique and
investors should note that there are special risks and costs associated with the
leveraging of the Fund's common shares. There can be no assurance that a
leveraging strategy will be successful during any period in which it is
employed. See "Leverage Program," "Risks--Leverage Risk" and "Description of
Shares."
You should read this prospectus and the applicable prospectus supplement, which
contain important information about the Fund, before deciding whether to invest
in the common shares of the Fund, and retain them for future reference. This
prospectus, together with any prospectus supplement, sets forth concisely the
information about the Fund that a prospective investor ought to know before
investing. The SAI, dated March 6, 2018 (as it may be supplemented), containing
additional information about the Fund, has been filed with the Securities and
Exchange Commission (the "SEC") and is incorporated by reference in its entirety
into this prospectus. You may request a free copy of the SAI, the table of
contents of which is on page 80 of this prospectus, annual and semi-annual
reports to shareholders, and other information about the Fund, and make
shareholder inquiries by calling (800) 988-5891; by writing to the Fund at 120
East Liberty Drive, Wheaton, Illinois 60187; or from the Fund's or Advisor's
website (https://www.ftportfolios.com). Please note that the information
contained in the Fund's, Advisor's or Sub-Advisor's website, whether currently
posted or posted in the future, is not part of this prospectus or the documents
incorporated by reference in this prospectus. You also may obtain a copy of the
SAI (and other information regarding the Fund) from the SEC's website
(http://www.sec.gov).
The Fund's common shares do not represent a deposit or obligation of, and are
not guaranteed or endorsed by, any bank or other insured depository institution,
and are not federally insured by the Federal Deposit Insurance Corporation, the
Federal Reserve Board or any other government agency.
PROSPECTUS DATED MARCH 6, 2018
ii
TABLE OF CONTENTS
PAGE
Prospectus Summary.......................................................... 1
Summary of Fund Expenses.................................................... 31
Financial Highlights........................................................ 33
Market and Net Asset Value Information...................................... 34
The Fund.................................................................... 35
Use of Proceeds............................................................. 35
The Fund's Investments...................................................... 35
Leverage Program............................................................ 43
Risks....................................................................... 46
Management of the Fund...................................................... 65
Net Asset Value............................................................. 67
Distributions............................................................... 68
Dividend Reinvestment Plan.................................................. 69
Plan of Distribution........................................................ 69
Description of Shares....................................................... 71
Certain Provisions in the Declaration of Trust and By-Laws.................. 73
Structure of the Fund; Common Share Repurchases and Change in
Fund Structure.......................................................... 74
Tax Matters................................................................. 75
Custodian, Administrator, Fund Accountant and Transfer Agent................ 79
Legal Opinions.............................................................. 79
Table of Contents for the Statement of Additional Information............... 80
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR INCORPORATED BY REFERENCE
IN THIS PROSPECTUS AND THE APPLICABLE PROSPECTUS SUPPLEMENT. NEITHER THE FUND
NOR ANY UNDERWRITERS HAVE AUTHORIZED ANY OTHER PERSON TO PROVIDE YOU WITH
DIFFERENT INFORMATION. IF ANYONE PROVIDES YOU WITH DIFFERENT OR INCONSISTENT
INFORMATION, YOU SHOULD NOT RELY ON IT. NEITHER THE FUND NOR ANY UNDERWRITERS
ARE MAKING AN OFFER TO SELL THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER
OR SALE IS NOT PERMITTED.
iii
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus, any accompanying prospectus supplement and the SAI, including
documents incorporated by reference, contain "forward-looking statements."
Forward- looking statements can be identified by the words "may," "will,"
"intend," "expect," "believe," "estimate," "continue," "plan," "anticipate," and
similar terms and the negative of such terms. By their nature, all
forward-looking statements involve risks and uncertainties, and actual results
could differ materially from those contemplated by the forward-looking
statements. Several factors that could materially affect the Fund's actual
results are the performance of the portfolio of securities held by the Fund, the
conditions in the U.S. and international financial, energy, energy utility, and
other markets, the price at which the Fund's common shares trade in the public
markets and other factors which may be discussed in this prospectus and in the
Fund's periodic filings with the SEC.
Although the Fund believes the expectations expressed in these forward-looking
statements are reasonable, actual results could differ materially from those
projected or assumed in these forward-looking statements. The Fund's future
financial condition and results of operations, as well as any forward-looking
statements, are subject to change and are subject to inherent risks and
uncertainties, such as those disclosed in the "Risks" section of this
prospectus. All forward-looking statements contained or incorporated by
reference in this prospectus or the accompanying prospectus supplement are made
as of the date of this prospectus or the accompanying prospectus supplement, as
the case may be. We do not intend, and we undertake no obligation, to update any
forward-looking statement. The forward-looking statements contained in this
prospectus and any accompanying prospectus supplement are excluded from the safe
harbor protection provided by Section 27A of the Securities Act of 1933, as
amended.
Currently known risk factors that could cause actual results to differ
materially from the Fund's expectations include, but are not limited to, the
factors described in the "Risks" section of this prospectus. The Fund urges you
to review carefully that section for a more detailed discussion of the risks of
an investment in the Fund's securities.
iv
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus. This
summary does not contain all of the information that you should consider before
investing in the Fund's common shares. You should carefully read the entire
prospectus, any related prospectus supplement and the Fund's Statement of
Additional Information ("SAI"), including the documents incorporated by
reference. In particular, you should carefully read the section entitled "Risks"
in this prospectus.
THE FUND AND
INVESTMENT
OBJECTIVE ........... First Trust MLP and Energy Income Fund (the "Fund") is a
non-diversified, closed-end management investment
company. The Fund's investment objective is to seek a
high level of total return with an emphasis on current
distributions paid to common shareholders. For purposes
of the Fund's investment objective, total return includes
capital appreciation of, and all distributions received
from, securities in which the Fund invests regardless of
the tax character of the distributions. There can be no
assurance that the Fund's investment objective will be
achieved.
The Fund seeks to provide its common shareholders with a
vehicle to invest in a portfolio of cash-generating
securities, with a focus on investing in publicly traded
master limited partnerships ("MLPs") and MLP-related
entities (as defined below) in the energy sector and
energy utility industries (each as defined below) that
are weighted towards non-cyclical, fee-for-service
revenues. The Fund considers investments in "MLP-related
entities" to include investments that offer economic
exposure to publicly traded MLPs and private investments
that have MLP characteristics, but are not publicly
traded. These investments may take the form of securities
of entities holding primarily general partner or managing
member interests in MLPs and securities that represent
indirect investments in MLPs, including I-Shares, which
represent an ownership interest of an MLP issued by an
affiliated party, and collective investment vehicles
(i.e., exchange-traded funds) that primarily hold MLP
interests. The Fund considers investments in the "energy
sector" to include companies that derive a majority of
their revenues or operating income from transporting,
processing, storing, distributing, marketing, exploring,
developing, managing or producing natural gas, natural
gas liquids ("NGLs") (including propane), crude oil,
refined petroleum products, coal or electricity, or from
supplying energy-related products and services, or any
such other companies within the energy sector as
classified under the Global Industry Classification
Standards developed by MSCI, Inc. and Standard & Poor's
("GICS"). The Fund considers investments in "energy
utility" to include companies that derive a majority of
their revenues or operating income from providing
products, services or equipment for the generation,
transmission, distribution or sale of electricity or gas
and such other companies within the electric, gas,
independent power and renewable electricity producers and
multi-utilities industries as classified under GICS.
The Fund commenced operations in November 2012. The Fund
completed its initial public offering of common shares in
November 2012, raising approximately $866 million in
equity after the payment of offering expenses (including
the exercise of the overallotment option). As of October
31, 2017, the Fund had 46,637,670 common shares
outstanding and net assets applicable to common shares of
$672,372,827. The common shares of beneficial interest
offered by this prospectus are called "Common Shares" and
the holders of Common Shares are called "Common
Shareholders" in this prospectus. As used in this
prospectus, unless the context requires otherwise,
"common shares" refers to the Fund's common shares of
beneficial interest currently outstanding as well as
those Common Shares offered by this prospectus and the
holders of common shares are called "common
shareholders." See "The Fund."
THE OFFERING ........ The Fund may offer, on an immediate, continuous or
delayed basis, up to 13,600,000 Common Shares on terms to
be determined at the time of the offering. The Common
Shares will be offered at prices and on terms to be set
forth in one or more prospectus supplements to this
prospectus. Offerings of the Common Shares will be
subject to the provisions of the Investment Company Act
of 1940, as amended (the "1940 Act"), which generally
require that the public offering price of common shares
of a closed-end investment company (exclusive of
distribution commissions and discounts) must equal or
exceed the net asset value per share of the company's
common stock (calculated within 48 hours of pricing),
1
absent shareholder approval or under certain other
circumstances. See "Description of Shares."
The Fund may offer the Common Shares directly to one or
more purchasers, through agents that the Fund or the
purchasers designate from time to time, or to or through
underwriters or dealers. The prospectus supplement
relating to the offering will identify any agents or
underwriters involved in the sale of the Common Shares,
and will set forth any applicable purchase price, fee,
commission or discount arrangement between the Fund and
such agents or underwriters or among underwriters or the
basis upon which such amount may be calculated. See "Plan
of Distribution." The Common Shares may not be sold
through agents, underwriters or dealers without delivery
of a prospectus supplement describing the method and
terms of the offering of the Common Shares.
On June 19, 2017, the Fund entered into a sales agreement
with the Advisor, Sub-Advisor, and JonesTrading
Institutional Services LLC pursuant to which the Fund may
offer and sell up to 4,600,000 Common Shares through
JonesTrading Institutional Services LLC as its agent. As
of October 31, 2017, 853,466 Common Shares have been sold
under this sales agreement.
USE OF PROCEEDS ..... Unless otherwise specified in a prospectus supplement,
the Fund expects to use the net proceeds from the sale
of the Common Shares primarily to invest in accordance
with its investment objective and policies, or use such
proceeds for other general corporate purposes within
approximately three months of receipt of such proceeds.
WHO MAY WANT
TO INVEST ........... Investors should consider their financial situations and
needs, other investments, investment goals and
experience, time horizons, liquidity needs and risk
tolerance before investing in the Fund. An investment in
the Fund is not appropriate for all investors, and the
Fund is not intended to be a complete investment program.
The Fund is designed as a long-term investment and not as
a trading vehicle. The Fund may be an appropriate
investment for long-term investors who are seeking:
o a high level of total return with an emphasis on
current distributions;
o a vehicle to invest in a portfolio containing
publicly traded MLPs, pipeline companies, energy
utility and Canadian energy infrastructure
companies;
o a structure that allows for tax filing
simplification: one Form 1099;
o a management team with extensive experience and
resources in this asset class;
o an anticipated monthly distribution to shareholders;
and
o exchange-traded liquidity.
Investing in the Common Shares involves certain risks,
including those described in the "Risks" section
beginning on page 46 of this prospectus.
The Fund is currently engaged in, and expects to continue
to engage in, the use of leverage to seek to enhance the
level of its current distributions to common
shareholders. See "Risks--Leverage Risk."
INVESTMENT ADVISOR
AND SUB-ADVISOR...... First Trust Advisors L.P. ("First Trust Advisors" or the
"Advisor") is the Fund's investment adviser and is
responsible for supervising the Fund's Sub-Advisor (as
defined below), monitoring the Fund's investment
portfolio, managing the Fund's business affairs and
providing certain clerical and bookkeeping and other
administrative services. The Advisor, in consultation
with the Sub-Advisor, will also be responsible for
determining the Fund's overall investment strategy and
overseeing its implementation. Energy Income Partners,
LLC ("Energy Income Partners" or the "Sub-Advisor") is
the Fund's sub-adviser and is primarily responsible for
the day-to-day supervision and investment strategy of,
and making investment decisions for, the Fund.
First Trust Advisors, a registered investment adviser, is
an Illinois limited partnership formed in 1991. First
Trust Advisors serves as investment adviser or portfolio
supervisor to investment portfolios with approximately
$117.3 billion in assets which it managed or supervised
as of November 30, 2017.
2
Energy Income Partners, a registered investment adviser,
is a Delaware limited liability company which provides
professional asset management services in the area of
energy- related MLPs, and other high-payout securities.
Founded in 2003, Energy Income Partners serves as
investment adviser to investment portfolios with
approximately $6.0 billion of assets which it managed as
of November 30, 2017.
INVESTMENT
OPPORTUNITIES ....... The Sub-Advisor believes there is a need to expand and
rebuild energy and energy utility infrastructure which
coincides with investors' demand for equity income not
tied to economic or financial cycles. The Sub-Advisor
believes there are two characteristics that make energy
infrastructure assets a good match for investors who
desire steady income: (i) certain investments in energy
sector companies are characterized by non-cyclical
fee-for-service revenues, and (ii) the low sustaining
capital requirements associated with pipelines, storage
and other infrastructure. Much of the opportunities in
higher payout energy infrastructure are in the form of
MLPs and other high payout energy sector companies (i.e.,
companies with a high payout ratio as described below)
that provide investors with an attractive alternative to
fixed income with the opportunity for growth. See
"--Investment Philosophy and Process."
INVESTMENT PHILOSOPHY
AND PROCESS.......... Investment Philosophy. The Sub-Advisor believes the
non-cyclical assets that best support a high-payout ratio
are those with steady, fee-for-service businesses with
relatively low sustaining capital obligations. In the
energy sector and energy utility industries, such
fee-for-service assets are comprised of interstate
pipelines, intrastate pipelines, power generation assets,
storage and terminal facilities and regulated power
transmission and distribution assets. By contrast, the
Sub-Advisor seeks to limit the cyclical energy exposure
of the portfolio. The Sub-Advisor believes portfolio
investments in oil and gas exploration, development and
production are less well suited for the Fund because the
cash flows from these investments are cyclical in nature,
being driven by commodity prices, and because oil and gas
assets are resource assets that diminish in value over
time due to depletion, extraction or removal.
The Sub-Advisor evaluates the dividend payout ratio of
companies in which it may invest, which provides how much
money a company returns to its shareholders compared to
how much money such company retains in order to reinvest
in its growth, pay off its debt and/or build its cash
reserves. A high payout ratio indicates when a
significant portion of dividends or distributions are
paid by a company to its shareholders relative to such
company's after tax free cash flow or net income.
The Sub-Advisor believes a professionally managed
portfolio of consistently high dividend paying MLPs,
MLP-related entities and other energy sector and energy
utility companies in non-cyclical segments offer an
attractive balance of growth and income. The Sub-Advisor
also believes the use of rigorous investment research and
analytical tools to identify appropriate non-cyclical
energy sector and energy utility company investments
provides a value added service to the individual investor
making an investment in the Common Shares of the Fund.
See "The Fund's Investments--Investment Philosophy and
Process--Capital Discipline."
Investment Process. The Sub-Advisor utilizes a three step
investment process for the Fund. The first step is for
the Sub-Advisor to define a universe of companies in the
energy sector and energy utility industries that have
high dividend payout ratios and/or are involved in the
energy infrastructure business. In general, the
Sub-Advisor seeks energy sector and energy utility
companies weighted towards:
o regulated monopoly or monopoly-like assets (i.e.,
companies that own unique assets that provide for a
sustainable competitive advantage due to control of
location);
o non-cyclical cash flows (i.e., companies that have
most or all of their assets in businesses whose
revenues tend not to fluctuate with commodity prices
and tend to be less sensitive to changes in the
economic cycle);
3
o fee-for-service revenues (i.e., companies that have
most or all of their assets in businesses whose
revenues are not tied to changes in commodity prices
and/or volumes actually shipped through or stored in
their facilities); and
o cost escalators (i.e., companies that have most or
all of their assets in businesses whose revenues
and/or margins can be adjusted to compensate for
changes in the company's costs).
The second step is for the Sub-Advisor to identify, among
this universe, companies that pass a quality threshold
established by the Sub-Advisor. The Sub-Advisor utilizes
both quantitative aspects to measuring quality, such as
the stability of cash flows, returns on invested capital,
financial leverage and earnings coverage of dividends, as
well as qualitative aspects, such as the confidence that
the Sub-Advisor has in the company's management team and
the quality of its assets. In its assessment of quality,
the Sub-Advisor will not invest in a company that fails
to qualify on quality criteria, even in instances where
it believes the company has a low valuation. The third
step of the Sub-Advisor's investment process is portfolio
construction, where the Sub-Advisor determines the
portfolio weighting of companies that have made it
through the first two steps. As part of this portfolio
construction, the Sub-Advisor balances each position's
expected rate of return against risks, limitations on
position sizes and Fund portfolio limitations.
INVESTMENT
POLICIES ............ The Fund concentrates its investments in the following
group of industries that are part of the energy sector:
transporting, processing, storing, distributing,
marketing, exploring, developing, managing and producing
natural gas, NGLs (including propane), crude oil, refined
petroleum products, coal and electricity, and supplying
products and services in support of pipelines, power
transmission, petroleum and natural gas production,
transportation and storage.
The Fund has adopted the following non-fundamental
investment policies:
o Under normal market conditions, the Fund invests at
least 85% of its Managed Assets (as defined below)
in equity and debt securities of MLPs, MLP-related
entities and other energy sector and energy utility
companies that the Fund's Sub-Advisor believes offer
opportunities for growth and income. See "The Fund's
Investments--Portfolio Composition" for a further
discussion of the Fund's principal investments.
o The Fund may invest up to 20% of its Managed Assets
in unregistered or otherwise restricted securities.
The term "restricted securities" refers to
securities that have not been registered under the
Securities Act of 1933, as amended (the "1933 Act"),
and continue to be subject to restrictions on
resale, securities held by control persons of the
issuer and securities that are subject to
contractual restrictions on their resale. The types
of unregistered or otherwise restricted securities
that the Fund may purchase consist of MLP common
units, MLP subordinated units and securities of
public and private energy sector and energy utility
companies. See "Special Risk
Considerations--Restricted Securities" below.
o The Fund may invest up to 20% of its Managed Assets
in debt securities of MLPs, MLP-related entities and
other energy sector and energy utility companies,
including certain below investment grade securities,
which are commonly referred to as "high yield" or
"junk" bonds. Below investment grade debt securities
will be rated at least "B3" by Moody's Investors
Service, Inc. ("Moody's") and at least "B-" by
Standard & Poor's Ratings Services ("S&P") at the
time of purchase, or comparably rated by another
nationally recognized statistical rating
organization ("NRSRO") or, if unrated, determined to
be of comparable quality by the Sub-Advisor. Below
investment grade securities are considered
speculative with respect to an issuer's capacity to
pay interest and repay principal. See "Special Risk
Considerations-- Below Investment Grade Securities
Risk."
o The Fund will not invest more than 15% of its
Managed Assets in any single issuer.
4
o The Fund will not engage in short sales, except to
the extent the Fund engages in derivative
investments to seek to hedge against interest rate
risk in connection with the Fund's use of leverage
or market risks associated with the Fund's
portfolio.
o The Fund may invest up to 30% of its Managed Assets
in non-U.S. securities and may hedge the currency
risk of the non-U.S. securities using derivative
instruments. Non-U.S. securities are securities
issued or guaranteed by companies organized under
the laws of countries other than the United States
and securities issued or guaranteed by foreign
governments, their agencies or instrumentalities and
supra-national governmental entities. See "Special
Risk Considerations--Non-U.S. Securities Risk" below
and "Other Investment Policies and
Techniques--Strategic Transactions" in the SAI.
"Managed Assets" means the average daily gross asset
value of the Fund (which includes assets attributable to
the Fund's preferred shares of beneficial interest
("Preferred Shares"), if any, and the principal amount of
any borrowings), minus the sum of the Fund's accrued and
unpaid dividends on any outstanding Preferred Shares and
accrued liabilities (other than the principal amount of
any borrowings of money incurred or of commercial paper
or notes issued by the Fund). For purposes of determining
Managed Assets, the liquidation preference of the
Preferred Shares, if any, is not treated as a liability.
To generate additional income, the Fund may write (or
sell) covered call options on up to 35% of its Managed
Assets.
Unless otherwise stated, all investment restrictions
apply at the time of purchase and the Fund will not be
required to reduce a position due solely to market value
fluctuations.
The types of MLPs in which the Fund invests historically
have made cash distributions to limited partners or
members that exceed the amount of taxable income
allocable to limited partners or members, due to a
variety of factors, including significant non-cash
deductions, such as depreciation and depletion. If cash
distributions from an MLP exceed the taxable income
reported in a particular tax year, a portion of the
excess cash distribution would not be treated as income
to the Fund in that tax year but would rather be treated
as a return of capital for federal income tax purposes to
the extent of the Fund's basis in its MLP units. The
Fund's tax basis in its MLP units is the amount paid for
the units, increased by the Fund's allocable share of net
income and gains and the MLP's debt, if any, and capital
contributions to the MLP, and decreased for any
distributions received by the Fund, by the Fund's
allocable share of net losses and by reductions in the
Fund's allocable share of the MLP's debt, if any. Thus,
although cash distributions in excess of taxable income
and net tax losses may create a temporary economic
benefit to the Fund, they will increase the amount of
gain (or decrease the amount of loss) on the sale of an
interest in an MLP. The Fund expects to distribute cash
in excess of its earnings and profits to common
shareholders, which may be treated as a return of capital
to the extent of the common shareholders' basis in the
common shares. See "Distributions" and "Tax Matters."
The Fund's investment objective and the investment
restrictions listed in the SAI are considered fundamental
and may not be changed without approval by holders of a
"majority of the outstanding voting securities" of the
Fund, as defined in the 1940 Act, which includes common
shares and Preferred Shares, if any, voting together as a
single class, and the holders of the outstanding
Preferred Shares, if any, voting as a single class. The
remainder of the Fund's investment policies, including
its investment strategy, are considered non-fundamental
and may be changed by the Board of Trustees of the Fund
(the "Board of Trustees") without the approval of the
holders of a "majority of the outstanding voting
securities" of the Fund provided that the holders of the
voting securities of the Fund receive at least 60 days
prior notice of any change. See "The Fund's Investments"
and "Risks" in this prospectus and "Investment Policies
and Techniques" in the Fund's SAI.
DISTRIBUTIONS ....... The Fund pays out substantially all of its distributable
cash flow ("DCF"), generally consisting of (i) cash and
paid in kind distributions from MLPs or their affiliates,
dividends from common stocks, interest from debt
instruments and income from other investments held by the
5
Fund less (ii) current or accrued operating expenses of
the Fund, including taxes on Fund taxable income and
leverage costs. Dividends to common shareholders relating
to in kind dividends or distributions received by the
Fund on its investments, including I-Shares will be paid
in cash or additional common shares of the Fund. See "The
Fund's Investments--Portfolio Composition--MLP I-Shares."
Unless a shareholder elects to receive distributions in
cash, distributions will be used to purchase additional
common shares of the Fund. See "Dividend Reinvestment
Plan."
Due to the tax treatment under current law of cash
distributions in excess of income made by MLPs in which
the Fund may invest, a portion of distributions the Fund
anticipates making to common shareholders may consist of
a return of capital and, depending on market conditions
and tax circumstances, in certain periods, such return of
capital may represent a significant portion of the Fund's
distributions. To the extent that distributions exceed
the Fund's earnings and profits, such distributions are
generally not treated as taxable income for the investor.
Instead, the Fund's common shareholders will experience a
reduction in the basis of their shares, which may
increase the capital gain, or reduce capital loss,
realized upon the sale of such shares. Section 19(a) of
the 1940 Act and Rule 19a-1 thereunder requires the Fund
to provide a written statement accompanying payment from
any source other than income that adequately discloses
the source or sources of such payment. Thus, if the
Fund's capital was the source of a distribution and the
payment amounted to a return of capital, the Fund would
be required to provide a written notice to that effect. A
"return of capital" represents a return on a
shareholder's original investment in the Fund's common
shares, and should not be confused with a dividend from
profits and earnings. Upon the sale of common shares,
common shareholders generally will recognize capital gain
or loss measured by the difference between the sale
proceeds received by the common shareholder and the
shareholder's federal income tax basis in common shares
sold, as adjusted to reflect return of capital.
Accordingly, common shareholders should carefully read
any written disclosure accompanying a distribution and
should not assume that the source of payment is the
Fund's income. See "Tax Matters."
Under normal market conditions, the Fund currently makes,
and intends to continue to make, payment of substantially
all DCF to common shareholders on an annual basis.
Subsequent distributions are paid each month out of DCF,
if any. There is no assurance that the Fund will continue
to make regular distributions.
HEDGING AND
STRATEGIC
TRANSACTIONS ........ The Fund may, but is not required to, use various hedging
and strategic transactions to seek to reduce interest
rate risks arising from any use of leverage, to
facilitate portfolio management and to mitigate risks,
including, without limitation, interest rate, currency
and credit risks and equity security price risk.
Collectively, these transactions referred to above are
"Strategic Transactions" and include the use of
derivative instruments such as those described below.
Certain Strategic Transactions may be considered a form
of economic leverage on the Fund's portfolio and may be
subject to the risks associated with the use of leverage.
See "Risks--Leverage Risk" below.
The Fund may write (or sell) covered call options on up
to 35% of its Managed Assets. Such call options give the
option holders the right, but not the obligation, to
purchase common equity at a specified price (the "strike
price") on one or more future dates (each, an "exercise
date"). The price of the option is determined from
trading activity in the broad options market, and
generally reflects the relationship between the market
price for the underlying common equity and the strike
price, as well as the time remaining until the expiration
date. The Fund will write call options only if they are
"covered." In the case of a call option on a common stock
or other security, the Fund considers an option to be
"covered" if the Fund owns the security underlying the
call. See "Risks--Covered Call Options Risk."
The Fund may utilize hedging techniques such as interest
rate swaps, caps, floors or collars or credit
transactions and credit default swaps (or any combination
thereof) to mitigate potential interest rate risk on a
portion of its leverage instruments. Such interest rate
and credit hedges would principally be used to protect
the Fund against higher costs on the Fund's leverage
instruments resulting from increases in short-term
6
interest rates. The Fund anticipates that the majority of
the Fund's interest rate hedges will be interest rate
swap contracts with financial institutions. In an
interest rate swap, the Fund exchanges with another party
their respective commitments to pay or receive interest
(e.g., an exchange of fixed rate payments for floating
rate payments). Interest rate swaps will allow the
Sub-Advisor to potentially manage the interest rate
portfolio of the Fund's portfolio. See "Risks--Interest
Rate Swaps Risk." The Fund currently intends to earmark
or segregate assets on the Funds records in the form of
cash, cash equivalents or liquid securities in an amount
equal to the notional value of the credit default swaps
of which it is the seller. If such assets are not fully
segregated by the Fund, the use of credit default swap
transactions could then be considered leverage for the
purposes of the 1940 Act.
The Fund also may enter into currency exchange
transactions to hedge the Fund's exposure to foreign
currency exchange rate risk to the extent the Fund
invests in non-U.S. dollar denominated securities of
non-U.S. issuers. The Fund's currency transactions, if
any, are limited to portfolio hedging involving portfolio
positions. Portfolio hedging is the use of a currency
forward contract with respect to a portfolio security
position denominated or quoted in a particular currency.
A currency forward contract is an agreement to purchase
or sell a specified currency at a specified future date
(or within a specified time period) and at a price set
(or determined pursuant to parameters provided) at the
time of the contract. Currency forward contracts are
usually entered into with banks, foreign exchange dealers
or broker-dealers, are not exchange- traded, and are
usually for less than one year, but may be renewed.
The Fund may purchase and sell other derivative
investments such as total return and equity swaps,
exchange-listed and over-the-counter put and call options
on currencies, securities, energy-related commodities,
equity, fixed-income and interest rate indices and other
financial instruments and purchase and sell financial
futures contracts and options thereon. The Fund also may
purchase derivative investments that combine features of
these instruments.
The Fund may seek to use Strategic Transactions as a
portfolio management or hedging technique to seek to
protect against possible adverse changes in the market
value of securities held in or to be purchased for the
Fund's portfolio, protect the value of the Fund's
portfolio, facilitate the sale of certain securities for
investment purposes, manage the effective interest rate
and currency exposure of the Fund, or establish positions
in the derivatives markets as a temporary substitute for
purchasing or selling particular securities. The market
value of the Fund's investments in these instruments and
transactions that increase or decrease the Fund's
exposure to energy sector MLPs, energy sector and energy
utility MLP-related entities and other energy sector and
energy utility companies, including investments in
derivatives, is counted towards the Fund's policy to
invest, under normal market conditions, 85% of its
Managed Assets in equity and debt securities of MLPs,
MLP-related entities and other energy sector and energy
utility companies. See "Risks--Derivatives Risk" and "The
Fund's Investments--Investment Practices--Strategic
Transactions" in this prospectus and "Additional
Information About the Fund's Investments and Investment
Risks--Strategic Transactions Risk" in the SAI.
TAX MATTERS ......... Fund Status. The Fund is taxed as a regular corporation
for federal income tax purposes and as such is obligated
to pay federal and applicable state, local and foreign
corporate taxes on its taxable income. This differs from
most investment companies, which elect to be treated as
"regulated investment companies" under the Internal
Revenue Code of 1986, as amended (the "Code"), in order
to avoid paying entity level income taxes. Under current
law, the Fund is not eligible to elect treatment as a
regulated investment company due to its investment of a
substantial portion of its Managed Assets in MLPs
invested in energy assets. As a result, the Fund is
obligated to pay taxes on its taxable income as opposed
to most other investment companies which are not so
obligated. Due to the entity-level income taxes payable
by the Fund, common shareholders of the Fund will likely
receive lower distributions than if they invested
directly in the same MLPs in which the Fund invests.
However, as discussed below, the Fund expects that a
portion of the distributions it receives from MLPs may be
treated as a return of capital. For purposes of computing
net asset value, the Fund accrues deferred income taxes
for its future tax liability associated with that portion
of MLP distributions considered to be a return of capital
as well as capital appreciation of its investments. The
Fund relies to some extent on information provided by
7
MLPs, which is usually not timely, to estimate deferred
tax liability for purposes of financial statement
reporting and determining the Fund's net asset value. In
addition, the Tax Cuts and Jobs Act has impacted the
determination of the Fund's net asset value as discussed
below in "Special Risk Considerations--Recent Market and
Economic Developments." From time to time the Fund will
modify its estimates and/or assumptions regarding its
deferred tax liability as new information becomes
available. The taxation of Fund distributions is
discussed further under "Tax Matters."
Fund Assets.
o Investments in MLPs. The Fund invests primarily in
MLPs and MLP-related entities. For purposes of this
prospectus, an MLP is a limited partnership or a
limited liability company that is treated as a
partnership for federal income tax purposes. If the
MLPs were recharacterized as corporations for
federal income tax purposes, the MLPs may themselves
be subject to tax, reducing the cash flow to the
Fund. In some instances, the character of the
distributions may change if the MLPs are
recharacterized. The benefit the Fund derives from
its investment in MLPs is largely dependent on MLPs
being treated as partnerships for federal income tax
purposes. As a partnership, an MLP generally has no
income tax liability on MLP qualified income at the
entity level. As a limited partner in the MLPs in
which it invests, the Fund is allocated its pro rata
share of income, gains, losses, deductions and
expenses from the MLPs. A significant portion of MLP
income has historically been offset by non-cash tax
deductions such as depreciation and depletion. The
Fund will incur a current tax liability on its
income allocation from an MLP not offset by tax
deductions. The Fund's tax basis in its MLP units
would be increased by the income allocated from an
MLP, and then reduced by all distributions from the
MLP (including any distributions in excess of
allocated income), which would either increase the
Fund's taxable gain or reduce the Fund's loss
recognized upon the sale of such MLP units. The MLPs
may have losses instead of income, which the Fund
may deduct to the extent of its outside basis in the
MLPs with the losses. Such allocations of losses
will currently reduce the Fund's basis in the MLPs,
increasing the Fund's gain or reducing the Fund's
loss upon the sale of the MLP units. The percentage
of an MLP's distribution which is offset by tax
deductions will fluctuate over time for various
reasons. A significant slowdown in acquisition or
investment activity by MLPs held by the Fund could
result in a reduction of accelerated depreciation or
other deductions generated by these activities,
which may result in increased current tax liability
to the Fund. A reduction in the percentage of income
offset by tax deductions or an increase in sales of
the Fund's MLP holdings that result in capital gains
will reduce that portion of the Fund's distribution
from an MLP treated as a return of capital and
increase that portion treated as income, and may
result in lower after-tax distributions to the
Fund's common shareholders.
o Investments in Other Securities. The Fund may also
invest in equity and debt securities of companies
that are organized and/or taxed as corporations.
Interest and dividend payments received by the Fund
with respect to such securities generally are
included in the Fund's corporate taxable income in
the year in which they are received, although the
Fund may qualify for the dividends-received
deduction with respect to dividends on certain of
the equity securities owned by the Fund.
o Limitations on Interest Deductions. After 2017, the
Fund may be subject to limitations on the amount of
interest deductions that it may take in each year.
Deductions for interest would be limited to 30
percent of a business's taxable income (before
interest, depreciation, and depletion). The
underlying MLP's may also be subject to a similar
limitation. The Fund intends to use leverage to make
its investments. See "Leverage Program." Because the
limitation on interest would be based upon income
before depletion, which is sometimes a significant
deduction allocated from MLPs, the significance of
the limitation is difficult to predict. However, it
is possible that the Fund will not be able to deduct
all of its interest expense in the year accrued. If
this occurs, the excess interest expense could be
8
carried forward to subsequent years, but the Fund's
tax in the year the expense is accrued could
increase.
Shareholder Tax Aspects.
o Current Distributions on Shares. Common shareholders
of the Fund hold common shares of beneficial
interest of a Massachusetts business trust which has
elected for federal income tax purposes to be taxed
as a corporation. There is a significant difference,
for federal income tax purposes, between owning
common shares of a taxable entity treated as a
corporation for federal income tax purposes (such as
the Fund) versus owning partnership interests in the
MLPs in which the Fund invests. Common shareholders
of the Fund will be subject to potential income tax
only if the Fund pays out distributions to common
shareholders. Depending on the nature of the
distribution made by the Fund, the tax character of
such distribution to common shareholders will vary.
Distributions made from current and accumulated
earnings and profits of the Fund will be taxable to
common shareholders as dividend income. Certain
qualified dividend income received by individual
shareholders would be taxed at long-term capital
gains rates, which reach a maximum of 23.8%
including a 3.8% tax on net investment income above
a certain threshold. Distributions that are in an
amount greater than the Fund's current and
accumulated earnings and profits will represent a
return of capital to the extent of a common
shareholder's basis in its common shares, and such
distributions would correspondingly reduce the
common shareholder's basis in its common shares. A
reduction in the common shareholder's basis would
potentially increase the common shareholder's gain
(or reduce the common shareholder's loss) recognized
upon the sale of the common shares. Additionally,
excess distributions that exceed a common
shareholder's tax basis in its common shares will
generally be taxed as gain. The past performance of
MLPs indicates that a portion of the Fund's
distributions to common shareholders will likely
represent a return of capital and, depending on
market conditions and tax circumstances, in certain
periods, such return of capital may represent a
significant portion of the Fund's distributions.
However, there can be no guarantee that the Fund's
expectation regarding the tax character of its
distributions will be realized or that the Fund will
make regular distributions. See "Distributions" and
"Tax Matters."
o Sale of Shares. Common shareholders generally will
recognize a gain or loss upon the sale of their
common shares. Such gain or loss is equal to the
difference between the common shareholder's federal
income tax basis in its common shares sold (as
adjusted to reflect return of capital) and the sale
proceeds received by the common shareholder upon the
disposition of common shares. As a general rule, the
sale of a capital asset, like common shares, held
for more than a year will result in a long-term
capital gain or loss. See "Tax Matters."
BENEFITS IN
COMPARISON WITH
DIRECT INVESTMENTS
IN MLPS ............. The Fund provides a method for investing in MLPs,
MLP-related entities and other energy sector and energy
utility companies. Some of the benefits of investing in
the Fund as opposed to directly investing in MLPs
include:
o The Fund provides, through a single investment
vehicle, an investment in a portfolio of a number of
MLPs, MLP-related entities and other energy sector
and energy utility companies;
o Direct investors in MLPs receive a partnership
statement (a Form K-1 statement) from each MLP they
own and may be required to file income tax returns
in each state in which the MLPs operate. Common
shareholders will receive a single Form 1099 and
will only be required to file income tax returns in
states in which they would ordinarily file; and
o Income received by tax-exempt investors, including
employee benefit plans and IRA accounts, from MLPs
is generally treated as unrelated business taxable
income ("UBTI"), whereas distributions these
investors receive from an entity treated for federal
income tax purposes as a corporation (such as the
Fund) will generally not be treated as UBTI, unless
the stock is debt-financed.
9
LEVERAGE PROGRAM .... Pursuant to the provisions of the 1940 Act, the Fund may
borrow or issue commercial paper or notes in an amount up
to 33-1/3% of its total assets or may issue Preferred
Shares in an amount up to 50% of its total assets
(including the proceeds from leverage). Under normal
market conditions, the Fund expects to use leverage in an
aggregate amount of approximately 25% to 30% of the
Fund's Managed Assets. The Fund is currently engaged in,
and expects to continue to engage in, the use of leverage
to make additional investments to seek to enhance the
level of its current distributions to common
shareholders. The Fund has a committed facility agreement
with The Bank of Nova Scotia that has a maximum
commitment amount of $270,000,000 (the "Nova Scotia
Facility"). The Fund's common shares are junior in
liquidation and distribution rights to amounts owed
pursuant to the Nova Scotia Facility. As of October 31,
2017, the principal amount of borrowings under the Nova
Scotia Facility was $235,500,000, representing
approximately 25.94% of the Fund's Managed Assets. As of
October 31, 2017, the Fund had $34,500,000 in unutilized
funds available for borrowing under the Nova Scotia
Facility. To date, the Fund has not issued any Preferred
Shares.
The issuance of common shares offered by this prospectus
will enable the Fund to increase the aggregate amount of
its leverage. The Fund may make further use of leverage
through additional borrowings and/or the issuance of
Preferred Shares to the extent permitted by the 1940 Act.
However, there is no assurance that the Fund will
increase the amount of its leverage or utilize leverage
in addition to the Nova Scotia Facility or that, if
additional leverage is utilized, it will be successful in
enhancing the level of the Fund's current distributions.
It is possible that the Fund will be unable to obtain
additional leverage. If the Fund is unable to increase
its leverage after the issuance of the common shares
pursuant to this prospectus, there could be an adverse
impact on the return to common shareholders. In addition,
to the extent additional leverage is utilized, the Fund
may consequently be subject to certain financial
covenants and restrictions that are not currently imposed
on the Fund. The Fund's common shares are likely to be
junior in liquidation and distribution rights to amounts
owed pursuant to any additional leverage instruments that
may be utilized by the Fund in the future. See "Leverage
Program."
Certain types of borrowings may result in the Fund being
subject to covenants in credit agreements relating to
asset coverage and portfolio composition requirements.
Leverage creates a greater risk of loss, as well as
potential for more gain, for the common shares than if
leverage is not used. The Fund's leveraging strategy may
not be successful. See "Risks--Leverage Risk."
The use of leverage will leverage your investment in the
common shares. The costs associated with the Fund's use
of leverage are borne immediately by common shareholders
through a reduction of the net asset value ("NAV") of the
common shares. Costs associated with any borrowings would
likely include legal fees, audit fees, structuring fees,
commitment fees, and a usage (borrowing) fee.
Preferred Shares, if issued, may pay fixed or floating
rate dividends based on short-term rates. Borrowings may
be at a fixed or floating rate and generally will be
based upon short-term rates.
So long as the rate of return, net of applicable Fund
expenses, on the Fund's portfolio investments purchased
with leverage exceeds the then current interest rate or
dividend rate on the leverage, the Fund will generate
more return or income than will be needed to pay such
dividends or interest payments. In this event, the excess
will be available to pay higher dividends to common
shareholders. When leverage is employed, the NAV and
market prices of the common shares and the yield to
common shareholders will be more volatile.
During periods when the Fund is using leverage, the fees
paid to the Advisor and the Sub-Advisor will be higher
than if the Fund did not use leverage because the fees
paid will be calculated on the basis of the Fund's
Managed Assets, which includes the assets obtained
through leverage. The Advisor and the Sub-Advisor will
make decisions on whether and how much leverage the Fund
will employ based on whether it is in the best interests
10
of the Fund. The Advisor and the Sub-Advisor will seek
approval for and periodically review the use of leverage
with the Board of Trustees.
There is no assurance that a leverage strategy will
continue to be utilized by the Fund or that, when
utilized, it will be successful. See "Risks--Leverage
Risk."
CUSTODIAN,
ADMINISTRATOR,
FUND ACCOUNTANT
AND TRANSFER AGENT... The Fund has retained The Bank of New York Mellon as
custodian, administrator and fund accountant and BNY
Mellon Investment Servicing (US) Inc. as transfer agent
for the Fund. The Advisor and the Board of Trustees are
responsible for overseeing the activities of the
custodian, administrator, fund accountant and transfer
agent. See "Custodian, Administrator, Fund Accountant and
Transfer Agent."
LISTING ............. The Fund's currently outstanding common shares are, and
the Common Shares offered in this prospectus and any
applicable prospectus supplement will be, subject to
notice of issuance, listed on the New York Stock Exchange
("NYSE") under the trading or "ticker" symbol "FEI." The
NAV of the Fund's common shares at the close of business
on February 15, 2018 was $14.10 per common share, and the
last sale price of the common shares on the NYSE on such
date was $14.69.
CLOSED-END
STRUCTURE ........... Closed-end funds differ from open-end management
investment companies (commonly referred to as mutual
funds) in that closed-end funds generally list their
shares for trading on a securities exchange and do not
redeem their shares at the option of the shareholder. By
comparison, mutual funds issue securities redeemable at
NAV at the option of the shareholder and typically engage
in a continuous offering of their shares. Mutual funds
are subject to continuous asset in-flows and out-flows
that can complicate portfolio management, whereas
closed-end funds generally can stay more fully invested
in securities consistent with the closed-end fund's
investment objective(s) and policies. In addition, in
comparison to open-end funds, closed-end funds have
greater flexibility in their ability to make certain
types of investments, including investments in illiquid
securities.
Shares of closed-end investment companies listed for
trading on a securities exchange frequently trade at a
discount from NAV, but in some cases trade at a premium.
The market price may be affected by NAV, dividend or
distribution levels (which are dependent, in part, on
expenses), supply of and demand for the shares, stability
of dividends or distributions, trading volume of the
shares, general market and economic conditions and other
factors beyond the control of the closed-end fund. The
foregoing factors may result in the market price of the
common shares of the Fund being greater than, less than
or equal to, NAV.
The Board of Trustees has reviewed the structure of the
Fund in light of its investment objective and policies
and has determined that the closed-end structure is
appropriate. As described in this prospectus, however,
the Board of Trustees may review periodically the trading
range and activity of the common shares with respect to
their NAV and may take certain actions to seek to reduce
or eliminate any such discount. Such actions may include
open-market repurchases or tender offers for the common
shares at or near NAV or the possible conversion of the
Fund to an open-end investment company. There can be no
assurance that the Board of Trustees will decide to
undertake any of these actions or that, if undertaken,
such actions would result in the common shares trading at
a price equal to or close to NAV per common share.
Investors should assume that it is highly unlikely that
the Board of Trustees would vote to convert the Fund to
an open-end investment company. See "Structure of the
Fund; Common Share Repurchases and Change in Fund
Structure."
SPECIAL RISK
CONSIDERATIONS ...... Risk is inherent in all investing. The following
discussion summarizes the principal risks that you should
consider before deciding whether to invest in the Fund.
For additional information about the risks associated
with investing in the Fund, see "Risks."
Investment and Market Risk. An investment in the common
shares is subject to investment risk, including the
possible loss of the entire amount that you invest. Your
11
investment in common shares represents an indirect
investment in the securities owned by the Fund, a
significant portion of which will be traded on a national
securities exchange or in the over-the-counter markets.
The value of these securities, like other market
investments, may move up or down, sometimes rapidly and
unpredictably. The value of the securities in which the
Fund invests will affect the value of the common shares.
Your common shares at any point in time may be worth less
than your original investment, even after taking into
account the reinvestment of Fund dividends and
distributions. The Fund has been designed primarily as a
long-term investment vehicle and is not intended to be
used as a short-term trading vehicle.
Market Discount from Net Asset Value. Although the Common
Shares offered under this prospectus will be offered at a
public offering price equal to or in excess of the NAV
per share of the Fund's common shares at the time such
Common Shares are initially sold, shares of closed-end
investment companies frequently trade at a discount from
their NAV. This characteristic is a risk separate and
distinct from the risk that the Fund's NAV per common
share could decrease as a result of its investment
activities and may be greater for investors expecting to
sell their Common Shares in a relatively short period
following completion of an offering under this prospectus
and the applicable prospectus supplement. The NAV of the
Common Shares offered under this prospectus may be
reduced immediately following an offering as a result of
the payment of certain offering costs. Although the value
of the Fund's net assets is generally considered by
market participants in determining whether to purchase or
sell common shares, whether investors will realize gains
or losses upon the sale of the common shares will depend
entirely upon whether the market price of the common
shares at the time of sale is above or below the
investor's purchase price for the common shares. Because
the market price of the common shares is affected by
factors such as NAV, dividend and distribution levels and
their stability (which are in turn affected by levels of
dividend and interest payments by the Fund's portfolio
holdings, the timing and success of the Fund's investment
strategies, regulations affecting the timing and
character of the Fund's distributions, the Fund's
expenses and other factors), supply of and demand for the
common shares, trading volume of the common shares,
general market, interest rate and economic conditions,
and other factors beyond the control of the Fund, the
Fund cannot predict whether the Common Shares offered
under this prospectus will trade at, below or above NAV
or at, below or above the public offering price thereof.
Market Impact Risk. The sale of the Common Shares (or the
perception that such sales may occur) may have an adverse
effect on prices in the secondary market for the Fund's
common shares through increasing the number of shares
available, which may put downward pressure on the market
price for the Fund's common shares. These sales also
might make it more difficult for the Fund to sell
additional equity securities in the future at a time and
price the Fund deems appropriate.
Management Risk and Reliance on Key Personnel. The Fund
is subject to management risk because it is an actively
managed portfolio. The Advisor and Sub-Advisor apply
investment techniques and risk analyses in making
investment decisions for the Fund, but there can be no
guarantee that these will produce the desired results.
In addition, the implementation of the Fund's investment
strategy depends upon the continued contributions of
certain key employees of the Advisor and Sub-Advisor,
some of whom have unique talents and experience and would
be difficult to replace. The loss or interruption of the
services of a key member of the portfolio management team
could have a negative impact on the Fund during the
transitional period that would be required for a
successor to assume the responsibilities of the position.
Potential Conflicts of Interest Risk. First Trust
Advisors, Energy Income Partners and the portfolio
managers have interests which may conflict with the
interests of the Fund. In particular, First Trust
Advisors and Energy Income Partners currently manage and
may in the future manage and/or advise other investment
funds or accounts with the same or substantially similar
investment objective and strategies as the Fund. As a
result, First Trust Advisors, Energy Income Partners and
the Fund's portfolio managers must allocate their time
and investment ideas across multiple funds and accounts.
First Trust Advisors, Energy Income Partners and the
Fund's portfolio managers may identify a limited
12
investment opportunity that may be suitable for multiple
funds and accounts, and the opportunity may be allocated
among these several funds and accounts, which may limit
the Fund's ability to take full advantage of the
investment opportunity. Additionally, transaction orders
may be aggregated for multiple accounts for purposes of
execution, which may cause the price or brokerage costs
to be less favorable to the Fund than if similar
transactions were not being executed concurrently for
other accounts. At times, a portfolio manager may
determine that an investment opportunity may be
appropriate for only some of the funds and accounts for
which he or she exercises investment responsibility, or
may decide that certain of the funds and accounts should
take differing positions with respect to a particular
security. In these cases, the portfolio manager may place
separate transactions for one or more funds or accounts
which may affect the market price of the security or the
execution of the transaction, or both, to the detriment
or benefit of one or more other funds and accounts. For
example, a portfolio manager may determine that it would
be in the interest of another account to sell a security
that the Fund holds, potentially resulting in a decrease
in the market value of the security held by the Fund.
The portfolio managers may also engage in cross trades
between funds and accounts, may select brokers or dealers
to execute securities transactions based in part on
brokerage and research services provided to First Trust
Advisors or Energy Income Partners which may not benefit
all funds and accounts equally and may receive different
amounts of financial or other benefits for managing
different funds and accounts. Finally, First Trust
Advisors or its affiliates may provide more services to
some types of funds and accounts than others.
There is no guarantee that the policies and procedures
adopted by First Trust Advisors, Energy Income Partners
and the Fund will be able to identify or mitigate the
conflicts of interest that arise between the Fund and any
other investment funds or accounts that First Trust
Advisors and/or Energy Income Partners may manage or
advise from time to time. For further information on
potential conflicts of interest and the terms of each of
the investment management agreement between First Trust
Advisors and the Fund (the "Investment Management
Agreement") and the sub-advisory agreement among First
Trust Advisors, Energy Income Partners and the Fund (the
"Sub-Advisory Agreement"), see "Investment Advisor" and
"Sub-Advisor" in the SAI.
In addition, while the Fund is using leverage, the amount
of the fees paid to the Advisor (and by the Advisor to
the Sub-Advisor) for investment advisory and management
services are higher than if the Fund did not use leverage
because the fees paid are calculated based on Managed
Assets, which include assets purchased with leverage.
Therefore, the Advisor and the Sub-Advisor have a
financial incentive to leverage the Fund, which creates a
conflict of interest between the Advisor and the
Sub-Advisor on the one hand and the common shareholders
of the Fund on the other.
MLP Risks. An investment in MLP units involves risks
which differ from an investment in common stock of a
corporation. Holders of MLP units have limited control
and voting rights on matters affecting the partnership.
The Fund is not responsible for operating MLPs and
similar entities and cannot control or monitor their
compliance with applicable tax, securities and other laws
and regulations necessary for the profitability of such
investments. Holders of MLP units could potentially
become subject to liability for all of the obligations of
an MLP, if a court determines that the rights of the
unitholders to take certain action under the limited
partnership agreement would constitute "control" of the
business of that MLP, or if a court or governmental
agency determines that the MLP is conducting business in
a state without complying with the limited partnership
statute of that state.
Furthermore, the structures and terms of the MLPs and
other entities described in this prospectus may not be
indicative of the structure and terms of every entity in
which the Fund invests. Although the energy sector has
grown significantly in past years, such market trends may
not exist from time to time due to economic conditions,
which are not predictable, or other factors. In addition,
certain conflicts of interest exist between common unit
holders and the general partner, including those arising
from incentive distribution payments. Conflicts of
interest may arise from incentive distribution payments
13
paid to the general partner, or referral of business
opportunities by the general partner or one of its
affiliates to an entity other than the MLP. Holders of
general partner or managing member interests typically
receive incentive distribution rights, which provide them
with an increasing share of the entity's aggregate cash
distributions upon the payment of per common unit
quarterly distributions that exceed specified threshold
levels above an established minimum amount ("minimum
quarterly distribution" or "MQD"). The ability of the
limited partners or members to remove the general partner
or managing member without cause is typically very
limited. In addition, some MLPs permit the holder of
incentive distribution rights to reset, under specified
circumstances, the incentive distribution levels and
receive compensation in exchange for the distribution
rights given up in the reset.
The MLPs in which the Fund invests are primarily in the
energy sector. See "--Investment Concentration Risk."
The federal income tax rules relating to the auditing of
partnerships and partners have recently changed. The Fund
may have little input in any audit asserted against an
MLP and may be contractually or legally obligated to make
payments in regard to deficiencies asserted without the
ability to put forward an independent defense.
Investment Concentration Risk. The Fund's investments are
concentrated in the group of industries that are part of
the energy sector, with a particular focus on MLPs,
MLP-related entities and other companies in the energy
sector and energy utility industries. See "--Recent
Market and Economic Developments" for a discussion of
recent developments impacting MLPs. The Fund's
concentration in the group of industries that are part of
the energy sector may present more risk than if the Fund
were broadly diversified over multiple sectors of the
economy. A downturn in one or more industries within the
energy sector, material declines in energy-related
commodity prices (such as the decline in commodity prices
experienced in recent years), adverse political,
legislative or regulatory developments or other events
could have a larger impact on the Fund than on an
investment company that does not concentrate in the group
of industries that are part of the energy sector. The
performance of companies in the group of industries that
are part of the energy sector may lag the performance of
other sectors or the broader market as a whole; in
particular, during a downturn like what has been
experienced in recent years in the energy sector.
Although the Fund invests in MLPs, MLP-related entities
and other energy sector and energy utility companies that
are weighted towards non-cyclical, fee-for-service
revenues, these companies may nonetheless have segments
of their respective businesses that are exposed to
cyclical assets and, therefore, risks associated with
such cyclical assets are also discussed below in addition
to those risks associated with non-cyclical,
fee-for-service revenues. Certain risks inherent in
investing in the business of the types of securities that
the Fund may invest include the following:
o Commodity Pricing Risk. The operations and financial
performance of MLPs, MLP-related entities and other
energy sector and energy utility companies may be
directly affected by energy commodity prices,
especially those MLPs, MLP-related entities and
other energy sector and energy utility companies
that own the underlying energy commodity or receive
payments for services that are based on commodity
prices. Such impact may be a result of changes in
the price for such commodity or a result of changes
in the price of one energy commodity relative to the
price of another energy commodity (for example, the
price of natural gas relative to the price of NGLs).
Commodity prices fluctuate for several reasons,
including changes in market and economic conditions,
the impact of weather on demand, levels of domestic
and international production, policies implemented
by Organization of Petroleum Exporting Countries,
energy conservation, domestic and foreign
governmental regulation and taxation and the
availability of local, intrastate and interstate
transportation systems. Volatility of commodity
prices, which may lead to a reduction in production
or supply, may also negatively impact the
performance of MLPs, MLP-related entities and other
energy sector and energy utility companies which are
solely involved in the transportation, processing,
storage, distribution or marketing of commodities.
Volatility of commodity prices may also make it more
difficult for MLPs, MLP-related entities and other
energy sector and energy utility companies to raise
14
capital to the extent the market perceives that
their performance may be directly or indirectly tied
to commodity prices and there is uncertainty
regarding these companies' ability to maintain or
grow cash distributions to their equity holders.
o Supply and Demand Risk. As noted above, a decrease
in the production of natural gas, NGLs, crude oil,
coal or other energy commodities or a decrease in
the volume of such commodities available for
transportation, processing, storage or distribution
may adversely impact the operations and financial
performance of MLPs, MLP-related entities and other
energy sector and energy utility companies.
Production declines and volume decreases could be
caused by various factors, including catastrophic
events affecting production, depletion of resources,
labor difficulties, environmental proceedings,
increased regulations, equipment failures and
unexpected maintenance problems, import supply
disruption, increased competition from alternative
energy sources, depressed commodity prices or access
to capital for companies engaged in exploration and
production. Alternatively, a sustained decline in
demand for such commodities could also impact the
financial performance of MLPs, MLP-related entities
and other energy sector and energy utility
companies. Factors which could lead to a decline in
demand include economic recession or other adverse
economic conditions, higher fuel taxes or
governmental regulations, increases in fuel economy,
consumer shifts to the use of alternative fuel
sources, an increase in commodity prices, or
weather.
o Lack of Diversification of Customers and Suppliers.
Certain MLPs, MLP-related entities and other energy
sector and energy utility companies depend upon a
limited number of customers for substantially all of
their revenue. Similarly, certain MLPs, MLP-related
entities and other energy sector and energy utility
companies depend upon a limited number of suppliers
of goods or services to continue their operations.
Energy industry downturns resulting from lower
commodity prices may put pressure on a number of
these customers and suppliers. The loss of any such
customers or suppliers, including through
bankruptcy, could materially adversely affect such
MLPs', MLP-related entities' and other energy sector
and energy utility companies' results of operations
and cash flow, and their ability to make
distributions to unit holders, such as the Fund,
would therefore be materially adversely affected.
o Depletion and Exploration Risk. MLPs, MLP-related
entities and other energy sector and energy utility
companies also engaged in the production
(exploration, development, management or production)
of natural gas, NGLs (including propane), crude oil,
refined petroleum products or coal are subject to
the risk that their commodity reserves naturally
deplete over time. Reserves are generally increased
through expansion of their existing business,
through exploration of new sources or development of
existing sources, through acquisitions or by
securing long-term contracts to acquire additional
reserves, each of which entails risk. The financial
performance of these issuers may be adversely
affected if they are unable to acquire,
cost-effectively, additional reserves at a rate at
least equal to the rate of natural decline. A
failure to maintain or increase reserves could
reduce the amount and change the characterization of
cash distributions paid by these MLPs, MLP-related
entities and other energy sector and energy utility
companies.
o Regulatory Risk. The energy sector and energy
utility industries are highly regulated. MLPs,
MLP-related entities and other energy sector and
energy utility companies are subject to significant
regulation of nearly every aspect of their
operations by federal, state and local governmental
agencies. Such regulation can change rapidly or over
time in both scope and intensity. For example, a
particular by-product or process may be declared
hazardous (sometimes retroactively) by a regulatory
agency which could unexpectedly increase production
costs. Various governmental authorities have the
power to enforce compliance with these regulations
and the permits issued under them, and violators are
subject to administrative, civil and criminal
penalties, including civil fines, injunctions or
both. Stricter laws, regulations or enforcement
policies could be enacted in the future which would
likely increase compliance costs and may adversely
15
affect the financial performance of MLPs,
MLP-related entities and other energy sector and
energy utility companies.
o Interest Rate Risk. Rising interest rates could
adversely impact the financial performance of MLPs,
MLP-related entities and other energy sector and
energy utility companies. Rising interest rates may
increase an MLP's, MLP-related entity's or other
energy sector or energy utility company's cost of
capital, which would increase operating costs and
may reduce an MLP's, MLP-related entity's or other
energy sector or energy utility company's ability to
execute acquisitions or expansion projects in a
cost-effective manner. Rising interest rates may
also impact the price of MLP units, MLP-related
entity securities and energy sector and energy
utility company shares as the yields on alternative
investments increase.
o Acquisition or Reinvestment Risk. The ability of
MLPs, MLP-related entities and other energy sector
and energy utility companies to grow and to increase
distributions to their equity holders can be
dependent in part on their ability to make
acquisitions or find organic projects that result in
an increase in adjusted operating cash flow. In the
event that MLPs, MLP-related entities and other
energy sector and energy utility companies are
unable to make such accretive acquisitions/projects
either because they are unable to identify
attractive acquisition/project candidates or
negotiate acceptable purchase contracts or because
they are unable to raise financing on economically
acceptable terms or because they are outbid by
competitors, their future growth and ability to
raise distributions may be hindered. Furthermore,
even if MLPs, MLP-related entities and other energy
sector and energy utility companies do consummate
acquisitions/projects that they believe will be
accretive, the acquisitions/projects may in fact
turn out to result in a decrease in adjusted
operating cash flow. Any acquisition/project
involves risks, including among other things:
mistaken assumptions about revenues and costs,
including synergies; the assumption of unknown
liabilities; limitations on rights to indemnity from
the seller; the diversion of management's attention
from other business concerns; unforeseen
difficulties operating in new product areas or new
geographic areas; and customer or key employee
losses at the acquired businesses.
o Affiliated Party Risk. Certain MLPs, MLP-related
entities and other energy sector and energy utility
companies may be dependent on their parents or
sponsors for a majority of their revenues. Any
failure by the parents or sponsors of such entities
to satisfy their payments or obligations would
impact the MLP's, MLP-related entity's or energy
sector or energy utility company's revenues and cash
flows and ability to make distributions.
o Weather Risk. Weather plays a role in the
seasonality of some MLPs', MLP-related entities' and
other energy sector and energy utility companies'
cash flows. MLPs, MLP-related entities and other
energy sector and energy utility companies in the
propane industry, for example, rely on the winter
season to generate a significant portion of their
earnings. In an unusually warm winter season,
propane MLPs, MLP-related entities and other energy
sector and energy utility companies may experience
decreased demand for their product.
o Catastrophe Risk. The operations of MLPs,
MLP-related entities and other energy sector and
energy utility companies are subject to many hazards
inherent in transporting, processing, storing,
distributing or marketing natural gas, NGLs, crude
oil, refined petroleum products or other
hydrocarbons, or in exploring, managing or producing
such commodities or products, including: damage to
pipelines, storage tanks or related equipment and
surrounding properties caused by hurricanes,
tornadoes, floods, fires and other natural disasters
and acts of terrorism; inadvertent damage from
construction and farm equipment; leaks of natural
gas, NGLs, crude oil, refined petroleum products or
other hydrocarbons; and explosions. These risks
could result in substantial losses due to personal
injury and/or loss of life, severe damage to and
destruction of property and equipment and pollution
or other environmental damage and may result in the
curtailment or suspension of their related
operations. Not all MLPs, MLP-related entities and
16
other energy sector and energy utility companies are
fully insured against all risks inherent to their
businesses. If a significant accident or event
occurs that is not fully insured, it could adversely
affect their operations and financial condition.
o Terrorism/Market Disruption Risk. MLPs, MLP-related
entities and other energy sector and energy utility
companies are subject to disruption as a result of
terrorist activities, war, and other geopolitical
events, including upheaval in the Middle East or
other energy producing regions. The U.S. government
has issued warnings that energy assets, specifically
those related to pipeline and other energy
infrastructure, production facilities and
transmission and distribution facilities, may be
targeted in future terrorist attacks. Internal
unrest, acts of violence or strained relations
between a government and energy companies or other
governments may affect the operations and
profitability of MLPs, MLP-related entities and
other energy sector and energy utility companies,
particularly marine transportation companies.
Political instability in other parts of the world
may also cause volatility and disruptions in the
market for the securities of MLPs, MLP-related
entities and other energy sector and energy utility
companies, even those that operate solely in North
America.
o Technology Risk. Some MLPs, MLP-related entities and
other energy sector and energy utility companies are
focused on developing new technologies and are
strongly influenced by technological changes.
Technology development efforts by MLPs, MLP-related
entities and other energy sector and energy utility
companies may not result in viable methods or
products. MLPs, MLP-related entities and other
energy sector and energy utility companies may bear
high research and development costs, which can limit
their ability to maintain operations during periods
of organizational growth or instability. Some MLPs,
MLP-related entities and other energy sector and
energy utility companies may be in the early stages
of operations and may have limited operating
histories and smaller market capitalizations on
average than companies in other sectors. As a result
of these and other factors, the value of investments
in MLPs, MLP-related entities and other energy
sector and energy utility companies may be
considerably more volatile than that in more
established segments of the economy.
o Industry Specific Risk. MLPs, MLP-related entities
and other energy sector and energy utility companies
are also subject to risks that are specific to the
industry they serve.
o MLPs, MLP-related entities and other energy
sector and energy utility companies that provide
crude oil, refined product and natural gas
services are subject to supply and demand
fluctuations in the markets they serve which will
be impacted by a wide range of factors including
fluctuating commodity prices, weather, increased
conservation or use of alternative fuel sources,
increased governmental or environmental
regulation, depletion, rising interest rates,
declines in domestic or foreign production,
accidents or catastrophic events, and economic
conditions, among others.
o MLPs, MLP-related entities and other energy
sector and energy utility companies that operate
assets are also subject to the credit risk of
their customers. For example, during 2015 and
2016, many MLPs, MLP-related entities and other
energy sector and energy utility companies that
explore for and produce oil, natural gas and NGLs
filed for bankruptcy. During the bankruptcy
process, the debtor entity may be able to reject
a contract that it has with an MLP, MLP-related
entity or other energy sector or energy utility
company that provides services for the debtor,
which services could include gathering,
processing, transporting, fractionating or
storing the debtor entity's production. If a
contract is successfully rejected during
bankruptcy, the affected MLP, MLP-related entity
or other energy sector or energy utility company
will have an unsecured claim for damages but will
likely only recover a portion of its claim for
damages and may not recover anything at all.
Furthermore, if the terms of the contract are not
economic for the MLP, MLP-related entity or other
energy sector or energy utility company, there
may be an incentive for the MLP or other company
17
to renegotiate the contract to increase the
utilization of its assets (whether or not the
MLP, MLP-related entity or other energy sector or
energy utility company has filed for bankruptcy).
In either case, an MLP or other company that
operates assets for an MLP, MLP-related entity or
other energy sector or energy utility company
that is in financial distress could experience a
material adverse impact to its financial
performance and results of operations.
o Propane companies are subject to earnings
variability based upon weather conditions in the
markets they serve, fluctuating commodity prices,
increased use of alternative fuels, increased
governmental or environmental regulation, and
accidents or catastrophic events, among others.
o MLPs, MLP-related entities and other energy
sector and energy utility companies with coal
assets are subject to supply and demand
fluctuations in the markets they serve which will
be impacted by a wide range of factors including,
fluctuating commodity prices, the level of their
customers' coal stockpiles, weather, increased
conservation or use of alternative fuel sources,
increased governmental or environmental
regulation, depletion, rising interest rates,
transportation issues, declines in domestic or
foreign production, mining accidents or
catastrophic events, health claims and economic
conditions, among others.
o MLPs, MLP-related entities and other energy
sector and energy utility companies that own
interstate pipelines are subject to regulation by
the Federal Energy Regulatory Commission ("FERC")
with respect to the tariff rates they may charge
for transportation services. An adverse
determination by FERC with respect to the tariff
rates of such a company could have a material
adverse effect on its business, financial
condition, results of operations and cash flows
and its ability to pay cash distributions or
dividends. In addition, FERC has a tax allowance
policy, which permits such companies to include
in their cost of service an income tax allowance
to the extent that their owners have an actual or
potential tax liability on the income generated
by them. If FERC's income tax allowance policy
were to change in the future to disallow a
material portion of the income tax allowance
taken by such interstate pipeline companies, it
would adversely impact the maximum tariff rates
that such companies are permitted to charge for
their transportation services, which in turn
could adversely affect such companies' financial
condition and ability to pay distributions to
shareholders.
o Marine shipping (or "tanker") companies are
exposed to many of the same risks as other MLPs,
MLP-related entities and other energy sector and
energy utility companies. In addition, the highly
cyclical nature of the industry may lead to
volatile changes in charter rates and vessel
values, which may adversely affect a tanker
company's earnings. Fluctuations in charter rates
and vessel values result from changes in the
supply and demand for tanker capacity and changes
in the supply and demand for oil and oil
products. Historically, the tanker markets have
been volatile because many conditions and factors
can affect the supply and demand for tanker
capacity. Changes in demand for transportation of
oil over longer distances and supply of tankers
to carry that oil may materially affect revenues,
profitability and cash flows of tanker companies.
The successful operation of vessels in the
charter market depends upon, among other things,
obtaining profitable spot charters and minimizing
time spent waiting for charters and traveling
unladen to pick up cargo. The value of tanker
vessels may fluctuate and could adversely affect
the value of tanker company securities. Declining
tanker values could affect the ability of tanker
companies to raise cash by limiting their ability
to refinance their vessels, thereby adversely
impacting tanker company liquidity. Tanker
company vessels are at risk of damage or loss
18
because of events such as mechanical failure,
collision, human error, war, terrorism, piracy,
cargo loss and bad weather. In addition, changing
economic, regulatory and political conditions in
some countries, including political and military
conflicts, have from time to time resulted in
attacks on vessels, mining of waterways, piracy,
terrorism, labor strikes, boycotts and government
requisitioning of vessels. These sorts of events
could interfere with shipping lanes and result in
market disruptions and a significant loss of
tanker company earnings.
o A variety of factors may adversely affect the
business or operations of companies in the energy
utility industries, including: high interest
costs in connection with capital construction and
improvement programs; governmental regulation of
rates charged to customers (including the
potential that costs incurred by the utility
change more rapidly than the rate the utility is
permitted to charge its customers); costs
associated with compliance with and changes in
environmental and other regulations; effects of
economic slowdowns and surplus capacity;
increased competition from other providers of
utilities services; inexperience with and
potential losses resulting from a developing
deregulatory environment; costs associated with
reduced availability of certain types of fuel;
the effects of energy conservation policies;
effects of a national energy policy;
technological innovations; potential impact of
terrorist activities; the impact of natural or
man-made disasters; regulation by various
governmental authorities, including the
imposition of special tariffs; and changes in tax
laws, regulatory policies and accounting
standards.
o Changes in laws or government regulations
regarding hydraulic fracturing could increase a
company's costs of doing business, limit the
areas in which it can operate and reduce oil and
natural gas production by the company.
Energy Utility Company Risk. A variety of factors may
adversely affect the business or operations of companies
in the energy utility industry, including: high interest
costs in connection with capital construction and
improvement programs; difficulty in raising capital in
adequate amounts on reasonable terms in periods of high
inflation and unsettled capital markets; governmental
regulation of rates charged to customers (including the
potential that costs incurred by the utility change more
rapidly than the rate the utility is permitted to charge
its customers); costs associated with compliance with and
changes in environmental and other regulations; effects
of economic slowdowns and surplus capacity; increased
competition from other providers of utilities services;
inexperience with and potential losses resulting from a
developing deregulatory environment; costs associated
with reduced availability of certain types of fuel,
occasionally reduced availability and high costs of
natural gas for resale and the effects of energy
conservation policies; the effects of a national energy
policy and lengthy delays and greatly increased costs and
other problems associated with the design, construction,
licensing, regulation and operation of nuclear facilities
for electric generation, including, among other
considerations, the problems associated with the use of
radioactive minerals and the disposal of radioactive
wastes; technological innovations that may render
existing plants, equipment or products obsolete;
potential impact of terrorist activities; the impact of
natural or man-made disasters; regulation by various
governmental authorities, including the imposition of
special tariffs; and changes in tax laws, regulatory
policies and accounting standards. See "Risks--Energy
Utility Companies Risk."
Cash Flow Risk. A substantial portion of the cash
distributions received by the Fund is derived from its
investment in equity securities of MLPs, MLP-related
entities and other energy sector and energy utility
companies. The amount of cash that an MLP, MLP-related
entity or other energy sector or energy utility company
has available for distributions to its equity holders
depends upon the amount of cash flow generated from the
MLP's, MLP-related entity's or other energy sector or
energy utility company's operations. Cash flow from
operations will vary from quarter to quarter and is
largely dependent on factors affecting the MLP's,
MLP-related entity's or other energy sector or energy
utility company's operations and factors affecting the
energy industry in general. Large declines in commodity
prices (such as those experienced in 2014-2015) can
result in material declines in cash flow from operations.
19
In addition to the risk factors described herein, other
factors which may reduce the amount of cash an MLP,
MLP-related entity and other energy sector and energy
utility company has available to pay its debt and equity
holders include increased operating costs, maintenance
capital expenditures, acquisition costs, expansion or
construction costs and borrowing costs (including
increased borrowing costs as a result of additional
collateral requirements as a result of ratings downgrades
by credit agencies). Further, covenants in debt
instruments issued by MLPs, MLP-related entities and
other energy sector and energy utility companies in which
the Fund invests may restrict distributions to equity
holders or, in certain circumstances, may not allow
distributions to be made to equity holders. To the extent
the Fund invests in MLPs, MLP-related entities and other
energy sector and energy utility companies that reduce
their distributions to equity holders, this will result
in reduced levels of net distributable income and can
cause the Fund to reduce its distributions.
MLP and Deferred Tax Risk. Much of the benefit the Fund
derives from its investments in equity securities of MLPs
is a result of MLPs generally being treated as
partnerships for United States federal income tax
purposes. Partnerships do not pay United States federal
income tax at the partnership level. Rather, each partner
of a partnership, in computing its United States federal
income tax liability, will include its allocable share of
the partnership's income, gains, losses, deductions and
expenses. A change in current tax law, a change in the
business of a given MLP, or a change in the types of
income earned by a given MLP could result in an MLP being
treated as a corporation for United States federal income
tax purposes, which would result in such MLP being
required to pay United States federal income tax on its
taxable income. Recent changes in regulations may cause
some MLPs to be reclassified as corporations. The
classification of an MLP as a corporation for United
States federal income tax purposes would have the effect
of reducing the amount of cash available for distribution
by the MLP and causing any such distributions received by
the Fund to be taxed as dividend income to the extent of
the MLP's current or accumulated earnings and profits.
Thus, if any of the MLPs owned by the Fund were treated
as a corporation for United States federal income tax
purposes, the value and after-tax return to the Fund with
respect to its investment in such MLPs would be
materially reduced, which could cause a substantial
decline in the value of the common shares.
Separately, a recent change in law has shifted the
primary obligation for taxes attributable to partnership
adjustments to the partnership. The MLPs may make certain
elections to push that liability out to the partners, but
the application of the new law is subject to substantial
uncertainties.
As a limited partner in the MLPs in which it may invest,
the Fund is allocated its pro rata share of income,
gains, losses, deductions and expenses from the MLPs. A
significant portion of MLP income has historically been
offset by non-cash tax deductions such as depreciation
and depletion. The Fund will incur a current tax
liability on its income allocation from an MLP not offset
by tax deductions. The Fund's tax basis in its MLP units
would be increased by the income allocated from an MLP,
and then reduced by all distributions from the MLP
(including any distributions in excess of allocated
income), which would either increase the Fund's taxable
gain or reduce the Fund's loss recognized upon the sale
of such MLP units. The percentage of an MLP's
distribution which is offset by tax deductions will
fluctuate over time for various reasons. A significant
slowdown in acquisition or investment activity by MLPs
held by the Fund could result in a reduction of
accelerated depreciation or other deductions generated by
these activities, which may result in an increased
current tax liability to the Fund.
A reduction in the percentage of the income offset by tax
deductions or an increase in sales of the Fund's MLP
holdings that result in capital gains will reduce that
portion of the Fund's distribution from an MLP treated as
a return of capital and increase that portion treated as
income, and may result in lower after-tax distributions
to the Fund's common shareholders.
The Fund will accrue deferred income taxes for its future
tax liability associated with the difference between the
Fund's tax basis in an MLP security and the fair market
value of the MLP security. Upon the Fund's sale of an MLP
security, the Fund may be liable for previously deferred
taxes. The Fund will rely to some extent on information
20
provided by MLPs, which may not necessarily be timely, to
estimate its deferred tax liability for purposes of
financial statement reporting and determining its NAV.
From time to time, the Fund will modify its estimates or
assumptions regarding its deferred tax liability as new
information becomes available.
Recent Market and Economic Developments. Prices of oil
and other energy commodities have declined significantly
and experienced significant volatility during recent
years. Such volatility has adversely impacted (and may
continue to impact) many of the MLPs, MLP-related
entities and other energy companies in which the Fund has
invested or may invest. For example, many MLPs,
MLP-related entities and other energy companies have in
recent years experienced eroding growth prospects,
reduced distribution levels or, in some cases,
bankruptcy. These conditions have impacted, and may
continue to impact, the NAV of the Fund and its ability
to pay distributions to shareholders at current or
historic levels.
During periods of market volatility, MLPs, MLP-related
entities and other energy companies may be unable to
obtain new debt or equity financing on acceptable terms
or at all when market conditions are most volatile, and
downgrades of the debt of MLPs, MLP-related entities and
other energy companies by rating agencies during times of
distress could exacerbate this challenge. In addition,
downgrades of the debt of MLPs, MLP-related entities and
other energy companies by ratings agencies may increase
the cost of borrowing under the terms of an MLP's,
MLP-related entity's and other energy company's credit
facility, and a downgrade from investment grade to below
investment may cause an MLP, MLP-related entity and other
energy company to be required to post collateral (or
additional collateral) by its contractual counterparties,
which could reduce the amount of liquidity available to
such MLP, MLP-related entity and other energy company and
increase its need for additional funding sources. If
funding is not available when needed, or is available
only on unfavorable terms, MLPs, MLP-related entities and
other energy companies may have to reduce their
distributions to manage their funding needs and may not
be able to meet their obligations, which may include
multi-year capital expenditure commitments, as they come
due. Moreover, without adequate funding, many MLPs,
MLP-related entities and other energy companies will be
unable to execute their growth strategies, complete
future acquisitions, take advantage of other business
opportunities or respond to competitive pressures, any of
which could have a material adverse effect on their
revenues and results of operations.
The number of energy-related MLPs has declined since 2014
for a number of reasons as discussed below. Many of the
assets held by MLPs were originally constructed decades
ago by pipeline and power utilities. When the United
States deregulated much of the energy industry, these
utilities became cyclical commodity companies with
significant levels of debt and the resulting financial
stress caused divestment of their pipeline assets to the
MLP space that was trading at higher valuations. This
trend has reversed since 2014.
While MLPs represented a way for the industry to lower
its cost of financing between 2004 and 2014, the severe
correction in the price of crude oil in 2014 caused a
collapse in MLP valuations as about half of the Alerian
MLP Index had become exposed to commodity prices between
2004 and 2014. MLP distribution cuts and even some
bankruptcies followed. Over the last 2 1/2 years as of
the date of this prospectus about 40% of the MLPs in the
Alerian MLP Index have cut or eliminated their dividends.
Currently, MLPs in the Alerian MLP Index trade at
valuations that are about 40% lower than 2014, while the
valuation multiples of non-MLP energy infrastructure
companies like utilities have risen. MLPs are now a
higher-cost way of financing these industries; the
reverse of the conditions that led to the growth of the
asset class in the early part of the last decade. As a
result, the industry is witnessing the consolidation or
simplification of corporate structures where the MLP
sleeve of capital is being eliminated because it no
longer reduces a company's cost of equity financing.
Even for MLPs that have avoided exposure to commodity
prices and have been successful in growing their
dividends, the cost of the MLP structure has risen due to
growing incentive payments to the general partner. These
incentives increase with per share dividend growth at the
limited partnership level and are due on newly issued
21
shares, as well as older shares that have experienced the
growth. As a result, the more successful the MLP is in
growing its dividends, the closer it gets to paying
incentives to the parent/general partner that are more
onerous than a tax at the corporate level. The lower the
corporate tax rate, the sooner this threshold is crossed.
In many cases, MLPs are merely a part of the corporate
finance structure of a company. MLPs are created when
they lower the cost of equity financing and are no longer
used when they don't. As a result of the foregoing, the
Fund may increase its non-MLP investments consistent with
its investment objective and policies.
In addition, on December 22, 2017, the Tax Cuts and Jobs
Act was signed into law, which, among other things,
reduced the top federal income tax rate applicable to the
Fund from 35% to 21% and, accordingly, reduced the Fund's
accrual rate for deferred federal income taxes. As a
result, the Fund's deferred tax liability was
significantly reduced which in turn resulted in an
increase in the Fund's NAV. As of December 22, 2017, the
Fund's NAV was increased by approximately $0.24, or
approximately 1.72%. See "Tax Matters" and "Market and
Net Asset Value Information."
Leverage Program Tax Risk. The Fund intends to use
leverage to make its investments. See "Leverage Program."
After 2017, the Fund may be subject to limitations on the
amount of interest deductions that it may take in each
year. The limitation on interest would be based upon
income before depletion, which is sometimes a significant
deduction allocated from MLPs. It is possible that the
Fund will not be able to deduct all of its interest
expense in the year accrued. If this occurs, the excess
interest expense could be carried forward to subsequent
years, but the Fund's tax in the year the expense is
accrued could increase.
Tax Law Change Risk. Changes in tax laws or regulations,
or interpretations thereof in the future, could adversely
affect the Fund or the MLPs, MLP-related entities and
other energy sector and energy utility companies in which
the Fund invests. Any such changes could negatively
impact the Fund and its common shareholders.
Non-U.S. Securities Risk. Investing in non-U.S.
securities involves certain risks not involved in
domestic investments, including, but not limited to:
fluctuations in currency exchange rates; future foreign
economic, financial, political and social developments;
different legal systems; the possible imposition of
exchange controls or other foreign governmental laws or
restrictions; lower trading volume; withholding taxes;
greater price volatility and illiquidity; different
trading and settlement practices; less governmental
supervision; high and volatile rates of inflation;
fluctuating interest rates; less publicly available
information; and different accounting, auditing and
financial recordkeeping standards and requirements.
Because the Fund may invest in securities denominated or
quoted in non-U.S. currencies, changes in the non-U.S.
currency/United States dollar exchange rate may affect
the value of the Fund's securities and the unrealized
appreciation or depreciation of investments.
Delay in Investing the Proceeds. Although the Fund
currently intends to invest the proceeds from the sale of
the Common Shares as soon as practicable, such
investments may be delayed if suitable investments are
unavailable at the time. The trading market and volumes
for MLP, MLP-related entity and other energy sector and
energy utility company shares may at times be less liquid
than the market for other securities. Prior to the time
the proceeds of any offering are invested, such proceeds
may be invested in cash, cash equivalents or other
securities, pending investment in MLP, MLP-related entity
or other energy sector or energy utility company
securities. As a result, the return and yield on the
common shares following the issuance of Common Shares may
be lower than when the Fund is fully invested in
accordance with its objective and policies. See "Use of
Proceeds."
Equity Securities Risk. MLP units and other equity
securities are sensitive to general movements in the
stock market and a drop in the stock market may depress
the price of securities to which the Fund has exposure.
MLP units and other equity securities prices fluctuate
for several reasons including changes in the financial
condition of a particular issuer (generally measured in
terms of distributable cash flow in the case of MLPs),
investors' perceptions of MLPs and other energy sector
and energy utility companies, the general condition of
22
the relevant stock market, such as the current market
volatility, or when political or economic events
affecting the issuers occur. In addition, the price of
equity securities may be particularly sensitive to rising
interest rates, as the cost of capital rises and
borrowing costs increase.
Certain of the MLPs, MLP-related entities and other
energy sector and energy utility companies in which the
Fund may invest may have comparatively smaller
capitalizations. Investing in securities of smaller MLPs,
MLP-related entities and other energy sector and energy
utility companies presents some unique investment risks.
These companies may have limited product lines and
markets, as well as shorter operating histories, less
experienced management and more limited financial
resources than larger MLPs, MLP-related entities and
other energy sector and energy utility companies and may
be more vulnerable to adverse general market or economic
developments. Stocks of smaller MLPs, MLP-related
entities and other energy sector and energy utility
companies may be less liquid than those of larger MLPs,
MLP-related entities and other energy sector and energy
utility companies and may experience greater price
fluctuations than larger MLPs, MLP-related entities and
other energy sector and energy utility companies. In
addition, small-cap securities may not be widely followed
by the investment community, which may result in reduced
demand.
MLP subordinated units in which the Fund may invest will
generally convert to common units at a one-to-one ratio.
The purchase or sale price is generally tied to the
common unit price less a discount. The size of the
discount varies depending on the likelihood of
conversion, the length of time remaining to conversion,
the size of the block purchased and other factors.
Debt Securities Risk. Debt securities in which the Fund
invests are subject to many of the risks described
elsewhere in this section. In addition, they are subject
to credit risk, interest rate risk, and, depending on
their quality, other special risks. An issuer of a debt
security may be unable to make interest payments and
repay principal. The Fund could lose money if the issuer
of a debt obligation is, or is perceived to be, unable or
unwilling to make timely principal and/or interest
payments, or to otherwise honor its obligations. The
downgrade of a security by rating agencies may further
decrease its value. Certain debt instruments,
particularly below investment grade securities, may
contain call or redemption provisions which would allow
the issuer thereof to prepay principal prior to the debt
instrument's stated maturity. This is known as prepayment
risk. Prepayment risk is greater during a falling
interest rate environment as issuers can reduce their
cost of capital by refinancing higher yielding debt
instruments with lower yielding debt instruments. An
issuer may also elect to refinance its debt instruments
with lower yielding debt instruments if the credit
standing of the issuer improves. To the extent debt
securities in its portfolio are called or redeemed, the
Fund may be forced to reinvest in lower yielding
securities. Debt securities have reinvestment risk, which
is the risk that income from the Fund's portfolio will
decline if and when the Fund invests the proceeds from
matured, traded or called fixed income instruments at
market interest rates that are below the portfolio's
current earnings rate. A decline in income could affect
the Fund's common share price or its overall return.
Below Investment Grade Securities Risk. The Fund may
invest up to 20% of its Managed Assets in debt securities
of MLPs, MLP-related entities and other energy sector and
energy utility companies, including certain below
investment grade securities. Below investment grade debt
securities are commonly referred to as "high yield" or
"junk" bonds. Below investment grade securities are
considered speculative with respect to an issuer's
capacity to pay interest and repay principal. They
involve greater risk of loss, are subject to greater
price volatility and are less liquid, especially during
periods of economic uncertainty or change, than higher
rated debt instruments. Below investment grade securities
may also be more susceptible to real or perceived adverse
economic and competitive industry conditions than higher
rated debt instruments. The Fund does not intend to
invest in securities issued by a partnership or company
in bankruptcy reorganization, subject to a public or
private debt restructuring or otherwise in default or in
significant risk of default in the payment of interest
and principal ("distressed securities"). In the event any
security held by the Fund becomes distressed, the Fund
may be required to incur extraordinary expenses in order
23
to attempt to protect and/or recover its investment. In
such situations, there can be no assurance as to when or
if the Fund will recover any of its investment in such
distressed securities, or the value thereof.
Leverage Risk. The use of leverage by the Fund can
magnify the effect of any losses. If the income and gains
earned on the securities and investments purchased with
leverage proceeds are greater than the cost of the
leverage, the common shares' return will be greater than
if leverage had not been used. Conversely, if the income
and gains from the securities and investments purchased
with such proceeds do not cover the cost of leverage, the
return to the common shares will be less than if leverage
had not been used. Leverage involves risks and special
considerations for common shareholders including:
o the likelihood of greater volatility of NAV and
market price of the common shares than a comparable
portfolio without leverage;
o the risk that fluctuations in interest rates on
borrowings and short-term debt or in the dividend
rates on any Preferred Shares that the Fund may pay
will reduce the return to the common shareholders or
will result in fluctuations in the dividends paid on
the common shares;
o the effect of leverage in a declining market, which
is likely to cause a greater decline in the NAV of
the common shares than if the Fund were not
leveraged, which may result in a greater decline in
the market price of the common shares; and
o when the Fund uses certain types of leverage, the
investment advisory fee payable to the Advisor and
by the Advisor to the Sub-Advisor will be higher
than if the Fund did not use leverage.
The use of leverage by the Fund involves expenses and
other costs, including interest or dividend payments,
which are borne directly by the common shareholders.
Increased operating costs, including the financing cost
associated with any leverage, may reduce the Fund's total
return. In addition, any turmoil in the credit markets
could adversely impact borrowing availability and costs.
Because common shareholders directly bear the cost of
leverage, an increase in interest and dividend
obligations on the Fund's financial leverage may reduce
the total return to common shareholders.
While the Fund may from time to time consider reducing
leverage in response to actual or anticipated changes in
interest rates or other market conditions or in an effort
to mitigate the increased volatility of current income
and NAV associated with leverage, there can be no
assurance that the Fund will actually reduce leverage in
the future or that any reduction, if undertaken, will
benefit the common shareholders. Changes in the future
direction of interest rates are very difficult to predict
accurately. If the Fund were to reduce leverage based on
a prediction about future changes to interest rates, and
that prediction turned out to be incorrect, the reduction
in leverage would likely operate to reduce the income
and/or total returns to common shareholders relative to
the circumstance if the Fund had not reduced leverage.
The Fund may decide that this risk outweighs the
likelihood of achieving the desired reduction to
volatility in income and common share price if the
prediction were to turn out to be correct, and determine
not to reduce leverage as described above.
The funds borrowed pursuant to a borrowing program (such
as the Nova Scotia Facility) or obtained through the
issuance of Preferred Shares constitute a substantial
lien and burden by reason of their prior claim against
the income of the Fund and against the net assets of the
Fund in liquidation. The rights of lenders to receive
payments of interest on and repayments of principal of
any borrowings made by the Fund under a borrowing program
are senior to the rights of holders of common shares and
the holders of Preferred Shares, with respect to the
payment of dividends or upon liquidation. Certain types
of leverage may result in the Fund being subject to
covenants relating to asset coverage and portfolio
composition and may impose special restrictions on the
Fund's use of various investment techniques or strategies
or in its ability to pay dividends and other
distributions on common shares in certain instances. The
Fund may not be permitted to declare dividends or other
distributions, including dividends and distributions with
respect to common shares or Preferred Shares, or purchase
common shares or Preferred Shares unless, at the time
24
thereof, the Fund meets these asset coverage and
portfolio composition requirements and no event of
default exists under any borrowing program. In addition,
the Fund may not be permitted to pay dividends on common
shares unless all dividends on the Preferred Shares
and/or accrued interest on borrowings have been paid, or
set aside for payment. In an event of default under a
borrowing program, the lenders have the right to cause a
liquidation of collateral (i.e., sell assets of the Fund)
and, if any such default is not cured, the lenders may be
able to control the liquidation as well. The Fund also
may be subject to certain restrictions on investments
imposed by guidelines of one or more rating agencies,
which may issue ratings for the Preferred Shares or other
leverage securities issued by the Fund. These guidelines
may impose asset coverage or Fund composition
requirements that are more stringent than those imposed
by the 1940 Act. The Sub-Advisor does not believe that
these covenants or guidelines will impede it from
managing the Fund's portfolio in accordance with the
Fund's investment objective and policies.
The loan documents under the Nova Scotia Facility include
various covenants and provisions. See "Leverage Program"
for examples of such covenants. There is no assurance
that the Fund will not violate financial covenants
relating to financial leverage in the future. In such
event, the Fund may be required to repay all outstanding
borrowings immediately. In order to repay such amounts,
the Fund may be required to sell assets quickly which
could have a material adverse effect on the Fund and
could trigger negative tax implications. In addition, the
Fund would be precluded from declaring or paying any
distribution on the common shares during the continuance
of such event of default.
The issuance of Common Shares offered by this prospectus
and any related prospectus supplement will enable the
Fund to increase the aggregate amount of its leverage.
However, it is possible that the Fund will be unable to
obtain additional leverage. If the Fund is unable to
increase its financial leverage after the issuance of
additional Common Shares pursuant to this prospectus and
the applicable prospectus supplement, there could be an
adverse impact on the return to common shareholders. See
"--Leverage Program Tax Risk" and "Risks--Leverage Risk."
There is no assurance that a leveraging strategy will be
successful. The Fund may continue to use leverage if the
benefits to the Fund's shareholders of maintaining the
leveraged position are believed by the Fund's Board of
Trustees to outweigh any current reduced return. See also
"Other Investment Policies and Techniques--Strategic
Transactions" in the SAI for more information about
Strategic Transactions in which the Fund may enter that
give rise to a form of financial leverage and the
associated risks.
Derivatives Risk. The Fund may, but is not required to,
enter into Strategic Transactions for hedging, risk
management or investment purposes. These transactions, if
any, generally provide for the transfer from one
counterparty to another of certain risks inherent in the
ownership of a financial asset such as a common stock or
debt instrument. Such risks include, among other things,
the risk of default and insolvency of the obligor of such
asset, the risk that the credit of the obligor or the
underlying collateral will decline or the risk that the
common stock of the underlying issuer will decline in
value. The transfer of risk pursuant to a derivative of
this type may be complete or partial, and may be for the
life of the related asset or for a shorter period. These
derivatives may be used for investment purposes or as a
risk management tool for a pool of financial assets,
providing the Fund with the opportunity to gain or reduce
exposure to one or more reference securities or other
financial assets without actually owning or selling such
assets in order, for example, to increase or reduce a
concentration risk or to diversify a portfolio.
Conversely, these derivatives may be used by the Fund to
reduce exposure to an owned asset without selling it.
Furthermore, the ability to successfully use Strategic
Transactions depends on the Sub-Advisor's ability to
predict pertinent market movements, which cannot be
assured. Thus, the use of Strategic Transactions for
hedging and interest rate management purposes may result
in losses greater than if they had not been used, may
require the Fund to sell or purchase portfolio securities
at inopportune times or for prices other than current
market values, may limit the amount of appreciation the
Fund can realize on an investment, or may cause the Fund
to hold a security that it might otherwise sell.
Additionally, amounts paid by the Fund as premiums and
25
cash or other assets held in margin accounts with respect
to Strategic Transactions are not otherwise available to
the Fund for investment purposes.
The derivatives markets have become subject to
comprehensive statutes, regulations and margin
requirements. In the event the Advisor or the Sub-Advisor
is required to register with the CFTC as a "commodity
pool operator" or a "commodity trading advisor", it will
become subject to additional recordkeeping and reporting
requirements with respect to the Fund. The Fund currently
limits its investments in derivative instruments so as
not to require the Advisor or the Sub-Advisor to register
as a commodity pool operator or commodity trading advisor
with respect to the Fund. On December 11, 2015, the SEC
published a proposed rule that, if adopted, would change
the regulation of the use of derivative instruments by
registered investment companies. Such regulations could
limit the implementation of the Fund's use of derivatives
and Strategic Transactions and impose additional
compliance costs on the Fund, which could have an adverse
impact on the Fund. See "Risks--Derivatives Risk" in this
prospectus and "Additional Information About the Fund's
Investments and Investment Risks--Strategic Transactions
Risk" in the SAI.
Covered Call Options Risk. There are various risks
associated with the Fund writing (or selling) covered
call options. As the writer (seller) of a call option,
the Fund receives cash (the premium) from the purchaser
of the option, and the purchaser has the right to receive
from the Fund any appreciation in the underlying security
over the strike price upon exercise. In effect, the Fund
forgoes, during the life of the option, the opportunity
to profit from increases in the market value of the
portfolio security covering the option above the sum of
the premium and the strike price of the call option but
retains the risk of loss should the price of the
underlying security decline. Therefore, the writing (or
selling) of covered call options may limit the Fund's
ability to benefit from the full upside potential of its
investment strategies.
The value of call options written by the Fund, which are
priced daily, are determined by trading activity in the
broad options market and will be affected by, among other
factors, changes in the value of the underlying security
in relation to the strike price, changes in dividend
rates of the underlying security, changes in interest
rates, changes in actual or perceived volatility of the
stock market and the underlying security, and the time
remaining until the expiration date. The value of call
options written by the Fund may be adversely affected if
the market for the option is reduced or becomes illiquid.
There can be no assurance that a liquid market will exist
when the Fund seeks to close out an option position.
Reasons for the absence of a liquid secondary market on
an exchange include the following: (i) insufficient
trading interest in certain options; (ii) restrictions
may be imposed by an exchange on opening transactions or
closing transactions or both; (iii) trading halts,
suspensions or other restrictions may be imposed with
respect to particular classes or series of options; (iv)
unusual or unforeseen circumstances may interrupt normal
operations on an exchange; (v) inadequate facilities of
an exchange or The Options Clearing Corporation to handle
current trading volume; or (vi) the decision of one or
more exchanges at some future date to discontinue the
trading of options (or a particular class or series of
options) for economic or other reasons. If trading were
discontinued, the secondary market on that exchange (or
in that class or series of options) would cease to exist.
However, outstanding options on that exchange would
continue to be exercisable in accordance with their
terms. To the extent that the Fund utilizes unlisted (or
"over-the- counter") options, the Fund's ability to
terminate these options may be more limited than with
exchange-traded options and may involve enhanced risk
that counterparties participating in such transactions
will not fulfill their obligations.
The hours of trading for options may not conform to the
hours during which the securities held by the Fund are
traded. To the extent that the options markets close
before the markets for the underlying securities,
significant price and rate movements can take place in
the underlying markets that cannot be reflected in the
options markets. Additionally, the exercise price of an
option may be adjusted downward before the option's
expiration as a result of the occurrence of certain
corporate events affecting the underlying security, such
as extraordinary dividends, stock splits, mergers or
other extraordinary distributions or events. A reduction
26
in the exercise price of options might reduce the Fund's
capital appreciation potential on underlying securities
held by the Fund.
The Fund's covered call options transactions are subject
to limitations established by each of the exchanges,
boards of trade or other trading facilities on which the
options are traded. These limitations govern the maximum
number of options in each class that may be written by a
single investor or group of investors acting in concert,
regardless of whether the options are written on the same
or different exchanges, boards of trade or other trading
facilities or are written in one or more accounts or
through one or more brokers. Thus, the number of covered
call options that the Fund may write may be affected by
options written by other investment advisory clients of
the Advisor, Sub-Advisor or their affiliates. An
exchange, board of trade or other trading facility may
order the liquidation of positions found to be in excess
of these limits, and it may impose other sanctions.
Interest Rate Swaps Risk. The use of interest rate swaps
is a highly specialized activity that involves investment
techniques and risks different from those associated with
ordinary portfolio security transactions. Depending on
market conditions in general, the Fund's use of swaps
could enhance or harm the overall performance of the
common shares. For example, the Fund may utilize interest
rate swaps in connection with the Fund's use of leverage.
To the extent there is a decline in interest rates, the
value of the interest rate swap could decline, and could
result in a decline in the NAV of the common shares. In
addition, if short-term interest rates are lower than the
Fund's fixed rate of payment on the interest rate swap,
the swap will reduce common share net earnings. If, on
the other hand, short-term interest rates are higher than
the fixed rate of payment on the interest rate swap, the
swap will enhance common share net earnings.
Interest rate swaps do not involve the delivery of
securities or other underlying assets or principal.
Accordingly, the risk of loss with respect to interest
rate swaps is limited to the net amount of interest
payments that the Fund is contractually obligated to
make. If the counterparty defaults, the Fund would not be
able to use the anticipated net receipts under the swap
to offset any declines in the value of the Fund's
portfolio assets being hedged or the increase in the
Fund's cost of leverage.
Depending on whether the Fund would be entitled to
receive net payments from the counterparty on the swap,
which in turn would depend on the general state of market
interest rates at that point in time, such a default
could negatively impact the performance of the common
shares. In addition, at the time an interest rate swap
transaction reaches its scheduled termination date, there
is a risk that the Fund would not be able to obtain a
replacement transaction or that the terms of the
replacement would not be as favorable as on the expiring
transaction. If this occurs, it could have a negative
impact on the performance of the common shares. If the
Fund fails to maintain any required asset coverage ratios
in connection with any use by the Fund of leverage, the
Fund may be required to redeem or prepay some or all of
the leverage. Such redemption or prepayment would likely
result in the Fund seeking to terminate early all or a
portion of any swap transactions. Early termination of a
swap could result in a termination payment by or to the
Fund. The Fund earmarks or maintains, in a segregated
account, cash or liquid securities having a value at
least equal to the amount required to make payment on
each of the Fund's swap transactions if the Fund were to
exit its positions in such transactions immediately and
was required to mark to market.
Portfolio Turnover Risk. The Fund's annual portfolio
turnover rate may vary greatly from year to year.
Although the Fund cannot accurately predict its annual
portfolio turnover rate, it is not expected to exceed 20%
under normal circumstances, but may be higher or lower in
certain periods. Portfolio turnover rate is not
considered a limiting factor in the execution of
investment decisions for the Fund. High portfolio
turnover may result in the Fund's recognition of gains
that will be taxable as ordinary income, reducing the
funds available to pay distributions to the Fund's Common
Shareholders.
A high portfolio turnover may also increase the Fund's
current and accumulated earnings and profits, resulting
in a greater portion of the Fund's distributions being
treated as a dividend to the Fund's Common Shareholders.
In addition, a higher portfolio turnover rate results in
27
correspondingly greater brokerage commissions and other
transactional expenses that are borne by the Fund. See
"The Fund's Investments--Investment Practices--Portfolio
Turnover" and "Tax Matters."
Competition Risk. A number of alternatives as vehicles
for investment in a portfolio of energy MLPs and their
affiliates currently exist, including other
publicly-traded investment companies, structured notes
and private funds. These competitive conditions may
adversely impact the Fund's ability to meet its
investment objective, which in turn could adversely
impact the Fund's ability to make distributions.
Restricted Securities Risk. The Fund may invest in
unregistered or otherwise restricted securities. The term
"restricted securities" refers to securities that have
not been registered under the 1933 Act and continue to be
subject to restrictions on resale, securities held by
control persons of the issuer and securities that are
subject to contractual restrictions on their resale. As a
result, restricted securities may be more difficult to
value and the Fund may have difficulty disposing of such
assets either in a timely manner or for a reasonable
price. Absent an exemption from registration, the Fund
will be required to hold the securities until they are
registered by the issuer. In order to dispose of an
unregistered security, the Fund, where it has contractual
rights to do so, may have to cause such security to be
registered. A considerable period may elapse between the
time the decision is made to sell the security and the
time the security is registered so that the Fund could
sell it. Contractual restrictions on the resale of
securities vary in length and scope and are generally the
result of a negotiation between the issuer and acquirer
of the securities. The Fund would, in either case, bear
market risks during that period.
Liquidity Risk. Although common units of MLPs, I-Shares
of MLP-related entities, and common stock of certain
other energy sector and energy utility companies trade on
the NYSE, NYSE MKT, and Nasdaq Stock Market LLC
("Nasdaq"), certain securities may trade less frequently,
particularly those of issuers with smaller
capitalizations. Securities with limited trading volumes
may display volatile or erratic price movements. Larger
purchases or sales of these securities by the Fund in a
short period of time may result in abnormal movements in
the market price of these securities. This may affect the
timing or size of Fund transactions and may limit the
Fund's ability to make alternative investments. If the
Fund requires significant amounts of cash on short notice
in excess of normal cash requirements or is required to
post or return collateral in connection with the Fund's
investment portfolio, Strategic transactions or leverage
restrictions, the Fund may have difficulty selling these
investments in a timely manner, be forced to sell them
for less than it otherwise would have been able to
realize, or both. The reported value of some of the
Fund's relatively illiquid types of investments and, at
times, the Fund's high quality, generally liquid asset
classes, may not necessarily reflect the current market
price for the asset. If the Fund was forced to sell
certain of its assets in the current market, there can be
no assurance that the Fund will be able to sell them for
the prices at which the Fund has recorded them and the
Fund may be forced to sell them at significantly lower
prices. See "The Fund's Investments--Investment
Philosophy and Process."
Valuation Risk. Market prices generally will not be
available for subordinated units, direct ownership of
general partner interests, restricted securities or
unregistered securities of certain MLPs or MLP-related
entities, and the value of such investments will
ordinarily be determined based on fair valuations
determined pursuant to procedures adopted by the Board of
Trustees. The value of these securities typically
requires more reliance on the judgment of the Sub-Advisor
than that required for securities for which there is an
active trading market. In addition, the Fund relies on
information provided by certain MLPs, which is usually
not timely, to calculate taxable income allocable to the
MLP units held in the Fund's portfolio and to determine
the tax character of distributions to common
shareholders. From time to time the Fund will modify its
estimates and/or assumptions as new information becomes
available. To the extent the Fund modifies its estimates
and/or assumptions, the NAV of the Fund would likely
fluctuate. See "Net Asset Value."
Interest Rate Risk. Interest rate risk is the risk that
securities will decline in value because of changes in
market interest rates. When market interest rates rise,
28
the market value of the securities in which the Fund
invests generally will fall. The Fund's investment in
such securities means that the NAV and market price of
the common shares will tend to decline if market interest
rates rise. Interest rates are at or near historic lows.
The historically low interest rate environment increases
the risks associated with rising interest rates,
including the potential for periods of volatility. The
Fund currently faces a heightened level of interest rate
risk, especially since the Federal Reserve Board has
ended its quantitative easing program.
Collective Investment Vehicles Risk. The Fund may,
subject to the limitations of the 1940 Act, invest in the
securities of other collective investment vehicles,
including open-end funds, closed-end funds and
exchange-traded funds ("ETFs"). Such investments are
subject to the risks of the purchased funds' portfolio
securities. The Fund's investments in other funds also
are subject to the ability of the managers of those funds
to achieve the funds' investment objectives. An ETF that
is based on a specific index may not be able to replicate
and maintain exactly the composition and relative
weighting of securities in the index. An ETF also incurs
certain expenses not incurred by its applicable index.
The market value of shares of ETFs may differ from their
net asset value.
In addition, the Fund, as a holder of the securities of
other investment companies, will bear its pro rata
portion of the other investment companies' expenses,
including advisory fees. These expenses are in addition
to the direct expenses of the Fund's own operations.
Common shareholders would therefore be subject to
duplicative expenses to the extent the Fund invests in
other funds.
The investment companies in which the Fund may invest may
be leveraged, which would magnify the Fund's leverage
risk described above. See "--Leverage Risk." Risks
associated with investments in closed-end funds generally
include the risks described in this prospectus associated
with the Fund's structure as a closed-end fund, including
market risk, risk of market price discount from net asset
value, risk of anti-takeover provisions and
non-diversification. In addition, investments in
closed-end funds may be subject to dilution risk, which
is the risk that strategies employed by a closed-end
fund, such as rights offerings, may, under certain
circumstances, have the effect of reducing its share
price and the Fund's proportionate interest.
Convertible Securities Risk. Convertible securities have
characteristics of both equity and debt securities and,
as a result, are exposed to certain risks associated with
equity securities and debt securities, including but not
limited to interest rate risk and below investment grade
securities risk. See "--Debt Securities Risk,"
"--Interest Rate Risk" and "--Below Investment Grade
Securities Risk." The value of a convertible security is
influenced by both the yield of non-convertible
securities of comparable issuers and by the value of the
underlying common stock. Convertible securities generally
offer lower interest or dividend yields than
non-convertible securities of similar credit quality. The
market values of convertible securities tend to decline
as interest rates increase and, conversely, to increase
as interest rates decline. However, the convertible
security's market value tends to reflect the market price
of the common stock of the issuing company when that
stock price is greater than the convertible security's
"conversion price." The conversion price is defined as
the predetermined price at which the convertible security
could be exchanged for the associated common stock. As
the market price of the underlying common stock declines,
the price of the convertible security tends to be
influenced more by the yield of the convertible security.
Thus, the convertible security may not decline in price
to the same extent as the underlying common stock.
Convertible securities fall below debt obligations of the
same issuer in order of preference or priority in the
event of a liquidation and are typically unrated or rated
lower than such debt obligations.
Non-Diversification. The Fund is a non-diversified
investment company under the 1940 Act and will not be
treated as a regulated investment company under the Code.
Accordingly, while Section 12(d)(3) of the 1940 Act
prohibits the Fund from making certain investments, there
are no diversification-specific regulatory requirements
under the 1940 Act or the Code on the minimum number or
size of securities held by the Fund. As of November 30,
2017, there were approximately 103 publicly traded MLPs
29
with a market capitalization of approximately $362
billion. The Fund selects its MLP investments from this
small pool of issuers.
Anti-Takeover Provisions. The Fund's Declaration of Trust
includes provisions that could limit the ability of other
entities or persons to acquire control of the Fund or
convert the Fund to open-end status. These provisions
could have the effect of depriving the common
shareholders of opportunities to sell their common shares
at a premium over the then current market price of the
common shares. See "Certain Provisions in the Declaration
of Trust and By-Laws."
Inflation Risk. Inflation risk is the risk that the value
of assets or income from investment will be worth less in
the future as inflation decreases the value of money. As
inflation increases, the real value of the common shares
and distributions can decline.
Secondary Market for the Fund's Common Shares Issued
under the Dividend Reinvestment Plan. The issuance of
common shares through the Fund's dividend reinvestment
plan may have an adverse effect on the secondary market
for the common shares. The increase in the number of
outstanding common shares resulting from issuances
pursuant to the Fund's dividend reinvestment plan and the
discount to the market price at which such common shares
may be issued, may put downward pressure on the market
price for the common shares. Common shares will not be
issued pursuant to the dividend reinvestment plan at any
time when common shares are trading at a lower price than
the Fund's NAV per common share. When the Fund's common
shares are trading at a premium, the Fund may also issue
common shares that may be sold through private
transactions effected on the NYSE or through
broker-dealers. The increase in the number of outstanding
common shares resulting from these offerings may put
downward pressure on the market price for common shares.
30
SUMMARY OF FUND EXPENSES
The following table and example contain information about the costs and expenses
that common shareholders will bear directly or indirectly. In accordance with
SEC requirements, the table below shows the Fund's expenses, including leverage
costs, as a percentage of the Fund's net assets as of October 31, 2017, and not
as a percentage of gross assets or Managed Assets. By showing expenses as a
percentage of net assets, expenses are not expressed as a percentage of all the
assets the Fund invests. The table and example is based on the Fund's capital
structure as of October 31, 2017. As of that date, the Fund had $235,500,000 of
leverage outstanding pursuant to the Nova Scotia Facility. Such leverage
represented 25.94% of Managed Assets as of October 31, 2017.
SHAREHOLDER TRANSACTION EXPENSES
Sales Load (as a percentage of offering price............................................................ --%*
Offering Expenses Borne by Common Shareholders (as a percentage of offering price)(1) ................... --%*
Dividend Reinvestment Plan Fees ......................................................................... None(2)
PERCENTAGE OF NET ASSETS
ATTRIBUTABLE TO COMMON
SHARES (ASSUMES 25.94%
LEVERAGE IS OUTSTANDING)
------------------------
ANNUAL EXPENSES
Management Fees(3)................................................................................ 1.35%
Interest and Fees on Leverage(4).................................................................. 0.74%
Other Expenses (exclusive of current and deferred income tax expense (benefit))(5)................ 0.13%
---------
Annual Expenses (exclusive of current and deferred income tax expense (benefit)) (5).............. 2.22%
Current Income Tax Expense (benefit).............................................................. 1.17%
Deferred Income Tax Expense (benefit)............................................................. (0.01)%
---------
Total Annual Expenses (including current and deferred income tax expenses)........................ 3.38%
=========
--------------------------------------------------------------------------------
* The applicable prospectus supplement to be used in connection with any
sales of Common Shares will set forth any applicable sales load and the
estimated offering expenses borne by the Fund.
(1) The Fund will pay all offering costs other than the sales load.
(2) You will pay brokerage charges if you direct BNY Mellon Investment
Servicing (US) Inc., as agent for the Common Shareholders Dividend
Reinvestment Plan, to sell your Common Shares held in a dividend
reinvestment account.
(3) Represents the aggregate fee payable to the Advisor, including the amount
payable by the Advisor to the Sub-Advisor.
(4) Interest and fees on leverage in the table reflect the cost to the Fund of
borrowings, expressed as a percentage of the Fund's net assets as of
October 31, 2017, based on interest rates in effect as of October 31,
2017. The table assumes total borrowings of $235,500,000, which reflects
leverage in an amount representing 25.94% of Managed Assets. The
borrowings bear interest at variable rates.
(5) Current and deferred income tax expense (benefit) varies based on the
Fund's net investment income and realized and unrealized investment gain
and losses, which cannot be predicted. Accordingly, other expenses do not
include current or deferred income tax expense (benefit). The Fund's
current and deferred income tax expense (benefit) as a percentage of
average net assets by fiscal year from inception through October 31, 2017
has been as follows:
Period November 27, 2012 (commencement of operations)
Through October 31, 2013 7.86%
Year Ended October 31, 2014 9.49%
Year Ended October 31, 2015 (12.40)%
Year Ended October 31, 2016 (1.99)%
Year Ended October 31, 2017 1.11%
The table set forth below presents the Fund's annual operating expenses as
a percentage of net assets attributable to Common Shares, excluding an
estimate of current and deferred income tax expense (benefit).
PERCENTAGE OF NET ASSETS
ATTRIBUTABLE TO COMMON
SHARES (ASSUMES 25.94%
LEVERAGE IS OUTSTANDING)
------------------------
ANNUAL EXPENSES
Management Fees.............................................................................. 1.35%
Interest and Fees on Leverage................................................................ 0.74%
Other Expenses (exclusive of current and deferred income tax expense (benefit)).............. 0.13%
---------
Total Annual Expenses (exclusive of current and deferred income tax expense (benefit))....... 2.22%
=========
The purpose of the tables above and the examples below is to help you understand
all fees and expenses that you, as a holder of Common Shares, would bear
directly or indirectly. The expenses shown in the tables under "Other Expenses"
and "Total Annual Expenses" are based on estimated amounts for the Fund's 12
months of operations after October 31, 2017 unless otherwise indicated and
assumes that the Fund has not issued any additional common shares.
31
The following example illustrates the expenses that you would pay on a $1,000
investment in Common Shares, assuming (i) total annual expenses before taxes of
3.38% of net assets attributable to common shares through year 10, including the
Fund's estimate of current and deferred income tax expense (benefit), (ii) a 5%
annual return, and (iii) all distributions are reinvested at net asset value:(1)
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
$34 $104 $176 $367
The following example illustrates the expenses that you would pay on a $1,000
investment in Common Shares, assuming (i) total annual expenses before taxes of
2.22% of net assets attributable to common shares through year 10, excluding the
Fund's estimate of current and deferred income tax expense (benefit), (ii) a 5%
annual return, and (iii) all distributions are reinvested at net asset value:(1)
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
$23 $69 $119 $255
--------------
(1) These examples do not include sales load or estimated offering costs. THE
EXAMPLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE EXPENSES. The
examples assume that the estimated "Other Expenses set forth in the Annual
Expenses table are accurate, that all dividends and distributions are
reinvested at net asset value and that the Fund is engaged in leverage of
25.94% of Managed Assets, assuming interest and fees on leverage of 2.10%.
The interest and fees on leverage is expressed as an interest rate and
represents interest and fees payable on the Nova Scotia Facility. ACTUAL
EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. Moreover, the Fund's
actual rate of return may be greater or less than the hypothetical 5%
return shown in the example.
32
FINANCIAL HIGHLIGHTS
The information in the following table shows selected data for a common share
outstanding throughout each period listed below. The information in this table
for the year ended October 31, 2017 and each of the prior years then ended is
derived from the Fund's financial statements audited by Deloitte & Touche LLP,
whose report on the 2017 financial statements and the financial highlights for
the four years in the period then ended and for the period from November 27,
2012 through October 31, 2013 is contained in the Fund's 2017 Annual Report. The
2017 Annual Report is incorporated by reference into the Fund's SAI and is
available from the Fund upon request.
FOR THE PERIOD
YEAR ENDED OCTOBER 31, 11/27/2012
------------------------------------------------------------ THROUGH
2017 2016 2015 2014 10/31/2013 (a)
------------ ------------ ------------ ------------ ------------
Net asset value, beginning of period............. $ 15.42 $ 17.37 $ 23.27 $ 20.80 $ 19.10 (b)
---------- ---------- ---------- ---------- ----------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss)..................... 0.05 (0.05) 0.07 (0.03) (0.05)
Net realized and unrealized gain (loss).......... 0.36 (0.48) (4.59) 3.83 2.81
---------- ---------- ---------- ---------- ----------
Total from investment operations................. 0.41 (0.53) (4.52) 3.80 2.76
---------- ---------- ---------- ---------- ----------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income............................ (0.68) -- -- -- --
Net realized gain................................ -- -- -- -- (0.25)
Return of capital................................ (0.74) (1.42) (1.38) (1.33) (0.73)
---------- ---------- ---------- ---------- ----------
Total distributions.............................. (1.42) (1.42) (1.38) (1.33) (0.98)
---------- ---------- ---------- ---------- ----------
Common Shares offering costs charged to paid-in
capital....................................... -- -- -- -- (0.02)
---------- ---------- ---------- ---------- ----------
Capital reduction resulting from issuance of
Common Shares related to over-allotment....... -- -- -- -- (0.06)
---------- ---------- ---------- ---------- ----------
Premiums from shares sold in at the market
offering...................................... 0.01 -- -- -- --
---------- ---------- ---------- ---------- ----------
Net asset value, end of period................... $ 14.42 $ 15.42 $ 17.37 $ 23.27 $ 20.80
========== ========== ========== ========== ==========
Market value, end of period...................... $ 14.49 $ 15.66 $ 16.86 $ 21.61 $ 19.63
========== ========== ========== ========== ==========
TOTAL RETURN BASED ON NET ASSET VALUE (c)........ 2.56% (1.57)% (d) (19.82)% 19.43% 14.27%
========== ========== ========== ========== ==========
TOTAL RETURN BASED ON MARKET VALUE (c)........... 1.48% 2.98% (16.20)% 17.52% 2.99%
========== ========== ========== ========== ==========
-----------------------------
Net assets, end of period (in 000's)............. $ 672,373 $ 701,457 $ 789,061 $1,057,317 $ 945,149
Portfolio turnover rate.......................... 50% 68% 32% 34% 35%
RATIOS OF EXPENSES TO AVERAGE NET ASSETS:
Including current and deferred income taxes (e).. 3.22% (0.11)% (10.66)% 11.28% 9.53% (f)
Excluding current and deferred income taxes...... 2.11% 1.88% 1.74% 1.79% 1.67% (f)
Excluding current and deferred income taxes
and interest expense.......................... 1.48% 1.47% 1.45% 1.51% 1.43% (f)
RATIOS OF NET INVESTMENT INCOME (LOSS) TO AVERAGE NET ASSETS:
Net investment income (loss) ratio before tax
expenses...................................... 0.09% (0.17)% 0.54% (0.24)% (0.42)% (f)
Net investment income (loss) ratio including
tax expenses (e).............................. (1.02)% 1.82% 12.93% (9.74)% (8.28)% (f)
INDEBTEDNESS:
Total loan outstanding (in 000's)................ $ 235,500 $ 222,500 $ 275,000 $ 350,000 $ 334,000
Asset coverage per $1,000 of indebtedness (g).... $ 3,855 $ 4,153 $ 3,869 $ 4,021 $ 3,830
-----------------------------
(a) The Fund was seeded on October 11, 2012 and commenced operations on
November 27, 2012.
(b) Beginning net asset value is net of sales load of $0.90 per share from the
initial offering.
(c) 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 of less than one year. Past performance is not
indicative of future results.
(d) The Fund received a reimbursement from the sub-advisor in the amount of
$23,511 in connection with a trade error. The reimbursement from the
sub-advisor represents less than $0.01 per share and had no effect on the
Fund's total return.
(e) Includes current and deferred income taxes associated with each component
of the Statement of Operations.
(f) Annualized.
(g) Calculated by taking the Fund's total assets less the Fund's total
liabilities (not including the loan outstanding) and dividing by the loan
outstanding in 000's.
33
MARKET AND NET ASSET VALUE INFORMATION
The Fund's currently outstanding common shares are, and the Common Shares
offered by this prospectus and the applicable prospectus supplement, subject to
notice of issuance, will be listed on the NYSE. The Fund's common shares
commenced trading on the NYSE on November 27, 2012.
The Fund's common shares have traded both at a premium and at a discount in
relation to net asset value. Shares of closed-end investment companies
frequently trade at a discount from net asset value. The Fund's issuance of the
Common Shares may have an adverse effect on prices in the secondary market for
the Fund's common shares by increasing the number of common shares available,
which may put downward pressure on the market price for the Fund's common
shares. Shares of common stock of closed-end investment companies frequently
trade at a discount from Net Asset Value. See "Risks--Market Discount from Net
Asset Value."
The following table sets forth for each of the periods indicated the high and
low closing market prices for common shares of the Fund on the NYSE, the net
asset value per share and the premium or discount to net asset value per share
at which the Fund's common shares were trading. Net asset value is determined
daily as of the close of regular trading on the NYSE (normally 4:00 p.m. Eastern
Time). See "Net Asset Value" for information as to the determination of the
Fund's net asset value.
PREMIUM/(DISCOUNT)
MARKET PRICE(1) NET ASSET VALUE(2) TO NET ASSET VALUE(3)
QUARTER ENDED HIGH LOW HIGH LOW HIGH LOW
December 31, 2012...................... $20.65 $19.98 $19.11 $19.07 8.06% 4.77%
March 31, 2013......................... $21.05 $20.02 $20.18 $19.60 4.31% 2.14%
June 30, 2013.......................... $22.29 $19.35 $21.20 $20.04 5.14% (3.44)%
September 30, 2013..................... $21.08 $18.91 $20.79 $20.08 1.39% (5.83)%
December 31, 2013...................... $20.01 $18.30 $21.02 $20.25 (4.80)% (9.63)%
March 31, 2014......................... $19.98 $18.80 $20.58 $20.61 (2.92)% (8.78)%
June 30, 2014.......................... $21.63 $19.53 $23.32 $21.37 (7.25)% (8.61)%
September 30, 2014..................... $22.15 $20.49 $24.09 $22.29 (8.05)% (8.08)%
December 31, 2014...................... $22.12 $18.95 $23.93 $21.23 (7.56)% (10.74)%
March 31, 2015......................... $21.45 $19.43 $23.10 $21.58 (7.14)% (9.96)%
June 30, 2015.......................... $21.15 $18.21 $22.03 $20.47 (3.99)% (11.04)%
September 30, 2015..................... $18.44 $15.20 $20.46 $15.54 (9.87)% (2.19)%
December 31, 2015...................... $17.20 $10.89 $17.78 $12.74 (3.26)% (14.52)%
March 31, 2016......................... $13.78 $ 8.84 $14.17 $10.64 (2.75)% (16.92)%
June 30, 2016.......................... $15.87 $12.75 $15.67 $13.22 1.28% (3.56)%
September 30, 2016..................... $16.56 $15.17 $15.86 $15.55 4.41% (2.44)%
December 31, 2016...................... $17.27 $14.63 $15.53 $14.90 11.20% (1.81)%
March 31, 2017......................... $17.50 $15.92 $16.26 $15.68 7.63% 1.53%
June 30, 2017.......................... $16.64 $14.61 $15.92 $14.41 4.52% 1.39%
September 30, 2017..................... $15.96 $14.59 $15.36 $14.23 3.91% 2.53%
The last reported sale price, net asset value per share and percentage premium
to net asset value per share of the common shares as of February 15, 2018 were
$14.69, $14.10 and 4.18%, respectively. As of December 31, 2017, the Fund had
46,753,872 common shares outstanding and net assets of the Fund were
$684,236,516. See "Risks--Recent Market and Economic Developments" for a
discussion of the impact that the Tax Cuts and Jobs Act had on the Fund's NAV.
(1) Based on high and low closing market price for the respective quarter.
(2) Based on the net asset value calculated on the day of the high and low
closing market prices, as applicable, as of the close of regular trading
on the NYSE (normally 4:00 p.m. Eastern Time).
(3) Calculated based on the information presented.
34
THE FUND
First Trust MLP and Energy Income Fund (the "Fund") is a non-diversified,
closed-end management investment company registered under the Investment Company
Act of 1940, as amended (the "1940 Act"). The Fund was organized on August 17,
2012, as a Massachusetts business trust pursuant to a Declaration of Trust (as
amended, the "Declaration of Trust"). On November 30, 2012, the Fund issued an
aggregate of 41,500,000 common shares in its initial public offering. Pursuant
to an overallotment option, the Fund issued an additional 3,913,066 common
shares for a total of 45,413,066.
On June 19, 2017, the Fund entered into a sales agreement with the Advisor,
Sub-Advisor, and JonesTrading Institutional Services LLC pursuant to which the
Fund may offer and sell up to 4,600,000 Common Shares through JonesTrading
Institutional Services LLC as its agent. As of October 31, 2017, 853,466 Common
Shares have been sold under this sales agreement. The Fund's currently
outstanding common shares are, and the Common Shares offered in this prospectus
and any applicable prospectus supplement will be, listed on the New York Stock
Exchange (the "NYSE") under the symbol "FEI." The Fund's principal office is
located at 10 Westport Road, Suite C101a, Wilton, Connecticut 06897, and its
telephone number is (630) 765-8000. Investment in the Fund involves certain
risks and special considerations including risks associated with the Fund's use
of leverage. See "Risks." The common shares of beneficial interest offered by
this prospectus and any applicable prospectus supplement are called "Common
Shares" and the holders of Common Shares are called "Common Shareholders" in
this prospectus. As used in this prospectus, unless the context requires
otherwise, "common shares" refers to the Fund's common shares of beneficial
interest currently outstanding as well as those Common Shares offered by this
prospectus and the holders of common shares are called "common shareholders."
The following table provides information about the Fund's outstanding securities
as of October 31, 2017:
AMOUNT HELD BY
AMOUNT THE FUND OR FOR AMOUNT
TITLE OF CLASS AUTHORIZED ITS ACCOUNT OUTSTANDING
Common shares......................Unlimited 0 46,637,670
USE OF PROCEEDS
Unless otherwise specified in a prospectus supplement, the Fund expects to
invest the net proceeds from any sales of Common Shares in accordance with the
Fund's investment objective and policies as stated below, or use such proceeds
for other general corporate purposes within approximately three months of
receipt of such proceeds. Pending any such use, the proceeds may be invested in
cash, cash equivalents or other securities.
THE FUND'S INVESTMENTS
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to seek a high level of total return with an
emphasis on current distributions paid to common shareholders. For purposes of
the Fund's investment objective, total return includes capital appreciation of,
and all distributions received from, securities in which the Fund invests
regardless of the tax character of the distributions. The Fund seeks to provide
its common shareholders with a vehicle to invest in a portfolio of
cash-generating securities, with a focus on investing in publicly traded master
limited partnerships ("MLPs"), MLP-related entities (as defined below) and other
companies in the energy sector and energy utility industries that are weighted
towards non-cyclical, fee for service revenues. These investments in which the
Sub-Advisor (as defined below) invests are represented by assets comprised of
interstate pipelines, intrastate pipelines, power generation assets, storage and
terminal facilities and regulated power transmission and distribution assets.
Due to the tax treatment under current law of cash distributions in excess of
income made by MLPs to their investors (such as the Fund), the Fund believes a
portion of the distributions it receives from MLP investments may be tax
deferred, thereby increasing cash available for current distribution by the Fund
to its common shareholders but potentially increasing the Fund's future tax
liability. See "Risks--MLP and Deferred Tax Risk." There can be no assurance
that the Fund will achieve its investment objective.
The Fund considers investments in "MLP-related entities" to include investments
that offer economic exposure to publicly traded MLPs and private investments
that have MLP characteristics, but are not publicly traded. These MLP-related
entity investments generally take the form of securities of entities holding
primarily general partner or managing member interests in MLPs and securities
that represent indirect investments in MLPs, including I-Shares, which represent
an ownership interest of an MLP issued by an affiliated party, and collective
investment vehicles (i.e., exchange-traded funds) that primarily hold MLP
interests. The Fund considers investments in the energy sector to include
companies that derive a majority of their revenues or operating income from
transporting, processing, storing, distributing, marketing, exploring,
developing, managing or producing natural gas, natural gas liquids ("NGLs")
(including propane), crude oil, refined petroleum products, coal or electricity,
or from supplying energy-related products and services, or any such other
companies within the energy sector as classified under the Global Industry
Classification Standards developed by MSCI, Inc. and Standard & Poor's ("GICS").
35
The Fund considers investments in energy utility to include companies that
derive a majority of their revenues or operating income from providing products,
services or equipment for the generation, transmission, distribution or sale of
electricity or gas and such other companies within the electric, gas,
independent power and renewable electricity producers and multi-utilities
industries as classified under GICS.
The types of MLPs in which the Fund invests historically have made cash
distributions to limited partners or members that exceed the amount of taxable
income allocable to limited partners or members, due to a variety of factors,
including significant non-cash deductions, such as depreciation and depletion.
If cash distributions from an MLP exceed the taxable income reported in a
particular tax year, a portion of the excess cash distribution would not be
treated as income to the Fund in that tax year but would rather be treated as a
return of capital for federal income tax purposes to the extent of the Fund's
basis in its MLP units. The Fund's tax basis in its MLP units is the amount paid
for the units, increased by the Fund's allocable share of net income and gains
and the MLP's debt, if any, and capital contributions to the MLP, and decreased
for any distributions received by the Fund, by the Fund's allocable share of net
losses and by reductions in the Fund's allocable share of the MLP's debt, if
any. Thus, although cash distributions in excess of taxable income and net tax
losses may create a temporary economic benefit to the Fund, they will increase
the amount of gain (or decrease the amount of loss) on the sale of an interest
in an MLP. The Fund expects to distribute cash in excess of its earnings and
profits to common shareholders, which will likely be treated as a return of
capital to the extent of the common shareholders' basis in the common shares.
See "Distributions" and "Tax Matters."
The Fund's investment objective and the investment restrictions listed in the
SAI are considered fundamental and may not be changed without the approval of
the holders of a "majority of the outstanding voting securities" of the Fund,
which includes common shares and preferred shares of beneficial interest
("Preferred Shares"), if any, voting together as a single class, and the holders
of the outstanding Preferred Shares, if any, voting as a single class. The
remainder of the Fund's investment policies, including its investment strategy,
are considered non-fundamental and may be changed by the Board of Trustees of
the Fund (the "Board of Trustees") without the approval of the holders of a
"majority of the outstanding voting securities" of the Fund provided that the
holders of the voting securities of the Fund receive at least 60 days' prior
written notice of any change. When used with respect to particular shares of the
Fund, a "majority of the outstanding voting securities" means (i) 67% or more of
the shares present at a meeting, if the holders of more than 50% of the shares
are present or represented by proxy, or (ii) more than 50% of the shares,
whichever is less (a "Majority Shareholder Vote").
The Fund concentrates its investments in the following group of industries that
are part of the energy sector: transporting, processing, storing, distributing,
marketing, exploring, developing, managing and producing natural gas, NGLs
(including propane), crude oil, refined petroleum products, coal and
electricity, and supplying products and services in support of pipelines, power
transmission, petroleum and natural gas production, transportation and storage.
In addition, the Fund has adopted the following non-fundamental investment
policies:
o Under normal market conditions, the Fund invests at least 85% of its
Managed Assets in equity and debt securities of MLPs, MLP-related
entities and other energy sector and energy utility companies that the
Fund's Sub-Advisor believes offer opportunities for growth and income.
See "The Fund's Investments--Portfolio Composition" for a further
discussion of the Fund's principal investments.
o The Fund may invest up to 20% of its Managed Assets in unregistered or
otherwise restricted securities. The term "restricted securities"
refers to securities that have not been registered under the Securities
Act of 1933, as amended (the "1933 Act"), and continue to be subject to
restrictions on resale, securities held by control persons of the
issuer and securities that are subject to contractual restrictions on
their resale. The types of unregistered or otherwise restricted
securities that the Fund may purchase consist of MLP common units, MLP
subordinated units and securities of public and private energy sector
and energy utility companies. See "Risks--Restricted Securities."
o The Fund may invest up to 20% of its Managed Assets in debt securities
of MLPs, MLP related entities and other energy sector and energy
utility companies, including certain securities rated below investment
grade, which are commonly referred to as "high yield" or "junk" bonds.
Below investment grade debt securities will be rated at least "B3" by
Moody's Investors Service, Inc. ("Moody's") and at least "B-" by
Standard & Poor's Ratings Services ("S&P") at the time of purchase, or
comparably rated by another nationally recognized statistical rating
organization ("NRSRO") or, if unrated, determined to be of comparable
quality by the Sub-Advisor. Below investment grade securities are
considered speculative with respect to an issuer's capacity to pay
interest and repay principal. See "Risks--Below Investment Grade
Securities Risk."
o The Fund will not invest more than 15% of its Managed Assets in any
single issuer.
o The Fund will not engage in short sales, except to the extent the Fund
engages in derivative investments to seek to hedge against interest
rate risk in connection with the Fund's use of leverage or market risks
associated with the Fund's portfolio.
36
o The Fund may invest up to 30% of its Managed Assets in non-U.S.
securities and may hedge the currency risk of the non- U.S. securities
using derivative instruments. Non-U.S. securities are securities issued
or guaranteed by companies organized under the laws of countries other
than the United States and securities issued or guaranteed by foreign
governments, their agencies or instrumentalities and supra-national
governmental entities. See "Risks--Non- U.S. Securities Risk" below and
"Other Investment Policies and Techniques--Strategic Transactions" in
the SAI.
To generate additional income, the Fund may write (or sell) covered call options
on up to 35% of its Managed Assets.
"Managed Assets" means the average daily gross asset value of the Fund (which
includes assets attributable to the Fund's Preferred Shares, if any, and the
principal amount of any borrowings (collectively, "Borrowings")), minus the sum
of the Fund's accrued and unpaid dividends on any outstanding Preferred Shares
and accrued liabilities (other than the principal amount of any borrowings of
money incurred or of commercial paper or notes issued by the Fund). For purposes
of determining Managed Assets, the liquidation preference of the Preferred
Shares, if any, is not treated as a liability.
Unless otherwise stated, all investment restrictions apply at the time of
purchase and the Fund will not be required to reduce a position due solely to
market value fluctuations.
For a more complete discussion of the Fund's portfolio composition, see
"Portfolio Composition."
INVESTMENT PHILOSOPHY AND PROCESS
Investment Philosophy. The Sub-Advisor believes the non-cyclical assets that
best support a high-payout ratio are those with steady, fee-for-service
businesses with relatively low sustaining capital obligations. In the energy
sector and energy utility industries, such fee-for-service assets are comprised
of interstate pipelines, intrastate pipelines, power generation assets, storage
and terminal facilities and regulated power transmission and distribution
assets. By contrast, the Sub-Advisor seeks to limit the cyclical energy exposure
of the portfolio. The Sub-Advisor believes portfolio investments in oil and gas
exploration, development and production are less well suited for the Fund
because the cash flows from these investments are cyclical in nature, being
driven by commodity prices, and because oil and gas assets are resource assets
that diminish in value over time due to depletion, extraction or removal.
The Sub-Advisor evaluates the dividend payout ratio of companies in which it may
invest, which provides how much money a company returns to its shareholders
compared to how much money such company retains in order to reinvest in its
growth, pay off its debt and/or build its cash reserves. A high payout ratio
indicates when a significant portion of dividends or distributions are paid by a
company to its shareholders relative to such company's after tax free cash flow
or net income.
The Sub-Advisor believes a professionally managed portfolio of consistently high
dividend paying MLPs, MLP-related entities and other energy sector and energy
utility companies in non-cyclical segments offer an attractive balance of growth
and income. The Sub-Advisor also believes the use of rigorous investment
research and analytical tools to identify appropriate non-cyclical energy sector
and energy utility company investments provides a value added service to the
individual investor making an investment in the Common Shares of the Fund.
The Sub-Advisor seeks securities that offer a combination of quality, growth and
yield intended to result in superior total returns over the long run. The
Sub-Advisor's securities selection process includes a comparison of
quantitative, qualitative, and relative value factors. While the Sub-Advisor
maintains an active dialogue with several research analysts in the energy sector
and energy utility industries, the Sub-Advisor's primary emphasis is placed on
proprietary analysis and valuation models conducted and maintained by its
in-house investment analysts. To determine whether a company meets its criteria,
the Sub-Advisor generally considers, among other things, a proven track record,
a strong record of distribution or dividend growth, solid ratios of debt to cash
flow, coverage ratios with respect to distributions to unit holders, incentive
structure, and management team.
Investment Process. The Sub-Advisor utilizes a three step investment process for
the Fund. The first step is for the Sub-Advisor to define a universe of
companies in the energy sector and energy utility industries that have high
dividend payout ratios and/or are involved in the energy infrastructure
business. In general, the Sub-Advisor seeks energy sector and energy utility
companies weighted towards:
o regulated monopoly or monopoly-like assets (i.e., companies that own
unique assets that provide for a sustainable competitive advantage due
to control of location);
o non-cyclical cash flows (i.e., companies that have most or all of their
assets in businesses whose revenues tend not to fluctuate with
commodity prices and tend to be less sensitive to changes in the
economic cycle);
o fee-for-service revenues (i.e., companies that have most or all of
their assets in businesses whose revenues are not tied to changes in
commodity prices and/or volumes actually shipped through or stored in
their facilities); and
37
o cost escalators (i.e., companies that have most or all of their assets
in businesses whose revenues and/or margins can be adjusted to
compensate for changes in the company's costs).
The second step is for the Sub-Advisor to identify, among this universe,
companies that pass a quality threshold established by the Sub-Advisor. The
Sub-Advisor utilizes both quantitative aspects to measuring quality, such as the
stability of cash flows, returns on invested capital, financial leverage and
earnings coverage of dividends, as well as qualitative aspects, such as the
confidence that the Sub-Advisor has in the company's management team and the
quality of its assets. In its assessment of quality, the Sub-Advisor will not
invest in a company that fails to qualify on quality criteria, even in instances
where it believes the company has a low valuation.
The third step of the Sub-Advisor's investment process is portfolio
construction, where the Sub-Advisor determines the portfolio weighting of
companies that have made it through the first two steps. As part of this
portfolio construction, the Sub-Advisor balances each position's expected rate
of return against risks, limitations on position sizes and Fund portfolio
limitations.
A more detailed description of investment policies and restrictions and more
detailed information about portfolio investments is contained in the Fund's SAI.
Capital Discipline. The Sub-Advisor believes successful investing in the energy
sector and energy utility industries requires strict capital spending discipline
because the sector is capital intensive, mature and has low rates of overall
growth. The Sub-Advisor believes there is a high correlation between rates of
return and the portion of cash flow reinvested in the business - the lower the
level of reinvestment, the higher the return. Capital spending discipline can
result from careful prudent management or an agreement with shareholders to pay
out most available free cash flow. The Sub-Advisor believes companies paying out
a large portion of their available free cash flow in the form of monthly or
quarterly distributions or dividends--MLPs in the U.S. and pipeline companies
and energy utility in the U.S. and Canada--have a built-in capital spending
discipline and provide an attractive investment universe from which to construct
a portfolio. While growth opportunities are still available to these companies,
they must go to the capital markets and justify to yield-sensitive shareholders
the issuance of more equity and debt in order to fund those opportunities. The
Sub-Advisor believes this transparency tends to discourage acquisitions and new
construction that would be dilutive to the dividend paying capability on
existing shares and tends to encourage expenditures that are accretive.
A high-payout ratio, however, brings with it an income obligation that the
Sub-Advisor believes is matched by an expectation on the part of shareholders
that such dividends will be steady. Retail investors that make up the bulk of
the shareholder base of these securities have sold their shares when dividends
or distributions have been cut or eliminated.
Energy Infrastructure. Unlike oil and gas exploration, development and
production and petroleum refining, the Sub-Advisor believes certain investments
in energy infrastructure companies are characterized by non-cyclical
fee-for-service revenues. Also, unlike the other segments of the energy sector,
the sustaining capital requirements for pipelines, storage and other
infrastructure is low. The Sub-Advisor believes these two characteristics make
energy infrastructure assets a good match for investors who desire steady income
that has the ability to grow. Much of the pipeline and storage infrastructure
currently owned by MLPs, MLP-related entities and other energy sector and energy
utility companies were built many years ago by the major oil companies and
pipeline and power utilities. Over the years, these assets have been sold off to
fund projects with higher risk such as oil drilling, unregulated power
generation or energy trading. The result is that MLPs now own a significant
portion of those legacy assets. As oil and gas production in the U.S. rises, new
technologies have made long known resources economic, even at lower prices. The
resulting higher margins for oil and gas drilling have made the oil and gas
production companies more willing to guarantee solid returns for long-term
contracts to pipeline owners as an incentive to add capacity so they can deliver
their oil and gas to market more quickly. In essence, certain MLPs, MLP-related
entities and other energy sector and energy utility infrastructure companies
have an increased ability to "lock-in" the attractive economics of today's
energy industry.
Energy Utility Companies. Electric utilities and gas utilities (also called
local distribution companies or "LDCs") deliver electricity and natural gas,
respectively, to residential, industrial and commercial customers within
specific geographic regions and are generally subject to the rules and
regulations of federal and/or state agencies. Pursuant to their regulation,
electric and gas utilities generate profits based on formulas as prescribed by
the regulating agency or agencies and, as such, are less sensitive to movements
in commodity prices and other macroeconomic factors than non-regulated entities.
However, LDCs do generally generate less profits and cash flows during certain
periods of abnormal weather conditions (i.e., warmer winters or cooler summers
than typical) as the amount of electricity or gas they distribute is negatively
affected by such weather events. Additionally, electric and gas utilities may
own certain non-regulated businesses, including electric generation, oil and gas
exploration and production, gas gathering and processing, and commodity
marketing businesses. Electric and gas utilities are either owned by public
investors or are public systems owned by local governments. Independent power
producers sell the electricity that they generate to electric utilities and
other load-serving entities (such as municipalities and electric cooperatives)
by way of bilateral contracts or open power exchanges. The electric utilities
and other load-serving entities, in turn, generally sell this electricity to
industrial, commercial and residential customers. In the independent power and
38
renewable electricity producer industry, electricity is generated from a number
of energy sources, including natural gas, coal, water, waste products such as
biomass (e.g., wood, wood waste, agricultural waste), landfill gas, geothermal,
solar and wind. Growth in electricity demand, environmental concerns, increasing
electricity rates, technological advances and other concerns have prompted
government policies that encourage the supply of electricity from independent
power producers.
Master Limited Partnerships. Much of the opportunities in higher payout energy
infrastructure are in the form of MLPs. The Sub-Advisor believes this investment
opportunity is difficult for many large investors to take advantage of, which
has left these securities largely in the hands of retail investors. Non-taxable
investors, such as pension funds and endowments, have not historically owned
significant portions of these securities because MLPs can generate a substantial
amount of "unrelated business taxable income," or UBTI, which can be
disadvantageous to such institutions. In addition, for tax years beginning on or
before October 22, 2004, MLPs represented non-qualifying income for mutual
funds. Prior to the rapid growth of these asset classes over the last few years,
MLPs were considered too small for most large investor allocations. As a result,
the Sub-Advisor believes the combination of the lack of institutional investment
and the growth in size of these asset classes has made this an attractive
investment universe. For purposes of this prospectus, an MLP is a limited
partnership or a limited liability company that is treated as a partnership for
federal income tax purposes, the interests in which (known as units) are traded
on securities exchanges or over- the-counter.
Sub-Advisor Strengths. The Sub-Advisor has many years of experience investing in
the energy sector. Combined, the five principals of Energy Income Partners have
over 125 years of work experience in the energy sector, investment research,
commodity trading and portfolio management. The Sub-Advisor believes investment
success in energy sector companies that operate infrastructure assets such as
pipelines and storage facilities requires a working knowledge of the entire
energy sector. In essence, it is the businesses the pipelines connect to, much
more than the pipe itself, that determines financial success. That means
knowledge of the oil and gas segment, refining and marketing, petrochemicals and
natural gas processing and storage. It also means understanding price and cost
competitiveness of competing fuels such as coal and nuclear as well as the
impact of imports and global markets in the North American energy industry.
In addition, the Sub-Advisor believes the attractive characteristics of the
energy infrastructure business can be materially enhanced by a rigorous
application of investment research and portfolio construction tools. There is
generally less research coverage of these companies than in other sectors of
comparable size whose securities are owned by institutional investors. In
addition, the Sub-Advisor believes retail investors have enjoyed in recent years
bond like yields from MLPs, MLP-related entities and energy sector and energy
utility companies and, as such, hold them as bond substitutes and pay little
attention to the growth rates of the dividends and distributions. The
Sub-Advisor believes this creates an opportunity to outperform the sector using
such investment research and portfolio construction tools. Since the companies
in this asset class are affected by virtually every phase of the energy business
(even if they are not directly invested in every phase), the Sub-Advisor
believes it is necessary to have a strong working knowledge of the business
including oil and gas production and gathering, transportation, refining and
marketing, gas liquids processing and fractionation, petrochemical demand and
cost structure as well as the regulatory framework that regulates the industry.
PORTFOLIO COMPOSITION
The Fund's portfolio is composed principally of the following investments. A
more detailed description of the Fund's investment policies and restrictions and
more detailed information about the Fund's portfolio investments are contained
in the SAI.
Master Limited Partnerships. For purposes of this prospectus, an "MLP" is a
limited partnership or a limited liability company that is treated as a
partnership for federal income tax purposes, the interests in which (known as
units) are traded on securities exchanges or over-the-counter. If publicly
traded, to be treated as a partnership for U.S. federal income tax purposes, the
entity must receive at least 90% of its income from qualifying sources as set
forth in the Internal Revenue Code of 1986 (the "Code"). These qualifying
sources include interest, dividends, real estate rents, gain from the sale or
disposition of real property, income and gain from mineral or natural resources
activities, income and gain from the transportation or storage of certain fuels,
gain from the sale or disposition of a capital asset held for the production of
income described in the foregoing and, in certain circumstances, income and gain
from commodities or futures, forwards and options with respect to commodities.
Mineral or natural resources activities include exploration, development,
production, mining, refining, marketing and transportation (including
pipelines), of oil and gas, minerals, geothermal energy, fertilizer, timber or
carbon dioxide.
MLPs typically are structured as limited partnerships and have two classes of
interests--general partner interests and limited partner interests. Both classes
of owners are governed by the terms of a limited partnership agreement
establishing their respective rights with regard to the income and liabilities
of the MLP. The general partner typically controls the operations and management
of the MLP through an equity interest in the MLP (typically up to 2% of total
equity) and will be eligible to receive incentive distributions that increase
based on specified profit targets attained by the MLP. Limited partners own the
remainder of the MLP and have a limited role in the MLP's operations and
management. Likewise, limited partners receive periodic distributions (usually
39
quarterly) on a pre-tax basis until the unitholder sells its ownership interest
in the MLP. MLPs often have two classes of limited partner interests--common
units and subordinated units. Common units and general partner interests
generally accrue arrearage rights to the extent certain distribution payment
schedules are not met, but the subordinated units generally do not accrue such
arrearages. The general partner of the MLP is typically owned by an energy
company, an investment fund, the direct management of the MLP or is an entity
owned by one or more of such parties. The general partner interest may be held
by either a private or publicly traded corporation or other entity. In many
cases, the general partner owns common units, subordinated units and incentive
distribution rights ("IDRs") of the MLP in addition to its general partner
interest in the MLP.
MLPs are typically structured such that common units and general partner
interests have first priority to receive quarterly cash distributions up to the
MQD (as defined below). Common units also accrue arrearages in distributions to
the extent the MQD is not paid. Once common units have been paid, subordinated
units receive distributions of up to the MQD; however, subordinated units do not
accrue arrearages. Distributable cash in excess of the MQD paid to both common
and subordinated units is distributed to both common and subordinated units
generally on a pro rata basis. Whenever a distribution is paid to either common
unitholders or subordinated unitholders, the general partner is paid a
proportional distribution. The holders of IDRs (usually the general partner) are
eligible to receive incentive distributions if the general partner operates the
business of the MLP in a manner which results in distributions paid per unit
surpassing specified target levels. As cash distributions to the limited
partners increase, the IDRs receive an increasingly higher percentage of the
incremental cash distributions. A common arrangement provides that the IDRs can
reach a tier where the holder of the IDR receives 48% of every incremental
dollar paid to partners. These IDRs encourage the general partner to streamline
costs, increase capital expenditures and acquire assets in order to increase the
MLP's cash flow and raise the quarterly cash distribution in order to reach
higher tiers. Such results benefit all security holders of the MLP.
MLPs structured as limited liability companies also issue common and
subordinated units. However, rights afforded to interest holders in a limited
liability company (called "members") vary from those granted under the limited
partnership ownership structure, in that limited liability company members
typically have broader voting rights than limited partners in a limited
partnership. Limited liability company common units represent an equity
ownership interest in an MLP, entitling the holders to a share of the MLP's
assets through distributions and/or capital appreciation. Limited liability
company MLPs generally have only one class of equity, but in cases where there
are subordinated classes, common unitholders generally have preferential
distribution rights relative to rights held by subordinated unitholders, as well
as arrearage rights if certain distribution payment schedules are not met. In
the event of liquidation, limited liability company common unitholders have a
right to the MLP's remaining assets after bondholders, other debt holders and
preferred unitholders, if any, have been paid in full. Limited liability company
common units may trade on a national securities exchange or over-the-counter. In
contrast to limited partnerships, limited liability companies have no general or
limited partner and often there are no incentive distribution rights, like those
that most limited partnerships have, which entitle management or other
unitholders to increased percentages of cash distributions as distributions
reach higher target levels. In addition, limited liability company common
unitholders typically have voting rights with respect to the limited liability
company, whereas limited partnership common unitholders generally have limited
voting rights.
The Fund generally seeks to invest in MLPs with stable cash flows and other
characteristics consistent with its investment objective. See "--Investment
Philosophy and Process" above. Consistent with its investment objective, the
Fund may invest in the equity securities issued by MLPs and MLP-related
entities, including common units and subordinated units of MLPs, I-Shares of
MLP-related entities and common stock of MLP-related entities, such as general
partners or other affiliates of the MLPs.
Equity Securities of MLPs and MLP-Related Entities. Equity securities currently
consist of common units and subordinated units of MLPs, I-Shares, which
represent an ownership interest of an MLP issued by an affiliated party, and
common stock of MLP-related entities, such as general partners or other
affiliates of the MLPs, and convertible securities that are in the money (i.e.,
the conversion price is less than the price of the underlying stock) and
immediately convertible into equity securities of such entities. Such
investments include equity securities issued by small- and mid-capitalization
companies. Energy sector MLPs are limited partnerships or limited liability
companies that derive at least 90% of their income from energy operations. MLPs
organized as limited partnerships often have two classes of limited partner
interests--common units and subordinated units. Common units generally accrue
arrearage rights to the extent certain distribution payment schedules are not
met, but the subordinated units generally do not accrue such arrearages. MLP
common units are typically listed and traded on U.S. securities exchanges,
including the NYSE and The Nasdaq Stock Market LLC ("Nasdaq"). The Fund
purchases MLP common units through open market transactions, but may also
acquire MLP common units through direct placements and initial public offerings.
MLP subordinated units are typically issued by MLPs to their original sponsors,
such as their founders, management teams, corporate general partners of MLPs,
entities that sell assets to MLPs and institutional investors. The Fund may
purchase subordinated units directly from these persons.
MLP Common Units. MLP common units represent a limited partnership interest in
an MLP and may be listed and traded on U.S. securities exchanges or
over-the-counter, with their value fluctuating predominantly based on prevailing
40
market conditions (such as changes in interest rates) and the success of an MLP.
The Fund purchases common units in market transactions but may also purchase
securities directly from the MLP or other parties in private placements. Unlike
owners of common stock of a corporation, owners of common units typically have
limited voting rights and, in most instances, have no ability to annually elect
directors. MLPs generally distribute all available cash flow (cash flow from
operations less maintenance capital expenditures) in the form of quarterly
distributions. Common unit holders have first priority to receive quarterly cash
distributions up to the MQD and have arrearage rights. In the event of
liquidation, common unit holders have preference over subordinated unit holders,
but not debt holders or preferred unit holders, to the remaining assets of the
MLP. MLPs also issue different classes of common units that may have different
voting, trading, and distribution rights. MLPs also may issue new classes of
units, such as class B units, that contain distinct structural modifications.
For example, a new class of equity could be used to issue securities that do not
receive a distribution for some specified period before converting into standard
common units.
MLP Subordinated Units. MLP subordinated units are typically issued by MLPs to
their original sponsors, such as their founders, management teams, corporate
general partners of MLPs, entities that sell assets to MLPs, and institutional
investors. The Fund may purchase subordinated units directly from these persons.
Subordinated units have similar limited voting rights as common units and are
generally not listed on an exchange nor publicly traded. Once the MQD on the
common units, including any arrearages, has been paid, subordinated units will
generally receive cash distributions up to the MQD prior to any incentive
payments to the MLP's general partner. Unlike common units, subordinated units
do not have arrearage rights. In the event of liquidation, common units and
general partner interests have priority over subordinated units. Subordinated
units are typically converted into common units on a one-to-one basis after
certain time periods and/or performance targets have been satisfied.
Subordinated units are generally valued based on the price of the common units,
discounted to reflect the timing or likelihood of their conversion to common
units and other factors.
MLP I-Shares. I-Shares represent an ownership interest issued by an affiliated
party of an MLP. The MLP affiliate uses the proceeds from the sale of I-Shares
to purchase limited partnership interests in the MLP in the form of i-units.
I-units have similar features as MLP common units in terms of voting rights,
liquidation preference and distributions. However, rather than receiving cash,
the MLP affiliate holding i-units receives distributions in the form of
additional i-units in an amount equal to the cash distributions received by the
holders of MLP common units. Similarly, holders of I-Shares will receive
additional I-Shares, in the same proportion as the MLP affiliates' receipt of
i-units, rather than cash distributions. I-Shares themselves have limited voting
rights which are similar to those applicable to MLP common units. The MLP
affiliate issuing the I-Shares is structured as a corporation for federal income
tax purposes. As a result, I-Shares holders, such as the Fund, will receive a
Form 1099 rather than a Form K-1 statement. I-Shares are typically listed and
traded on the NYSE and the NYSE MKT.
Other Equity Securities. In addition to the investments described above, the
Fund may invest in other equity securities, including depositary receipts.
Depositary receipts represent underlying shares of non-U.S. issuers, and include
American Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs"),
and Global Depositary Receipts ("GDRs"). U.S. dollar-denominated ADRs, which are
traded in the United States on exchanges or over-the-counter, are issued by
domestic banks. ADRs represent the right to receive securities of non-U.S.
issuers deposited in a domestic bank or a correspondent bank. ADRs do not
eliminate all the risk inherent in investing in the securities of non-U.S.
issuers. However, by investing in ADRs rather than directly in non-U.S. issuers'
stock, the Fund can avoid currency risks during the settlement period for either
purchases or sales. In general, there is a large, liquid market in the United
States for many ADRs. The information available for ADRs is subject to the
accounting, auditing and financial reporting standards of the domestic market or
exchange on which they are traded, which standards are more uniform and more
exacting than those to which many non-U.S. issuers may be subject. The Fund also
may invest in EDRs, GDRs, and other similar instruments representing securities
of non-U.S. companies. EDRs and GDRs are securities that are typically issued by
foreign banks or foreign trust companies, although U.S. banks or U.S. trust
companies may issue them. EDRs and GDRs are structured similarly to the
arrangements of ADRs. EDRs, in bearer form, are designed for use in European
securities markets and are not necessarily denominated in the currency of the
underlying security.
Certain depositary receipts, typically those denominated as unsponsored, require
the holders thereof to bear most of the costs of the facilities while issuers of
sponsored facilities normally pay more of the costs thereof. The depository of
an unsponsored facility frequently is under no obligation to distribute
shareholder communications received from the issuer of the deposited securities
or to pass through the voting rights to facility holders in respect to the
deposited securities, whereas the depository of a sponsored facility typically
distributes shareholder communications and passes through voting rights. See
"Risks--Non-U.S. Securities Risk."
Debt Securities. The Fund may invest up to 20% of its Managed Assets in debt
securities of MLPs, MLP-related entities and other energy sector and energy
utility companies, including certain securities rated below investment grade.
The debt securities in which the Fund may invest may provide for fixed or
variable principal payments and various types of interest rate and reset terms.
To the extent that the Fund invests in below investment grade debt securities,
such securities will be rated, at the time of investment, at least "B-" by S&P
or "B3" by Moody's or a comparable rating by another NRSRO or, if unrated,
41
determined to be of comparable quality by the Sub-Advisor. If a security
satisfies the Fund's minimum rating criteria at the time of purchase and is
subsequently downgraded below such rating, the Fund will not be required to
dispose of such security. If a downgrade occurs, the Sub-Advisor will consider
what action, including the sale of such security, is in the best interest of the
Fund and its common shareholders. In light of the risks of below investment
grade securities, the Sub-Advisor, in evaluating the creditworthiness of an
issue, whether rated or unrated, will take various factors into consideration,
which may include, as applicable, the issuer's operating history, financial
resources and its sensitivity to economic conditions and trends, the market
support for the facility financed by the issue (if applicable), the perceived
ability and integrity of the issuer's management and regulatory matters.
Short-Term Debt Securities; Temporary Defensive Position; Invest-Up Period.
During the period in which the net proceeds of the offering of Common Shares
offered by this prospectus and any applicable prospectus supplement are being
invested, or during periods in which the Sub-Advisor determines that it is
temporarily unable to follow the Fund's investment strategy or that it is
impractical to do so, the Fund may deviate from its investment strategy and
invest all or any portion of its net assets in cash, cash equivalents or other
short-term debt securities. The Sub-Advisor's determination that it is
temporarily unable to follow the Fund's investment strategy or that it is
impractical to do so will generally occur only in situations in which a market
disruption event has occurred and where trading in the securities selected
through application of the Fund's investment strategy is extremely limited or
absent. In such a case, shares of the Fund may be adversely affected and the
Fund may not pursue or achieve its investment objective.
INVESTMENT PRACTICES
Strategic Transactions. The Fund may, but is not required to, use various
hedging and strategic transactions described below to seek to reduce interest
rate risks arising from any use of leverage by the Fund, to facilitate portfolio
management and mitigate risks, including, without limitation, interest rate,
currency and credit risks and equity security price risk. Collectively, these
transactions referred to above are "Strategic Transactions" and include the use
of derivative instruments such as those described below. Hedging and strategic
transactions are generally accepted under modern portfolio management theory and
are regularly used by many investment companies and other institutional
investors. Although the Sub-Advisor may seek to use such practices to further
the Fund's investment objective, no assurance can be given that these practices,
if used, will achieve this result.
Strategic Transactions have risks, including the imperfect correlation between
the value of such instruments and the underlying assets, the possible default of
the other party to the transactions or illiquidity of the derivative
investments. Furthermore, the ability to successfully use Strategic Transactions
depends on the Sub-Advisor's ability to predict pertinent market movements,
which cannot be assured. Thus, the use of Strategic Transactions may result in
losses greater than if they had not been used, may require the Fund to sell or
purchase portfolio securities at inopportune times or for prices other than
current market values, may limit the amount of appreciation the Fund can realize
on an investment, or may cause the Fund to hold a security that it might
otherwise sell. Additionally, amounts paid by the Fund as premiums and cash or
other assets held in margin accounts with respect to Strategic Transactions are
not otherwise available to the Fund for investment purposes. Furthermore,
certain Strategic Transactions may be considered a form of economic leverage on
the Fund's portfolio and may be subject to the risks associated with the use of
leverage. See "Risks--Leverage Risk."
To generate additional income, the Fund may write (or sell) covered call options
on up to 35% of its Managed Assets. Such call options give the option holders
the right, but not the obligation, to purchase common equity at a specified
price (the "strike price") on one or more future dates (each, an "exercise
date"). The price of the option is determined from trading activity in the broad
options market, and generally reflects the relationship between the current
market price for the underlying common equity and the strike price, as well as
the time remaining until the expiration date. The Fund writes call options only
if they are "covered." In the case of a call option on a common stock or other
security, the Fund considers an option to be "covered" if the Fund owns the
security underlying the call. If an option written by the Fund expires
unexercised, the Fund will realize on the expiration date a capital gain equal
to the premium received by the Fund at the time the option was written. If an
option purchased by the Fund expires unexercised, the Fund will realize a
capital loss equal to the premium paid at the time the option expires. Prior to
the earlier of exercise or expiration, an exchange-traded option may be closed
out by an offsetting purchase or sale of an option of the same series (type,
underlying security, exercise price, and expiration). There can be no assurance,
however, that a closing purchase or sale transaction can be effected when the
Fund desires. The Fund may sell put or call options it has previously purchased,
which could result in a net gain or loss depending on whether the amount
realized on the sale is more or less than the premium and other transaction
costs paid on the put or call option purchased. See "Risks--Covered Call Options
Risk" and "Tax Matters" below.
In addition to writing (selling) covered call options, the Fund may enter into
interest rate swaps as a principal part of its investment strategy. In an
interest rate swap, the Fund exchanges with another party their respective
commitments to pay or receive interest (e.g., an exchange of an obligation to
make fixed rate payments for an obligation to make floating rate payments). For
example, if the Fund holds a debt instrument with an interest rate that is reset
only once each year, it may swap the right to receive interest at this fixed
rate for the right to receive interest at a rate that is reset every week. This
42
would enable the Fund to offset a decline in the value of the debt instrument
due to rising interest rates but would also limit its ability to benefit from
falling interest rates. Conversely, if the Fund holds a debt instrument with an
interest rate that is reset every week and it would like to lock in what it
believes to be a high interest rate for one year, it may swap the right to
receive interest at this variable weekly rate for the right to receive interest
at a rate that is fixed for one year. Such a swap would protect the Fund from a
reduction in yield due to falling interest rates and may permit the Fund to
enhance its income through the positive differential between one week and one
year interest rates, but would preclude it from taking full advantage of rising
interest rates. Interest rate swaps will allow the Sub-Advisor to potentially
manage the interest rate profile of the Fund's portfolio. See "Risks--Interest
Rate Swaps Risk" below. See also "Other Investment Policies and
Techniques--Strategic Transactions" in the SAI for a more complete discussion of
Strategic Transactions and their risks.
In addition to interest rate swaps, the Fund also may utilize hedging techniques
such as interest rate caps, floors or collars or credit transactions and credit
default swaps (or any combination thereof) to mitigate potential interest rate
risk on a portion of its leverage instruments. Such interest rate and credit
hedges would principally be used to protect the Fund against higher costs on the
Fund's leverage instruments resulting from increases in short-term interest
rates. The Fund anticipates that the majority of the Fund's interest rate hedges
will be interest rate swap contracts with financial institutions.
The Fund also may enter into currency exchange transactions to hedge the Fund's
exposure to foreign currency exchange rate risk to the extent the Fund invests
in non-U.S. dollar denominated securities of non-U.S. issuers. The Fund's
currency transactions, if any, will be limited to portfolio hedging involving
portfolio positions. Portfolio hedging is the use of a currency forward contract
with respect to a portfolio security position denominated or quoted in a
particular currency. A currency forward contract is an agreement to purchase or
sell a specified currency at a specified future date (or within a specified time
period) and at a price set (or determined pursuant to parameters provided) at
the time of the contract. Currency forward contracts are usually entered into
with banks, foreign exchange dealers or broker-dealers, are not exchange-traded,
and are usually for less than one year, but may be renewed.
The Fund also may purchase and sell derivative investments such as total return
and equity swaps, exchange-listed and over- the-counter put and call options on
currencies, securities, energy-related commodities, equity, fixed-income and
interest rate indices and other financial instruments and purchase and sell
financial futures contracts and options thereon. The Fund also may purchase
derivative investments that combine features of these instruments. The Fund may
seek to use these and other Strategic Transactions as a portfolio management or
hedging technique to seek to protect against possible adverse changes in the
market value of securities held in or to be purchased for the Fund's portfolio,
protect the value of the Fund's portfolio, facilitate the sale of certain
securities for investment purposes, manage the effective interest rate and
currency exposure of the Fund, including the effective yield paid on any
leverage issued by the Fund, or establish positions in the derivatives markets
as a temporary substitute for purchasing or selling particular securities.
The market value of the Fund's investments in these instruments and transactions
that increase or decrease the Fund's exposure to energy sector MLPs, energy
sector and energy utility MLP-related entities and other energy sector and
energy utility companies, including investments in derivatives, is counted
towards the Fund's policy to invest, under normal market conditions, 85% of its
Managed Assets in equity and debt securities of MLPs, MLP-related entities and
other energy sector and energy utility companies. See "Risks--Derivatives Risk"
in this prospectus and "Additional Information About the Fund's Investments and
Investment Risks--Strategic Transactions Risk" in the SAI for a more complete
discussion of Strategic Transactions and their risks.
Portfolio Turnover. The Fund's annual portfolio turnover rate may vary greatly
from year to year. Although the Fund cannot accurately predict its annual
portfolio turnover rate, it is not expected to exceed 20% under normal
circumstances, but may be higher or lower in certain periods. For the fiscal
year ended October 31, 2017, the Fund's portfolio turnover rate was
approximately 50%. Portfolio turnover rate is not considered a limiting factor
in the execution of investment decisions for the Fund. A higher turnover rate
results in correspondingly greater brokerage commissions and other transactional
expenses that are borne by the Fund. High portfolio turnover may result in the
Fund's recognition of gains that will be taxable as ordinary income, reducing
the funds available to pay distributions to the Fund's common shareholders. In
addition, high portfolio turnover may increase the Fund's current and
accumulated earnings and profits, resulting in a greater portion of the Fund's
distributions being treated as taxable dividends for federal income tax
purposes. See "Tax Matters."
LEVERAGE PROGRAM
Any use of leverage by the Fund will be consistent with the provisions of the
1940 Act. Leverage instruments leverage the common shares of the Fund and have
complete priority upon distribution of assets over the common shares and may be
secured by the assets of the Fund. Although the timing of any leverage and the
terms of the leverage are determined by the Fund's Board of Trustees, the Fund
invests, and expects to continue to invest, the proceeds derived from any
leverage offering in securities consistent with the Fund's investment objective
and policies. So long as the Fund's portfolio is invested in securities that
provide a higher rate of return than the dividend rate or interest rate of the
43
leverage, after taking expenses in consideration, the leverage will cause common
shareholders to receive a higher rate of return than if the Fund were not
leveraged.
Under normal market conditions, the Fund expects to use leverage in an aggregate
amount of approximately 25% to 30% of the Fund's Managed Assets to make
additional investments to seek to enhance the level of its current distributions
to common shareholders. The Fund is not, however, required to reduce leverage to
the extent the above percentage limitation is exceeded as a result of a decline
in the value of the Fund's assets. The Fund is currently engaged in, and expects
to continue to engage in, the use of leverage through borrowings from a bank (or
other financial institution). In this regard, the Fund entered into a committed
facility agreement with The Bank of Nova Scotia that has a maximum commitment
amount of $270,000,000 (the "Nova Scotia Facility"). The borrowing rate under
the Nova Scotia Facility is equal to the 1-month LIBOR plus 85 basis points. In
addition, the Fund pays a commitment fee of 0.25% on the undrawn amount of such
facility when the utilization is below 75% of the maximum commitment amount. The
average amount outstanding for the year ended October 31, 2017 was $236,831,507
with a weighted average interest rate of 1.84%. As of October 31, 2017, the Fund
had outstanding borrowings of $235,500,000 under the Nova Scotia Facility,
representing approximately 25.94% of the Fund's Managed Assets. As of October
31, 2017, the Fund had $34,500,000 in unutilized funds available for borrowing
under the Nova Scotia Facility. Borrowings under the Nova Scotia Facility
represent the only borrowings of the Fund as of the date of this prospectus. To
date, the Fund has not issued any Preferred Shares.
Leverage creates risk and involves special considerations for the common
shareholders, including the likelihood of greater volatility of net asset value
and market price of the common shares, and the risk that fluctuations in
interest rates on borrowings and debt or in the dividend rates on any Preferred
Shares may affect the return to the common shareholders or will result in
fluctuations in the dividends paid on the common shares. To the extent total
return derived from securities purchased with funds received from the use of
leverage exceeds the cost of leverage, the Fund's return will be greater than if
leverage had not been used. Conversely, if the total return derived from
securities purchased with funds received from the use of leverage is less than
the cost of leverage, the Fund's return will be less than if leverage had not
been used, and therefore the amount available for distribution to common
shareholders as dividends and other distributions will be reduced. In the latter
case, the Fund's Board of Trustees in its best judgment nevertheless may
determine to maintain the Fund's leveraged position if it expects that the
benefits to the Fund's common shareholders of maintaining the leveraged position
will outweigh the current reduced return. Under normal market conditions, the
Fund anticipates that it will be able to invest the proceeds from leverage at a
higher rate of return than the costs of leverage, which enhances returns to
common shareholders. See "Risks--Leverage Risk."
The fees paid to the Advisor and by the Advisor to the Sub-Advisor will be
calculated on the basis of the Managed Assets, including proceeds from
borrowings for leverage and the issuance of Preferred Shares. During periods in
which the Fund is utilizing leverage, the investment advisory and sub-advisory
fees payable to the Advisor and by the Advisor to the Sub-Advisor, respectively,
will be higher than if the Fund did not utilize a leveraged capital structure.
Therefore, the Advisor and the Sub-Advisor have a financial incentive to
leverage the Fund, which may create a conflict of interest between the Advisor
and Sub-Advisor on the one hand and the common shareholders on the other. The
Advisor and the Sub-Advisor will make decisions on whether and how much leverage
the Fund will employ based on whether it is in the best interests of the Fund.
The Advisor and the Sub-Advisor will seek approval for and periodically review
the use of leverage with the Board of Trustees. See "Risks--Potential Conflicts
of Interest Risk." Because payments on any leverage would be paid by the Fund at
a specified rate, only the Fund's common shareholders would bear the Fund's
management fees and other expenses.
The issuance of Common Shares offered by this prospectus will enable the Fund to
increase the aggregate amount of its leverage. The Fund may make further use of
leverage through additional borrowings and/or the issuance of Preferred Shares
to the extent permitted by the 1940 Act. However, there is no assurance that the
Fund will increase the amount of its leverage or utilize leverage in addition to
the Nova Scotia Facility or that, if additional leverage is utilized, it will be
successful in enhancing the level of the Fund's current distributions. It is
possible that the Fund will be unable to obtain additional leverage. If the Fund
is unable to increase its leverage after the issuance of the Common Shares
pursuant to this prospectus and any prospectus supplement, there could be an
adverse impact on the return to common shareholders. In addition, to the extent
additional leverage is utilized, the Fund may consequently be subject to certain
financial covenants and restrictions that are not currently imposed on the Fund.
The Fund's common shares are likely to be junior in liquidation and distribution
rights to amounts owed pursuant to any additional leverage instruments that may
be utilized by the Fund in the future.
The Fund's Declaration of Trust authorizes the Fund, without prior approval of
the common shareholders, to borrow money (such as pursuant to the Nova Scotia
Facility). In this connection, the Fund may issue notes or other evidence of
indebtedness (including bank borrowings or commercial paper) and may secure any
such borrowings by mortgaging, pledging or otherwise subjecting as security the
Fund's assets. In connection with such borrowing, the Fund may be required to
maintain minimum average balances with the lender or to pay a commitment or
other fee to maintain a line of credit. Any such requirements will increase the
cost of borrowing over the stated interest rate. Under the requirements of the
1940 Act, the Fund, immediately after any such borrowings, must have an "asset
coverage" of at least 300% (i.e., the aggregate amount of outstanding borrowings
44
may not exceed 33-1/3% of total assets). With respect to such borrowing, asset
coverage means the ratio which the value of the total assets of the Fund, less
all liabilities and indebtedness not represented by senior securities (as
defined in the 1940 Act), bears to the aggregate amount of such borrowing.
The rights of lenders to the Fund to receive interest on and repayment of
principal of any such borrowings are senior to those of the common shareholders,
and the terms of any such borrowings may contain provisions which limit certain
activities of the Fund, including the payment of dividends to common
shareholders in certain circumstances. Further, the 1940 Act does (in certain
circumstances) grant to the lenders to the Fund certain voting rights in the
event of default in the payment of interest on or repayment of principal. Any
borrowing will likely be ranked senior or equal to all other existing and future
borrowings of the Fund.
Certain types of borrowings may result in the Fund being subject to covenants in
credit agreements, such as the committed facility agreement for the Nova Scotia
Facility, relating to asset coverage and portfolio composition requirements.
There is no assurance that the Fund will not violate asset coverage covenants
relating to the Nova Scotia Facility in the future. In such event, the Fund may
be required to repay all outstanding borrowings immediately. In order to repay
such amounts, the Fund may be required to sell assets quickly which could have a
material adverse effect on the Fund and could trigger negative tax implications.
In addition, the Fund would be precluded from declaring or paying any
distribution on the common shares during the continuance of such event of
default.
Generally, covenants to which the Fund may be subject include affirmative
covenants, negative covenants, financial covenants, and investment covenants. An
example of an affirmative covenant would be one that requires the Fund to send
its annual audited financial report to the lender. An example of a negative
covenant would be one that prohibits the Fund from making any amendments to its
fundamental policies. An example of a financial covenant is one that would
require the Fund to maintain a 3:1 asset coverage ratio. An example of an
investment covenant is one that would require the Fund to limit its investment
in a particular asset class. Loan documents and other credit agreements also may
restrict the Fund's ability to change its investment adviser, sub-adviser or
custodian, amend its fundamental investment policies or fundamental investment
objective, or take on additional indebtedness without prior consent with the
counterparty thereto. The Fund may be subject to certain restrictions on
investments imposed by guidelines of one or more rating agencies, which may
issue ratings for debt securities or Preferred Shares issued by the Fund. These
guidelines may impose asset coverage or portfolio composition requirements that
are more stringent than those imposed by the 1940 Act. It is not anticipated
that these covenants or guidelines will impede the Advisor and Sub-Advisor from
managing the Fund's portfolio in accordance with the Fund's investment objective
and policies.
Under the 1940 Act, the Fund is not permitted to issue Preferred Shares unless
immediately after such issuance the value of the total assets of the Fund is at
least 200% of the liquidation value of the outstanding Preferred Shares (i.e.,
the liquidation value may not exceed 50% of the Fund's total assets). In
addition, the Fund is not permitted to declare any cash dividend or other
distribution on its common shares unless, at the time of such declaration, the
value of the Fund's total assets is at least 200% of such liquidation value. If
Preferred Shares are issued, the Fund intends, to the extent possible, to
purchase or redeem Preferred Shares from time to time to the extent necessary in
order to maintain coverage of any Preferred Shares of at least 200%. In
addition, as a condition to obtaining ratings on the Preferred Shares, the terms
of any Preferred Shares issued are expected to include more stringent asset
coverage maintenance provisions which will require the redemption of the
Preferred Shares in the event of non-compliance by the Fund and may also
prohibit dividends and other distributions on the common shares in such
circumstances. In order to meet redemption requirements, the Fund may have to
liquidate portfolio securities. Such liquidations and redemptions would cause
the Fund to incur related transaction costs and could result in capital losses
to the Fund. If the Fund has Preferred Shares outstanding, two of the Fund's
Trustees will be elected by the holders of Preferred Shares as a class. The
remaining Trustees of the Fund will be elected by holders of common shares and
Preferred Shares voting together as a single class. In the event the Fund failed
to pay dividends on Preferred Shares for two years, holders of Preferred Shares
would be entitled to elect a majority of the Trustees of the Fund.
The Fund may also borrow money as a temporary measure for extraordinary or
emergency purposes, including the payment of dividends and the settlement of
securities transactions which otherwise might require untimely dispositions of
Fund securities.
EFFECTS OF LEVERAGE
The aggregate principal amount of borrowings under the Nova Scotia Facility
represented approximately 25.94% of Managed Assets as of October 31, 2017. Asset
coverage with respect to the borrowings under the Nova Scotia Facility was 386%
and the Fund had $34,500,000 in unutilized funds available for borrowing under
the Nova Scotia Facility as of that date. The borrowing rate under the Nova
Scotia Facility agreement is equal to 1-month LIBOR plus 85 basis points. In
addition, the Fund pays a commitment fee of 0.25% on the undrawn amount of such
facility when the utilization is below 75% of the maximum commitment amount. The
total annual interest and fee rate as of October 31, 2017 was 2.10%.
45
Assuming that the Fund's leverage costs remain as described above (at an assumed
average annual cost of 2.10%), the annual return that the Fund's portfolio must
experience (net of expenses) in order to cover its leverage costs would be
0.54%.
The following table is furnished in response to requirements of the SEC. It is
designed to illustrate the effect of leverage on common share total return,
assuming investment portfolio total returns (comprised of income and changes in
the value of securities held in the Fund's portfolio) of (10)%, (5)%, 0%, 5% and
10%. These assumed investment portfolio returns are hypothetical figures and are
not necessarily indicative of the investment portfolio returns experienced or
expected to be experienced by the Fund. See "Risks."
The table further assumes leverage representing 25.94% of the Fund's Managed
Assets, net expenses, and the Fund's current annual leverage interest and fee
rate of 2.10%.
Assumed Portfolio Total Return (Net of Expenses)......... (10)% (5)% 0% 5% 10%
Common Share Total Return................................ (14.24)% (7.49)% (0.74)% 6.02% 12.77%
Common share total return is composed of two elements: the common share
dividends paid by the Fund (the amount of which is largely determined by the net
investment income of the Fund after paying dividends or interest on its
leverage) and gains or losses on the value of the securities the Fund owns. As
required by SEC rules, the table above assumes that the Fund is more likely to
suffer capital losses than to enjoy capital appreciation.
RISKS
Risk is inherent in all investing. The following discussion summarizes the
principal risks that you should consider before deciding whether to invest in
the Fund.
INVESTMENT AND MARKET RISK
An investment in the common shares is subject to investment risk, including the
possible loss of the entire amount that you invest. Your investment in common
shares represents an indirect investment in the securities owned by the Fund, a
significant portion of which will be traded on a national securities exchange or
in the over-the-counter markets. The value of these securities, like other
market investments, may move up or down, sometimes rapidly and unpredictably.
The value of the securities in which the Fund invests will affect the value of
the common shares. Your common shares at any point in time may be worth less
than your original investment, even after taking into account the reinvestment
of Fund dividends and distributions. The Fund has been designed primarily as a
long-term investment vehicle and is not intended to be used as a short-term
trading vehicle.
MARKET DISCOUNT FROM NET ASSET VALUE
Although the Common Shares offered under this prospectus will be offered at a
public offering price equal to or in excess of the NAV per share of the Fund's
common shares at the time such Common Shares are initially sold, shares of
closed-end investment companies frequently trade at a discount from their NAV.
This characteristic is a risk separate and distinct from the risk that the
Fund's NAV per common share could decrease as a result of its investment
activities and may be greater for investors expecting to sell their Common
Shares in a relatively short period following completion of an offering under
this prospectus and the applicable prospectus supplement. The NAV of the Common
Shares offered under this prospectus may be reduced immediately following an
offering as a result of the payment of certain offering costs. Although the
value of the Fund's net assets is generally considered by market participants in
determining whether to purchase or sell common shares, whether investors will
realize gains or losses upon the sale of the common shares will depend entirely
upon whether the market price of the common shares at the time of sale is above
or below the investor's purchase price for the common shares. Because the market
price of the common shares is affected by factors such as NAV, dividend and
distribution levels and their stability (which are in turn affected by levels of
dividend and interest payments by the Fund's portfolio holdings, the timing and
success of the Fund's investment strategies, regulations affecting the timing
and character of the Fund's distributions, the Fund's expenses and other
factors), supply of and demand for the common shares, trading volume of the
common shares, general market, interest rate and economic conditions, and other
factors beyond the control of the Fund, the Fund cannot predict whether the
Common Shares offered under this prospectus will trade at, below or above NAV or
at, below or above the public offering price thereof.
MARKET IMPACT RISK
The sale of the Common Shares (or the perception that such sales may occur) may
have an adverse effect on prices in the secondary market for the Fund's common
shares through increasing the number of shares available, which may put downward
pressure on the market price for the Fund's common shares. These sales also
might make it more difficult for the Fund to sell additional equity securities
in the future at a time and price the Fund deems appropriate.
46
MANAGEMENT RISK AND RELIANCE ON KEY PERSONNEL
The Fund is subject to management risk because it is an actively managed
portfolio. The Advisor and Sub-Advisor apply investment techniques and risk
analyses in making investment decisions for the Fund, but there can be no
guarantee that these will produce the desired results.
In addition, the implementation of the Fund's investment strategy depends upon
the continued contributions of certain key employees of the Advisor and
Sub-Advisor, some of whom have unique talents and experience and would be
difficult to replace. The loss or interruption of the services of a key member
of the portfolio management team could have a negative impact on the Fund during
the transitional period that would be required for a successor to assume the
responsibilities of the position.
POTENTIAL CONFLICTS OF INTEREST RISK
First Trust Advisors (as defined below), Energy Income Partners (as defined
below) and the portfolio managers have interests which may conflict with the
interests of the Fund. In particular, First Trust Advisors and Energy Income
Partners currently manage and may in the future manage and/or advise other
investment funds or accounts with the same or substantially similar investment
objective and strategies as the Fund. As a result, First Trust Advisors, Energy
Income Partners and the Fund's portfolio managers must allocate their time and
investment ideas across multiple funds and accounts. First Trust Advisors,
Energy Income Partners and the Fund's portfolio managers may identify a limited
investment opportunity that may be suitable for multiple funds and accounts, and
the opportunity may be allocated among these several funds and accounts, which
may limit the Fund's ability to take full advantage of the investment
opportunity. Additionally, transaction orders may be aggregated for multiple
accounts for purposes of execution, which may cause the price or brokerage costs
to be less favorable to the Fund than if similar transactions were not being
executed concurrently for other accounts. At times, a portfolio manager may
determine that an investment opportunity may be appropriate for only some of the
funds and accounts for which he or she exercises investment responsibility, or
may decide that certain of the funds and accounts should take differing
positions with respect to a particular security. In these cases, the portfolio
manager may place separate transactions for one or more funds or accounts which
may affect the market price of the security or the execution of the transaction,
or both, to the detriment or benefit of one or more other funds and accounts.
For example, a portfolio manager may determine that it would be in the interest
of another account to sell a security that the Fund holds, potentially resulting
in a decrease in the market value of the security held by the Fund.
The portfolio managers may also engage in cross trades between funds and
accounts, may select brokers or dealers to execute securities transactions based
in part on brokerage and research services provided to First Trust Advisors or
Energy Income Partners which may not benefit all funds and accounts equally and
may receive different amounts of financial or other benefits for managing
different funds and accounts. Finally, First Trust Advisors or its affiliates
may provide more services to some types of funds and accounts than others.
There is no guarantee that the policies and procedures adopted by First Trust
Advisors, Energy Income Partners and the Fund will be able to identify or
mitigate the conflicts of interest that arise between the Fund and any other
investment funds or accounts that First Trust Advisors and/or Energy Income
Partners may manage or advise from time to time.
In addition, while the Fund is using leverage, the amount of the fees paid to
the Advisor (and by the Advisor to the Sub-Advisor) for investment advisory and
management services are higher than if the Fund did not use leverage because the
fees paid are calculated based on Managed Assets, which include assets purchased
with leverage. Therefore, the Advisor and the Sub-Advisor have a financial
incentive to leverage the Fund, which creates a conflict of interest between the
Advisor and the Sub-Advisor on the one hand and the Common Shareholders of the
Fund on the other. For further information on potential conflicts of interest
and the terms of each of the Investment Management Agreement and the
Sub-Advisory Agreement, see "Investment Advisor" and "Sub-Advisor" in the SAI.
MLP RISKS
An investment in MLP units involves risks which differ from an investment in
common stock of a corporation. Holders of MLP units have limited control and
voting rights on matters affecting the partnership. The Fund is not responsible
for operating MLPs and similar entities and cannot control or monitor their
compliance with applicable tax, securities and other laws and regulations
necessary for the profitability of such investments. Holders of MLP units could
potentially become subject to liability for all of the obligations of an MLP, if
a court determines that the rights of the unitholders to take certain action
under the limited partnership agreement would constitute "control" of the
business of that MLP, or if a court or governmental agency determines that the
MLP is conducting business in a state without complying with the limited
partnership statute of that state.
Furthermore, the structures and terms of the MLPs and other entities described
in this prospectus may not be indicative of the structure and terms of every
entity in which the Fund invests. Although the energy sector has grown
significantly in past years, such market trends may not exist from time to time
due to economic conditions, which are not predictable, or other factors. In
47
addition, certain conflicts of interest exist between common unit holders and
the general partner, including those arising from incentive distribution
payments. Conflicts of interest may arise from incentive distribution payments
paid to the general partner, or referral of business opportunities by the
general partner or one of its affiliates to an entity other than the MLP.
Holders of general partner or managing member interests typically receive
incentive distribution rights, which provide them with an increasing share of
the entities' aggregate cash distributions upon the payment of per common unit
quarterly distributions that exceed specified threshold levels above the an
established minimum amount ("minimum quarterly distribution" or "MQD"). The
ability of the limited partners or members to remove the general partner or
managing member without cause is typically very limited. In addition, some MLPs
permit the holder of incentive distribution rights to reset, under specified
circumstances, the incentive distribution levels and receive compensation in
exchange for the distribution rights given up in the reset.
The MLPs in which the Fund invests are primarily in the energy sector. See
"--Investment Concentration Risk."
The federal income tax rules relating to the auditing of partnerships and
partners have recently changed. The Fund may have little input in any audit
asserted against an MLP and may be contractually or legally obligated to make
payments in regard to deficiencies asserted without the ability to put forward
an independent defense.
INVESTMENT CONCENTRATION RISK
The Fund's investments are concentrated in the group of industries that are part
of the energy sector, with a particular focus on MLPs, MLP-related entities and
other companies in the energy sector and energy utility industries. The Fund's
concentration in the group of industries that are part of the energy sector may
present more risk than if the Fund were broadly diversified over multiple
sectors of the economy. A downturn in one or more industries within the energy
sector, material declines in energy-related commodity prices (such as the
decline in commodity prices experienced in recent years), adverse political,
legislative or regulatory developments or other events could have a larger
impact on the Fund than on an investment company that does not concentrate in
the group of industries that are part of the energy sector. The performance of
companies in the group of industries that are part of the energy sector may lag
the performance of other sectors or the broader market as a whole; in
particular, during a downturn like what has been experienced in recent years in
the energy sector. Although the Fund invests in MLPs, MLP-related entities and
other energy sector and energy utility companies that are weighted towards
non-cyclical, fee-for-service revenues, these companies may nonetheless have
segments of their respective businesses that are exposed to cyclical assets and,
therefore, risks associated with such cyclical assets are also discussed below
in addition to those risks associated with non-cyclical, fee-for-service
revenues. Certain risks inherent in investing in the business of the types of
securities that the Fund may invest include the following:
o Commodity Pricing Risk. The operations and financial performance of
MLPs, MLP-related entities and other energy sector and energy utility
companies may be directly affected by energy commodity prices,
especially those MLPs, MLP-related entities and other energy sector and
energy utility companies that own the underlying energy commodity or
receive payments for services that are based on commodity prices. Such
impact may be a result of changes in the price for such commodity or a
result of changes in the price of one energy commodity relative to the
price of another energy commodity (for example, the price of natural
gas relative to the price of NGLs). Commodity prices fluctuate for
several reasons, including changes in market and economic conditions,
the impact of weather on demand, levels of domestic and international
production, policies implemented by the Organization of the Petroleum
Exporting Countries, energy conservation, domestic and foreign
governmental regulation and taxation and the availability of local,
intrastate and interstate transportation systems. Volatility of
commodity prices, which may lead to a reduction in production or
supply, may also negatively impact the performance of MLPs, MLP-related
entities and other energy sector and energy utility companies which are
solely involved in the transportation, processing, storage,
distribution or marketing of commodities. Volatility of commodity
prices may also make it more difficult for MLPs, MLP-related entities
and other energy sector and energy utility companies to raise capital
to the extent the market perceives that their performance may be
directly or indirectly tied to commodity prices and there is
uncertainty regarding these companies' ability to maintain or grow cash
distributions to their equity holders.
o Supply and Demand Risk. As noted above, a decrease in the production of
natural gas, NGLs, crude oil, coal or other energy commodities or a
decrease in the volume of such commodities available for
transportation, processing, storage or distribution may adversely
impact the operations and financial performance of MLPs, MLP-related
entities and other energy sector and energy utility companies.
Production declines and volume decreases could be caused by various
factors, including catastrophic events affecting production, depletion
of resources, labor difficulties, environmental proceedings, increased
regulations, equipment failures and unexpected maintenance problems,
import supply disruption, increased competition from alternative energy
sources, depressed commodity prices or access to capital for companies
engaged in exploration and production. Alternatively, a sustained
decline in demand for such commodities could also impact the financial
performance of MLPs, MLP-related entities and other energy sector and
energy utility companies. Factors which could lead to a decline in
48
demand include economic recession or other adverse economic conditions,
higher fuel taxes or governmental regulations, increases in fuel
economy, consumer shifts to the use of alternative fuel sources, an
increase in commodity prices, or weather.
o Lack of Diversification of Customers and Suppliers. Certain MLPs,
MLP-related entities and other energy sector and energy utility
companies depend upon a limited number of customers for substantially
all of their revenue. Similarly, certain MLPs, MLP-related entities and
other energy sector and energy utility companies depend upon a limited
number of suppliers of goods or services to continue their operations.
Energy industry downturns resulting from lower commodity prices may put
pressure on a number of these customers and suppliers. The loss of any
such customers or suppliers, including through bankruptcy, could
materially adversely affect such MLPs', MLP-related entities' and other
energy sector and energy utility companies' results of operations and
cash flow, and their ability to make distributions to unit holders,
such as the Fund, would therefore be materially adversely affected.
o Depletion and Exploration Risk. MLPs, MLP-related entities and other
energy sector and energy utility companies also engaged in the
production (exploration, development, management or production) of
natural gas, NGLs (including propane), crude oil, refined petroleum
products or coal are subject to the risk that their commodity reserves
naturally deplete over time. Reserves are generally increased through
expansion of their existing business, through exploration of new
sources or development of existing sources, through acquisitions or by
securing long-term contracts to acquire additional reserves, each of
which entails risk. The financial performance of these issuers may be
adversely affected if they are unable to acquire, cost-effectively,
additional reserves at a rate at least equal to the rate of natural
decline. A failure to maintain or increase reserves could reduce the
amount and change the characterization of cash distributions paid by
these MLPs, MLP-related entities and other energy sector and energy
utility companies.
As a result of the downturn in recent years in energy-related commodity prices,
many MLPs, MLP-related entities and other energy sector and energy utility
companies have significantly reduced capital expenditures to develop their
reserve bases. This resulted in declines in domestic production levels. Many
MLPs, MLP-related entities and other energy sector and energy utility companies
were forced to monetize reserves to manage the balance sheets and maintain
adequate liquidity levels. Some MLPs, MLP-related entities and other energy
sector and energy utility companies have been forced to file for bankruptcy in
an effort to restructure their balance sheets. These actions have had a negative
impact on the operating results and financial performance for MLPs, MLP-related
entities and other energy sector and energy utility companies engaged in the
transportation, storage, distribution and processing of production from such
MLPs, MLP-related entities and other energy sector and energy utility companies.
o Regulatory Risk. The energy sector and energy utility industries are
highly regulated. MLPs, MLP-related entities and other energy sector
and energy utility companies are subject to significant regulation of
nearly every aspect of their operations by federal, state and local
governmental agencies. Such regulation can change rapidly or over time
in both scope and intensity. For example, a particular by-product or
process may be declared hazardous (sometimes retroactively) by a
regulatory agency which could unexpectedly increase production costs.
Various governmental authorities have the power to enforce compliance
with these regulations and the permits issued under them, and violators
are subject to administrative, civil and criminal penalties, including
civil fines, injunctions or both. Stricter laws, regulations or
enforcement policies could be enacted in the future which would likely
increase compliance costs and may adversely affect the financial
performance of MLPs, MLP-related entities and other energy sector and
energy utility companies.
Specifically, the operations of wells, gathering systems, pipelines, refineries
and other facilities are subject to stringent and complex federal, state and
local environmental laws and regulations. These include, for example:
o the federal Clean Air Act and comparable state laws and regulations
that impose obligations related to air emissions;
o the federal Clean Water Act and comparable state laws and regulations
that impose obligations related to discharges of pollutants into
regulated bodies of water;
o the Resource Conservation and Recovery Act ("RCRA") and comparable
state laws and regulations that impose requirements for the handling
and disposal of waste from facilities; and
o the Comprehensive Environmental Response, Compensation, and Liability
Act ("CERCLA," also known as "Superfund") and comparable state laws and
regulations that regulate the cleanup of hazardous substances that may
have been released at properties currently or previously owned or
operated by MLPs, MLP-related entities or other energy sector or energy
utility companies or at locations to which they have sent waste for
disposal.
49
Failure to comply with these laws and regulations may trigger a variety of
administrative, civil and criminal enforcement measures, including the
assessment of monetary penalties, the imposition of remedial requirements, and
the issuance of orders enjoining future operations. Certain environmental
statutes, including RCRA, CERCLA, the federal Oil Pollution Act and analogous
state laws and regulations, impose strict, joint and several liability for costs
required to clean up and restore sites where hazardous substances have been
disposed of or otherwise released. Moreover, it is not uncommon for neighboring
landowners and other third parties to file claims for personal injury and
property damage allegedly caused by the release of hazardous substances or other
waste products into the environment.
There is an inherent risk that MLPs, MLP-related entities and other energy
sector and energy utility companies may incur environmental costs and
liabilities due to the nature of their businesses and the substances they
handle. For example, an accidental release from wells or gathering pipelines
could subject them to substantial liabilities for environmental cleanup and
restoration costs, claims made by neighboring landowners and other third parties
for personal injury and property damage, and fines or penalties for related
violations of environmental laws or regulations. Moreover, the possibility
exists that stricter laws, regulations or enforcement policies could
significantly increase the compliance costs of MLPs, MLP-related entities or
other energy sector or energy utility companies. For example, hydraulic
fracturing, a technique used in the completion of certain oil and gas wells, has
become a subject of increasing regulatory scrutiny and may be subject in the
future to more stringent, and more costly to comply with, requirements.
Similarly, the implementation of more stringent environmental requirements could
significantly increase the cost of any remediation that may become necessary.
MLPs, MLP-related entities and other energy sector and energy utility companies
may not be able to recover these costs from insurance.
Voluntary initiatives and mandatory controls have been adopted or are being
discussed both in the United States and worldwide to reduce emissions of
"greenhouse gases" such as carbon dioxide, a by-product of burning fossil fuels,
and methane, the major constituent of natural gas, which many scientists and
policymakers believe contribute to global climate change. These measures and
future measures could result increased costs to certain companies in which the
Fund may invest to operate and maintain facilities and administer and manage a
greenhouse gas emissions program and may reduce demand for fuels that generate
greenhouse gases and that are managed or produced by companies in which the Fund
may invest.
In the wake of a Supreme Court decision holding that the United States
Environmental Protection Agency (the "EPA") has some legal authority to deal
with climate change under the Clean Air Act, the EPA and the Department of
Transportation jointly wrote regulations to cut gasoline use and control
greenhouse gas emissions from cars and trucks. The EPA has also taken action to
require certain entities to measure and report greenhouse gas emissions and
certain facilities may be required to control emissions of greenhouse gases
pursuant to EPA air permitting and other regulatory programs.
These measures, and other programs addressing greenhouse gas emissions, could
reduce demand for energy or raise prices, which may adversely affect the total
return of certain of the Fund's investments. In addition, certain states
(individually or in regional cooperation), have taken or proposed measures to
reduce emissions of greenhouse gases.
o Interest Rate Risk. Rising interest rates could adversely impact the
financial performance of MLPs, MLP-related entities and other energy
sector and energy utility companies. Rising interest rates may increase
an MLP's, MLP-related entity's or other energy sector or energy utility
company's cost of capital, which would increase operating costs and may
reduce an MLP's, MLP-related entity's or other energy sector or energy
utility company's ability to execute acquisitions or expansion projects
in a cost-effective manner. Rising interest rates may also impact the
price of MLP units, MLP-related entity securities and energy sector and
energy utility company shares as the yields on alternative investments
increase.
o Acquisition or Reinvestment Risk. The ability of MLPs, MLP-related
entities and other energy sector and energy utility companies to grow
and to increase distributions to their equity holders can be dependent
in part on their ability to make acquisitions or find organic projects
that result in an increase in adjusted operating cash flow. In the
event that MLPs, MLP-related entities and other energy sector and
energy utility companies are unable to make such accretive
acquisitions/projects either because they are unable to identify
attractive acquisition/project candidates or negotiate acceptable
purchase contracts or because they are unable to raise financing on
economically acceptable terms or because they are outbid by
competitors, their future growth and ability to raise distributions may
be hindered. Furthermore, even if MLPs, MLP-related entities and other
energy sector and energy utility companies do consummate
acquisitions/projects that they believe will be accretive, the
acquisitions/projects may in fact turn out to result in a decrease in
adjusted operating cash flow. Any acquisition/project involves risks,
including among other things: mistaken assumptions about revenues and
costs, including synergies; the assumption of unknown liabilities;
limitations on rights to indemnity from the seller; the diversion of
management's attention from other business concerns; unforeseen
difficulties operating in new product areas or new geographic areas;
and customer or key employee losses at the acquired businesses.
o Affiliated Party Risk. Certain MLPs, MLP-related entities and other
energy sector and energy utility companies may be dependent on their
parents or sponsors for a majority of their revenues. Any failure by
50
the parents or sponsors of such entities to satisfy their payments or
obligations would impact the MLP's, MLP-related entity's or energy
sector or energy utility company's revenues and cash flows and ability
to make distributions.
o Weather Risk. Weather plays a role in the seasonality of some MLPs',
MLP-related entities' and other energy sector and energy utility
companies' cash flows. MLPs, MLP-related entities and other energy
sector and energy utility companies in the propane industry, for
example, rely on the winter season to generate a significant portion of
their earnings. In an unusually warm winter season, propane MLPs,
MLP-related entities and other energy sector and energy utility
companies may experience decreased demand for their product.
o Catastrophe Risk. The operations of MLPs, MLP-related entities and
other energy sector and energy utility companies are subject to many
hazards inherent in transporting, processing, storing, distributing or
marketing natural gas, NGLs, crude oil, refined petroleum products or
other hydrocarbons, or in exploring, managing or producing such
commodities or products, including: damage to pipelines, storage tanks
or related equipment and surrounding properties caused by hurricanes,
tornadoes, floods, fires and other natural disasters and acts of
terrorism; inadvertent damage from construction and farm equipment;
leaks of natural gas, NGLs, crude oil, refined petroleum products or
other hydrocarbons; and explosions. These risks could result in
substantial losses due to personal injury and/or loss of life, severe
damage to and destruction of property and equipment and pollution or
other environmental damage and may result in the curtailment or
suspension of their related operations. Not all MLPs, MLP-related
entities and other energy sector and energy utility companies are fully
insured against all risks inherent to their businesses. If a
significant accident or event occurs that is not fully insured, it
could adversely affect their operations and financial condition.
o Terrorism/Market Disruption Risk. MLPs, MLP-related entities and other
energy sector and energy utility companies are subject to disruption as
a result of terrorist activities, war, and other geopolitical events,
including upheaval in the Middle East or other energy producing
regions. The U.S. government has issued warnings that energy assets,
specifically those related to pipeline and other energy infrastructure,
production facilities and transmission and distribution facilities, may
be targeted in future terrorist attacks. Internal unrest, acts of
violence or strained relations between a government and energy
companies or other governments may affect the operations and
profitability of MLPs, MLP-related entities and other energy sector and
energy utility companies, particularly marine transportation companies.
Political instability in other parts of the world may also cause
volatility and disruptions in the market for the securities of MLPs,
MLP-related entities and other energy sector and energy utility
companies, even those that operate solely in North America.
o Technology Risk. Some MLPs, MLP-related entities and other energy
sector and energy utility companies are focused on developing new
technologies and are strongly influenced by technological changes.
Technology development efforts by MLPs, MLP-related entities and other
energy sector and energy utility companies may not result in viable
methods or products. MLPs, MLP-related entities and other energy sector
and energy utility companies may bear high research and development
costs, which can limit their ability to maintain operations during
periods of organizational growth or instability. Some MLPs, MLP-related
entities and other energy sector and energy utility companies may be in
the early stages of operations and may have limited operating histories
and smaller market capitalizations on average than companies in other
sectors. As a result of these and other factors, the value of
investments in MLPs, MLP-related entities and other energy sector and
energy utility companies may be considerably more volatile than that in
more established segments of the economy.
INDUSTRY SPECIFIC RISK
MLPs, MLP-related entities and other energy sector and energy utility companies
are also subject to risks that are specific to the industry they serve.
o MLPs, MLP-related entities and other energy sector and energy utility
companies that provide crude oil, refined product and natural gas
services are subject to supply and demand fluctuations in the markets
they serve which will be impacted by a wide range of factors including
fluctuating commodity prices, weather, increased conservation or use of
alternative fuel sources, increased governmental or environmental
regulation, depletion, rising interest rates, declines in domestic or
foreign production, accidents or catastrophic events, and economic
conditions, among others.
o MLPs, MLP-related entities and other energy sector and energy utility
companies that operate assets are also subject to the credit risk of
their customers. For example, during 2015 and 2016, many MLPs,
MLP-related entities and other energy sector and energy utility
companies that explore for and produce oil, natural gas and NGLs filed
for bankruptcy. During the bankruptcy process, the debtor entity may be
able to reject a contract that it has with an MLP, MLP-related entity
or other energy sector or energy utility company that provides services
for the debtor, which services could include gathering, processing,
transporting, fractionating or storing the debtor entity's production.
If a contract is successfully rejected during bankruptcy, the affected
MLP, MLP-related entity or other energy sector or energy utility
51
company will have an unsecured claim for damages but will likely only
recover a portion of its claim for damages and may not recover anything
at all. Furthermore, if the terms of the contract are not economic for
the MLP, MLP-related entity or other energy sector or energy utility
company, there may be an incentive for the MLP or other company to
renegotiate the contract to increase the utilization of its assets
(whether or not the MLP, MLP-related entity or other energy sector or
energy utility company has filed for bankruptcy). In either case, an
MLP or other company that operates assets for an MLP, MLP-related
entity or other energy sector or energy utility company that is in
financial distress could experience a material adverse impact to its
financial performance and results of operations.
o Propane companies are subject to earnings variability based upon
weather conditions in the markets they serve, fluctuating commodity
prices, increased use of alternative fuels, increased governmental or
environmental regulation, and accidents or catastrophic events, among
others.
o MLPs, MLP-related entities and other energy sector and energy utility
companies with coal assets are subject to supply and demand
fluctuations in the markets they serve which will be impacted by a wide
range of factors including, fluctuating commodity prices, the level of
their customers' coal stockpiles, weather, increased conservation or
use of alternative fuel sources, increased governmental or
environmental regulation, depletion, rising interest rates,
transportation issues, declines in domestic or foreign production,
mining accidents or catastrophic events, health claims and economic
conditions, among others.
o MLPs, MLP-related entities and other energy sector and energy utility
companies that own interstate pipelines are subject to regulation by
the Federal Energy Regulatory Commission ("FERC") with respect to the
tariff rates they may charge for transportation services. An adverse
determination by FERC with respect to the tariff rates of such a
company could have a material adverse effect on its business, financial
condition, results of operations and cash flows and its ability to pay
cash distributions or dividends. In addition, FERC has a tax allowance
policy, which permits such companies to include in their cost of
service an income tax allowance to the extent that their owners have an
actual or potential tax liability on the income generated by them. If
FERC's income tax allowance policy were to change in the future to
disallow a material portion of the income tax allowance taken by such
interstate pipeline companies, it would adversely impact the maximum
tariff rates that such companies are permitted to charge for their
transportation services, which in turn could adversely affect such
companies' financial condition and ability to pay distributions to
shareholders.
o Marine shipping (or "tanker") companies are exposed to many of the same
risks as other MLPs, MLP-related entities and other energy sector and
energy utility companies. In addition, the highly cyclical nature of
the industry may lead to volatile changes in charter rates and vessel
values, which may adversely affect a tanker company's earnings.
Fluctuations in charter rates and vessel values result from changes in
the supply and demand for tanker capacity and changes in the supply and
demand for oil and oil products. Historically, the tanker markets have
been volatile because many conditions and factors can affect the supply
and demand for tanker capacity. Changes in demand for transportation of
oil over longer distances and supply of tankers to carry that oil may
materially affect revenues, profitability and cash flows of tanker
companies. The successful operation of vessels in the charter market
depends upon, among other things, obtaining profitable spot charters
and minimizing time spent waiting for charters and traveling unladen to
pick up cargo. The value of tanker vessels may fluctuate and could
adversely affect the value of tanker company securities. Declining
tanker values could affect the ability of tanker companies to raise
cash by limiting their ability to refinance their vessels, thereby
adversely impacting tanker company liquidity. Tanker company vessels
are at risk of damage or loss because of events such as mechanical
failure, collision, human error, war, terrorism, piracy, cargo loss and
bad weather. In addition, changing economic, regulatory and political
conditions in some countries, including political and military
conflicts, have from time to time resulted in attacks on vessels,
mining of waterways, piracy, terrorism, labor strikes, boycotts and
government requisitioning of vessels. These sorts of events could
interfere with shipping lanes and result in market disruptions and a
significant loss of tanker company earnings.
o A variety of factors may adversely affect the business or operations of
companies in the energy utility industry, including: high interest
costs in connection with capital construction and improvement programs;
governmental regulation of rates charged to customers (including the
potential that costs incurred by the utility change more rapidly than
the rate the utility is permitted to charge its customers); costs
associated with compliance with and changes in environmental and other
regulations; effects of economic slowdowns and surplus capacity;
increased competition from other providers of utilities services;
inexperience with and potential losses resulting from a developing
deregulatory environment; costs associated with reduced availability of
certain types of fuel; the effects of energy conservation policies;
effects of a national energy policy; technological innovations;
potential impact of terrorist activities; the impact of natural or
man-made disasters; regulation by various governmental authorities,
including the imposition of special tariffs; and changes in tax laws,
regulatory policies and accounting standards.
52
o Changes in laws or government regulations regarding hydraulic
fracturing could increase a company's costs of doing business, limit
the areas in which it can operate and reduce oil and natural gas
production by the company.
ENERGY UTILITY COMPANY RISK
Risks that are intrinsic to energy utility companies include difficulty in
obtaining an adequate return on invested capital, difficulty in financing large
construction programs during an inflationary period, restrictions on operations
and increased cost and delays attributable to environmental considerations and
regulation, difficulty in raising capital in adequate amounts on reasonable
terms in periods of high inflation and unsettled capital markets, technological
innovations that may render existing plants, equipment or products obsolete, the
potential impact of natural or man-made disasters, increased costs and reduced
availability of certain types of fuel, occasional reduced availability and high
costs of natural gas and other fuels, the effects of energy conservation, the
effects of a national energy policy and lengthy delays and greatly increased
costs and other problems associated with the design, construction, licensing,
regulation and operation of nuclear facilities for electric generation,
including, among other considerations, the problems associated with the use of
radioactive materials, the disposal of radioactive wastes, shutdown of
facilities or release of radiation resulting from catastrophic events,
disallowance of costs by regulators which may reduce profitability, and changes
in market structure that increase competition.
There are substantial differences among the regulatory practices and policies of
various jurisdictions, and any given regulatory agency may make major shifts in
policy from time to time. There is no assurance that regulatory authorities
will, in the future, grant rate increases or that such increases will be
adequate to permit the payment of dividends on common stocks issued by certain
energy utility companies. Additionally, existing and possible future regulatory
legislation may make it even more difficult for energy utility companies to
obtain adequate relief. Certain energy utility companies may own or operate
nuclear generating facilities. Governmental authorities may from time to time
review existing policies and impose additional requirements governing the
licensing, construction and operation of nuclear power plants. Prolonged changes
in climatic conditions can also have a significant impact on both the revenues
of an electric and gas utility as well as the expenses of a utility,
particularly a hydro-based electric utility.
Energy utility companies in the United States and in foreign countries are
generally subject to regulation. In the United States, most energy utility
companies are regulated by state and/or federal authorities. Such regulation is
intended to ensure appropriate standards of service and adequate capacity to
meet public demand. Generally, prices are also regulated in the United States
and in foreign countries with the intention of protecting the public while
ensuring that the rate of return earned by energy utility companies is
sufficient to allow them to attract capital in order to grow and continue to
provide appropriate services. There is no assurance that such pricing policies
or rates of return will continue in the future.
The nature of regulation of the energy utility industry continues to evolve both
in the United States and in foreign countries. In recent years, changes in
regulation in the United States increasingly have allowed certain energy utility
companies to provide services and products outside their traditional geographic
areas and lines of business, creating new areas of competition within the
industry. In some instances, energy utility companies are operating on an
unregulated basis. Because of trends toward deregulation and the evolution of
independent power producers, non-regulated providers of utility services have
become a significant part of their respective industry sectors. The emergence of
competition and deregulation may result in certain energy utility companies
being forced to defend their core business from increased competition, thus
becoming less profitable. Reduced profitability, as well as new uses of funds
(such as for expansion, operations or stock buybacks) could result in cuts in
dividend payout rates.
Foreign energy utility companies are also subject to regulation, although such
regulations may or may not be comparable to those in the United States. Foreign
energy utility companies may be more heavily regulated by their respective
governments than energy utility companies in the United States and, as in the
United States, generally are required to seek government approval for rate
increases. In addition, many foreign energy utility companies use fuels that may
cause more pollution than those used in the United States, which may require
such energy utility companies to invest in pollution control equipment to meet
any proposed pollution restrictions. Foreign regulatory systems vary from
country to country and may evolve in ways different from regulation in the
United States.
Although many foreign energy utility companies currently are government-owned,
thereby limiting current investment opportunities for the Fund, foreign
governments may seek global investors through the privatization of their utility
industries. Privatization, which refers to the trend toward investor ownership
of assets rather than government ownership, may be more likely to occur in
newer, faster-growing economies than in mature economies. There is no assurance
that such developments will occur or that investment opportunities in foreign
markets will increase or that regulatory structures will remain stable over
time.
The revenues of domestic and foreign energy utility companies generally reflect
the economic growth and development in the geographic areas in which they do
business.
Certain segments of the energy utility industry, and individual energy utility
companies within such segments, may not perform as well as the energy utility
industry as a whole. Many energy utility companies have historically been
53
subject to risks of increases in fuel and other operating costs, high interest
costs on borrowings needed for capital improvement programs and costs associated
with compliance with and changes in environmental and other governmental
regulations. In particular, regulatory changes with respect to nuclear and
conventionally fueled power generating and transmission facilities could
increase costs or impair the ability of energy utility companies to operate and
utilize such facilities, thus reducing the companies' earnings or resulting in
losses. Rates of return on investment of certain energy utility companies are
subject to review by government regulators. Changes in regulatory policies or
accounting standards may negatively affect the earnings or dividends of energy
utility companies. Costs incurred by energy utility companies, such as fuel and
purchased power costs, often are subject to immediate market action resulting
from such things as political or military forces operating in geographic regions
where oil production is concentrated or global or regional weather conditions,
such as droughts, while the rates of return of energy utility companies
generally are subject to review and limitation by state and/or national public
utility commissions, which results ordinarily in a lag or an absence of
correlation between costs and return. It is also possible that costs may not be
offset by return. Energy utility companies have, in recent years, been affected
by increased competition, which could adversely affect the profitability or
viability of such companies. Electric utilities may also be subject to
increasing economic pressures due to deregulation of generation, transmission
and other aspects of their business.
CASH FLOW RISK
A substantial portion of the cash distributions received by the Fund is derived
from its investment in equity securities of MLPs, MLP-related entities and other
energy sector and energy utility companies. The amount of cash that an MLP,
MLP-related entity or other energy sector or energy utility company has
available for distributions to its equity holders depends upon the amount of
cash flow generated from the MLP's, MLP-related entity's or other energy sector
or energy utility company's operations. Cash flow from operations will vary from
quarter to quarter and is largely dependent on factors affecting the MLP's,
MLP-related entity's or other energy sector or energy utility company's
operations and factors affecting the energy industry in general. Large declines
in commodity prices (such as those experienced in 2014-2015) can result in
material declines in cash flow from operations. In addition to the risk factors
described herein, other factors which may reduce the amount of cash an MLP's,
MLP-related entity's or other energy sector or energy utility company has
available to pay its debt and equity holders include increased operating costs,
maintenance capital expenditures, acquisition costs, expansion or construction
costs and borrowing costs (including increased borrowing costs as a result of
additional collateral requirements as a result of ratings downgrades by credit
agencies). Further, covenants in debt instruments issued by MLPs, MLP-related
entities and other energy sector and energy utility companies in which the Fund
invests may restrict distributions to equity holders or, in certain
circumstances, may not allow distributions to be made to equity holders. To the
extent the Fund invests in MLPs, MLP-related entities and other energy sector
and energy utility companies that reduce their distributions to equity holders,
this will result in reduced levels of net distributable income and can cause the
Fund to reduce its distributions.
MLP AND DEFERRED TAX RISK
Much of the benefit the Fund derives from its investments in equity securities
of MLPs is a result of MLPs generally being treated as partnerships for United
States federal income tax purposes. Partnerships do not pay United States
federal income tax at the partnership level. Rather, each partner of a
partnership, in computing its United States federal income tax liability, will
include its allocable share of the partnership's income, gains, losses,
deductions and expenses. A change in current tax law, a change in the business
of a given MLP, or a change in the types of income earned by a given MLP could
result in an MLP being treated as a corporation for United States federal income
tax purposes, which would result in such MLP being required to pay United States
federal income tax on its taxable income. Recent changes in regulations may
cause some MLPs to be reclassified as corporations. The classification of an MLP
as a corporation for United States federal income tax purposes would have the
effect of reducing the amount of cash available for distribution by the MLP and
causing any such distributions received by the Fund to be taxed as dividend
income to the extent of the MLP's current or accumulated earnings and profits.
Thus, if any of the MLPs owned by the Fund were treated as a corporation for
United States federal income tax purposes, the value and after-tax return to the
Fund with respect to its investment in such MLPs would be materially reduced,
which could cause a substantial decline in the value of the common shares.
Separately, a recent change in law has shifted the primary obligation for taxes
attributable to partnership adjustments to the partnership. The MLPs may make
certain elections to push that liability out to the partners, but the
application of the new law is subject to substantial uncertainties.
In addition, the potential tax benefit to the Fund of investing in MLPs will
depend in part on the particular MLP securities selected, and whether any
distributions paid by such MLPs will be treated as a return of capital (as
opposed to currently taxable income). The Fund will rely on the Sub-Advisor to
select MLP securities that provide distributions in excess of allocable taxable
income. If the Sub-Advisor fails to do so, a greater portion of the
distributions received by the Fund may be comprised of taxable income (which
would reduce the ability of the Fund to make distributions to common
shareholders that are treated as a return of capital for United States federal
income tax purposes). In such case, the Fund may have more corporate income tax
expense than expected, which will result in less cash available to distribute to
54
common shareholders. Also, in connection with managing the Fund's portfolio in
order to seek to maximize the potential tax benefits discussed above, the
Sub-Advisor may be forced to sell securities at times or prices that may be
disadvantageous to the Fund.
The Fund will be treated as a regular corporation, or a "C" corporation, for
United States federal income tax purposes and, as a result, unlike most
investment companies, will be subject to corporate income tax to the extent the
Fund recognizes taxable income. Any taxes paid by the Fund will reduce the
amount available to pay distributions to common shareholders, and therefore
investors in the Fund will likely receive lower distributions than if they
invested directly in MLPs.
As a limited partner in the MLPs in which it may invest, the Fund is allocated
its pro rata share of income, gains, losses, deductions and expenses from the
MLPs. A significant portion of MLP income has historically been offset by
non-cash tax deductions such as depreciation and depletion. The Fund will incur
a current tax liability on its income allocation from an MLP not offset by tax
deductions. The Fund's tax basis in its MLP units would be in increased by the
income allocated from an MLP, and then reduced by all distributions from the MLP
(including any distributions in excess of allocated income), which would either
increase the Fund's taxable gain or reduce the Fund's loss recognized upon the
sale of such MLP units. The percentage of an MLP's distribution which is offset
by tax deductions will fluctuate over time for various reasons. A significant
slowdown in acquisition or investment activity by MLPs held by the Fund could
result in a reduction of accelerated depreciation or other deductions generated
by these activities, which may result in an increased current tax liability to
the Fund A reduction in the percentage of the income offset by tax deductions or
an increase in sales of the Fund's MLP holdings that result in capital gains
will reduce that portion of the Fund's distribution from and MLP treated as a
return of capital and increase that portion treated as income, and may result in
lower after-tax distributions to the Fund's common shareholders.
The Fund will accrue deferred income taxes for its future tax liability
associated with the difference between the Fund's tax basis in an MLP security
and the fair market value of the MLP security. Upon the Fund's sale of an MLP
security, the Fund may be liable for previously deferred taxes. The Fund will
rely to some extent on information provided by MLPs, which may not necessarily
be timely, to estimate its deferred tax liability for purposes of financial
statement reporting and determining its NAV. In addition, the Tax Cuts and Jobs
Act has impacted the determination of the Fund's NAV as discussed below in
"--Recent Market and Economic Developments." From time to time, the Fund will
modify its estimates or assumptions regarding its deferred tax liability as new
information becomes available.
Because of the Fund's status as a corporation for United States federal income
tax purposes and its investments in equity securities of MLPs, the Fund's
earnings and profits may be calculated using accounting methods that are
different from those used for calculating taxable income. Because of these
differences, the Fund may make distributions out of its current or accumulated
earnings and profits, which will be treated as taxable dividends, in excess of
its taxable income. See "Tax Matters."
RECENT MARKET AND ECONOMIC DEVELOPMENTS
Prices of oil and other energy commodities have declined significantly and
experienced significant volatility during recent years. Such volatility has
adversely impacted (and may continue to impact) many of the MLPs, MLP-related
entities and other energy companies in which the Fund has invested or may
invest. For example, many MLPs, MLP-related entities and other energy companies
have in recent years experienced eroding growth prospects, reduced distribution
levels or, in some cases, bankruptcy. These conditions have impacted, and may
continue to impact, the NAV of the Fund and its ability to pay distributions to
shareholders at current or historic levels.
During periods of market volatility, MLPs, MLP-related entities and other energy
companies may be unable to obtain new debt or equity financing on acceptable
terms or at all when market conditions are most volatile, and downgrades of the
debt of MLPs, MLP-related entities and other energy companies by rating agencies
during times of distress could exacerbate this challenge. In addition,
downgrades of the debt of MLPs, MLP-related entities and other energy companies
by ratings agencies may increase the cost of borrowing under the terms of an
MLP's, MLP-related entity's and other energy company's credit facility, and a
downgrade from investment grade to below investment may cause an MLP,
MLP-related entity and other energy company to be required to post collateral
(or additional collateral) by its contractual counterparties, which could reduce
the amount of liquidity available to such MLP, MLP-related entity and other
energy company and increase its need for additional funding sources. If funding
is not available when needed, or is available only on unfavorable terms, MLPs,
MLP-related entities and other energy companies may have to reduce their
distributions to manage their funding needs and may not be able to meet their
obligations, which may include multi-year capital expenditure commitments, as
they come due. Moreover, without adequate funding, many MLPs, MLP-related
entities and other energy companies will be unable to execute their growth
strategies, complete future acquisitions, take advantage of other business
opportunities or respond to competitive pressures, any of which could have a
material adverse effect on their revenues and results of operations.
The number of energy-related MLPs has declined since 2014 for a number of
reasons as discussed below. Many of the assets held by MLPs were originally
constructed decades ago by pipeline and power utilities. When the United States
deregulated much of the energy industry, these utilities became cyclical
commodity companies with significant levels of debt and the resulting financial
55
stress caused divestment of their pipeline assets to the MLP space that was
trading at higher valuations. This trend has reversed since 2014.
While MLPs represented a way for the industry to lower its cost of financing
between 2004 and 2014, the severe correction in the price of crude oil in 2014
caused a collapse in MLP valuations as about half of the Alerian MLP Index had
become exposed to commodity prices between 2004 and 2014. MLP distribution cuts
and even some bankruptcies followed. Over the last 2 1/2 years as of the date of
this prospectus about 40% of the MLPs in the Alerian MLP Index have cut or
eliminated their dividends. Currently, MLPs in the Alerian MLP Index trade at
valuations that are about 40% lower than 2014, while the valuation multiples of
non-MLP energy infrastructure companies like utilities have risen. MLPs are now
a higher-cost way of financing these industries; the reverse of the conditions
that led to the growth of the asset class in the early part of the last decade.
As a result, the industry is witnessing the consolidation or simplification of
corporate structures where the MLP sleeve of capital is being eliminated because
it no longer reduces a company's cost of equity financing.
Even for MLPs that have avoided exposure to commodity prices and have been
successful in growing their dividends, the cost of the MLP structure has risen
due to growing incentive payments to the general partner. These incentives
increase with per share dividend growth at the limited partnership level and are
due on newly issued shares, as well as older shares that have experienced the
growth. As a result, the more successful the MLP is in growing its dividends,
the closer it gets to paying incentives to the parent/general partner that are
more onerous than a tax at the corporate level. The lower the corporate tax
rate, the sooner this threshold is crossed. In many cases, MLPs are merely a
part of the corporate finance structure of a company. MLPs are created when they
lower the cost of equity financing and are no longer used when they don't. As a
result of the foregoing, the Fund may increase its non-MLP investments
consistent with its investment objective and policies.
In addition, on December 22, 2017, the Tax Cuts and Jobs Act was signed into
law, which, among other things, reduced the top federal income tax rate
applicable to the Fund from 35% to 21% and, accordingly, reduced the Fund's
accrual rate for deferred federal income taxes. As a result, the Fund's deferred
tax liability was significantly reduced which in turn resulted in an increase in
the Fund's NAV. As of December 22, 2017, the Fund's NAV was increased by
approximately $0.24, or approximately 1.72%. See "Tax Matters" and "Market and
Net Asset Value Information."
LEVERAGE PROGRAM TAX RISK
Changes in tax laws or regulations, or interpretations thereof in the future,
could adversely affect the Fund or the MLPs, MLP-related entities and other
energy sector and energy utility companies in which the Fund invests. Any such
changes could negatively impact the Fund and its common shareholders. For
example, if as a result of a change in the tax laws, MLPs are required to be
treated as corporations rather than partnerships for tax purposes, MLPs would be
subject to entity level tax at corporate tax rates and any distributions
received by the Fund from an MLP would be treated as dividend income to the
extent it was attributable to the MLP's current or accumulated earnings and
profits. Such treatment would negatively impact the amount and tax
characterization of distributions received by the Fund and its common
shareholders. The IRS has adopted regulations that limit the nature of
qualifying income for MLPs. Some MLPs may convert to corporations under these
regulations or restructure their activities to qualify under these regulations.
In addition, there have been proposals in Congress to eliminate certain tax
incentives widely used by oil and gas companies and to impose new fees on
certain energy producers. The elimination of such tax incentives and imposition
of such fees could adversely affect MLPs, MLP-related entities and other energy
sector and energy utility companies and/or the energy sector generally.
Furthermore, recently enacted legislation (which by its terms is scheduled to
become effective for taxable years beginning after December 31, 2017) generally
requires that taxes, penalties, and interest associated with an audit of a
partnership be assessed and collected at the partnership level. Therefore, an
adverse federal income tax audit of an MLP that the Fund invests in could result
in the Fund being required to pay federal income tax or pay a deficiency
dividend (without having received additional cash). The Fund may have little
input in any audit asserted against an MLP and may be contractually or legally
obligated to make payments in regard to deficiencies asserted without the
ability to put forward an independent defense. Accordingly, even if an MLP in
which the Fund invests were to remain classified as a partnership, it could be
required to pay additional taxes, interest and penalties as a result of an audit
adjustment, and the Fund, as a direct or indirect partner of such MLP, could be
required to bear the economic burden of those taxes, interest and penalties,
which would reduce the value of the common shares.
TAX LAW CHANGE RISK
Changes in tax laws or regulations, or interpretations thereof in the future,
could adversely affect the Fund or the MLPs, MLP-related entities and other
energy sector and energy utility companies in which the Fund invests. Any such
changes could negatively impact the Fund and its common shareholders. For
example, if as a result of a change in the tax laws, MLPs are required to be
treated as corporations rather than partnerships for tax purposes, MLPs would be
subject to entity level tax at corporate tax rates and any distributions
received by the Fund from an MLP would be treated as dividend income to the
extent it was attributable to the MLP's current or accumulated earnings and
profits. Such treatment would negatively impact the amount and tax
characterization of distributions received by the Fund and its common
shareholders. The IRS has adopted regulations, which are currently in effect,
that limit the nature of qualifying income for MLPs. Some MLPs may convert to
corporations under these regulations or restructure their activities to qualify
56
under these regulations. In addition, there have been proposals in Congress to
eliminate certain tax incentives widely used by oil and gas companies and to
impose new fees on certain energy producers. The elimination of such tax
incentives and imposition of such fees could adversely affect MLPs, MLP-related
entities and other energy sector and energy utility companies and/or the energy
sector generally. Furthermore, recently enacted legislation (which by its terms
became effective for taxable years beginning after December 31, 2017) generally
requires that taxes, penalties, and interest associated with an audit of a
partnership be assessed and collected at the partnership level. Therefore, an
adverse federal income tax audit of an MLP that the Fund invests in could result
in the Fund being required to pay federal income tax or pay a deficiency
dividend (without having received additional cash). The Fund may have little
input in any audit asserted against an MLP and may be contractually or legally
obligated to make payments in regard to deficiencies asserted without the
ability to put forward an independent defense. Accordingly, even if an MLP in
which the Fund invests were to remain classified as a partnership, it could be
required to pay additional taxes, interest and penalties as a result of an audit
adjustment, and the Fund, as a direct or indirect partner of such MLP, could be
required to bear the economic burden of those taxes, interest and penalties,
which would reduce the value of the common shares.
NON-U.S. SECURITIES RISK
Investing in non-U.S. securities involves certain risks not involved in domestic
investments, including, but not limited to: fluctuations in currency exchange
rates; future foreign economic, financial, political and social developments;
different legal systems; the possible imposition of exchange controls or other
foreign governmental laws or restrictions; lower trading volume; withholding
taxes; greater price volatility and illiquidity; different trading and
settlement practices; less governmental supervision; high and volatile rates of
inflation; fluctuating interest rates; less publicly available information; and
different accounting, auditing and financial recordkeeping standards and
requirements. Because the Fund may invest in securities denominated or quoted in
non-U.S. currencies, changes in the non-U.S. currency/United States dollar
exchange rate may affect the value of the Fund's securities and the unrealized
appreciation or depreciation of investments.
DELAY IN INVESTING THE PROCEEDS
Although the Fund currently intends to invest the proceeds from the sale of the
Common Shares as soon as practicable, such investments may be delayed if
suitable investments are unavailable at the time. The trading market and volumes
for MLP, MLP-related entity and other energy sector and energy utility company
shares may at times be less liquid than the market for other securities. Prior
to the time the proceeds of any offering are invested, such proceeds may be
invested in cash, cash equivalents or other securities, pending investment in
MLP, MLP-related entity or other energy sector or energy utility company
securities. As a result, the return and yield on the Common Shares following the
issuance of Common Shares may be lower than when the Fund is fully invested in
accordance with its objective and policies. See "Use of Proceeds."
EQUITY SECURITIES RISK
MLP units and other equity securities are sensitive to general movements in the
stock market and a drop in the stock market may depress the price of securities
to which the Fund has exposure. MLP units and other equity securities prices
fluctuate for several reasons including changes in the financial condition of a
particular issuer (generally measured in terms of distributable cash flow in the
case of MLPs), investors' perceptions of MLPs and other energy sector and energy
utility companies, the general condition of the relevant stock market, such as
the current market volatility, or when political or economic events affecting
the issuers occur. In addition, the price of equity securities may be
particularly sensitive to rising interest rates, as the cost of capital rises
and borrowing costs increase.
Certain of the MLPs, MLP-related entities and other energy sector and energy
utility companies in which the Fund may invest may have comparatively smaller
capitalizations. Investing in securities of smaller MLPs, MLP-related entities
and other energy sector and energy utility companies presents some unique
investment risks. These companies may have limited product lines and markets, as
well as shorter operating histories, less experienced management and more
limited financial resources than larger MLPs, MLP-related entities and other
energy sector and energy utility companies and may be more vulnerable to adverse
general market or economic developments. Stocks of smaller MLPs, MLP-related
entities and other energy sector and energy utility companies may be less liquid
than those of larger MLPs, MLP-related entities and other energy sector and
energy utility companies and may experience greater price fluctuations than
larger MLPs, MLP-related entities and other energy sector and energy utility
companies. In addition, small-cap securities may not be widely followed by the
investment community, which may result in reduced demand.
MLP subordinated units in which the Fund may invest will generally convert to
common units at a one-to-one ratio. The purchase or sale price is generally tied
to the common unit price less a discount. The size of the discount varies
depending on the likelihood of conversion, the length of time remaining to
conversion, the size of the block purchased and other factors.
DEBT SECURITIES RISK
Debt securities in which the Fund invests are subject to many of the risks
described elsewhere in this section. In addition, they are subject to credit
risk, interest rate risk, and, depending on their quality, other special risks.
An issuer of a debt security may be unable to make interest payments and repay
57
principal. The Fund could lose money if the issuer of a debt obligation is, or
is perceived to be, unable or unwilling to make timely principal and/or interest
payments, or to otherwise honor its obligations. The downgrade of a security by
rating agencies may further decrease its value. Certain debt instruments,
particularly below investment grade securities, may contain call or redemption
provisions which would allow the issuer thereof to prepay principal prior to the
debt instrument's stated maturity. This is known as prepayment risk. Prepayment
risk is greater during a falling interest rate environment as issuers can reduce
their cost of capital by refinancing higher yielding debt instruments with lower
yielding debt instruments. An issuer may also elect to refinance its debt
instruments with lower yielding debt instruments if the credit standing of the
issuer improves. To the extent debt securities in its portfolio are called or
redeemed, the Fund may be forced to reinvest in lower yielding securities. Debt
securities have reinvestment risk, which is the risk that income from the Fund's
portfolio will decline if and when the Fund invests the proceeds from matured,
traded or called fixed income instruments at market interest rates that are
below the portfolio's current earnings rate. A decline in income could affect
the Fund's common share price or its overall return.
BELOW INVESTMENT GRADE SECURITIES RISK
The Fund may invest up to 20% of its Managed Assets in debt securities of MLPs,
MLP-related entities and other energy sector and energy utility companies,
including certain below investment grade securities. Below investment grade
securities are rated "Ba1" or lower by Moody's, "BB+" or lower by S&P, or
comparably rated by another NRSRO or, if unrated, determined to be of comparable
quality by the Sub-Advisor. Below investment grade securities, also sometimes
referred to as "high yield" or "junk" bonds, generally pay a premium above the
yields of U.S. government securities or debt securities of investment grade
issuers because they are subject to greater risks than these securities. These
risks, which reflect their speculative character, include the following:
o greater yield and price volatility;
o greater credit risk and risk of default;
o potentially greater sensitivity to general economic or industry
conditions;
o potential lack of attractive resale opportunities (illiquidity); and
o additional expenses to seek recovery from issuers who default.
In addition, the prices of these below investment grade securities are more
sensitive to negative developments, such as a decline in the issuer's revenues,
downturns in profitability in the relevant industry or a general economic
downturn, than are the prices of higher grade securities. Below investment grade
securities tend to be less liquid than investment grade securities and the
market for below investment grade securities could contract further under
adverse market or economic conditions. In such a scenario, it may be more
difficult for the Fund to sell these securities in a timely manner or for as
high a price as could be realized if such securities were more widely traded.
The market value of below investment grade securities may be more volatile than
the market value of investment grade securities and generally tends to reflect
the market's perception of the creditworthiness of the issuer and short-term
market developments to a greater extent than investment grade securities, which
primarily reflect fluctuations in general levels of interest rates. In the event
of a default by a below investment grade security held in the Fund's portfolio
in the payment of principal or interest, the Fund may incur additional expense
to the extent it is required to seek recovery of such principal or interest.
The Fund does not intend to invest in securities issued by a partnership or
company in bankruptcy reorganization, subject to a public or private debt
restructuring or otherwise in default or in significant risk of default in the
payment of interest and principal ("distressed securities"). In the event any
security held by the Fund becomes distressed, the Fund may be required to incur
extraordinary expenses in order to attempt to protect and/or recover its
investment. In such situations, there can be no assurance as to when or if the
Fund will recover any of its investment in such distressed securities, or the
value thereof.
Ratings are relative and subjective and not absolute standards of quality.
Securities ratings are based largely on an issuer's historical financial
condition and the rating agencies' analyses at the time of rating. Consequently,
the rating assigned to any particular security or instrument is not necessarily
a reflection of an issuer's current financial condition. Subsequent to its
purchase by the Fund, the security or instrument may cease to be rated or its
rating may be reduced. In addition, it is possible that NRSROs might not change
their ratings of a particular security or instrument to reflect subsequent
events on a timely basis. Moreover, such ratings do not assess the risk of a
decline in market value. None of these events will require the sale of such
securities or instruments by the Fund, although the Sub-Advisor will consider
these events in determining whether the Fund should continue to hold the
securities.
The market for below investment grade and comparable unrated securities has
experienced periods of significantly adverse price and liquidity several times,
particularly at or around times of economic recession. Past market recessions
have adversely affected the value of such securities as well as the ability of
certain issuers of such securities to repay principal and pay interest thereon
or to refinance such securities. The market for these securities may react in a
similar fashion in the future.
58
For a further description of below investment grade securities and the risks
associated therewith, see "Other Investment Policies and Techniques" in the SAI.
For a description of the ratings categories of certain NRSROs, see Appendix A to
the SAI.
LEVERAGE RISK
The use of leverage by the Fund can magnify the effect of any losses. If the
income and gains earned on the securities and investments purchased with
leverage proceeds are greater than the cost of the leverage, the common shares'
return will be greater than if leverage had not been used. Conversely, if the
income and gains from the securities and investments purchased with such
proceeds do not cover the cost of leverage, the return to the common shares will
be less than if leverage had not been used. Leverage involves risks and special
considerations for common shareholders including:
o the likelihood of greater volatility of NAV and market price of the
common shares than a comparable portfolio without leverage;
o the risk that fluctuations in interest rates on borrowings and
short-term debt or in the dividend rates on any Preferred Shares that
the Fund may pay will reduce the return to the common shareholders or
will result in fluctuations in the dividends paid on the common shares;
o the effect of leverage in a declining market, which is likely to cause
a greater decline in the NAV of the common shares than if the Fund were
not leveraged, which may result in a greater decline in the market
price of the common shares; and
o when the Fund uses certain types of leverage, the investment advisory
fee payable to the Advisor and by the Advisor to the Sub-Advisor will
be higher than if the Fund did not use leverage.
The use of leverage by the Fund involves expenses and other costs, including
interest or dividend payments, which are borne directly by the common
shareholders. Increased operating costs, including the financing cost associated
with any leverage, may reduce the Fund's total return. In addition, any turmoil
in the credit markets could adversely impact borrowing availability and costs.
Because common shareholders directly bear the cost of leverage, an increase in
interest and dividend obligations on the Fund's financial leverage may reduce
the total return to common shareholders.
While the Fund may from time to time consider reducing leverage in response to
actual or anticipated changes in interest rates or other market conditions or in
an effort to mitigate the increased volatility of current income and NAV
associated with leverage, there can be no assurance that the Fund will actually
reduce leverage in the future or that any reduction, if undertaken, will benefit
the common shareholders. Changes in the future direction of interest rates are
very difficult to predict accurately. If the Fund were to reduce leverage based
on a prediction about future changes to interest rates, and that prediction
turned out to be incorrect, the reduction in leverage would likely operate to
reduce the income and/or total returns to common shareholders relative to the
circumstance if the Fund had not reduced leverage. The Fund may decide that this
risk outweighs the likelihood of achieving the desired reduction to volatility
in income and common share price if the prediction were to turn out to be
correct, and determine not to reduce leverage as described above.
The funds borrowed pursuant to a borrowing program (such as the Nova Scotia
Facility) or obtained through the issuance of Preferred Shares constitute a
substantial lien and burden by reason of their prior claim against the income of
the Fund and against the net assets of the Fund in liquidation. The rights of
lenders to receive payments of interest on and repayments of principal of any
Borrowings made by the Fund under a borrowing program are senior to the rights
of holders of common shares and the holders of Preferred Shares, with respect to
the payment of dividends or upon liquidation. Certain types of leverage may
result in the Fund being subject to covenants relating to asset coverage and
portfolio composition and may impose special restrictions on the Fund's use of
various investment techniques or strategies or in its ability to pay dividends
and other distributions on common shares in certain instances. The Fund may not
be permitted to declare dividends or other distributions, including dividends
and distributions with respect to common shares or Preferred Shares, or purchase
common shares or Preferred Shares unless, at the time thereof, the Fund meets
these asset coverage and portfolio composition requirements and no event of
default exists under any borrowing program. In addition, the Fund may not be
permitted to pay dividends on common shares unless all dividends on the
Preferred Shares and/or accrued interest on Borrowings have been paid, or set
aside for payment. In an event of default under a borrowing program, the lenders
have the right to cause a liquidation of collateral (i.e., sell assets of the
Fund) and, if any such default is not cured, the lenders may be able to control
the liquidation as well. The Fund also may be subject to certain restrictions on
investments imposed by guidelines of one or more rating agencies, which may
issue ratings for the Preferred Shares or other leverage securities issued by
the Fund. These guidelines may impose asset coverage or Fund composition
requirements that are more stringent than those imposed by the 1940 Act. The
Sub-Advisor does not believe that these covenants or guidelines will impede it
from managing the Fund's portfolio in accordance with the Fund's investment
objective and policies.
The loan documents under the Nova Scotia Facility include various covenants and
provisions. There is no assurance that the Fund will not violate financial
covenants relating to financial leverage in the future. In such event, the Fund
59
may be required to repay all outstanding borrowings immediately. In order to
repay such amounts the Fund may be required to sell assets quickly which could
have a material adverse effect on the Fund and could trigger negative tax
implications. In addition, the Fund would be precluded from declaring or paying
any distribution on the common shares during the continuance of such event of
default.
The issuance of Common Shares offered by this prospectus and any related
prospectus supplement will enable the Fund to increase the aggregate amount of
its leverage. However, it is possible that the Fund will be unable to obtain
additional leverage. If the Fund is unable to increase its financial leverage
after the issuance of additional Common Shares pursuant to this prospectus and
the applicable prospectus supplement, there could be an adverse impact on the
return to common shareholders. See "--Leverage Program Tax Risk."
There is no assurance that a leveraging strategy will be successful. The Fund
may continue to use leverage if the benefits to the Fund's shareholders of
maintaining the leveraged position are believed by the Fund's Board of Trustees
to outweigh any current reduced return. See also "Other Investment Policies and
Techniques--Strategic Transactions" in the SAI for more information about
Strategic Transactions in which the Fund may enter that give rise to a form of
financial leverage and the associated risks.
The Fund also may be subject to certain restrictions on investments imposed by
guidelines of one or more rating agencies, which may issue ratings for the
Preferred Shares or other leverage securities issued by the Fund. These
guidelines may impose asset coverage or Fund composition requirements that are
more stringent than those imposed by the 1940 Act. The Sub-Advisor does not
believe that these covenants or guidelines will impede it from managing the
Fund's portfolio in accordance with the Fund's investment objective and
policies. While the Fund may from time to time consider reducing leverage in
response to actual or anticipated changes in interest rates in an effort to
mitigate the increased volatility of current income and NAV associated with
leverage, there can be no assurance that the Fund will actually reduce leverage
in the future or that any reduction, if undertaken, will benefit the common
shareholders. If the Fund were to reduce leverage based on a prediction about
future changes to interest rates, and that prediction turned out to be
incorrect, the reduction in leverage would likely operate to reduce the income
and/or total returns to common shareholders relative to the circumstance if the
Fund had not reduced leverage. The Fund may decide that this risk outweighs the
likelihood of achieving the desired reduction to volatility in income and common
share price if the prediction were to turn out to be correct, and determine not
to reduce leverage as described above.
DERIVATIVES RISK
The Fund may, but is not required to, enter into Strategic Transactions for
hedging, risk management or investment purposes. These transactions, if any,
generally provide for the transfer from one counterparty to another of certain
risks inherent in the ownership of a financial asset such as a common stock or
debt instrument. Such risks include, among other things, the risk of default and
insolvency of the obligor of such asset, the risk that the credit of the obligor
or the underlying collateral will decline or the risk that the common stock of
the underlying issuer will decline in value. The transfer of risk pursuant to a
derivative of this type may be complete or partial, and may be for the life of
the related asset or for a shorter period. These derivatives may be used for
investment purposes or as a risk management tool for a pool of financial assets,
providing the Fund with the opportunity to gain or reduce exposure to one or
more reference securities or other financial assets without actually owning or
selling such assets in order, for example, to increase or reduce a concentration
risk or to diversify a portfolio. Conversely, these derivatives may be used by
the Fund to reduce exposure to an owned asset without selling it. Furthermore,
the ability to successfully use Strategic Transactions depends on the
Sub-Advisor's ability to predict pertinent market movements, which cannot be
assured. Thus, the use of Strategic Transactions for hedging and interest rate
management purposes may result in losses greater than if they had not been used,
may require the Fund to sell or purchase portfolio securities at inopportune
times or for prices other than current market values, may limit the amount of
appreciation the Fund can realize on an investment, or may cause the Fund to
hold a security that it might otherwise sell. Additionally, amounts paid by the
Fund as premiums and cash or other assets held in margin accounts with respect
to Strategic Transactions are not otherwise available to the Fund for investment
purposes.
There are several risks associated with transactions in options on securities.
For example, there are significant differences between the securities and
options markets that could result in an imperfect correlation between these
markets, causing a given transaction not to achieve its objectives. A decision
as to whether, when and how to use options involves the exercise of skill and
judgment, and even a well-conceived transaction may be unsuccessful to some
degree because of market behavior or unexpected events. See "--Covered Call
Options Risk."
There are several risks associated with the use of futures contracts and futures
options. The purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract. While the Fund may enter
into futures contracts and options on futures contracts for hedging purposes,
the use of futures contracts and options on futures contracts might result in a
poorer overall performance for the Fund than if it had not engaged in any such
transactions. There may be an imperfect correlation between the Fund's portfolio
holdings and futures contracts or options on futures contracts entered into by
the Fund, which may prevent the Fund from achieving the intended hedge or expose
the Fund to risk of loss. The degree of imperfection of correlation depends on
60
circumstances such as variations in market demand for futures, options on
futures and their related securities, including technical influences in futures
and futures options trading, and differences between the securities markets and
the securities underlying the standard contracts available for trading. Further,
the Fund's use of futures contracts and options on futures contracts to reduce
risk involves costs and will be subject to the Sub-Advisor's ability to predict
correctly changes in interest rate relationships or other factors.
Depending on whether the Fund would be entitled to receive net payments from the
counterparty on a swap or cap, which in turn would depend on the general state
of short-term interest rates at that point in time, a default by a counterparty
could negatively impact the performance of the common shares. In addition, at
the time an interest rate swap or cap transaction reaches its scheduled
termination date, there is a risk that the Fund would not be able to obtain a
replacement transaction or that the terms of the replacement would not be as
favorable as on the expiring transaction. If this occurs, it could have a
negative impact on the performance of the common shares. If the Fund fails to
maintain any required asset coverage ratios in connection with any use by the
Fund of leverage, the Fund may be required to redeem or prepay some or all of
the leverage. Such redemption or prepayment would likely result in the Fund
seeking to terminate early all or a portion of any swap or cap transactions.
Early termination of a swap could result in a termination payment by or to the
Fund. Early termination of a cap could result in a termination payment to the
Fund. The Fund earmarks or maintains, in a segregated account, cash or liquid
securities having a value at least equal to the Fund's net payment obligations
under any swap transaction, marked to market daily. The Fund will not enter into
interest rate swap or cap transactions having a notional amount that exceeds the
outstanding amount of the Fund's leverage. See "--Interest Rate Swaps Risk."
The Fund may enter into currency exchange transactions to hedge the Fund's
exposure to foreign currency exchange rate risk to the extent the Fund invests
in non-U.S. dollar denominated securities of non-U.S. issuers. The Fund's
currency transactions, if any, will be limited to portfolio hedging involving
portfolio positions. Portfolio hedging is the use of a forward contract with
respect to a portfolio security position denominated or quoted in a particular
currency. A currency forward contract is an agreement to purchase or sell a
specified currency at a specified future date (or within a specified time
period) and at a price set (or determined pursuant to parameters provided) at
the time of the contract. Forward contracts are usually entered into with banks,
foreign exchange dealers or broker-dealers, are not exchange-traded, and are
usually for less than one year, but may be renewed.
At the maturity of a forward contract to deliver a particular currency, the Fund
may either sell the portfolio security related to such contract and make
delivery of the currency, or it may retain the security and either acquire the
currency on the spot market or terminate its contractual obligation to deliver
the currency by purchasing an offsetting contract with the same currency trader
obligating the Fund to purchase on the same maturity date the same amount of the
currency.
It is impossible to forecast with absolute precision the market value of
portfolio securities at the expiration of a forward contract. Accordingly, it
may be necessary for the Fund to purchase additional currency on the spot market
(and bear the expense of such purchase) if a decision is made to sell the
security and make delivery of the currency and the market value of the security
is less than the amount of currency that the Fund is obligated to deliver.
Conversely, it may be necessary to sell on the spot market some of the currency
received upon the sale of the portfolio security if its market value exceeds the
amount of currency the Fund is obligated to deliver under the forward contract.
If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward contract to buy the
currency. Should forward prices decline during the period between the Fund's
entering into a forward contract for the sale of a currency and the date it
enters into an offsetting contract for the purchase of the currency, the Fund
will realize a gain to the extent the price of the currency it has agreed to
sell exceeds the price of the currency it has agreed to purchase. Should forward
prices increase, the Fund will suffer a loss to the extent the price of the
currency it has agreed to purchase exceeds the price of the currency it has
agreed to sell. A default on the contract would deprive the Fund of unrealized
profits or force the Fund to cover its commitments for purchase or sale of
currency, if any, at the current market price.
Hedging against a decline in the value of a currency does not eliminate
fluctuations in the prices of portfolio securities or prevent losses if the
prices of such securities decline. Such transactions may also preclude the
opportunity for gain if the value of the hedged currency should rise. Moreover,
it may not be possible for the Fund to hedge against a devaluation that is so
generally anticipated that the Fund is not able to contract to sell the currency
at a price above the devaluation level it anticipates. The cost to the Fund of
engaging in currency exchange transactions varies with such factors as the
currency involved, the length of the contract period, and prevailing market
conditions. Since currency exchange transactions are usually conducted on a
principal basis, no fees or commissions are involved.
In the event that the Fund's investments in derivative instruments regulated
under the Commodity Exchange Act, including futures, swaps and certain options,
exceeds a certain threshold, the Advisor and/or the Sub-Advisor may be required
to register as a "commodity pool operator" and/or "commodity trading advisor"
with the Commodity Futures Trading Commission ("CFTC"). In the event the Advisor
or the Sub-Advisor is required to register with the CFTC, it will become subject
61
to additional recordkeeping and reporting requirements with respect to the Fund.
The Fund currently intends to limit its investments in derivative instruments so
as not to require the Advisor or the Sub-Advisor to register as a commodity pool
operator or commodity trading advisor with respect to the Fund.
On December 11, 2015, the SEC published a proposed rule that, if adopted, would
change the regulation of the use of derivative instruments by registered
investment companies. Such regulations could limit the implementation of the
Fund's use of derivatives and Strategic Transactions and impose additional
compliance costs on the Fund, which could have an adverse impact on the Fund.
See "Additional Information About the Fund's Investments and Investment
Risks--Strategic Transactions Risks" in the SAI.
COVERED CALL OPTIONS RISK
There are various risks associated with the Fund writing (or selling) covered
call options. As the writer (seller) of a call option, the Fund receives cash
(the premium) from the purchaser of the option, and the purchaser has the right
to receive from the Fund any appreciation in the underlying security over the
strike price upon exercise. In effect, the Fund forgoes, during the life of the
option, the opportunity to profit from increases in the market value of the
portfolio security covering the option above the sum of the premium and the
strike price of the call option but retains the risk of loss should the price of
the underlying security decline. Therefore, the writing (or selling) of covered
call options may limit the Fund's ability to benefit from the full upside
potential of its investment strategies.
The value of call options written by the Fund, which are priced daily, are
determined by trading activity in the broad options market and will be affected
by, among other factors, changes in the value of the underlying security in
relation to the strike price, changes in dividend rates of the underlying
security, changes in interest rates, changes in actual or perceived volatility
of the stock market and the underlying security, and the time remaining until
the expiration date. The value of call options written by the Fund may be
adversely affected if the market for the option is reduced or becomes illiquid.
There can be no assurance that a liquid market will exist when the Fund seeks to
close out an option position. Reasons for the absence of a liquid secondary
market on an exchange include the following: (i) insufficient trading interest
in certain options; (ii) restrictions may be imposed by an exchange on opening
transactions or closing transactions or both; (iii) trading halts, suspensions
or other restrictions may be imposed with respect to particular classes or
series of options; (iv) unusual or unforeseen circumstances may interrupt normal
operations on an exchange; (v) inadequate facilities of an exchange or the
Options Clearing Corporation to handle current trading volume; or (vi) the
decision of one or more exchanges at some future date to discontinue the trading
of options (or a particular class or series of options) for economic or other
reasons. If trading were discontinued, the secondary market on that exchange (or
in that class or series of options) would cease to exist. However, outstanding
options on that exchange would continue to be exercisable in accordance with
their terms. To the extent that the Fund utilizes unlisted (or
"over-the-counter") options, the Fund's ability to terminate these options may
be more limited than with exchange-traded options and may involve enhanced risk
that counterparties participating in such transactions will not fulfill their
obligations.
The hours of trading for options may not conform to the hours during which the
securities held by the Fund are traded. To the extent that the options markets
close before the markets for the underlying securities, significant price and
rate movements can take place in the underlying markets that cannot be reflected
in the options markets. Additionally, the exercise price of an option may be
adjusted downward before the option's expiration as a result of the occurrence
of certain corporate events affecting the underlying security, such as
extraordinary dividends, stock splits, mergers or other extraordinary
distributions or events. A reduction in the exercise price of options might
reduce the Fund's capital appreciation potential on underlying securities held
by the Fund.
The Fund's covered call options transactions are subject to limitations
established by each of the exchanges, boards of trade or other trading
facilities on which the options are traded. These limitations govern the maximum
number of options in each class that may be written by a single investor or
group of investors acting in concert, regardless of whether the options are
written on the same or different exchanges, boards of trade or other trading
facilities or are written in one or more accounts or through one or more
brokers. Thus, the number of covered call options that the Fund may write may be
affected by options written by other investment advisory clients of the Advisor,
Sub-Advisor or their affiliates. An exchange, board of trade or other trading
facility may order the liquidation of positions found to be in excess of these
limits, and it may impose other sanctions.
INTEREST RATE SWAPS RISK
The use of interest rate swaps is a highly specialized activity that involves
investment techniques and risks different from those associated with ordinary
portfolio security transactions. Depending on market conditions in general, the
Fund's use of swaps could enhance or harm the overall performance of the common
shares. For example, the Fund may utilize interest rate swaps in connection with
the Fund's use of leverage. To the extent there is a decline in interest rates,
the value of the interest rate swap could decline, and could result in a decline
in the NAV of the common shares. In addition, if short-term interest rates are
62
lower than the Fund's fixed rate of payment on the interest rate swap, the swap
will reduce common share net earnings. If, on the other hand, short-term
interest rates are higher than the fixed rate of payment on the interest rate
swap, the swap will enhance common share net earnings.
Interest rate swaps do not involve the delivery of securities or other
underlying assets or principal. Accordingly, the risk of loss with respect to
interest rate swaps is limited to the net amount of interest payments that the
Fund is contractually obligated to make. If the counterparty defaults, the Fund
would not be able to use the anticipated net receipts under the swap to offset
any declines in the value of the Fund's portfolio assets being hedged or the
increase in the Fund's cost of leverage.
Depending on whether the Fund would be entitled to receive net payments from the
counterparty on the swap, which in turn would depend on the general state of
market interest rates at that point in time, such a default could negatively
impact the performance of the common shares. In addition, at the time an
interest rate swap transaction reaches its scheduled termination date, there is
a risk that the Fund would not be able to obtain a replacement transaction or
that the terms of the replacement would not be as favorable as on the expiring
transaction. If this occurs, it could have a negative impact on the performance
of the common shares. If the Fund fails to maintain any required asset coverage
ratios in connection with any use by the Fund of leverage, the Fund may be
required to redeem or prepay some or all of the leverage. Such redemption or
prepayment would likely result in the Fund seeking to terminate early all or a
portion of any swap transactions. Early termination of a swap could result in a
termination payment by or to the Fund. The Fund earmarks or maintains, in a
segregated account, cash or liquid securities having a value at least equal to
the amount required to make payment on each of the Fund's swap transactions if
the Fund were to exit its positions in such transactions immediately and was
required to mark to market.
PORTFOLIO TURNOVER RISK
The Fund's annual portfolio turnover rate may vary greatly from year to year.
Although the Fund cannot accurately predict its annual portfolio turnover rate,
it is not expected to exceed 20% under normal circumstances, but may be higher
or lower in certain periods. Portfolio turnover rate is not considered a
limiting factor in the execution of investment decisions for the Fund. High
portfolio turnover may result in the Fund's recognition of gains that will be
taxable as ordinary income, reducing the funds available to pay distributions to
the Fund's common shareholders. A high portfolio turnover may also increase the
Fund's current and accumulated earnings and profits, resulting in a greater
portion of the Fund's distributions being treated as a dividend to the Fund's
common shareholders. In addition, a higher portfolio turnover rate results in
correspondingly greater brokerage commissions and other transactional expenses
that are borne by the Fund. See "The Fund's Investments--Investment Practices--
Portfolio Turnover" and "Tax Matters."
COMPETITION RISK
A number of alternatives as vehicles for investment in a portfolio of energy
MLPs and their affiliates currently exist, including other publicly-traded
investment companies, structured notes and private funds. These competitive
conditions may adversely impact the Fund's ability to meet its investment
objective, which in turn could adversely impact the Fund's ability to make
distributions.
RESTRICTED SECURITIES RISK
The Fund may invest in unregistered or otherwise restricted securities. The term
"restricted securities" refers to securities that have not been registered under
the 1933 Act and continue to be subject to restrictions on resale, securities
held by control persons of the issuer and securities that are subject to
contractual restrictions on their resale. As a result, restricted securities may
be more difficult to value and the Fund may have difficulty disposing of such
assets either in a timely manner or for a reasonable price.
Absent an exemption from registration, the Fund will be required to hold the
securities until they are registered by the issuer. In order to dispose of an
unregistered security, the Fund, where it has contractual rights to do so, may
have to cause such security to be registered. A considerable period may elapse
between the time the decision is made to sell the security and the time the
security is registered so that the Fund could sell it. Contractual restrictions
on the resale of securities vary in length and scope and are generally the
result of a negotiation between the issuer and acquirer of the securities. The
Fund would, in either case, bear market risks during that period.
LIQUIDITY RISK
Although common units of MLPs, I-Shares of MLP-related entities, and common
stock of certain other energy sector and energy utility companies trade on the
NYSE, NYSE MKT, and Nasdaq, certain securities may trade less frequently,
particularly those of issuers with smaller capitalizations. Securities with
limited trading volumes may display volatile or erratic price movements. Larger
purchases or sales of these securities by the Fund in a short period of time may
result in abnormal movements in the market price of these securities. This may
affect the timing or size of Fund transactions and may limit the Fund's ability
to make alternative investments. If the Fund requires significant amounts of
cash on short notice in excess of normal cash requirements or is required to
post or return collateral in connection with the Fund's investment portfolio,
Strategic Transactions or leverage restrictions, the Fund may have difficulty
selling these investments in a timely manner, be forced to sell them for less
63
than it otherwise would have been able to realize, or both. The reported value
of some of the Fund's relatively illiquid types of investments and, at times,
the Fund's high quality, generally liquid asset classes, may not necessarily
reflect the current market price for the asset. If the Fund was forced to sell
certain of its assets in the current market, there can be no assurance that the
Fund will be able to sell them for the prices at which the Fund has recorded
them and the Fund may be forced to sell them at significantly lower prices. See
"The Fund's Investments--Investment Philosophy and Process."
VALUATION RISK
Market prices generally will not be available for subordinated units, direct
ownership of general partner interests, restricted securities or unregistered
securities of certain MLPs or MLP-related entities, and the value of such
investments will ordinarily be determined based on fair valuations determined
pursuant to procedures adopted by the Board of Trustees. The value of these
securities typically requires more reliance on the judgment of the Sub-Advisor
than that required for securities for which there is an active trading market.
In addition, the Fund relies on information provided by certain MLPs, which is
usually not timely, to calculate taxable income allocable to the MLP units held
in the Fund's portfolio and to determine the tax character of distributions to
common shareholders. From time to time the Fund will modify its estimates and/or
assumptions as new information becomes available. To the extent the Fund
modifies its estimates and/or assumptions, the NAV of the Fund would likely
fluctuate. See "Net Asset Value."
INTEREST RATE RISK
Interest rate risk is the risk that securities will decline in value because of
changes in market interest rates. When market interest rates rise, the market
value of the securities in which the Fund invests generally will fall. The
Fund's investment in such securities means that the NAV and market price of the
common shares will tend to decline if market interest rates rise. Interest rates
are at or near historic lows. The historically low interest rate environment
increases the risks associated with rising interest rates, including the
potential for periods of volatility. The Fund currently faces a heightened level
of interest rate risk, especially since the Federal Reserve Board has ended its
quantitative easing program.
COLLECTIVE INVESTMENT VEHICLES RISK
The Fund may, subject to the limitations of the 1940 Act, invest in the
securities of other collective investment vehicles, including open-end funds,
closed-end funds and exchange-traded funds ("ETFs"). Such investments are
subject to the risks of the purchased funds' portfolio securities. The Fund's
investments in other funds also are subject to the ability of the managers of
those funds to achieve the funds' investment objectives. An ETF that is based on
a specific index may not be able to replicate and maintain exactly the
composition and relative weighting of securities in the index. An ETF also
incurs certain expenses not incurred by its applicable index. The market value
of shares of ETFs may differ from their net asset value.
In addition, the Fund, as a holder of the securities of other investment
companies, will bear its pro rata portion of the other investment companies'
expenses, including advisory fees. These expenses are in addition to the direct
expenses of the Fund's own operations. Common Shareholders would therefore be
subject to duplicative expenses to the extent the Fund invests in other funds.
The investment companies in which the Fund may invest may be leveraged, which
would magnify the Fund's leverage risk described above. See "--Leverage Risk."
Risks associated with investments in closed-end funds generally include the
risks described in this prospectus associated with the Fund's structure as a
closed-end fund, including market risk, risk of market price discount from net
asset value, risk of anti-takeover provisions and non-diversification. In
addition, investments in closed-end funds may be subject to dilution risk, which
is the risk that strategies employed by a closed-end fund, such as rights
offerings, may, under certain circumstances, have the effect of reducing its
share price and the Fund's proportionate interest.
CONVERTIBLE SECURITIES RISK
Convertible securities have characteristics of both equity and debt securities
and, as a result, are exposed to certain risks associated with equity securities
and debt securities, including but not limited to interest rate risk and below
investment grade securities risk. See "--Debt Securities Risk," "--Interest Rate
Risk" and "--Below Investment Grade Securities Risk." The value of a convertible
security is influenced by both the yield of non-convertible securities of
comparable issuers and by the value of the underlying common stock. Convertible
securities generally offer lower interest or dividend yields than
non-convertible securities of similar credit quality. The market values of
convertible securities tend to decline as interest rates increase and,
conversely, to increase as interest rates decline. However, the convertible
security's market value tends to reflect the market price of the common stock of
the issuing company when that stock price is greater than the convertible
security's "conversion price." The conversion price is defined as the
predetermined price at which the convertible security could be exchanged for the
associated common stock. As the market price of the underlying common stock
declines, the price of the convertible security tends to be influenced more by
the yield of the convertible security. Thus, the convertible security may not
64
decline in price to the same extent as the underlying common stock. Convertible
securities fall below debt obligations of the same issuer in order of preference
or priority in the event of a liquidation and are typically unrated or rated
lower than such debt obligations.
NON-DIVERSIFICATION
The Fund is a non-diversified investment company under the 1940 Act and will not
be treated as a regulated investment company under the Code. Accordingly, while
Section 12(d)(3) of the 1940 Act prohibits the Fund from making certain
investments, there are no diversification-specific regulatory requirements under
the 1940 Act or the Code on the minimum number or size of securities held by the
Fund. As of November 30, 2017, there were approximately 103 publicly traded MLPs
with a market capitalization of approximately $362 billion. The Fund selects its
MLP investments from this small pool of issuers.
ANTI-TAKEOVER PROVISIONS
The Fund's Declaration of Trust includes provisions that could limit the ability
of other entities or persons to acquire control of the Fund or convert the Fund
to open-end status. These provisions could have the effect of depriving the
common shareholders of opportunities to sell their common shares at a premium
over the then current market price of the common shares. See "Certain Provisions
in the Declaration of Trust and By-Laws."
INFLATION RISK
Inflation risk is the risk that the value of assets or income from investment
will be worth less in the future as inflation decreases the value of money. As
inflation increases, the real value of the common shares and distributions can
decline.
SECONDARY MARKET FOR THE FUND'S COMMON SHARES ISSUED UNDER THE DIVIDEND
REINVESTMENT PLAN
The issuance of common shares through the Fund's dividend reinvestment plan may
have an adverse effect on the secondary market for the common shares. The
increase in the number of outstanding common shares resulting from issuances
pursuant to the Fund's dividend reinvestment plan and the discount to the market
price at which such common shares may be issued, may put downward pressure on
the market price for the common shares. Common shares will not be issued
pursuant to the dividend reinvestment plan at any time when common shares are
trading at a lower price than the Fund's NAV per common share. When the Fund's
common shares are trading at a premium, the Fund may also issue common shares
that may be sold through private transactions effected on the NYSE or through
broker-dealers. The increase in the number of outstanding common shares
resulting from these offerings may put downward pressure on the market price for
common shares.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
General oversight of the duties performed by the Advisor and Sub-Advisor is the
responsibility of the Board of Trustees. There are five Trustees of the Fund,
one of whom is an "interested person" (as defined in the 1940 Act) and four of
whom are not "interested persons." The names and business addresses of the
Trustees and officers of the Fund and their principal occupations and other
affiliations during the past five years are set forth under "Management of the
Fund" in the SAI.
INVESTMENT ADVISOR
First Trust Advisors L.P. ("First Trust Advisors" or the "Advisor") is the
investment adviser to the Fund. First Trust Advisors L.P. serves as investment
adviser or portfolio supervisor to investment portfolios with approximately
$117.3 billion in assets which it managed or supervised as of November 30, 2017.
It is located at 120 East Liberty Drive, Wheaton, Illinois 60187.
First Trust Advisors L.P. is responsible for supervising the Sub-Advisor,
monitoring the Fund's investment portfolio, managing the Fund's business affairs
and providing certain clerical, bookkeeping and other administrative services.
First Trust Advisors L.P. is an Illinois limited partnership formed in 1991 and
an investment adviser registered with the SEC under the Advisers Act. First
Trust Advisors L.P. is a limited partnership with one limited partner, Grace
Partners of DuPage L.P. ("Grace Partners"), and one general partner, The Charger
Corporation. Grace Partners is a limited partnership with one general partner,
The Charger Corporation, and a number of limited partners. Grace Partners' and
The Charger Corporation's primary business is investment advisory and
broker-dealer services through their ownership interests. The Charger
Corporation is an Illinois corporation controlled by James A. Bowen, Chief
Executive Officer of the Advisor. First Trust Advisors L.P. is controlled by
Grace Partners and The Charger Corporation.
For additional information concerning First Trust Advisors, including a
description of the services provided, see the SAI under "Investment Advisor."
65
SUB-ADVISOR
Energy Income Partners, LLC ("Energy Income Partners" or the "Sub-Advisor")
serves as the Fund's Sub-Advisor. In this capacity, Energy Income Partners is
primarily responsible for the day-to-day supervision and investment strategy of,
and making investment decisions for, the Fund.
Energy Income Partners, located at 10 Wright Street, Westport, Connecticut
06880, is a registered investment adviser and serves as investment adviser to
investment portfolios with approximately $6.0 billion of assets as of November
30, 2017.
Energy Income Partners is a Delaware limited liability company and an
SEC-registered investment adviser, founded in October 2003 by James J. Murchie
to provide professional asset management services in the area of energy-related
MLPs and other high-payout securities in the energy infrastructure sector. In
addition to serving as sub-adviser to the Fund, Energy Income Partners serves as
the investment manager to separately managed accounts, unregistered investment
companies, a registered investment company and provides a model portfolio to
unified managed accounts. Energy Income Partners also serves as the sub-adviser
to three other registered investment companies advised by First Trust Advisors,
an actively managed exchange traded fund, a sleeve of an actively managed
exchange-traded fund, a sleeve of a variable insurance trust and an Irish
Domiciled UCITs fund. Energy Income Partners mainly focuses on portfolio
companies that operate infrastructure assets such as pipelines, storage and
terminals that receive fee-based or regulated income from their customers.
First Trust Capital Partners, LLC, an affiliate of the Advisor, owns, through a
wholly-owned subsidiary, a 15% ownership interest in each of the Sub-Advisor
and Energy Income Partners, LLC, a Delaware limited liability company and
affiliate of the Sub-Advisor.
James J. Murchie is the Founder, Chief Executive Officer, Principal of Energy
Income Partners and a co-portfolio manager. After founding Energy Income
Partners in October 2003, Mr. Murchie and the Energy Income Partners investment
team joined Pequot Capital Management Inc. ("Pequot Capital") in December 2004.
In August 2006, Mr. Murchie and the Energy Income Partners investment team left
Pequot Capital and re-established Energy Income Partners. Prior to founding
Energy Income Partners, Mr. Murchie was a Portfolio Manager at Lawhill Capital
Partners, LLC ("Lawhill Capital"), a long/short equity hedge fund investing in
commodities and equities in the energy and basic industry sectors. Before
Lawhill Capital, Mr. Murchie was a Managing Director at Tiger Management, LLC,
where his primary responsibility was managing a portfolio of investments in
commodities and related equities. Mr. Murchie was also a Principal at Sanford C.
Bernstein. He began his career at British Petroleum, PLC. Mr. Murchie holds a BA
from Rice University and an MA from Harvard University.
Eva Pao is a Principal of Energy Income Partners and a co-portfolio manager. She
has been with Energy Income Partners since inception in 2003. From 2005 to
mid-2006, Ms. Pao joined Pequot Capital Management during Energy Income
Partner's affiliation with Pequot. Prior to Harvard Business School, Ms. Pao was
a Manager at Enron Corp where she managed a portfolio in Canadian oil and gas
equities for Enron's internal hedge fund that specialized in energy-related
equities and managed a natural gas trading book. Ms. Pao holds degrees from Rice
University and Harvard Business School.
John K. Tysseland is a Principal of Energy Income Partners and a co-portfolio
manager. Mr. Tysseland has been a portfolio manager of the Fund since 2016.
Prior to joining Energy Income Partners in 2014, he worked at Citi Research,
most recently serving as a Managing Director where he covered midstream energy
companies and MLPs. From 1998 to 2005, he worked at Raymond James & Associates
as a Vice President who covered the oilfield service industry and established
the firm's initial coverage of MLPs in 2001. Prior to that, he was an Equity
Trader at Momentum Securities from 1997 to 1998 and an Assistant Executive
Director at Sumar Enterprises from 1996 to 1997. He graduated from The
University of Texas at Austin with a BA in economics.
Linda Longville is the Research Director and a Principal of Energy Income
Partners. Ms. Longville has been with Energy Income Partners since its inception
in 2003, including the time the Energy Income Partners investment team spent at
Pequot Capital between December 2004 and July 2006. From April 2001 through
September 2003, she was a research analyst for Lawhill Capital. Prior to Lawhill
Capital, Ms. Longville held positions in finance and business development at
British Petroleum, PLC and Advanced Satellite Communications, Inc. She has a BAS
from Miami University (Ohio) and an MA from Case Western Reserve University.
Saul Ballesteros is the Head of Trading and Operations and a Principal of Energy
Income Partners. Mr. Ballesteros joined Energy Income Partners in 2006 after six
years as a proprietary trader at FPL Group and Mirant Corp. From 1994 through
1999, he was with Enron's internal hedge fund in various positions of increased
responsibility, and, from 1991 through 1994, Mr. Ballesteros was a manager of
financial planning at IBM. Mr. Ballesteros holds a BS from Duke University and
an MBA from Northwestern University.
For additional information concerning Energy Income Partners, including a
description of the services provided and additional information about the Fund's
portfolio managers, including the portfolio managers' compensation, other
accounts managed by the portfolio managers and the portfolio managers' ownership
of Fund shares, see "Sub-Advisor" in the SAI.
66
INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an investment management agreement between First Trust Advisors and
the Fund (the "Investment Management Agreement"), the Fund has agreed to pay for
the services and facilities provided by First Trust Advisors an annual
management fee, payable on a monthly basis, equal to 1.00% of the Fund's Managed
Assets.
In addition to the management fee of First Trust Advisors, the Fund pays all
other costs and expenses of its operations, including compensation of its
trustees (other than those affiliated with First Trust Advisors), custodian,
transfer agency, administrative, accounting and dividend disbursing expenses,
legal fees, leverage expenses, expenses of independent auditors, expenses of
repurchasing shares, expenses of preparing, printing and distributing
shareholder reports, notices, proxy statements and reports to governmental
agencies, and taxes, if any.
The Sub-Advisor receives a portfolio management fee equal to 0.50% of the Fund's
Managed Assets. The Sub-Advisor's fee is paid by the Advisor out of the
Advisor's management fee.
Because the fee paid to the Advisor (and by the Advisor to the Sub-Advisor) is
calculated on the basis of the Fund's Managed Assets, which include the proceeds
of leverage, the dollar amount of the Advisor's fees from the Fund (and
Sub-Advisor's fees from the Advisor) will be higher (and the Advisor and
Sub-Advisor will be benefited to that extent) when leverage is utilized. The
Advisor and the Sub-Advisor will make decisions on whether and how much leverage
the Fund will employ based on whether it is in the best interests of the Fund.
The Advisor and the Sub-Advisor will seek approval for and periodically review
the use of leverage with the Board of Trustees. In this regard, if the Fund uses
leverage in the amount equal to 25.94% of the Fund's Managed Assets (after their
issuance), the Fund's management fee would be 1.35% of net assets attributable
to common shares. See "Summary of Fund Expenses."
A discussion regarding the basis for approval by the Board of Trustees of the
Investment Management Agreement and the Sub-Advisory Agreement is available in
the Fund's Annual Report to Shareholders for the year ended October 31, 2017.
NET ASSET VALUE
The Fund determines the NAV of its common shares daily as of the close of
regular session trading on the NYSE (normally 4:00 p.m. Eastern Time). NAV is
computed by dividing the value of all assets of the Fund (including option
premiums, accrued interest and dividends), less all Fund liabilities (including
accrued expenses, dividends payable, current and deferred income taxes, any
borrowings of the Fund and the market value of written call options) and the
liquidation value of any outstanding Preferred Shares, by the total number of
shares outstanding. The Fund relies to some extent on information provided by
the MLPs, which is usually not timely, to estimate taxable income allocable to
the MLP units held in the Fund's portfolio. From time to time the Fund will
modify its estimates and/or assumptions as new information becomes available. To
the extent the Fund modifies its estimates and/or assumptions, the NAV of the
Fund would likely fluctuate.
For purposes of determining the NAV of the Fund, readily marketable portfolio
securities listed on any exchange other than Nasdaq are valued, except as
indicated below, at the last sale price on the business day as of which such
value is being determined. If there has been no sale on such day, the securities
are valued at the mean of the most recent bid and asked prices on such day.
Securities admitted to trade on Nasdaq are valued at the Nasdaq Official Closing
Price as determined by Nasdaq. Portfolio securities traded on more than one
securities exchange are valued at the last sale price on the business day as of
which such value is being determined at the close of the exchange representing
the principal market for such securities.
Equity securities traded in the over-the-counter market, but excluding
securities admitted to trading on Nasdaq, will be valued at the closing bid
prices. Fixed-income securities with a remaining maturity of 60 days or more are
valued by the Fund using a pricing service. When price quotes are not available,
fair market value is based on prices of comparable securities. Fixed-income
securities maturing within 60 days are valued by the Fund on an amortized cost
basis. In the event that market quotations are not readily available, a pricing
service does not provide a valuation for a particular asset, or the valuations
are deemed unreliable, or if events occurring after the close of the principal
markets for particular securities (e.g., domestic debt and foreign securities),
but before the Fund values its assets, would call into doubt whether the market
quotations or pricing service valuations represent fair value, the Fund may use
a fair value method in good faith to value the Fund's securities and
investments. The use of fair value pricing by the Fund is governed by valuation
procedures approved by the Fund's Board of Trustees, and in accordance with the
provisions of the 1940 Act.
When applicable, fair value of securities of an issuer is determined by the
Board or a committee of the Board or a designee of the Board. In fair valuing
the Fund's investments, consideration is given to several factors, which may
include, among others, the following:
o the fundamental business data relating to the issuer;
o an evaluation of the forces which influence the market in which the
securities of the issuer are purchased and sold;
o the type, size and cost of the security;
67
o the financial statements of the issuer;
o the credit quality and cash flow of the issuer, based on the
Sub-Advisor's or external analysis;
o the information as to any transactions in or offers for the security;
o the price and extent of public trading in similar securities (or equity
securities) of the issuer, or comparable companies;
o the coupon payments;
o the quality, value and saleability of collateral, if any, securing the
security;
o the business prospects of the issuer, including any ability to obtain
money or resources from a parent or affiliate and an assessment of the
issuer's management;
o the prospects for the issuer's industry, and multiples (of earnings
and/or cash flow) being paid for similar businesses in that industry;
o the issuer's competitive position within the industry;
o the issuer's ability to access additional liquidity through public and
private markets; and
o other relevant factors.
Any derivative transaction that the Fund enters into may, depending on the
applicable market environment, have a positive or negative value for purposes of
calculating NAV. Any option transaction that the Fund enters into may, depending
on the applicable market environment, have no value or a positive value.
Exchange-traded options and futures contracts are valued at the closing price in
the market where such contracts are principally traded.
DISTRIBUTIONS
Under normal market conditions, the Fund currently makes, and intends to
continue to make, monthly distributions of its distributable cash flow ("DCF")
to common shareholders and to make payment of substantially all DCF to holders
of common shares on an annual basis. Distributions to common shareholders will
be recorded on the ex-date and are determined based on U.S. generally accepted
accounting principles, which may differ from their ultimate characterization for
federal income tax purposes. There is no assurance that the Fund will make
regular distributions.
Due to the tax treatment under current law of cash distributions made by MLPs in
which the Fund invests, a portion of the distributions the Fund anticipates
making to common shareholders may consist of a return of capital. To the extent
that distributions exceed the Fund's earnings and profits, such distributions
are generally not treated as taxable income for the investor. Instead, the
common shareholders will experience a reduction in the basis of their shares,
which may increase the capital gain or reduce capital loss realized upon the
sale of such shares. Section 19(a) of the 1940 Act and Rule 19a-1 thereunder
requires the Fund to provide a written statement accompanying payment of a
distribution from any source other than income that adequately discloses the
source or sources of payment. Thus, if the Fund's capital was the source of a
distribution and the payment amounted to a return of capital, the Fund would be
required to provide a written notice to that effect. A "return of capital"
represents a return on a shareholder's original investment in the Fund's common
Shares, and should not be confused with a dividend from profits and earnings.
Upon the sale of common shares, common shareholders generally will recognize
capital gain or loss measured by the difference between the sale proceeds
received by the common shareholder and the shareholder's federal income tax
basis in Common Shares sold, as adjusted to reflect return of capital.
Accordingly, common shareholders should carefully review any written disclosure
accompanying a distribution and should not assume that the source of payment is
the Fund's income. See "Tax Matters."
Distributions made from current and accumulated earnings and profits of the Fund
are taxable to shareholders as dividend income. Distributions that are in an
amount greater than the Fund's current and accumulated earnings and profits will
represent a return of capital to the extent of a shareholder's basis in the
common shares, and such distributions will correspondingly increase the realized
gain upon the sale of the common shares. Additionally, distributions not paid
from current and accumulated earnings and profits that exceed a shareholder's
tax basis in the common shares will be taxed as a capital gain. Unless a
shareholder elects to receive cash distributions, distributions will
automatically be reinvested into additional common shares pursuant to the Fund's
Dividend Reinvestment Plan. Shareholders will be taxed upon the reinvested
amounts as if they actually received the distribution in cash and then
reinvested it in common shares.
Distributions by the Fund, whether paid in cash or in additional common shares,
are taken into account in measuring the performance of the Fund with respect to
its investment objective.
68
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 to receive cash distributions,
all dividends and distributions on your common shares will be automatically
reinvested by the Plan Agent, BNY Mellon Investment Servicing (US) Inc., 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 BNY Mellon Investment Servicing (US) Inc., as dividend paying
agent.
You are automatically enrolled in the Plan when you become a shareholder of the
Fund. As a participant in the Plan, the number of common shares you will receive
will be determined as follows:
(1) If the common shares are trading at or above NAV at the time of
valuation, the Fund will issue new shares 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) 331-1710, in
accordance with such reasonable requirements as the Plan Agent and Fund may
agree upon. If you withdraw or the Plan is terminated, you will receive a 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 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. See
"Tax Matters."
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.
Consult your financial adviser for more information.
Neither the Fund nor the Plan Agent shall be liable with respect to the Plan for
any act done in good faith or for any good faith omission to act, including,
without limitation, any claim of liability: (i) arising out of failure to
terminate any participant's account upon such participant's death prior to
receipt of notice in writing of such death; and (ii) with respect to the prices
at which common shares are purchased and sold for the participant's account and
the times such purchases and sales are made.
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 from BNY
Mellon Investment Servicing (US) Inc., 301 Bellevue Parkway, Wilmington,
Delaware 19809.
PLAN OF DISTRIBUTION
The Fund may sell its Common Shares from time to time under this prospectus and
any related prospectus supplement in any one or more of the following ways: (1)
directly to one or more purchasers; (2) through agents; (3) to or through
underwriters; or (4) through dealers. See also "Dividend Reinvestment Plan"
above.
69
Each prospectus supplement relating to an offering of the Common Shares will
state the terms of the offering, including as applicable:
o the names of any agents, underwriters or dealers;
o any sales loads or other items constituting underwriters' compensation;
o any discounts, commissions, fees or concessions allowed or reallowed or
paid to dealers or agents;
o the public offering or purchase price of the offered securities and the
estimated net proceeds we will receive from the sale; and
o any securities exchange on which the offered Common Shares may be
listed.
Any public offering price and any discounts or concessions allowed or reallowed
or paid to dealers may be changed from time to time.
DIRECT SALES
The Fund may sell the Common Shares directly to, and solicit offers from,
purchasers, including institutional investors or others who may be deemed to be
underwriters as defined in the 1933 Act for any resales of the Common Shares. In
this case, no underwriters or agents would be involved. The Fund may use
electronic media, including the Internet, to sell Common Shares directly. The
terms of any of those sales will be described in a prospectus supplement.
BY AGENTS
The Fund may offer the Common Shares through agents that it designates. Any
agent involved in the offer and sale will be named and any commissions payable
by the Fund will be described in the prospectus supplement. Unless otherwise
indicated in the prospectus supplement, the agents will be acting on a best
efforts basis for the period of their appointment.
The Fund may engage in at-the-market offerings to or through a market maker or
into an existing trading market, on an exchange or otherwise, in accordance with
Rule 415(a)(4). An at-the-market offering may be through one or more
underwriters or dealers acting as principal or agent for the Fund.
BY UNDERWRITERS
The Fund may offer and sell the Common Shares from time to time to one or more
underwriters who would purchase the Common Shares as principal for resale to the
public, either on a firm commitment or best efforts basis. If the Fund sells
Common Shares to underwriters, the Fund will execute an underwriting agreement
with them at the time of the sale and will name them in the prospectus
supplement. In connection with these sales, the underwriters may be deemed to
have received compensation from the Fund in the form of underwriting discounts
and commissions. The underwriters also may receive commissions from purchasers
of the Common Shares for whom they may act as agent. Unless otherwise stated in
the prospectus supplement, the underwriters will not be obligated to purchase
the Common Shares unless the conditions set forth in the underwriting agreement
are satisfied, and if the underwriters purchase any of the Common Shares, they
will be required to purchase all of the offered Common Shares. In the event of
default by any underwriter, in certain circumstances, the purchase commitments
may be increased among the non-defaulting underwriters or the underwriting
agreement may be terminated. The underwriters may sell the offered Common Shares
to or through dealers, and those dealers may receive discounts, concessions or
commissions from the underwriters as well as from the purchasers for whom they
may act as agent.
If a prospectus supplement so indicates, the Fund may grant the underwriters an
option to purchase additional Common Shares at the public offering price, less
the underwriting discounts and commissions, within a specified number of days
from the date of the prospectus supplement, to cover any overallotments.
BY DEALERS
The Fund may offer and sell the Common Shares from time to time to one or more
dealers who would purchase the securities as principal. The dealers then may
resell the offered Common Shares to the public at fixed or varying prices to be
determined by those dealers at the time of resale. The names of the dealers and
the terms of the transaction will be set forth in the prospectus supplement.
GENERAL INFORMATION
Agents, underwriters, or dealers participating in an offering of the Common
Shares may be deemed to be underwriters, and any discounts and commission
received by them and any profit realized by them on resale of the offered Common
Shares for whom they may act as agent may be deemed to be underwriting discounts
and commissions under the 1933 Act.
The Fund may offer to sell the Common Shares either at a fixed price or at
prices that may vary, at market prices prevailing at the time of sale, at prices
related to prevailing market prices, or at negotiated prices.
70
To facilitate an offering of the Common Shares in an underwritten transaction
and in accordance with industry practice, the underwriters may engage in
transactions that stabilize, maintain, or otherwise affect the market price of
the Common Shares. Those transactions may include overallotment, entering
stabilizing bids, effecting syndicate covering transactions, and reclaiming
selling concessions allowed to an underwriter or a dealer.
o An overallotment in connection with an offering creates a short
position in the Common Shares for the underwriters' own account.
o An underwriter may place a stabilizing bid to purchase the Common
Shares for the purpose of pegging, fixing, or maintaining the price of
the Common Shares.
o Underwriters may engage in syndicate covering transactions to cover
overallotments or to stabilize the price of the Common Shares by
bidding for, and purchasing, the Common Shares or any other securities
in the open market in order to reduce a short position created in
connection with the offering.
o The managing underwriter may impose a penalty bid on a syndicate member
to reclaim a selling concession in connection with an offering when the
Common Shares originally sold by the syndicate member are purchased in
syndicate covering transactions or otherwise.
Any of these activities may stabilize or maintain the market price of the Common
Shares above independent market levels. The underwriters are not required to
engage in these activities, and may end any of these activities at any time.
Any underwriters to whom the Common Shares are sold for offering and sale may
make a market in the Common Shares, but the underwriters will not be obligated
to do so and may discontinue any market-making at any time without notice.
Under agreements entered into with the Fund, underwriters and agents may be
entitled to indemnification by the Fund against certain civil liabilities,
including liabilities under the 1933 Act, or to contribution for payments the
underwriters or agents may be required to make. The underwriters, agents, and
their affiliates may engage in financial or other business transactions with the
Fund and its subsidiaries, if any, in the ordinary course of business.
The maximum commission or discount to be received by any member of the Financial
Industry Regulatory Authority or independent broker-dealer will not be greater
than eight percent of the initial gross proceeds from the sale of any security
being sold.
To the extent permitted under the 1940 Act and the rules and regulations
promulgated thereunder, the underwriters may from time to time act as a broker
or dealer and receive fees in connection with the execution of our portfolio
transactions after the underwriters have ceased to be underwriters and, subject
to certain restrictions, each may act as a broker while it is an underwriter.
DESCRIPTION OF SHARES
COMMON SHARES
The Declaration of Trust authorizes the issuance of an unlimited number of
common shares. The Common Shares being offered in an offering under this
prospectus and the applicable prospectus supplement have a par value of $0.01
per share and, subject to the rights of the holders of Preferred Shares, if
issued, have equal rights to the payment of dividends and the distribution of
assets upon liquidation. As of October 31, 2017, the Fund had 46,637,670 common
shares outstanding. The Common Shares being offered by this prospectus will,
when issued, be fully paid and subject to matters discussed in "Certain
Provisions in the Declaration of Trust and By-Laws," non-assessable, and
currently have no preemptive or conversion rights (except as may otherwise be
determined by the Board of Trustees in its sole discretion) or rights to
cumulative voting.
The Fund's currently outstanding common shares are, and the Common Shares
offered in this prospectus will be, subject to notice of issuance, listed on the
NYSE under the trading or "ticker" symbol "FEI." The Fund will continue to hold
annual meetings of shareholders so long as the common shares continue to be
listed on a national securities exchange and such meetings are required as a
condition to such listing.
Unlike open-end funds, closed-end funds like the Fund do not continuously offer
shares and do not provide daily redemptions. Rather, if a shareholder determines
to buy additional common shares or sell shares already held, the shareholder may
conveniently do so by trading on the exchange through a broker or otherwise.
Shares of closed-end investment companies may frequently trade on an exchange at
prices lower than NAV. Shares of closed-end investment companies like the Fund
have during some periods traded at prices higher than NAV and during other
periods have traded at prices lower than NAV. Because the market value of the
common shares may be influenced by such factors as dividend levels (which are in
turn affected by expenses), dividend stability, portfolio credit quality, NAV,
relative demand for and supply of such shares in the market, general market and
economic conditions, and other factors beyond the control of the Fund, the Fund
cannot assure you that common shares will trade at a price equal to or higher
71
than NAV in the future. The common shares are designed primarily for long-term
investors, and investors in the Common Shares should not view the Fund as a
vehicle for trading purposes.
PREFERRED SHARES
The Declaration of Trust provides that the Fund's Board of Trustees may
authorize and issue Preferred Shares with rights as determined by the Board of
Trustees, by action of the Board of Trustees without the approval of the common
shareholders.
Common shareholders have no preemptive right to purchase any Preferred Shares
that might be issued.
The Fund may elect to issue Preferred Shares as part of its leverage strategy.
The Fund currently has the ability to issue leverage through borrowings in an
amount up to 33-1/3% of the Fund's total assets less all liabilities other than
borrowings. The Board of Trustees also reserves the right to authorize the Fund
to issue Preferred Shares to the extent permitted by the 1940 Act, which
currently limits the aggregate liquidation preference of all outstanding
Preferred Shares plus the principal amount of any outstanding leverage
consisting of debt to 50% of the value of the Fund's total assets. Although the
terms of any Preferred Shares, including dividend rate, liquidation preference
and redemption provisions, will be determined by the Board of Trustees, subject
to applicable law and the Declaration of Trust, the Preferred Shares may be
structured to carry a relatively short-term dividend rate reflecting interest
rates on short-term bonds, by providing for the periodic redetermination of the
dividend rate at relatively short intervals. The Fund also believes it is likely
that the liquidation preference, voting rights and redemption provisions of the
Preferred Shares will be similar to those stated below.
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Fund, the holders of Preferred
Shares will be entitled to receive a preferential liquidating distribution,
which is expected to equal the original purchase price per Preferred Share plus
accrued and unpaid dividends, whether or not declared, before any distribution
of assets is made to common shareholders. After payment of the full amount of
the liquidating distribution to which they are entitled, the holders of
Preferred Shares will not be entitled to any further participation in any
distribution of assets by the Fund.
Voting Rights. The 1940 Act requires that the holders of any Preferred Shares,
voting separately as a single class, have the right to elect at least two
trustees at all times. The remaining trustees will be elected by holders of
common shares and Preferred Shares, voting together as a single class. In
addition, subject to the prior rights, if any, of the holders of any other class
of senior securities outstanding, the holders of any Preferred Shares have the
right to elect a majority of the trustees of the Fund at any time that two years
of dividends on any Preferred Shares are unpaid. The 1940 Act also requires
that, in addition to any approval by shareholders that might otherwise be
required, the approval of the holders of a majority of any outstanding Preferred
Shares, voting separately as a class, would be required to: (i) adopt any plan
of reorganization that would adversely affect the Preferred Shares; and (ii)
take any action requiring a vote of security holders under Section 13(a) of the
1940 Act, including, among other things, changes in the Fund's subclassification
as a closed-end investment company or changes in its fundamental investment
restrictions. See "Certain Provisions in the Declaration of Trust and By-Laws."
As a result of these voting rights, the Fund's ability to take any such actions
may be impeded to the extent that there are any Preferred Shares outstanding.
The Board of Trustees presently intends that, except as otherwise indicated in
this prospectus and except as otherwise required by applicable law or the
Declaration of Trust, holders of Preferred Shares will have equal voting rights
with common shareholders (one vote per share, unless otherwise required by the
1940 Act) and will vote together with common shareholders as a single class.
The affirmative vote of the holders of a majority of the outstanding Preferred
Shares, voting as a separate class, will be required to amend, alter or repeal
any of the preferences, rights or powers of holders of Preferred Shares so as to
affect materially and adversely such preferences, rights or powers, or to
increase or decrease the authorized number of Preferred Shares. The class vote
of holders of Preferred Shares described above will in each case be in addition
to any other vote required to authorize the action in question.
Redemption, Purchase and Sale of Preferred Shares by the Fund. The terms of any
Preferred Shares issued are expected to provide that: (i) they are redeemable by
the Fund in whole or in part at the original purchase price per share plus
accrued dividends per share; (ii) the Fund may tender for or purchase Preferred
Shares; and (iii) the Fund may subsequently resell any shares so tendered for or
purchased. Any redemption or purchase of Preferred Shares by the Fund will
reduce any leverage applicable to the common shares, while any resale of shares
by the Fund will increase that leverage.
The discussion above describes the possible offering of Preferred Shares by the
Fund. If the Board of Trustees determines to proceed with such an offering, the
terms of the Preferred Shares may be the same as, or different from, the terms
described above, subject to applicable law and the Fund's Declaration of Trust.
The Board of Trustees, without the approval of the common shareholders, may
authorize an offering of Preferred Shares or may determine not to authorize such
an offering, and may fix the terms of the Preferred Shares to be offered.
72
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST AND BY-LAWS
Under Massachusetts law, shareholders, in certain circumstances, could be held
personally liable for the obligations of the Fund. However, the Declaration of
Trust contains an express disclaimer of shareholder liability for debts or
obligations of the Fund and requires that notice of such limited liability be
given in each agreement, obligation or instrument entered into or executed by
the Fund or the Board of Trustees. The Declaration of Trust further provides for
indemnification out of the assets and property of the Fund for all loss and
expense of any shareholder of the Fund held personally liable for the
obligations of the Fund solely by reason of being a shareholder. Thus, the risk
of a shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which the Fund would be unable to meet its
obligations. The Fund believes the likelihood of such circumstances is remote.
The Declaration of Trust generally requires a common shareholder vote only on
those matters where the 1940 Act or the Fund's listing with an exchange require
a common shareholder vote, but otherwise permits the Board of Trustees to take
action without seeking the consent of common shareholders. For example, the
Declaration of Trust gives the Board of Trustees broad authority to approve most
reorganizations between the Fund and another entity, such as another closed-end
fund, and the sale of all or substantially all of its assets without common
shareholder approval if the 1940 Act would not require such approval. The
Declaration of Trust further provides that the Board of Trustees may amend the
Declaration of Trust in any respect without Common Shareholder approval. The
Declaration of Trust, however, prohibits amendments that impair the exemption
from personal liability granted in the Declaration of Trust to persons who are
or have been shareholders, trustees, officers or employees of the Fund or that
limit the rights to indemnification or insurance provided in the Declaration of
Trust with respect to actions or omissions of persons entitled to
indemnification under the Declaration of Trust prior to the amendment.
The By-Laws may be amended only by action of the trustees. The Declaration of
Trust and By-Laws include provisions that could limit the ability of other
entities or persons to acquire control of the Fund or to convert the Fund to
open-end status.
The number of trustees is currently five, but by action of two-thirds of the
trustees, the number of trustees may from time to time be increased or
decreased. Under the By-Laws, the Board of Trustees is divided into three
classes of trustees serving staggered three year terms, with the terms of one
class expiring at each annual meeting of shareholders. If the Fund issues
Preferred Shares, the Fund may establish a separate class for the trustees
elected by the holders of the Preferred Shares. Subject to applicable provisions
of the 1940 Act, vacancies on the Board of Trustees may be filled by a majority
action of the remaining trustees. Removal of a trustee requires either (a) a
vote of two-thirds of the outstanding shares (or if the trustee was elected or
appointed with respect to a particular class, two-thirds of the outstanding
shares of such class), or (b) the action of at least two-thirds of the remaining
trustees. Such provisions may work to delay a change in the majority of the
Board of Trustees. The provisions of the Declaration of Trust relating to the
election and removal of trustees may be amended only by a vote of two-thirds of
the trustees then in office. Generally, the Declaration of Trust requires a vote
by holders of at least two-thirds of the common shares and Preferred Shares, if
any, voting together as a single class, except as described below and in the
Declaration of Trust, to authorize: (1) a conversion of the Fund from a
closed-end to an open-end investment company, if required pursuant to the
provisions of the 1940 Act; (2) a merger or consolidation of the Fund with any
corporation, association, trust or other organization, including a series or
class of such other organization (only in the limited circumstances where a vote
by shareholders is otherwise required under the 1940 Act or the Declaration of
Trust); (3) a sale, lease or exchange of all or substantially all of the Fund's
assets (only in the limited circumstances where a vote by shareholders is
otherwise required under the 1940 Act or the Declaration of Trust); (4) certain
transactions such as a sale, lease or exchange of all or substantially all of
the assets of the Fund, a merger or consolidation of the Fund, or the issuance
of securities of the Fund, in which a principal shareholder (as defined in the
Declaration of Trust) is a party to the transaction. However, with respect to
(1) above, if there are Preferred Shares outstanding, the affirmative vote of
the holders of two-thirds of the Preferred Shares voting as a separate class
shall also be required. With respect to (2) and (3) above, except as otherwise
may be required, if the transaction constitutes a plan of reorganization which
adversely affects Preferred Shares, if any, then an affirmative vote of
two-thirds of the Preferred Shares voting together as a separate class is
required as well. With respect to (1) through (3), if such transaction has
already been authorized by the affirmative vote of two-thirds of the trustees,
then the affirmative vote of the majority of the outstanding voting securities,
as defined in the 1940 Act (a "Majority Shareholder Vote") is required, provided
that when only a particular class is affected, only the required vote of the
particular class will be required. Such affirmative vote or consent shall be in
addition to the vote or consent of the holders of the Fund's shares otherwise
required by law or any agreement between the Fund and any national securities
exchange. See the SAI under "Certain Provisions in the Declaration of Trust and
By-Laws."
The provisions of the Declaration of Trust described above could have the effect
of depriving the common shareholders of opportunities to sell their common
shares at a premium over the then current market price of the common shares by
discouraging a third party from seeking to obtain control of the Fund in a
tender offer or similar transaction. The overall effect of these provisions is
to render more difficult the accomplishment of a merger or the assumption of
control by a third party. They provide, however, the advantage of potentially
requiring persons seeking control of the Fund to negotiate with its management
regarding the price to be paid and facilitating the continuity of the Fund's
73
investment objective and policies. The Board of Trustees of the Fund has
considered the foregoing anti-takeover provisions and concluded that they are in
the best interests of the Fund.
The Declaration of Trust also provides that prior to bringing a derivative
action, a demand must first be made on the Board of Trustees by at least three
unrelated shareholders that hold shares representing at least 5% of the voting
power of the Fund or affected class. The Declaration of Trust details various
information, certifications, undertakings and acknowledgements that must be
included in the demand. Following receipt of the demand, the trustees who are
considered independent for the purposes of considering the demand have a period
of 90 days, which may be extended by an additional 60 days, to consider the
demand. If a majority of the trustees who are considered independent for the
purposes of considering the demand determine that maintaining the suit would not
be in the best interests of the Fund, the Board of Trustees is required to
reject the demand and the complaining shareholders may not proceed with the
derivative action unless the shareholders are able to sustain the burden of
proof to a court that the decision of the Board of Trustees not to pursue the
requested action was not a good faith exercise of their business judgment on
behalf of the Fund. If a demand is rejected, the complaining shareholders will
be responsible for the costs and expenses (including attorneys' fees) incurred
by the Fund in connection with the consideration of the demand under a number of
circumstances. If a derivative action is brought in violation of the Declaration
of Trust, the shareholders bringing the action may be responsible for the Fund's
costs, including attorney's fees. The Declaration of Trust also includes a forum
selection clause requiring that any shareholder litigation be brought in certain
courts in Illinois and further provides that any shareholder bringing an action
against the Fund waive the right to trial by jury to the fullest extent
permitted by law.
Reference should be made to the Declaration of Trust on file with the SEC for
the full text of these provisions.
STRUCTURE OF THE FUND; COMMON SHARE REPURCHASES AND
CHANGE IN FUND STRUCTURE
CLOSED-END STRUCTURE
Closed-end funds differ from open-end management investment companies (commonly
referred to as mutual funds) in that closed-end funds generally list their
shares for trading on a securities exchange and do not redeem their shares at
the option of the shareholder. By comparison, mutual funds issue securities
redeemable at NAV at the option of the shareholder and typically engage in a
continuous offering of their shares. Mutual funds are subject to continuous
asset in-flows and out-flows, whereas closed-end funds generally can stay more
fully invested in securities consistent with the closed-end fund's investment
objective and policies. In addition, in comparison to open-end funds, closed-end
funds have greater flexibility in their ability to make certain types of
investments, including investments in illiquid securities.
However, shares of closed-end investment companies listed for trading on a
securities exchange frequently trade at a discount from NAV, but in some cases
trade at a premium. The market price may be affected by trading volume of the
shares, general market and economic conditions and other factors beyond the
control of the closed-end fund. The foregoing factors may result in the market
price of the common shares being greater than, less than or equal to NAV. The
Board of Trustees has reviewed the structure of the Fund in light of its
investment objective and policies and has determined that the closed-end
structure is in the best interests of the shareholders. As described below,
however, the Board of Trustees will review periodically the trading range and
activity of the Fund's shares with respect to its NAV, and the Board may take
certain actions to seek to reduce or eliminate any such discount. Such actions
may include open-market repurchases or tender offers for the common shares at or
near NAV or the possible conversion of the Fund to an open-end fund. There can
be no assurance that the Board will decide to undertake any of these actions or
that, if undertaken, such actions would result in the common shares trading at a
price equal to or close to their NAV. In addition, as noted above, the Board of
Trustees determined in connection with the initial offering of the common shares
of the Fund that the closed-end structure is appropriate, given the Fund's
investment objective and policies. Investors should assume, therefore, that it
is highly unlikely that the Board would vote to propose to shareholders that the
Fund convert to an open-end investment company.
REPURCHASE OF COMMON SHARES AND TENDER OFFERS
Shares of closed-end funds frequently trade at a discount to their NAV. Because
of this possibility and the recognition that any such discount may not be in the
interest of common shareholders, the Board of Trustees might consider from time
to time engaging in open-market repurchases, tender offers for shares or other
programs intended to reduce the discount. The Fund cannot guarantee or assure,
however, that the Board of Trustees will decide to engage in any of these
actions. After any consideration of potential actions to seek to reduce any
significant market discount, the Board of Trustees may, subject to its fiduciary
obligations and compliance with applicable state and federal laws and the
requirements of the principal stock exchange on which the common shares are
listed, authorize the commencement of a share repurchase program or tender
offer. The size and timing of any such share repurchase program or tender offer
will be determined by the Board of Trustees in light of the market discount of
the common shares, trading volume of the common shares, information presented to
the Board of Trustees regarding the potential impact of any such share
repurchase program or tender offer, and general market and economic conditions.
There can be no assurance that the Fund will in fact effect repurchases of or
74
tender offers for any of its common shares. The Fund may, subject to its
investment limitation with respect to borrowings, incur debt to finance such
repurchases or a tender offer or for other valid purposes. Interest on any such
borrowings would increase the Fund's expenses and reduce the Fund's net income.
There can be no assurance that repurchases of common shares or tender offers, if
any, will cause the common shares to trade at a price equal to or in excess of
their NAV. Nevertheless, the possibility that a portion of the Fund's
outstanding common shares may be the subject of repurchases or tender offers may
reduce the spread between market price and NAV that might otherwise exist. In
the opinion of the Fund, sellers may be less inclined to accept a significant
discount in the sale of their common shares if they have a reasonable
expectation of being able to receive a price of NAV for a portion of their
common shares in conjunction with an announced repurchase program or tender
offer for the common shares.
Although repurchases or tender offers may have a favorable effect on the market
price of the common shares, the acquisition of common shares by the Fund will
decrease the Managed Assets of the Fund and therefore will have the effect of
increasing the Fund's expense ratio and decreasing the asset coverage with
respect to any borrowings or Preferred Shares outstanding. Because of the nature
of the Fund's investment objective, policies and portfolio, the Advisor does not
anticipate that repurchases of common shares or tender offers should interfere
with the ability of the Fund to manage its investments in order to seek its
investment objective, and does not anticipate any material difficulty in
borrowing money or disposing of portfolio securities to consummate repurchases
of or tender offers for common shares, although no assurance can be given that
this will be the case.
CONVERSION TO OPEN-END FUND
The Fund may be converted to an open-end investment company at any time if
approved by the holders of two-thirds of the Fund's shares outstanding and
entitled to vote, provided that, unless otherwise required by law, if there are
Preferred Shares outstanding, the affirmative vote of the holders of two-thirds
of the Preferred Shares voting as a separate class shall also be required;
provided, however, that such votes shall be by Majority Shareholder Vote if the
action in question was previously approved by the affirmative vote of two-thirds
of the Board of Trustees. Such affirmative vote or consent shall be in addition
to the vote or consent of the holders of the shares otherwise required by law or
any agreement between the Fund and any national securities exchange. In the
event of conversion, the common shares would cease to be listed on the NYSE or
other national securities exchange. Any Preferred Shares or borrowings would
need to be redeemed or repaid upon conversion to an open-end investment company.
The Board of Trustees believes, however, that the closed-end structure is
appropriate, given the Fund's investment objective and policies. Investors
should assume, therefore, that it is highly unlikely that the Board of Trustees
would vote to propose to shareholders that the Fund convert to an open-end
investment company. Shareholders of an open-end investment company may require
the company to redeem their shares at any time (except in certain circumstances
as authorized by or under the 1940 Act) at their NAV, less such redemption
charge or contingent deferred sales charge, if any, as might be in effect at the
time of a redemption. The Fund would expect to pay all such redemption requests
in cash, but would intend to reserve the right to pay redemption requests in a
combination of cash or securities. If such partial payment in securities were
made, investors may incur brokerage costs in converting such securities to cash.
If the Fund were converted to an open-end fund, it is possible that new common
shares would be sold at NAV plus a sales load.
TAX MATTERS
The following discussion of federal income tax matters is based on the advice of
Chapman and Cutler LLP, counsel to the Fund.
MATTERS ADDRESSED
This section and the discussion in the SAI provide a general summary of the
material U.S. federal income tax consequences to the persons who purchase, own
and dispose of the common shares. It does not address all U.S. federal income
tax consequences that may apply to investment in the common shares. Unless
otherwise indicated, this discussion is limited to taxpayers who are U.S.
persons, as defined herein. The discussion that follows is based on the
provisions of the Code, on Treasury regulations promulgated thereunder as in
effect on the date hereof and on existing judicial and administrative
interpretations thereof. These authorities are subject to change and to
differing interpretations, which could apply retroactively. Potential investors
should consult their own tax advisers in determining the federal, state, local,
foreign and any other tax consequences to them of the purchase, ownership and
disposition of the common shares. This discussion does not address all tax
consequences that may be applicable to a U.S. person that is a beneficial owner
of common shares, nor does it address, unless specifically indicated, the tax
consequences to, among others, (i) persons that may be subject to special
treatment under U.S. federal income tax law, including, but not limited to,
banks, insurance companies, thrift institutions, regulated investment companies,
real estate investment trusts, tax-exempt organizations, partnerships and other
pass-through entities, United States expatriates, and dealers in securities or
currencies, (ii) persons that will hold common shares as part of a position in a
"straddle" or as part of a "hedging," "conversion" or other integrated
investment transaction for U.S. federal income tax purposes and traders that
have elected the mark-to-market method of accounting, (iii) persons whose
75
functional currency is not the U.S. dollar or (iv) persons that do not hold
common shares as capital assets within the meaning of Section 1221 of the Code.
For purposes of this discussion, a "U.S. person" is (i) an individual citizen or
resident of the United States, (ii) a corporation or partnership organized in or
under the laws of the United States or any state thereof or the District of
Columbia (other than a partnership that is not treated as a U.S. person under
any applicable Treasury regulations), (iii) an estate the income of which is
subject to U.S. federal income taxation regardless of its source, or (iv) a
trust if a court within the United States is able to exercise primary
supervision over the administration of such trust and one or more U.S. persons
have the authority to control all the substantial decisions of such trust.
Notwithstanding clause (iv) above, to the extent provided in regulations,
certain trusts in existence on August 20, 1996 and treated as U.S. persons prior
to such date that elect to continue to be so treated also shall be considered
U.S. persons.
TAX CHARACTERIZATION OF THE FUND FOR U.S. FEDERAL INCOME TAX PURPOSES
The Fund has elected to be treated as a regular C corporation for U.S. federal
income tax purposes. Thus, the Fund is subject to U.S. corporate income tax on
its U.S. taxable income. Such taxable income would generally include all of the
Fund's net income from the MLPs. The current U.S. federal maximum graduated
income tax rate for corporations is 21%. However, certain ordinary income
dividends received by the Fund that are attributable to qualifying dividends
from certain corporations may be eligible for the dividend received deduction.
However, the presence of covered call options in the portfolio may reduce the
amount of dividends that are treated as qualifying dividends.
Any such U.S. corporate income tax could materially reduce cash available to
make payments on the common shares. The Fund will also be obligated to pay state
income tax on its taxable income.
The MLPs in which the Fund invests are generally treated as partnerships for
U.S. federal income tax purposes. As a partner in the MLPs, the Fund will be
required to report its allocable share of MLP income, gain, loss, deduction and
expense, whether or not any cash is distributed from the MLPs.
The Fund invests in energy MLPs, so the majority of the Fund's items of income,
gain, loss, deduction and expense is related to energy ventures. However, some
items are likely to relate to the temporary investment of the Fund's capital,
which may be unrelated to energy ventures.
Although the Fund generally holds the interests in the MLPs for investment, the
Fund may sell interests in a particular MLP from time to time. On any such sale,
the Fund generally will recognize gain or loss based upon the difference between
the consideration received for tax purposes on the sale and the Fund's tax basis
in the interest sold. The consideration received is generally the amount paid by
the purchaser plus any debt of the MLP allocated to the Fund that will shift to
the purchaser on the sale. The Fund's tax basis in an MLP is the amount paid for
the interest, increased by the Fund's allocable share of net income and gains
and the MLP's debt, if any, and capital contributions to the MLP, and decreased
for any distributions received by the Fund, by reductions in the Fund's
allocable share of the MLP's debt, if any, and by the Fund's allocable share of
net losses. Thus, although cash distributions in excess of taxable income and
net tax losses may create a temporary economic benefit to the Fund, they will
increase the amount of gain (or decrease the amount of loss) on the sale of an
interest in an MLP. No favorable U.S. federal income tax rate applies to
long-term capital gains for entities treated as corporations for U.S. federal
income tax purposes, such as the Fund. Thus, the Fund will be subject to U.S.
federal income tax on its long-term capital gains, like ordinary income, at
rates of up to 21%.
The Fund may have income that is sourced to other countries and taxed in other
countries. Because of the differences in the way countries calculate taxable
income, the Fund may have net taxable income in other countries in years in
which the Fund has net losses for U.S. tax purposes. Similarly, the Fund may
have net taxable income for U.S. tax purposes in years in which the Fund has net
losses in one or more other countries. This mismatch may cause the Fund to not
be able to use foreign taxes paid as credit against U.S. taxes in all
circumstances.
The Fund is not treated as a regulated investment company for U.S. federal
income tax purposes. In order to qualify as a regulated investment company, the
income and assets of the company must meet certain minimum threshold tests.
Because the Fund invests a substantial portion of its Managed Assets in MLPs
that invest in energy ventures, the Fund does not meet such tests under current
law. In contrast to the tax rules that will apply to the Fund, a regulated
investment company generally does not pay corporate income tax. Thus, the
regulated investment company taxation rules have no application to the Fund or
common shareholders of the Fund.
LIMITATIONS ON INTEREST DEDUCTIONS
Since 2017, the Fund has been subject to limitations on the amount of interest
deductions that it may take in each year. Deductions for interest would be
limited to 30 percent of a business's taxable income (before interest,
depreciation, and depletion). The underlying MLP's may also be subject to a
similar limitation. The Fund intends to use leverage to make its investments.
See "Leverage Program." Because the limitation on interest would be based upon
income before depletion, which is sometimes a significant deduction allocated
from MLPs, the significance of the limitation is difficult to predict. However,
76
it is possible that the Fund will not be able to deduct all of its interest
expense in the year accrued. If this occurs, the excess interest expense could
be carried forward to subsequent years, but the Fund's tax in the year the
expense is accrued could increase.
TAXATION OF THE SHAREHOLDERS
Distributions. The Fund's distributions will be treated as dividends to common
shareholders to the extent of the Fund's current or accumulated earnings and
profits as determined for U.S. federal income tax purposes.
The portion of the Fund's distributions treated as a dividend for U.S. federal
income tax purposes should be treated as qualified dividend income for U.S.
federal income tax purposes, subject to certain holding period and other
requirements. Certain qualified dividend income received by individual
shareholders will be taxed at long-term capital gains rates, which reach a
maximum of 20%. Corporations are generally subject to tax on dividends at a
maximum 21% rate, but, for tax years beginning after December 31, 2017,
corporations may be eligible to exclude 50% of the dividends if certain holding
period requirements are met.
If a Fund distribution exceeds the Fund's current and accumulated earnings and
profits, the distribution will be treated as a non-taxable adjustment to the
basis of the common shares to the extent of such basis, and then as capital gain
to the extent the distribution exceeds the basis of the common shares. Such gain
will be long-term capital gain if the holding period for the common shares is
more than one year. Individuals are currently subject to a maximum tax rate of
23.8% (including a 3.8% tax on net investment income above a certain threshold)
on long-term capital gains. Corporations are taxed on capital gains at their
ordinary income rates.
A corporation's earnings and profits are generally calculated by making certain
adjustments to the corporation's reported taxable income. Based upon the
historic performance of similar MLPs, the Fund anticipates that the distributed
cash from the MLPs in its portfolio will exceed the Fund's earnings and profits
derived from its investments in the MLPs in its portfolio. Thus, the Fund
anticipates that only a portion of its distributions will be treated as
dividends to its common shareholders for U.S. federal income tax purposes.
Special rules apply to the calculation of earnings and profits for corporations
invested in energy ventures. The Fund's earnings and profits will be calculated
using (i) straight-line depreciation rather than a percentage depletion method
and (ii) five-year and ten-year amortization of drilling costs and exploration
and development costs, respectively. Thus, these deductions may be significantly
lower for purposes of calculating earnings and profits than they are for
purposes of calculating taxable income.
Because of these differences, the Fund may make distributions out of earnings
and profits, treated as dividends, in years in which Fund distributions exceed
the Fund's taxable income.
A common shareholder participating in the Fund's automatic dividend reinvestment
plan will be taxed upon the reinvested amount as if actually received by the
participating common shareholder and the participating common shareholder
reinvested such amount in additional Fund common shares.
The Fund will notify common shareholders annually as to the U.S. federal income
tax status of Fund distributions to them.
Distributions from the Fund may be subject to a U.S. withholding tax of 30% in
the case of distributions to (i) certain non-U.S. financial institutions that
either (A) have not entered into an agreement with the U.S. Treasury to collect
and disclose certain information or (B) are not resident for tax purposes in a
jurisdiction that has entered into an agreement with the IRS to collect and
provide the information otherwise required and (ii) certain other non-U.S.
entities that do not provide certain certifications and information about the
entity's U.S. owners.
Sale of Shares. Upon the sale of common shares, a common shareholder will
generally recognize capital gain or loss measured by the difference between the
amount received on the sale and the common shareholder's tax basis of common
shares sold. As discussed above, such tax basis may be less than the price paid
for the common shares as a result of prior Fund distributions in excess of the
Fund's earnings and profits. Such capital gain or loss will generally be
long-term capital gain or loss, if such common shares were capital assets held
for more than one year. The U.S. federal income tax treatment of long-term
capital gains is described above. The deductibility of capital losses is subject
to limitations. In addition, the gross proceeds from dispositions of interests
in the Fund after December 31, 2018 may be subject to a U.S. withholding tax of
30% in the case of payments to (i) certain non-U.S. financial institutions that
either (A) have not entered into an agreement with the U.S. Treasury to collect
and disclose certain information or (B) are not resident for tax purposes in a
jurisdiction that has entered into an agreement with the IRS to collect and
provide the information otherwise required and (ii) certain other non-U.S.
entities that do not provide certain certifications and information about the
entities' U.S. owners.
Medicare Tax. Income from the Fund may also be subject to a 3.8% "Medicare tax."
This tax will generally apply to the net investment income (such as interest and
dividends, including dividends paid with respect to the common shares) and gains
77
of a shareholder who is an individual if such shareholder's adjusted gross
income exceeds certain threshold amounts, which are $250,000 in the case of a
married couple filing joint returns and $200,000 in the case of single
individuals.
Information Reporting and Withholding. The Fund will be required to report
annually to the Internal Revenue Service (the "IRS"), and to each common
shareholder, the amount of distributions and consideration paid in redemptions,
and the amount withheld for U.S. federal income taxes, if any, for each calendar
year, except as to exempt holders (including certain corporations, tax-exempt
organizations, qualified pension and profit-sharing trusts, and individual
retirement accounts). Each common shareholder (other than common shareholders
who are not subject to the reporting requirements without supplying any
documentation) that is a U.S. person will be required to provide the Fund, under
penalties of perjury, an IRS Form W-9 or an equivalent form containing the
common shareholder's name, address, correct federal taxpayer identification
number and a statement that the common shareholder is not subject to backup
withholding. Should a non-exempt common shareholder fail to provide the required
certification, backup withholding will apply. The current backup withholding
rate is 24%. Backup withholding is not an additional tax. Any such withholding
will be allowed as a credit against the common shareholder's U.S. federal income
tax liability provided the required information is timely furnished to the IRS.
TAX CONSEQUENCES OF CERTAIN INVESTMENTS
U.S. Federal Income Taxation of MLPs. MLPs are generally intended to be taxed as
partnerships for U.S. federal income tax purposes. As a partnership, an MLP is
treated as a pass-through entity for U.S. federal income tax purposes. This
means that the U.S. federal income items of the MLP, though calculated and
determined at the partnership level, are allocated among the partners in the MLP
and are included directly in the calculation of the taxable income of the
partners whether or not cash flow is distributed from the MLP. The MLP files an
information return, but normally pays no U.S. federal income tax.
MLPs are often publicly traded. Publicly traded partnerships are generally
treated as corporations for federal income tax purposes. However, if an MLP
satisfies certain income character requirements, the MLP will generally continue
to be treated as partnership for federal income tax purposes. Under these
requirements, an MLP must receive at least 90% of its gross income from certain
"qualifying income" sources.
Qualifying income for this purpose generally includes interest, dividends, real
property rents, real property gains, and income and gain from the exploration,
development, mining or production, processing, refining, transportation or
marketing of any mineral or natural resource (including fertilizer, geothermal
energy, and timber). As discussed above, the Fund invests in energy MLPs that
derive income from such sources, so the income of the MLPs in the Fund's
portfolio should qualify as qualifying income. The IRS has finalized regulations
that limit the nature of qualifying income for MLPs. Some MLPs may convert to
corporations under these regulations or restructure their activities to qualify
under these regulations.
As discussed above, the tax items of an MLP are allocated through to the
partners of the MLP whether or not an MLP makes any distributions of cash. In
part because estimated tax payments are payable quarterly, partnerships often
make quarterly cash distributions. A distribution from a partnership will
generally be treated as a non-taxable adjustment to the basis of the Fund's
interest in the partnership to the extent of such basis, and then as gain to the
extent of the excess distribution. The gain will generally be capital gain, but
a variety of rules could potentially recharacterize the gain as ordinary income.
The Fund's initial tax basis is the price paid for the MLP interest plus any
debt of the MLP allocated to the Fund. The tax basis is decreased for
distributions received by the Fund, by reductions in the Fund's allocable share
of the MLP's debt, if any, and by the Fund's allocable share of net losses, and
increased for capital contributions and the Fund's allocable share of net income
and gains.
When interests in a partnership are sold, the difference between (i) the sum of
the sales price and the Fund's share of debt of the partnership that will be
allocated to the purchaser and (ii) the Fund's adjusted tax basis will be
taxable gain or loss, as the case may be.
The Fund should receive a Form K-1 from each MLP, showing its share of each item
of MLP income, gain, loss, deductions and expense. The Fund will use that
information to calculate its taxable income and its earnings and profits.
Because the Fund has elected to be taxed as a corporation, the Fund will report
the tax items of the MLPs and any gain or loss on the sale of interests in the
MLPs on its own tax returns. The Fund's common shareholders will be viewed for
federal income tax purposes as having income or loss on their investment in the
Fund rather than in the underlying MLPs. common shareholders will receive a Form
1099 from the Fund based upon the distributions made (or deemed to have been
made) to the common shareholders rather than based upon the income, gain, loss
or deductions of the MLPs in which the Fund invests.
Other Investments. The Fund may attempt to generate premiums from the sale of
call options. These premiums typically will result in short-term capital gains
to the Fund. Transactions involving the disposition of the Fund's underlying
securities (whether pursuant to the exercise of a call option, put option or
otherwise) will give rise to capital gains or losses. Because the Fund does not
have control over the exercise of the call options it writes, such exercises or
other required sales of the underlying stocks may cause the Fund to realize
capital gains or losses at inopportune times.
78
Certain of the Fund's investment practices may be subject to special and complex
federal income tax provisions that may, among other things, (i) disallow,
suspend or otherwise limit the allowance of certain losses or deductions, (ii)
convert an ordinary loss or a deduction into a capital loss (the deductibility
of which is more limited) or (iii) cause the Fund to recognize income or gain
without a corresponding receipt of cash. The Fund will monitor its transactions
and may make certain tax elections in order to mitigate the effect of these
provisions, if possible.
CUSTODIAN, ADMINISTRATOR, FUND ACCOUNTANT AND TRANSFER AGENT
The custodian of the assets of the Fund is The Bank of New York Mellon, One Wall
Street, New York, New York 10286. The Fund's transfer, shareholder services and
dividend paying agent is BNY Mellon Investment Servicing (US) Inc., 301 Bellevue
Parkway, Wilmington, Delaware 19809. Pursuant to an administration and
accounting services agreement, The Bank of New York Mellon also provides certain
administrative and accounting services to the Fund, including maintaining the
Fund's books of account, records of the Fund's securities transactions, and
certain other books and records; acting as liaison with the Fund's independent
registered public accounting firm by providing such accountant with various
audit-related information with respect to the Fund; and providing other
continuous accounting and administrative services. As compensation for these
services, the Fund has agreed to pay The Bank of New York Mellon an annual fee,
calculated daily and payable on a monthly basis, of 0.05% of the Fund's first
$500 million of average Managed Assets, subject to decrease with respect to
additional Fund Managed Assets.
LEGAL OPINIONS
Certain legal matters in connection with the Common Shares will be passed upon
for the Fund by Chapman and Cutler LLP, Chicago, Illinois. Chapman and Cutler
LLP may rely as to certain matters of Massachusetts law on the opinion of
Morgan, Lewis & Bockius LLP. If certain legal matters in connection with an
offering of Common Shares are passed upon by counsel for the underwriters or
sales agent of such offering, such counsel will be named in a prospectus
supplement.
79
TABLE OF CONTENTS FOR THE
STATEMENT OF ADDITIONAL INFORMATION
PAGE
Use of Proceeds........................................................... 1
Investment Objective...................................................... 1
Investment Policies and Restrictions...................................... 2
Investment Policies and Techniques........................................ 4
Additional Information About the Fund's Investments and
Investment Risks....................................................... 7
Other Investment Policies and Techniques.................................. 35
Management of the Fund.................................................... 44
Investment Advisor........................................................ 55
Sub-Advisor............................................................... 58
Proxy Voting Policies and Procedures...................................... 62
Portfolio Transactions and Brokerage...................................... 63
Description of Shares..................................................... 65
Certain Provisions in the Declaration of Trust and By-Laws................ 67
Repurchase of Fund Shares; Conversion to Open-End Fund.................... 69
Net Asset Value........................................................... 72
Federal Tax Matters....................................................... 74
Independent Registered Public Accounting Firm............................. 80
Custodian, Administrator, Fund Accountant and Transfer Agent.............. 80
Additional Information.................................................... 81
Financial Statements and Report of Independent Registered Public
Accounting Firm........................................................ 82
Appendix A--Ratings of Investments........................................ A-1
Appendix B--Energy Income Partners, LLC Proxy Voting Policies and
Procedures.................................................... B-1
80
FIRST TRUST MLP AND ENERGY INCOME FUND
UP TO 4,600,000 COMMON SHARES
---------------------
PROSPECTUS SUPPLEMENT
---------------------
MARCH 8, 2018
UNTIL APRIL 2, 2018 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS SUPPLEMENT), ALL
DEALERS THAT BUY, SELL OR TRADE THE COMMON SHARES, WHETHER OR NOT PARTICIPATING
IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY
REQUIREMENT IS IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS.
FIRST TRUST MLP AND ENERGY INCOME FUND
STATEMENT OF ADDITIONAL INFORMATION
First Trust MLP and Energy Income Fund (the "Fund") is a non-diversified,
closed-end management investment company which commenced operations in November
2012.
This Statement of Additional Information relates to the offering, on an
immediate, continuous or delayed basis, of up to 13,600,000 common shares of
beneficial interest in the Fund in one or more offerings (the "Common Shares").
This Statement of Additional Information does not constitute a prospectus, but
should be read in conjunction with the Fund's Prospectus dated March 6, 2018 and
any related prospectus supplement. The Fund's currently outstanding common
shares are, and the Common Shares offered by the Prospectus and any prospectus
supplement will be, subject to notice of issuance, listed on the New York Stock
Exchange under the symbol "FEI."
This Statement of Additional Information does not include all information
that a prospective investor should consider before purchasing Common Shares.
Investors should obtain and read the Prospectus and any prospectus supplement
prior to purchasing such Common Shares. A copy of the Fund's Prospectus and any
prospectus supplement may be obtained without charge by calling (800) 988-5891.
You also may obtain a copy of the Prospectus on the Securities and Exchange
Commission's web site (http://www.sec.gov). As used in this Statement of
Additional Information, unless the context requires otherwise, "common shares"
refer to the Fund's common shares of beneficial interest currently outstanding
as well as those Common Shares offered by the Prospectus and any prospectus
supplement and the holders of the common shares are called "common
shareholders." Capitalized terms used but not defined in this Statement of
Additional Information have the meanings ascribed to them in the Prospectus and
any prospectus supplement.
This Statement of Additional Information is dated March 6, 2018.
TABLE OF CONTENTS
PAGE
USE OF PROCEEDS................................................................1
INVESTMENT OBJECTIVE...........................................................1
INVESTMENT POLICIES AND RESTRICTIONS...........................................2
INVESTMENT POLICIES AND TECHNIQUES.............................................4
ADDITIONAL INFORMATION ABOUT THE FUND'S INVESTMENTS AND
INVESTMENT RISKS............................................................6
OTHER INVESTMENT POLICIES AND TECHNIQUES......................................35
MANAGEMENT OF THE FUND........................................................44
INVESTMENT ADVISOR............................................................55
SUB-ADVISOR...................................................................58
PROXY VOTING POLICIES AND PROCEDURES..........................................62
PORTFOLIO TRANSACTIONS AND BROKERAGE..........................................63
DESCRIPTION OF SHARES.........................................................65
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST AND BY-LAWS....................67
REPURCHASE OF FUND SHARES; CONVERSION TO OPEN-END FUND........................69
NET ASSET VALUE...............................................................72
FEDERAL TAX MATTERS...........................................................74
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.................................80
CUSTODIAN, ADMINISTRATOR AND TRANSFER AGENT...................................80
ADDITIONAL INFORMATION........................................................80
FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM............................................................82
APPENDIX A -- Ratings of Investments.........................................A-1
APPENDIX B -- Energy Income Partners, LLC Proxy Voting Policies
and Procedures....................B-1
- ii -
USE OF PROCEEDS
The Fund expects to invest substantially all of the net proceeds from any
sales of Common Shares pursuant to the Prospectus and any prospectus supplement
in accordance with the Fund's investment objective and policies as stated below
or for other general corporate purposes within approximately three months of
receipt of such proceeds.
Pending investment in securities that meet the Fund's investment objective
and policies, the net proceeds of an offering under the Prospectus and the
applicable prospectus supplement will be invested in cash or cash equivalents.
INVESTMENT OBJECTIVE
The Fund's investment objective is to seek a high level of total return
with an emphasis on current distributions paid to common shareholders. For
purposes of the Fund's investment objective, total return includes capital
appreciation of, and all distributions received from, securities in which the
Fund invests regardless of the tax character of the distributions. The Fund
seeks to provide its common shareholders with a vehicle to invest in a portfolio
of cash-generating securities, with a focus on investing in publicly traded
MLPs, MLP-related entities and other companies in the energy sector and energy
utility industries that are weighted towards non-cyclical, fee-for-service
revenues. The Fund also may invest in other securities set forth below if Energy
Income Partners, LLC, the sub-adviser of the Fund ("Energy Income Partners" or
the "Sub-Advisor"), expects to achieve the Fund's objective with such
investments. There can be no assurance that the Fund's investment objective will
be achieved.
Due to the tax treatment under current law of cash distributions in excess
of income made by MLPs in which the Fund may invest, a portion of distributions
the Fund anticipates making to common shareholders may consist of a return of
capital and, depending on market conditions and tax circumstances, in certain
periods, such return of capital may represent a significant portion of the
Fund's distributions. To the extent that distributions exceed the Fund's
earnings and profits, such distributions are generally not treated as taxable
income for the investor. Instead, the Fund's common shareholders will experience
a reduction in the basis of their shares, which may increase the capital gain,
or reduce capital loss, realized upon the sale of such shares.
As used in this Statement of Additional Information, unless the context
requires otherwise, MLPs are MLPs in the energy sector. The Fund considers
investments in "MLP-related entities" to include investments that offer economic
exposure to publicly traded MLPs and private investments that have MLP
characteristics, but are not publicly traded. The Fund considers investments in
the energy sector to include companies that derive a majority of their revenues
or operating income from transporting, processing, storing, distributing,
marketing, exploring, developing, managing or producing natural gas, natural gas
liquids ("NGLs") (including propane), crude oil, refined petroleum products,
coal or electricity, or from supplying energy-related products and services, or
any such other companies within the energy sector as classified under the Global
Industry Classification Standards developed by MSCI, Inc. and Standard & Poor's
("GICS"). The Fund considers investments in energy utility to include companies
1
that derive a majority of their revenues or operating income from providing
products, services or equipment for the generation, transmission, distribution
or sale of electricity or gas and such other companies within the electric, gas,
independent power and renewable electricity producers and multi-utilities
industries as classified under GICS.
The types of MLPs in which the Fund invests historically have made cash
distributions to limited partners or members that exceed the amount of taxable
income allocable to limited partners or members, due to a variety of factors,
including significant non-cash deductions, such as depreciation and depletion.
If cash distributions from an MLP exceed the taxable income reported in a
particular tax year, a portion of the excess cash distribution would not be
treated as income to the Fund in that tax year but would rather be treated as a
return of capital for federal income tax purposes to the extent of the Fund's
basis in its MLP units. The Fund's tax basis in its MLP units is the amount paid
for the units, increased by the Fund's allocable share of net income and gains
and the MLP's debt, if any, and capital contributions to the MLP, and decreased
for any distributions received by the Fund, by the Fund's allocable share of net
losses and by reductions in the Fund's allocable share of the MLP's debt, if
any. Thus, although cash distributions in excess of taxable income and net tax
losses may create a temporary economic benefit to the Fund, they will increase
the amount of gain (or decrease the amount of loss) on the sale of an interest
in an MLP. The Fund expects to distribute cash in excess of its earnings and
profits to common shareholders, which may be treated as a return of capital to
the extent of the common shareholders' basis in the common shares.
INVESTMENT POLICIES AND RESTRICTIONS
NON-FUNDAMENTAL INVESTMENT POLICIES
The Fund has adopted the following non-fundamental policies:
o Under normal market conditions, the Fund invests at least 85% of its
Managed Assets in equity and debt securities of MLPs, MLP-related
entities and other energy sector and energy utility companies that the
Fund's Sub-Advisor believes offer opportunities for growth and income.
o The Fund may invest up to 20% of its Managed Assets in unregistered or
otherwise restricted securities. The types of unregistered or
otherwise restricted securities that the Fund may purchase consist of
MLP common units, MLP subordinated units and securities of public and
private energy sector and energy utility companies.
o The Fund may invest up to 20% of its Managed Assets in debt securities
of MLPs, MLP-related entities and other energy sector and energy
utility companies, including certain below investment grade
securities, which are commonly referred to as "high yield" or "junk"
bonds. Below investment grade debt securities will be rated at least
"B3" by Moody's Investors Service, Inc. ("Moody's") and at least "B-"
by Standard & Poor's Ratings Services ("S&P") at the time of purchase,
or comparably rated by another nationally recognized statistical
2
rating organization ("NRSRO") or, if unrated, determined to be of
comparable quality by the Sub-Advisor.
o The Fund will not invest more than 15% of its Managed Assets in any
single issuer.
o The Fund will not engage in short sales, except to the extent the Fund
engages in derivative investments to seek to hedge against interest
rate risk in connection with the Fund's use of leverage or market
risks associated with the Fund's portfolio.
o The Fund may invest up to 30% of its Managed Assets in non-U.S.
securities and may hedge the currency risk of the non-U.S. securities
using derivative instruments.
To generate additional income, the Fund may write (or sell) covered call
options on up to 35% of its Managed Assets.
FUNDAMENTAL INVESTMENT POLICIES
The Fund, as a fundamental policy, may not:
(1) Issue senior securities, as defined in the Investment Company
Act of 1940, as amended, other than (i) preferred shares which immediately
after issuance will have asset coverage of at least 200%, (ii)
indebtedness which immediately after issuance will have asset coverage of
at least 300%, or (iii) the borrowings permitted by investment restriction
(2) set forth below;
(2) Borrow money, except as permitted by the Investment Company Act
of 1940, as amended, the rules thereunder and interpretations thereof or
pursuant to a Securities and Exchange Commission exemptive order;
(3) Act as underwriter of another issuer's securities, except to
the extent that the Fund may be deemed to be an underwriter within the
meaning of the Securities Act of 1933, as amended, in connection with the
purchase and sale of portfolio securities;
(4) Purchase or sell real estate, but this shall not prevent the
Fund from investing in securities of companies that deal in real estate or
are engaged in the real estate business, including real estate investment
trusts, and securities secured by real estate or interests therein and the
Fund may hold and sell real estate or mortgages on real estate acquired
through default, liquidation, or other distributions of an interest in
real estate as a result of the Fund's ownership of such securities;
(5) Purchase or sell physical commodities unless acquired as a
result of ownership of securities or other instruments (but this shall not
prevent the Fund from purchasing or selling options, futures contracts,
derivative instruments or from investing in securities or other
instruments backed by physical commodities);
3
(6) Make loans of funds or other assets, other than by entering
into repurchase agreements, lending portfolio securities and through the
purchase of securities in accordance with its investment objective,
policies and limitations; or
(7) Concentrate (invest 25% or more of total assets) the Fund's
investments in any particular industry, except that the Fund will
concentrate its assets in the following group of industries that are part
of the energy sector: transporting, processing, storing, distributing,
marketing, exploring, developing, managing and producing natural gas,
natural gas liquids (including propane), crude oil, refined petroleum
products, coal and electricity, and supplying products and services in
support of pipelines, power transmission, petroleum and natural gas
production, transportation and storage.
The Fund may incur borrowings and/or issue series of notes or other senior
securities in an amount up to 33-1/3% (or such other percentage to the extent
permitted by the Investment Company Act of 1940, as amended (the "1940 Act")) of
its total assets (including the amount borrowed) less all liabilities other than
borrowings. For a further discussion of the limitations imposed on borrowing by
the 1940 Act, please see the section entitled "Leverage Program" in the Fund's
Prospectus.
The Fund's investment objective is considered fundamental and may not be
changed without the approval of the holders of a "majority of the outstanding
voting securities" of the Fund, which includes common shares and Preferred
Shares, if any, voting together as a single class, and the holders of the
outstanding Preferred Shares, if any, voting as a single class. The remainder of
the Fund's investment policies other than the Fund's fundamental investment
restrictions listed above, including its investment strategy, are considered
non-fundamental and may be changed by the Board of Trustees of the Fund (the
"Board of Trustees") without the approval of the holders of a "majority of the
outstanding voting securities," provided that the holders of the voting
securities of the Fund receive at least 60 days prior written notice of any
change. When used with respect to particular shares of the Fund, a "majority of
the outstanding voting securities" means (i) 67% or more of the shares present
at a meeting, if the holders of more than 50% of the shares are present or
represented by proxy, or (ii) more than 50% of the shares, whichever is less.
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the Fund's
investment objective, policies and techniques that are described in the Fund's
Prospectus.
Temporary Investments and Defensive Position. During the period where the
net proceeds of this offering of Common Shares, the issuance of Preferred
Shares, if any, commercial paper or notes and/or Borrowings (as defined below)
are being invested or during periods in which the Sub-Advisor determines that it
is temporarily unable to follow the Fund's investment strategy or that it is
impractical to do so, the Fund may deviate from its investment strategy and
invest all or any portion of its net assets in cash, cash equivalents or other
securities. The Sub-Advisor's determination that it is temporarily unable to
follow the Fund's investment strategy or that it is impracticable to do so
generally will occur only in situations in which a market disruption event has
4
occurred and where trading in the securities selected through application of the
Fund's investment strategy is extremely limited or absent. In such a case, the
Fund may not pursue or achieve its investment objective.
Cash and cash equivalents are defined to include, without limitation, the
following:
(1) U.S. government securities, including bills, notes and bonds
differing as to maturity and rates of interest that are either issued or
guaranteed by the U.S. Treasury or by U.S. government agencies or
instrumentalities. U.S. government agency securities include securities
issued by: (a) the Federal Housing Administration, Farmers Home
Administration, Export-Import Bank of the United States, Small Business
Administration, and the Government National Mortgage Association, whose
securities are supported by the full faith and credit of the U.S.
government; (b) the Federal Home Loan Banks, Federal Intermediate Credit
Banks, and the Tennessee Valley Authority, whose securities are supported
by the right of the agency to borrow from the U.S. Treasury; (c) the
Federal National Mortgage Association and the Federal Home Loan Mortgage
Corporation; and (d) the Student Loan Marketing Association, whose
securities are supported only by its credit. While the U.S. government
provides financial support to such U.S. government-sponsored agencies or
instrumentalities, no assurance can be given that it always will do so
since it is not so obligated by law. The U.S. government, its agencies,
and instrumentalities do not guarantee the market value of their
securities. Consequently, the value of such securities may fluctuate.
(2) Certificates of deposit issued against funds deposited in a
bank or a savings and loan association. Such certificates are for a
definite period of time, earn a specified rate of return, and are normally
negotiable. The issuer of a certificate of deposit agrees to pay the
amount deposited plus interest to the bearer of the certificate on the
date specified thereon. Under current Federal Deposit Insurance
Corporation ("FDIC") regulations, the maximum insurance payable as to any
one certificate of deposit is $250,000, therefore, certificates of deposit
purchased by the Fund may not be fully insured.
(3) Repurchase agreements, which involve purchases of debt
securities. At the time the Fund purchases securities pursuant to a
repurchase agreement, it simultaneously agrees to resell and redeliver
such securities to the seller, who also simultaneously agrees to buy back
the securities at a fixed price and time. This assures a predetermined
yield for the Fund during its holding period, since the resale price is
always greater than the purchase price and typically reflects current
market rates. Such actions afford an opportunity for the Fund to invest
temporarily available cash. Pursuant to the Fund's policies and
procedures, the Fund may enter into repurchase agreements for temporary or
defensive purposes only with respect to obligations of the U.S.
government, its agencies or instrumentalities; certificates of deposit; or
bankers' acceptances in which the Fund may invest. Repurchase agreements
may be considered loans to the seller, collateralized by the underlying
securities. The risk to the Fund is limited to the ability of the seller
to pay the agreed-upon sum on the repurchase date; in the event of
default, the repurchase agreement provides that the Fund is entitled to
5
sell the underlying collateral. If the seller defaults under a repurchase
agreement when the value of the underlying collateral is less than the
repurchase price, the Fund could incur a loss of both principal and
interest. The Sub-Advisor monitors the value of the collateral at the time
the action is entered into and at all times during the term of the
repurchase agreement. The Sub-Advisor does so in an effort to determine
that the value of the collateral always equals or exceeds the agreed-upon
repurchase price to be paid to the Fund. If the seller were to be subject
to a federal bankruptcy proceeding, the ability of the Fund to liquidate
the collateral could be delayed or impaired because of certain provisions
of the bankruptcy laws.
(4) Commercial paper, which consists of short-term unsecured
promissory notes, including variable rate master demand notes issued by
corporations to finance their current operations. Master demand notes are
direct lending arrangements between the Fund and a corporation. There is
no secondary market for such notes. However, they are redeemable by the
Fund at any time. The Sub-Advisor will consider the financial condition of
the corporation (e.g., earning power, cash flow, and other liquidity
measures) and will continuously monitor the corporation's ability to meet
all its financial obligations, because the Fund's liquidity might be
impaired if the corporation were unable to pay principal and interest on
demand. Investments in commercial paper for temporary or defensive
purposes will be limited to commercial paper rated in the highest
categories by a NRSRO and which mature within one year of the date of
purchase or carry a variable or floating rate of interest.
(5) The Fund may invest in bankers' acceptances, which are
short-term credit instruments used to finance commercial transactions.
Generally, an acceptance is a time draft drawn on a bank by an exporter or
an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by a bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
asset or it may be sold in the secondary market at the going rate of
interest for a specific maturity.
(6) The Fund may invest in bank time deposits, which are monies
kept on deposit with banks or savings and loan associations for a stated
period of time at a fixed rate of interest. There may be penalties for the
early withdrawal of such time deposits, in which case the yields of these
investments will be reduced.
(7) The Fund may invest in shares of money market funds in
accordance with the provisions of the 1940 Act, the rules thereunder and
interpretations thereof.
ADDITIONAL INFORMATION ABOUT THE FUND'S INVESTMENTS AND INVESTMENT RISKS
ENERGY SECTOR COMPANIES
Investments in the energy sector include companies that derive a majority
of their revenues or operating income from transporting, processing, storing,
distributing, marketing, exploring, developing, managing or producing natural
6
gas, NGLs (including propane), crude oil, refined petroleum products, coal or
electricity, or from supplying energy-related products and services, or any such
other companies within the energy sector as classified under GICS.
Energy sector MLPs are limited partnerships or limited liability companies
that derive at least 90% of their income from energy operations. The business of
energy sector MLPs is affected by supply and demand for energy commodities
because most MLPs derive revenue and income based upon the volume of the
underlying commodity transported, processed, distributed, and/or marketed.
Specifically, MLPs that provide natural gas processing services and MLPs that
either produce coal or receive royalties from the production of coal may be
directly affected by energy commodity prices. MLPs that provide handling and
delivery of propane or crude oil often own the underlying energy commodity, and
therefore have direct exposure to energy commodity prices, although the
Sub-Advisor seeks high quality MLPs that are able to mitigate or manage direct
margin or price exposure to commodity prices. The MLP asset class in general
could be hurt by market perception that MLPs' performance and valuation are
directly tied to commodity prices.
Some energy companies operate as "public utilities" or "local distribution
companies," and therefore are subject to rate regulation by state or federal
utility commissions. However, some energy companies or certain operations of
public utilities and local distribution companies may be subject to greater
competitive factors than utility companies, including competitive pricing in the
absence of regulated tariff rates, which could cause a reduction in revenue and
which could adversely affect profitability. Some but not all Midstream MLPs with
transmission pipeline assets are subject to government regulation concerning the
construction, pricing and operation of pipelines. In many cases, the rates and
tariffs charged by these pipelines are monitored by the Federal Energy
Regulatory Commission ("FERC") or various state regulatory agencies.
Energy MLPs in which the Fund invests generally can be classified as
Midstream MLPs, Propane MLPs and Coal MLPs.
Midstream MLP natural gas services include treating, gathering,
compression, processing, transmission and storage of natural gas and the
transportation, fractionation and storage of NGLs (primarily propane, ethane,
butane and natural gasoline). Midstream MLP crude oil services include
gathering, transportation, storage and terminalling of crude oil. Midstream MLP
refined petroleum product services include the transportation (usually via
pipelines, barges, rail cars and trucks), storage and terminalling of refined
petroleum products (primarily gasoline, diesel fuel and jet fuel) and other
hydrocarbon by-products. Midstream MLPs also may operate ancillary businesses,
including the marketing of the products and logistical services.
Propane MLP services include the distribution of propane to homeowners for
space and water heating and to commercial, industrial and agriculture customers.
Propane serves approximately 5% of the household energy needs in the United
States, largely for homes beyond the geographic reach of natural gas
7
distribution pipelines. Volumes are weather dependent and a majority of annual
cash flow is earned during the winter heating season (October through March).
Coal MLP services include the owning, leasing, managing, production and
sale of coal and coal reserves. Electricity generation is the primary use of
coal in the United States. Demand for electricity and pricing and supply of
alternative fuels to generators are the primary drivers of coal demand.
MLPs and MLP-related entities and other energy sector companies typically
achieve distribution growth by internal and external means. For example, MLPs
and MLP-related entities achieve growth internally by experiencing higher
commodity volume driven by the economy and population or a rise in domestic
energy production, and through the expansion of existing operations, including
increasing the use of underutilized capacity, pursuing projects that can
leverage and gain synergies with existing assets and pursuing so called
"greenfield projects." External growth is achieved by making accretive
acquisitions. Greenfield projects are energy-related projects built by private
joint ventures formed by energy infrastructure companies. Greenfield projects
may include the creation of a new pipeline, processing plant or storage facility
or other energy infrastructure asset that is integrated with the company's
existing assets. The primary risk involved with greenfield projects is execution
risk or construction risk. Changing project requirements, elevated costs for
labor and materials and unexpected construction hurdles all can increase
construction costs. Financing risk exists should changes in construction costs
or financial markets occur. Regulatory risk exists should changes in regulation
occur during construction or the necessary permits are not secured prior to
beginning construction. External growth is achieved by making accretive
acquisitions.
MLPs, MLP-related entities and other energy sector companies are subject
to various federal, state and local environmental laws and health and safety
laws as well as laws and regulations specific to their particular activities.
Such laws and regulations address, among other things: health and safety
standards for the operation of facilities, transportation systems and the
handling of materials; air and water pollution requirements and standards; solid
waste disposal requirements; land reclamation requirements; and requirements
relating to the handling and disposition of hazardous materials. Energy MLPs,
MLP-related entities and other energy sector companies are directly or
indirectly subject to the costs of compliance with such laws applicable to them,
and changes in such laws and regulations may adversely affect their results of
operations.
MLPs, MLP-related entities and other energy sector companies operating
interstate pipelines and related storage facilities are subject to substantial
regulation by FERC, which regulates interstate transportation rates, services
and other matters regarding natural gas pipelines including: the establishment
of rates for service; regulation of pipeline storage and liquefied natural gas
facility construction; issuing certificates of need for companies intending to
provide energy services or constructing and operating interstate pipeline and
related storage facilities; and certain other matters. FERC also regulates the
interstate transportation of crude oil and petroleum products, including:
regulation of rates and practices of oil pipeline companies; establishing equal
service conditions to provide shippers with equal access to pipeline
8
transportation; and establishment of reasonable rates for transporting petroleum
and petroleum products by pipeline.
MLPs, MLP-related entities and other energy sector companies may be
subject to liability relating to the release of substances into the environment,
including liability under federal "SuperFund" and similar state laws for
investigation and remediation of releases and threatened releases of hazardous
materials, as well as liability for injury and property damage for accidental
events, such as explosions or discharges of materials causing personal injury
and damage to property. Such potential liabilities could have a material adverse
effect upon the financial condition and results of operations of MLPs,
MLP-related entities and other energy sector companies.
MLPs, MLP-related entities and other energy sector companies are subject
to numerous business related risks, including: deterioration of business
fundamentals reducing profitability due to development of alternative energy
sources, changing demographics in the markets served, unexpectedly prolonged and
precipitous changes in commodity prices and increased competition which takes
market share; reliance on growth through acquisitions; disruptions in
transportation systems; the dependence of certain MLPs, MLP-related entities and
other energy sector companies upon the energy exploration and development
activities of unrelated third parties; availability of capital for expansion and
construction of needed facilities; a significant decrease in natural gas
production due to depressed commodity prices or otherwise; the inability of
MLPs, MLP-related entities and other energy sector companies to successfully
integrate recent or future acquisitions; and the general level of the economy.
Energy sector and energy utility companies may be adversely affected by
possible terrorist attacks in the United States and throughout the world. It is
possible that facilities of energy sector and energy utility companies, due to
the critical nature of their energy and energy utility businesses to the United
States, could be direct targets of terrorist attacks or be indirectly affected
by attacks on others. They may have to incur significant additional costs in the
future to safeguard their assets. In addition, in the past, terrorist attacks
have resulted in changes in the insurance markets making certain types of
insurance more difficult to obtain or obtainable only at significant additional
cost. To the extent terrorism results in a lower level of economic activity,
energy consumption could be adversely affected, which would reduce revenues and
impede growth. Terrorist or war related disruption of the capital markets could
also affect the ability of energy sector and energy utility companies to raise
needed capital. Moreover, global political and economic instability could affect
the operations of MLP entities and other companies in the energy sector in
unpredictable ways.
Recent Developments Regarding Commodity Prices. Although the Fund invests
in MLP, MLP-related entities and other energy sector and energy utility
companies that are, among other things, weighted towards fee-for-service
revenues (i.e., companies that have most or all of their assets in businesses
whose revenues are not tied to changes in commodity prices and/or volumes
actually shipped through or stored in their facilities), certain of the Fund's
investments and the energy sector in general may nonetheless be impacted by
changes in commodity prices. Prices of oil and other energy commodities have
declined significantly and experienced significant volatility during recent
years and oil prices have recently approached ten year lows. Companies engaged
9
in crude oil and natural gas exploration, development or production, natural gas
gathering and processing, crude oil refining and transportation and coal mining
or sales may be directly affected by the commodity prices of such natural
resources. The volatility of commodity prices may also indirectly affect certain
companies engaged in the transportation, processing, storage or distribution of
such commodities. Some companies that own the underlying commodities may be
unable to effectively mitigate or manage direct margin exposure to commodity
price levels. The energy sector as a whole may also be impacted by the
perception that the performance of energy sector companies is directly linked to
commodity prices. As a result, many companies in which the Fund may invest have
been and may continue to be adversely impacted by declines in, and volatility
of, prices of energy commodities. Demand for energy commodities has recently
declined. Reductions in production of oil and other energy commodities may lag
decreases in demand or declines in commodity prices, resulting in global
oversupply in such commodities. Slower global growth may lower demand for oil
and other energy commodities and increased exports by Iran with the end of
sanctions may increase supply, exacerbating oversupply of such commodities and
further reducing commodity prices. Continued low prices for energy commodities,
or continued volatility of such prices, could further erode such companies'
growth prospects and negatively impact such companies' ability to sustain
attractive distribution levels, which could adversely impact the net asset value
("NAV") of the common shares and the ability of the Fund to continue to pay
distributions on the common shares at current levels. Because the Fund is
focused in MLP and energy infrastructure companies operating in the industry or
group of industries that make up the energy sector of the economy, the Fund may
be more susceptible to risks associated with energy commodity prices than an
investment company that does not concentrate in such sector.
Recent Developments Regarding MLP Distributions. Recently, a number of
MLPs have reduced, suspended or eliminated their distributions. Such
distribution reductions could adversely impact the ability of the Fund to
continue to pay distributions on the common shares at current levels.
Recent Developments Regarding MLP Debt Restructurings. Adverse
developments in the energy sector may result in MLPs seeking to restructure debt
or file for bankruptcy. Limited partners in such MLPs, such as the Fund, may owe
taxes on debt that is forgiven in a bankruptcy or an out-of-court restructuring,
as cancellation of debt income, which creates a tax liability for investors
without an associated cash distribution. While an MLP facing a debt
restructuring may seek to implement structures that would limit the tax
liability associated with the debt restructuring, there can be no assurance that
such structures could be successfully implemented or would not have other
adverse impacts on the Fund as an investor in the MLP.
ENERGY UTILITY COMPANIES
Investments in energy utility include companies that derive a majority of
of their revenues or operating income from providing products, services or
equipment for the generation, transmission, distribution or sale of electricity
or gas and such other companies within the electric, gas, independent power and
renewable electricity producers and multi-utilities industries as classified
under GICS.
10
Securities prices of energy utility companies are affected by supply and
demand, operating costs, government regulation, environmental factors,
liabilities for environmental damage and general civil liabilities, and rate
caps or rate changes. Although rate changes of energy utility companies usually
fluctuate in approximate correlation with financing costs due to political and
regulatory factors, rate changes ordinarily occur only following a delay after
the changes in financing costs. This factor will tend to favorably affect a
regulated energy utility company's earnings and dividends in times of decreasing
costs, but conversely, will tend to adversely affect earnings and dividends when
costs are rising. The value of regulated energy utility company securities may
tend to have an inverse relationship to the movement of interest rates. Certain
energy utility companies have experienced full or partial deregulation in recent
years. These energy utility companies are frequently more similar to industrial
companies in that they are subject to greater competition and have been
permitted by regulators to diversify outside of their original geographic
regions and their traditional lines of business. These opportunities may permit
certain energy utility companies to earn more than their traditional regulated
rates of return. Some companies, however, may be forced to defend their core
business and may be less profitable. In addition, natural disasters, terrorist
attacks, government intervention or other factors may render an energy utility
company's equipment unusable or obsolete and negatively impact profitability.
Risks that are intrinsic to energy utility companies include difficulty in
obtaining an adequate return on invested capital, difficulty in financing large
construction programs during an inflationary period, restrictions on operations
and increased cost and delays attributable to government regulation,
environmental considerations and regulation, difficulty in raising capital in
adequate amounts on reasonable terms in periods of high inflation and unsettled
capital markets, technological innovations that may render existing plants,
equipment or products obsolete, the potential impact of natural or man-made
disasters, increased costs and reduced availability of certain types of fuel,
the effects of energy conservation, the effects of a government energy policy
and lengthy delays and greatly increased costs and other problems associated
with the design, construction, licensing, regulation and operation of nuclear
facilities for electric generation, including, among other considerations, the
problems associated with the use of radioactive materials, the disposal of
radioactive wastes, shutdown of facilities or release of radiation resulting
from catastrophic events, disallowance of costs by regulators which may reduce
profitability, and changes in market structure that increase competition.
MASTER LIMITED PARTNERSHIPS
Under normal circumstances the Fund invests in equity securities issued by
energy sector MLPs and energy sector and energy utility MLP-related entities.
For purposes of this document, an MLP is a limited partnership or a limited
liability company, the interests in which (known as units) are traded on
securities exchanges or over-the-counter. Qualification as a partnership for
U.S. federal income tax purposes eliminates U.S. federal income tax on MLP
income at the entity level.
An MLP that is a limited partnership may have one or more general partners
(who may be individuals, corporations, or other partnerships) which manage the
partnership, and limited partners, which provide capital to the partnership but
have no role in its management. Typically, the general partner is owned by
11
company management or another publicly traded sponsoring corporation. When an
investor buys units in a MLP, he or she becomes a limited partner. The shares of
some general partner interests are also publicly traded which securities often
include interests in limited partner units and general partner interests.
MLPs are formed in several ways. A nontraded partnership may decide to go
public. Several nontraded partnerships may roll up into a single MLP. A
corporation may spin-off a group of assets or part of its business into a MLP of
which it is the general partner in order to realize the assets' full value on
the marketplace by selling the assets and using the cash proceeds received from
the MLP to address debt obligations or to invest in higher growth opportunities,
while retaining control of the MLP. A corporation may fully convert to a MLP,
although since 1986 the tax consequences have made this an unappealing option
for most corporations. Also, a newly formed company may operate as a MLP from
its inception.
The sponsor or general partner of an MLP and other energy sector and
energy utility companies may sell assets to MLPs in order to generate cash to
fund expansion projects or repay debt. The MLP structure essentially transfers
cash flows generated from these acquired assets directly to MLP limited partner
unit holders.
In the case of an MLP buying assets from its sponsor or general partner
the transaction is intended to be based upon comparable terms in the acquisition
market for similar assets. To help insure that appropriate protections are in
place, the board of the MLP generally creates an independent committee to review
and approve the terms of the transaction. The committee often obtains a fairness
opinion and can retain counsel or other experts to assist its evaluation. Since
both parties normally have a significant equity stake in the MLP, both parties
generally have an incentive to see that the transaction is accretive and fair to
the MLP.
MLPs tend to pay relatively higher distributions as a percentage of
earnings and cash flow than other types of companies and the Fund uses these MLP
distributions in an effort to meet its investment objective.
As a motivation for the general partner to manage the MLP successfully and
increase cash flows, the terms of MLPs typically provide that the general
partner receives a larger portion of the net income as distributions reach
higher target levels. As cash flow grows, the general partner receives a greater
interest in the incremental income compared to the interest of limited partners.
Although the percentages vary among MLPs, the general partner's marginal
interest in distributions generally increases from 2% to 15% at the first
designated distribution target level moving up to 25% and ultimately 50% as
pre-established distribution per unit thresholds are met. Nevertheless, the
aggregate amount distributed to limited partners will increase as MLP
distributions reach higher target levels. Given this incentive structure, the
general partner has an incentive to streamline operations and undertake
acquisitions and growth projects in order to increase distributions to all
partners.
Because the MLP itself does not pay U.S. federal income tax on MLP income,
its income or loss is allocated to its investors, irrespective of whether the
investors receive any cash payment from the MLP. An MLP typically makes
quarterly cash distributions. Although they resemble corporate dividends, MLP
12
distributions are treated differently for tax purposes. The MLP distribution is
treated as a return of capital to the extent of the investor's basis in its MLP
interest and, to the extent the distribution exceeds the investor's basis in the
MLP, capital gain. The investor's original basis is the price paid for the units
plus such investor's allocable share of the MLP's debt, if any. The basis is
adjusted downwards with each distribution and allocation of deductions (such as
depreciation) and losses, and upwards with each capital contribution and
allocation of taxable income. If an MLP has losses, the Fund may deduct its
share of the losses to the extent of the Fund's outside basis in the MLP. Such
allocation of losses will currently reduce the Fund's basis in the MLPs,
increasing the Fund's loss upon the sale of the MLP units.
For purposes of this Statement of Additional Information, an MLP is a
limited partnership or a limited liability company that is treated as a
partnership for federal income tax purposes. A change in current tax law, a
change in the business of a given MLP, or a change in the types of income earned
by a given MLP could result in an MLP being treated as a corporation for United
States federal income tax purposes, which would result in such MLP being
required to pay United States federal income tax on its taxable income. Also,
recent changes in regulations may cause some MLPs to be reclassified as
corporations. If the MLPs were recharacterized as corporations for federal
income tax purposes, the MLPs may themselves be subject to tax, reducing the
cash flow to the Fund. In some instances, the character of the distributions may
change if the MLPs are recharacterized. The benefit the Fund derives from its
investment in MLPs is largely dependent on MLPs being treated as partnerships
for federal income tax purposes. As a partnership, an MLP generally has no
income tax liability on MLP qualified income at the entity level. As a limited
partner in the MLPs in which it invests, the Fund is allocated its pro rata
share of income, gains, losses, deductions and expenses from the MLPs. A
significant portion of MLP income has historically been offset by non-cash tax
deductions such as depreciation and depletion. The Fund will incur a current tax
liability on its income allocation from an MLP not offset by tax deductions. The
Fund's tax basis in its MLP units would be increased by the income allocated
from an MLP, and then reduced by all distributions from the MLP (including any
distributions in excess of allocated income), which would either increase the
Fund's taxable gain or reduce the Fund's loss recognized upon the sale of such
MLP units. The MLPs may have losses instead of income, which the Fund may deduct
to the extent of its outside bases in the MLPs with the losses. Such allocations
of losses will currently reduce the Fund's bases in the MLPs, increasing the
Fund's gain or reducing the Fund's loss upon the sale of the MLP units. The
percentage of an MLP's distribution which is offset by tax deductions will
fluctuate over time for various reasons. A significant slowdown in acquisition
or investment activity by MLPs held by the Fund could result in a reduction of
accelerated depreciation or other deductions generated by these activities,
which may result in increased current tax liability to the Fund. A reduction in
the percentage of income offset by tax deductions or an increase in sales of the
Fund's MLP holdings that result in capital gains will reduce that portion of the
Fund's distribution from an MLP treated as a return of capital and increase that
portion treated as income, and may result in lower after-tax distributions to
the Fund's common shareholders.
An investment in MLP units involves risks which differ from an investment
in common stock of a corporation. Holders of MLP units have limited control and
voting rights on matters affecting the partnership. The Fund is not responsible
for operating MLPs and similar entities and cannot control or monitor their
compliance with applicable tax, securities and other laws and regulations
necessary for the profitability of such investments. Holders of MLP units could
potentially become subject to liability for all of the obligations of an MLP, if
a court determines that the rights of the unitholders parto take certain action
under the limited partnership agreement would constitute "control" of the
13
business of that MLP, or if a court or governmental agency determines that the
MLP is conducting business in a state without complying with the limited
partnership statute of that state.
Furthermore, the structures and terms of the MLPs and other entities
described in this Statement of Additional Information may not be indicative of
the structure and terms of every entity in which the Fund invests. Although the
energy sector has grown significantly in past years, such market trends may not
exist from time to time due to economic conditions, which are not predictable,
or other factors. In addition, certain conflicts of interest exist between
common unit holders and the general partner, including those arising from
incentive distribution payments. Conflicts of interest may arise from incentive
distribution payments paid to the general partner, or referral of business
opportunities by the general partner or one of its affiliates to an entity other
than the MLP. Holders of general partner or managing member interests typically
receive incentive distribution rights, which provide them with an increasing
share of the entity's aggregate cash distributions upon the payment of per
common unit quarterly distributions that exceed specified threshold levels above
an established minimum amount ("minimum quarterly distribution" or "MQD"). The
ability of the limited partners or members to remove the general partner or
managing member without cause is typically very limited. In addition, some MLPs
permit the holder of incentive distribution rights to reset, under specified
circumstances, the incentive distribution levels and receive compensation in
exchange for the distribution rights given up in the reset.
The federal income tax rules relating to the auditing of partnerships and
partners have recently changed. The Fund may have little input in any audit
asserted against an MLP and may be contractually or legally obligated to make
payments in regard to deficiencies asserted without the ability to put forward
an independent defense.
For a further discussion and a description of MLP tax matters, see the
section entitled "Federal Tax Matters."
THE FUND'S INVESTMENTS
The types of securities in which the Fund may invest include, but are not
limited to, the following:
Equity Securities of MLPs and MLP-Related Entities. The Fund invests in
equity securities issued by energy sector MLPs and energy sector and energy
utility MLP-related entities (such as general partners, parent or sponsor
corporations or other affiliates of the MLPs). Equity securities currently
consist of common units and subordinated units of MLPS, and I-Shares, which
represent an ownership interest of an MLP issued by an affiliated party, and
common stock of MLP-related entities, such as general partners or other
affiliates of the MLPs. The Fund also may invest in equity or debt securities of
non-MLPs or energy sector or energy utility companies.
The value of equity securities will be affected by changes in the stock
markets, which may be the result of domestic or international political or
economic news, changes in interest rates or changing investor sentiment. At
times, stock markets can be volatile and stock prices can change substantially.
Equity securities risk will affect the Fund's NAV per share, which will
14
fluctuate as the value of the securities held by the Fund change. Not all stock
prices change uniformly or at the same time, and not all stock markets move in
the same direction at the same time. Other factors affect a particular stock's
price, such as poor earnings reports by an issuer, loss of major customers,
major litigation against an issuer or changes in governmental regulations
affecting an industry. Adverse news affecting one company can sometimes depress
the stock prices of all companies in the same industry. Not all factors can be
predicted.
Certain of the MLPs, MLP-related entities and other energy sector and
energy utility companies in which the Fund invests and may in the future invest
may have comparatively smaller capitalizations. Investing in securities of
smaller MLPs, MLP-related entities and other energy sector and energy utility
companies may involve greater risk than is associated with investing in more
established MLPs, MLP-related entities and other energy sector and energy
utility companies. Smaller capitalization MLPs, MLP-related entities and other
energy sector and energy utility companies may have limited product lines,
markets or financial resources; may lack management depth or experience; and may
be more vulnerable to adverse general market or economic developments than
larger more established MLPs, MLP-related entities and other energy sector and
energy utility companies.
MLP Common Units. MLP common units represent a limited partnership
interest in an MLP and may be listed and traded on U.S. securities exchanges or
over-the-counter with their value fluctuating predominantly based on prevailing
market conditions (such as changes in interest rates) and the success of the
MLP. The Fund purchases common units in market transactions but may also
purchase securities directly from the MLP or other parties in private
placements. Unlike owners of common stock of a corporation, owners of common
units typically have limited voting rights and, in most instances, have no
ability to annually elect directors. MLPs generally distribute all available
cash flow (cash flow from operations less maintenance capital expenditures) in
the form of quarterly distributions. Common unit holders have first priority
over any subordinated shares to receive quarterly cash distributions up to the
MQD (Minimum Quarterly Distribution) and have arrearage rights. In the event of
liquidation, common unit holders have preference over subordinated unit holders,
but not debt holders or preferred unit holders, to the remaining assets of the
MLP. MLPs also issue different classes of common units that may have different
voting, trading and distribution rights. MLPs also may issue new classes of
units, such as class B units, that contain distinct structural modifications.
For example, a new class of equity could be used to issue securities that do not
receive a distribution for some specified period before converting into standard
common units.
MLP Subordinated Units. MLP subordinated units typically are issued by
MLPs to their original sponsors, such as their founders, management teams,
corporate general partners of MLPs, entities that sell assets to MLPs and
institutional investors. The Fund may purchase subordinated units directly from
these persons. Subordinated units have similar limited voting rights as common
units and are generally not listed on an exchange nor publicly traded. Once the
MQD on the common units, including arrearage, has been paid, subordinated units
will receive cash distributions up to the MQD prior to any incentive payments to
the MLP's general partner. Unlike common units, subordinated units do not have
arrearage rights. In the event of liquidation, common units and general partner
interests have priority over subordinated units. Subordinated units are
typically converted into common units on a one-to-one basis after certain time
15
periods and/or performance targets have been satisfied. Subordinated units are
generally valued based on the price of the common units, discounted to reflect
the timing or likelihood of their conversion to common units and other factors.
MLP I-Shares. I-Shares represent an ownership interest issued by an
affiliated party of an MLP. The MLP affiliate uses the proceeds from the sale of
I-Shares to purchase limited partnership interests in the MLP in the form of
I-Units. I-Units have features similar to MLP common units in terms of voting
rights, liquidation preference and distributions. However, rather than receiving
cash, the MLP affiliate holding I-units receives distributions in the form of
additional I-Units in an amount equal to the cash distributions received by the
holders of MLP common units. Similarly, holders of I-Shares will receive
additional I-Shares, in the same proportion as the MLP affiliate's receipt of
I-Units, rather than cash distributions. I-Shares themselves have limited voting
rights similar to those applicable to MLP common units. While not precise, the
price of I-Shares and their volatility tend to be correlated to the price of
common units. I-Shares are subject to the same risks as MLP common units.
The MLP affiliate issuing the I-Shares is structured as a corporation for
U.S. federal income tax purposes. As a result, I-Shares holders, such as the
Fund, will receive a Form 1099 rather than a Form K-1 statement. I-Shares are
typically listed and traded on the New York Stock Exchange (the "NYSE") and the
NYSE MKT.
Equity Securities of Energy Sector and Energy Utility Companies. The Fund
may invest in equity securities issued by energy sector and energy utility
companies which are not MLPs. The Fund purchases these equity securities in
market transactions but also may purchase securities directly from the issuers
in private placements. To generate additional income, the Fund may write (or
sell), covered call options on the common stock of energy sector and energy
utility companies held in the Fund's portfolio. The Fund may also sell covered
call options on MLPs, MLP I-Shares and MLP-related entities.
Private Investment in a Public Entity ("PIPE"). PIPE investors purchase
securities directly from publicly traded companies in a private placement
transaction, typically at a discount to the market price of the company's common
stock. Because the sale of the securities is not registered under the Securities
Act of 1933, as amended (the "1933 Act"), the securities are "restricted" and
cannot be immediately resold by the investors into the public markets. Until the
Fund can sell such securities into the public markets, the Fund's holdings, if
any, will be less liquid and any sale will need to be made pursuant to an
exemption under the 1933 Act.
Collective Investment Vehicles. The Fund's investments in MLP-related
entities include investments in collective investment vehicles (i.e.,
exchange-traded funds and other registered funds such as closed-end funds) that
primarily hold MLP interests. There is risk that the Fund may suffer losses due
to the investment practices or operations of such collective investment
vehicles. The use of leverage by these vehicles magnifies gains and losses on
amounts invested and increases the risks associated with investing in such
vehicles. Further, although the Fund seeks to invest in collective investment
vehicles (if at all) that primarily hold MLP interests, the vehicles are not
subject to the Fund's investment policies and restrictions. The Fund cannot
dictate how the collective investment vehicles invest their assets. These
16
vehicles may invest their assets in securities and other instruments, and may
use investment techniques and strategies, that are not described in the
Prospectus. To the extent the Fund invests in collective investment vehicles,
the common shareholders of the Fund bear two layers of fees and expenses with
respect to such investments because each of the Fund and the vehicles in which
the Fund invests charge fees and incur separate expenses.
Other Equity Securities. The Fund may invest in common and preferred
stock, convertible securities, warrants and depositary receipts of companies
that are organized as corporations, limited liability companies or limited
partnerships (other than MLPs). The Fund intends to purchase these equity
securities in market transactions but may also purchase securities directly from
the issuers in private placements. Only those convertible securities that are in
the money and immediately convertible into equity securities will be treated as
equity securities for purposes of the Fund's policy to invest, under normal
market conditions, at least 85% of its Managed Assets in equity and debt
securities of MLPs, MLP-related entities and other energy sector and energy
utility companies.
Common stock generally represents an equity ownership interest in an
issuer. Although common stocks have historically generated higher average total
returns than fixed-income securities over the long term, common stocks also have
experienced significantly more volatility in those returns and may underperform
relative to fixed-income securities during certain periods. An adverse event,
such as an unfavorable earnings report, may depress the value of a particular
common stock held by the Fund. Also, prices of common stocks are sensitive to
general movements in the stock market and a drop in the stock market may depress
the price of common stocks to which the Fund has exposure. Common stock prices
fluctuate for several reasons including changes in investors' perceptions of the
financial condition of an issuer or the general condition of the relevant stock
market, or the occurrence of political or economic events which effect the
issuers. In addition, common stock prices may be particularly sensitive to
rising interest rates, which increases borrowing costs and the costs of capital.
Preferred stock has a preference over common stock in liquidation (and
generally as to dividends as well) but is subordinated to the liabilities of the
issuer in all respects. As a general rule, the market value of preferred stock
with a fixed dividend rate and no conversion element varies inversely with
interest rates and perceived credit risk, while the market price of convertible
preferred stock generally also reflects some element of conversion value.
Because preferred stock is junior to debt securities and other obligations of
the issuer, deterioration in the credit quality of the issuer will cause greater
changes in the value of a preferred stock than in a more senior debt security
with similarly stated yield characteristics. The market value of preferred stock
will also generally reflect whether (and if so when) the issuer may force
holders to sell their preferred shares back to the issuer and whether (and if so
when) the holders may force the issuer to buy back their preferred shares.
Generally, the right of the issuer to repurchase the preferred stock tends to
reduce any premium that the preferred stock might otherwise trade at due to
interest rate or credit factors, while the right of the holders to require the
issuer to repurchase the preferred stock tends to reduce any discount that the
preferred stock might otherwise trade at due to interest rate or credit factors.
In addition, some preferred stocks are non-cumulative, meaning that the
dividends do not accumulate and need not ever be paid. A portion of the Fund's
portfolio may include investments in non-cumulative preferred securities,
17
whereby the issuer does not have an obligation to make up any arrearages to its
shareholders. There is no assurance that dividends or distributions on
non-cumulative preferred stocks in which the Fund invests will be declared or
otherwise paid. Preferred stock of certain companies offers the opportunity for
capital appreciation as well as periodic income. This may be particularly true
in the case of companies that have performed below expectations. If a company's
performance has been poor enough, its preferred stock may trade more like common
stock than like other fixed income securities, which may result in above average
appreciation if the company's performance improves.
A convertible security is a preferred stock, warrant or other security
that may be converted into or exchanged for a prescribed amount of common stock
or other security of the same or a different issuer or into cash within a
particular period of time at a specified price or formula. A convertible
security generally entitles the holder to receive the dividend paid on preferred
stock until the convertible security matures or is redeemed, converted or
exchanged. Before conversion, convertible securities generally have
characteristics similar to both fixed income and equity securities. The value of
convertible securities tends to decline as interest rates rise and, because of
the conversion feature, tends to vary with fluctuations in the market value of
the underlying securities. Convertible securities ordinarily provide a stream of
income with generally higher yields than those of common stock of the same or
similar issuers. Convertible securities generally rank senior to common stock in
a corporation's capital structure but are usually subordinated to comparable
non-convertible securities. Convertible securities generally do not participate
directly in any dividend increases or decreases of the underlying securities
although the market prices of convertible securities may be affected by any
dividend changes or other changes in the underlying securities.
Debt Securities. The Fund may invest up to 20% of its Managed Assets in
debt securities of MLPs, MLP-related entities and other energy sector and energy
utility companies, including securities rated below investment grade. The debt
securities in which the Fund may invest may provide for fixed or variable
principal payments and various types of interest rate and reset terms, including
fixed rate, adjustable rate, zero coupon, contingent, deferred, payment-in-kind
and auction rate features. Certain debt securities are "perpetual" in that they
have no maturity date. Certain debt securities are zero coupon bonds. A zero
coupon bond is a bond that does not pay interest either for the entire life of
the obligations or for an initial period after the issuance of the obligation.
To the extent that the Fund invests in below investment grade debt securities,
such securities will be rated, at the time of investment, at least "B-" by S&P's
or "B3" by Moody's or a comparable rating by at least one other rating agency
or, if unrated, determined by the Sub-Advisor to be of comparable quality. If a
security satisfies the Fund's minimum rating criteria at the time of purchase
and is subsequently downgraded below such rating, the Fund will not be required
to dispose of such security. If a downgrade occurs, the Sub-Advisor will
consider what action, including the sale of such security, is in the best
interest of the Fund and its shareholders. In light of the risks of below
investment grade securities, the Sub-Advisor, in evaluating the creditworthiness
of an issue, whether rated or unrated, will take various factors into
consideration, which may include, as applicable, the issuer's operating history,
financial resources and its sensitivity to economic conditions and trends, the
market support for the facility financed by the issue (if applicable), the
perceived ability and integrity of the issuer's management and regulatory
matters.
18
Below Investment Grade Debt Securities. The Fund may invest in below
investment grade securities. The below investment grade debt securities in which
the Fund invests are rated from "B3" to Bal by Moody's, from "B-" to "BB+" by
S&P's, are comparably rated by another nationally recognized rating agency or
are unrated but determined by the Sub-Advisor to be of comparable quality.
Investment in below investment grade securities involves substantial risk
of loss. Below investment grade debt securities or comparable unrated securities
are commonly referred to as "high yield" or "junk" bonds and are considered
predominantly speculative with respect to the issuer's ability to pay interest
and principal and are susceptible to default or decline in market value due to
adverse economic and business developments. 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, to the extent the Fund
invests in below investment grade securities, your investment in the Fund is
subject to the following specific risks:
o increased price sensitivity to changing interest rates and to a
deteriorating economic environment;
o greater risk of loss due to default or declining credit quality;
o adverse company specific events are more likely to render the issuer
unable to make interest and/or principal payments; and
o if a negative perception of the below investment grade debt market
develops, the price and liquidity of below investment grade debt
securities may be depressed. This negative perception could last for a
significant period of time.
Adverse changes in economic conditions are more likely to lead to a
weakened capacity of a below investment grade debt issuer to make principal
payments and interest payments than an investment grade issuer. The principal
amount of below investment grade securities outstanding has proliferated in the
past decade as an increasing number of issuers have used below investment grade
securities for corporate financing. An economic downturn could severely affect
the ability of highly leveraged issuers to service their debt obligations or to
repay their obligations upon maturity. Similarly, down-turns in profitability in
specific sectors and industries, such as the energy sector, could adversely
affect the ability of below investment grade debt issuers in that sector or
industry to meet their obligations. The market values of lower quality debt
securities tend to reflect individual developments of the issuer to a greater
extent than do higher quality securities, which react primarily to fluctuations
in the general level of interest rates. Factors having an adverse impact on the
market value of lower quality securities may have an adverse effect on the
Fund's NAV and the market value of its common shares. In addition, the Fund may
incur additional expenses to the extent it is required to seek recovery upon a
default in payment of principal or interest on its portfolio holdings. In
certain circumstances, the Fund may be required to foreclose on an issuer's
assets and take possession of its property or operations. In such circumstances,
the Fund would incur additional costs in disposing of such assets and potential
liabilities from operating any business acquired.
19
The secondary market for below investment grade securities may not be as
liquid as the secondary market for more highly rated securities, a factor which
may have an adverse effect on the Fund's ability to dispose of a particular
security when necessary to meet its liquidity needs. There are fewer dealers in
the market for below investment grade securities than investment grade
obligations. The prices quoted by different dealers may vary significantly and
the spread between the bid and asked price is generally much larger than higher
quality instruments. Under adverse market or economic conditions, the secondary
market for below investment grade securities could contract further, independent
of any specific adverse changes in the conditions of a particular issuer, and
these instruments 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.
Because investors generally perceive that there are greater risks
associated with lower quality debt securities of the type in which the Fund may
invest a portion of its assets, the yields and prices of such securities may
tend to fluctuate more than those for higher rated securities. In the lower
quality segments of the debt securities market, changes in perceptions of an
issuer's creditworthiness tend to occur more frequently and in a more pronounced
manner than do changes in higher quality segments of the debt securities market,
resulting in greater yield and price volatility.
The Fund will not invest in distressed, below investment grade securities
(those that are in default or the issuers of which are in bankruptcy). If a debt
security becomes distressed while held by the Fund, the Fund may be required to
bear certain extraordinary expenses in order to protect and recover its
investments if it is recoverable at all.
See Appendix A to this Statement of Additional Information for a
description of Moody's, S&P's and Fitch's ratings.
Restricted Securities. The Fund may invest up to 20% of its Managed Assets
in unregistered or otherwise restricted securities. The term "restricted
securities" refers to securities that have not been registered under the 1933
Act and continue to be subject to restrictions on resale, securities held by
control persons of the issuer and securities that are subject to contractual
restrictions on their resale. As a result, restricted securities may be more
difficult to value and the Fund may have difficulty disposing of such assets
either in a timely manner or for a reasonable price. The Sub-Advisor has the
ability to deem restricted securities as liquid. Absent an exemption from
registration, the Fund will be required to hold the securities until they are
registered by the issuer. In order to dispose of an unregistered security, the
Fund, where it has contractual rights to do so, may have to cause such security
to be registered. A considerable period may elapse between the time the decision
is made to sell the security and the time the security is registered so that the
Fund could sell it. Contractual restrictions on the resale of securities vary in
length and scope and are generally the result of a negotiation between the
issuer and acquirer of the securities. The Fund would, in either case, bear
market risks during that period.
In recent years, a large institutional market has developed for certain
securities that are not registered under the 1933 Act, including private
placements, repurchase agreements, commercial paper, foreign securities and
20
corporate bonds and notes. These instruments are often restricted securities
because the securities are either themselves exempt from registration or sold in
transactions not requiring registration, such as Rule 144A transactions.
Institutional investors generally will not seek to sell these instruments to the
general public, but instead will often depend on an efficient institutional
market in which such unregistered securities can be readily resold or on an
issuer's ability to honor a demand for repayment. Therefore, the fact that there
are contractual or legal restrictions on resale to the general public or certain
institutions is not dispositive of the liquidity of such investments.
Rule 144A under the 1933 Act establishes a "safe harbor" from the
registration requirements of the 1933 Act for resales of certain securities to
qualified institutional buyers. Institutional markets for restricted securities
that exist or may develop as a result of Rule 144A may provide both readily
ascertainable values for restricted securities and the ability to liquidate an
investment. An insufficient number of qualified institutional buyers interested
in purchasing Rule 144A-eligible securities held by the Fund, however, could
affect adversely the marketability of such portfolio securities and the Fund
might be unable to dispose of such securities promptly or at reasonable prices.
Thinly-Traded Securities. The Fund also may invest in securities that may
not be restricted, but are thinly-traded. Although common units of MLPs,
I-Shares of MLP-related entities and common stock of certain energy sector and
energy utility companies trade on the NYSE, The Nasdaq Stock Market LLC
("Nasdaq") or other securities exchanges or markets, such securities may trade
less than those of larger companies due to their relatively smaller
capitalizations. Such securities may be difficult to dispose of at a fair price
during times when the Fund believes it is desirable to do so. Thinly-traded
securities also are more difficult to value and the Sub-Advisor's judgment as to
value will often be given greater weight than market quotations, if any exist.
If market quotations are not available, thinly-traded securities will be valued
in accordance with procedures established by the Board. Investment of the Fund's
capital in thinly-traded securities may restrict the Fund's ability to take
advantage of market opportunities. The risks associated with thinly-traded
securities may be particularly acute in situations in which the Fund's
operations require cash and could result in the Fund borrowing to meet its short
term needs or incurring losses on the sale of thinly-traded securities.
Non-U.S. Securities. The Fund may invest in non-U.S. securities and may
hedge the currency risk of the non-U.S. securities using Strategic Transactions.
A fund that invests in non-U.S. securities may experience more rapid and extreme
changes in value than a fund that invests exclusively in securities of U.S.
companies. The securities markets of many foreign countries are relatively
small, with a limited number of companies representing a small number of
industries. Investments in foreign securities (including those denominated in
U.S. dollars) are subject to economic and political developments in the
countries and regions where the issuers operate or are domiciled, or where the
securities are traded, such as changes in economic or monetary policies. Values
may also be affected by restrictions on receiving the investment proceeds from a
foreign country. Less information may be publicly available about foreign
companies than about U.S. companies. Foreign companies are generally not subject
to the same accounting, auditing and financial reporting standards as are U.S.
companies. In addition, the Fund's investments in non-U.S. securities may be
subject to the risk of nationalization or expropriation of assets, imposition of
21
currency exchange controls or restrictions on the repatriation of foreign
currency, confiscatory taxation, political or financial instability and adverse
diplomatic developments. In addition, there may be difficulty in obtaining or
enforcing a court judgment abroad. Dividends or interest on, or proceeds from
the sale of, non-U.S. securities may be subject to non-U.S. withholding taxes,
and special U.S. tax considerations may apply.
The risks of foreign investment are greater for investments in emerging
markets. Emerging market countries typically have economic and political systems
that are less fully developed, and that can be expected to be less stable, than
those of more advanced countries. Low trading volumes may result in a lack of
liquidity and in price volatility. Emerging market countries may have policies
that restrict investment by foreigners, that require governmental approval prior
to investments by foreign persons, or that prevent foreign investors from
withdrawing their money at will. An investment in emerging market securities
should be considered speculative.
The Fund also may invest in foreign government debt, which includes bonds
that are issued or backed by foreign governments or their agencies,
instrumentalities or political subdivisions or by foreign central banks. The
governmental authorities that control the repayment of the debt may be unable or
unwilling to repay principal and/or interest when due in accordance with terms
of such debt, and the Fund may have limited legal recourse in the event of
default. Continuing uncertainty as to the status of the Euro and the European
Monetary Union and the potential for certain countries to withdraw from the
institution has created significant volatility in currency and financial markets
generally. Any partial or complete dissolution of the European Union ("EU")
could have significant adverse effects on currency and financial markets, and on
the values of a Fund's portfolio investments. The United Kingdom's referendum on
June 23, 2016 to leave the European Union (known as "Brexit") sparked
depreciation in the value of the British pound, short-term declines in the stock
markets and heightened risk of continued economic volatility worldwide. Although
the long-term effects of Brexit are difficult to gauge and cannot be fully
known, they could have wide ranging implications for the United Kingdom's
economy, including: possible inflation or recession, continued depreciation of
the pound, or disruption to Britain's trading arrangements with the rest of
Europe. The United Kingdom is one of the EU's largest economies; its departure
also may negatively impact the EU and Europe as a whole, such as by causing
volatility within the union, triggering prolonged economic downturns in certain
European countries or sparking additional member states to contemplate departing
the EU (thereby perpetuating political instability in the region).
The cost of servicing external debt will also generally be adversely
affected by rising international interest rates, as many external debt
obligations bear interest at rates which are adjusted based upon international
interest rates. Because non-U.S. securities may trade on days when the Fund's
common shares are not priced and the NYSE is closed, NAV can change at times
when common shares cannot be sold.
Because the Fund may invest in securities or other instruments denominated
or quoted in currencies other than the U.S. dollar, changes in foreign currency
exchange rates may affect the value of instruments held by the Fund and the
22
unrealized appreciation or depreciation of investments. Currencies of certain
countries may be volatile and therefore may affect the value of instruments
denominated in such currencies, which means that NAV could decline as a result
of changes in the exchange rates between foreign currencies and the U.S. dollar.
The Fund may incur costs in connection with the conversions between various
currencies. In addition, certain countries may impose foreign currency exchange
controls or other restrictions on the repatriation, transferability or
convertibility of currency.
Continuing uncertainty as to the status of the euro and the European
Monetary Union (the "EMU") has created significant volatility in currency and
financial markets generally. Any partial or complete dissolution of the EMU
could have significant adverse effects on currency and financial markets, and on
the values of the Fund's portfolio investments. If one or more EMU countries
were to stop using the euro as its primary currency, the Fund's investments in
such countries, if any, may be redenominated into a different or newly adopted
currency. As a result, the value of those investments could decline
significantly and unpredictably. In addition, instruments or other investments
that are redenominated may be subject to foreign currency risk, liquidity risk
and valuation risk to a greater extent than similar investments currently
denominated in euros.
Margin Borrowing. Although it does not currently intend to, the Fund may
in the future use margin borrowing of up to 33-1/3% of total assets (together
with other Fund borrowings and senior securities) for investment purposes when
the Sub-Advisor believes it will enhance returns. Margin borrowings by the Fund
create certain additional risks. For example, should the securities that are
pledged to brokers to secure margin accounts decline in value, or should brokers
from which the Fund has borrowed increase their maintenance margin requirements
(i.e., reduce the percentage of a position that can be financed), then the Fund
could be subject to a "margin call," pursuant to which it must either deposit
additional funds with the broker or suffer mandatory liquidation of the pledged
securities to compensate for the decline in value. In the event of a precipitous
drop in the value of the assets of the Fund, it might not be able to liquidate
assets quickly enough to pay off the margin debt and might suffer mandatory
liquidation of positions in a declining market at relatively low prices, thereby
incurring substantial losses. For these reasons, the use of borrowings for
investment purposes is considered a speculative investment practice.
COVERED CALL OPTION TRANSACTIONS
The Fund may write (or sell) covered call options on up to 35% of its
Managed Assets. Call options are contracts representing the right to purchase a
common stock at a specified price (the "strike price") at a specified future
date (the "expiration date"). The price of the option is determined from trading
activity in the broad options market, and generally reflects the relationship
between the current market price for the underlying common stock and the strike
price, as well as the time remaining until the expiration date. The Fund writes
call options only if they are "covered." In the case of a call option on a
common stock or other security, the Fund considers an option to be "covered" if
the Fund owns the security underlying the call.
23
If an option written by the Fund expires unexercised, the Fund realizes on
the expiration date a capital gain equal to the premium received by the Fund at
the time the option was written. If an option purchased by the Fund expires
unexercised, the Fund realizes a capital loss equal to the premium paid at the
time the option expires. Prior to the earlier of exercise or expiration, an
exchange-traded option may be closed out by an offsetting purchase or sale of an
option of the same series (type, underlying security, exercise price, and
expiration). There can be no assurance, however, that a closing purchase or sale
transaction can be effected when the Fund desires. The Fund may sell put or call
options it has previously purchased, which could result in a net gain or loss
depending on whether the amount realized on the sale is more or less than the
premium and other transaction costs paid on the put or call option purchased.
STRATEGIC TRANSACTIONS
The Fund may, but is not required to, enter into various hedging and
strategic transactions to seek to reduce interest rate risks arising from the
use of leverage by the Fund, to facilitate portfolio management and mitigate
risks, including, without limitation, interest rate, currency and credit risks
and equity security price risk. Certain of these hedging and strategic
transactions involve derivative instruments. A derivative is a financial
instrument whose performance is derived at least in part from the performance of
an underlying index, security or asset. The values of certain derivatives can be
affected dramatically by even small market movements, sometimes in ways that are
difficult to predict. There are many different types of derivatives, with many
different uses. The Fund may purchase and sell derivative instruments such as
exchange-listed and over-the-counter put and call options on currencies,
securities, energy-related commodities, equity, fixed income and interest rate
indices, and other financial instruments, purchase and sell financial futures
contracts and options thereon, enter into various interest rate transactions
such as swaps, caps, floors, collars or credit transactions and credit default
swaps. The Fund also may purchase derivative instruments that combine features
of these instruments. Collectively, all of the above are referred to as
"Strategic Transactions." The Fund generally seeks to use Strategic Transactions
as a portfolio management or hedging technique to seek to protect against
possible adverse changes in the market value of securities held in or to be
purchased for the Fund's portfolio, protect the value of the Fund's portfolio,
facilitate the sale of certain securities for investment purposes, manage the
effective interest rate and currency exposure of the Fund, including the
effective yield paid on any leverage issued by the Fund, or establish positions
in the derivatives markets as a temporary substitute for purchasing or selling
particular securities. Certain Strategic Transactions may provide investment
leverage to the Fund's portfolio. See "Leverage Program" in the Fund's
Prospectus. Market conditions determine whether and in what circumstances the
Fund employs any of the hedging and strategic techniques described below. The
Fund incurs brokerage and other costs in connection with its hedging
transactions. No assurance can be given that these practices will achieve the
desired result. The successful utilization of Strategic Transactions requires
skills different from those needed in the selection of the Fund's portfolio. See
"Other Investment Policies and Techniques" below for further discussion of
Strategic Transactions and their associated risks.
24
Options on Securities and Securities Indices. The Fund may purchase and
write (sell) call and put options on any securities and securities indices.
These options may be listed on national domestic securities exchanges or foreign
securities exchanges or traded in the over-the-counter market. The Fund may
write covered put and call options and purchase put and call options as a
substitute for the purchase or sale of securities or to protect against declines
in the value of the portfolio securities and against increases in the cost of
securities to be acquired.
Writing Covered Options. The Fund may write (or sell), covered call
options on the common equities of companies held in the Fund's portfolio. A call
option on securities written by the Fund obligates the Fund to sell specified
securities to the holder of the option at a specified price if the option is
exercised at any time before the expiration date. A put option on securities
written by the Fund obligates the Fund to purchase specified securities from the
option holder at a specified price if the option is exercised at any time before
the expiration date. Options on securities indices are similar to options on
securities, except that the exercise of securities index options requires cash
settlement payments and does not involve the actual purchase or sale of
securities. In addition, securities index options are designed to reflect price
fluctuations in a group of securities or segment of the securities market rather
than price fluctuations in a single security. Writing covered call options may
deprive the Fund of the opportunity to profit from an increase in the market
price of the securities in its portfolio. Writing covered put options may
deprive the Fund of the opportunity to profit from a decrease in the market
price of the securities to be acquired for its portfolio.
All call and put options written by the Fund are covered. In the case of a
call option on a common stock or other security, the Fund considers an option to
be "covered" if the Fund owns the security underlying the call.
The Fund may terminate its obligations under an exchange traded call or
put option by purchasing an option identical to the one it has written.
Obligations under over-the-counter options may be terminated only by entering
into an offsetting transaction with the counterparty to such option. Such
purchases are referred to as "closing purchase transactions."
Writing options on portfolio securities may be considered senior
securities for the purposes of the 1940 Act, unless appropriate steps are taken
to segregate the Fund's assets or otherwise cover its obligations. The Fund will
segregate assets or otherwise cover its positions with respect to its options in
accordance with the applicable federal securities laws, the rules thereunder and
the various interpretive positions of the SEC and its staff.
Purchasing Options. The Fund would normally purchase call options in
anticipation of an increase, or put options in anticipation of a decrease
("protective puts"), in the market value of securities of the type in which it
may invest. The Fund may also sell call and put options to close out its
purchased options.
The purchase of a call option would entitle the Fund, in return for the
premium paid, to purchase specified securities or currency at a specified price
during the option period. The Fund would ordinarily realize a gain on the
purchase of a call option if, during the option period, the value of such
securities or currency exceeded the sum of the exercise price, the premium paid
25
and transaction costs; otherwise the Fund would realize either no gain or a loss
on the purchase of the call option.
The purchase of a put option would entitle the Fund, in exchange for the
premium paid, to sell specified securities at a specified price during the
option period. The purchase of protective puts is designed to offset or hedge
against a decline in the market value of the Fund's portfolio securities. Put
options may also be purchased by the Fund for the purpose of affirmatively
benefiting from a decline in the price of securities which it does not own. The
Fund would ordinarily realize a gain if, during the option period, the value of
the underlying securities decreased below the exercise price sufficiently to
cover the premium and transaction costs; otherwise the Fund would realize either
no gain or a loss on the purchase of the put option. Gains and losses on the
purchase of put options may be offset by countervailing changes in the value of
the Fund's portfolio securities.
The Fund's options transactions will be subject to limitations established
by each of the exchanges, boards of trade or other trading facilities on which
such options are traded. These limitations govern the maximum number of options
in each class which may be written or purchased by a single investor or group of
investors acting in concert, regardless of whether the options are written or
purchased on the same or different exchanges, boards of trade or other trading
facilities or are held or written in one or more accounts or through one or more
brokers. Thus, the number of options which the Fund may write or purchase may be
affected by options written or purchased by other investment advisory clients of
the Sub-Advisor. An exchange, board of trade or other trading facility may order
the liquidation of positions found to be in excess of these limits, and it may
impose certain other sanctions.
Certain Considerations Regarding Options. The hours of trading for options
may not conform to the hours during which the underlying securities are traded.
To the extent that the options markets close before the markets for the
underlying securities, significant price and rate movements can take place in
the underlying markets that cannot be reflected in the options markets. The
purchase of options is a highly specialized activity which involves investment
techniques and risks different from those associated with ordinary portfolio
securities transactions. The purchase of options involves the risk that the
premium and transaction costs paid by the Fund in purchasing an option will be
lost as a result of unanticipated movements in prices of the securities on which
the option is based. Imperfect correlation between the options and securities
markets may detract from the effectiveness of attempted hedging. Options
transactions may result in significantly higher transaction costs and portfolio
turnover for the Fund.
Risks Associated with Options Transactions. There is no assurance that a
liquid secondary market on a domestic or foreign options exchange will exist for
any particular exchange-traded option or at any particular time and, for some
options, no secondary market on an exchange or elsewhere may exist. If the Fund
is unable to effect a closing purchase transaction with respect to covered
options it has written, the Fund will not be able to sell the underlying
securities or dispose of assets held in a segregated account until the options
expire or are exercised. Similarly, if the Fund is unable to effect a closing
sale transaction with respect to options it has purchased, it would have to
26
exercise the options in order to realize any profit and will incur transaction
costs upon the purchase or sale of underlying securities or currencies.
Reasons for the absence of a liquid secondary market on an exchange
include the following: (1) there may be insufficient trading interest in certain
options; (2) restrictions may be imposed by an exchange on opening transactions
or closing transactions or both; (3) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or series of
options; (4) unusual or unforeseen circumstances may interrupt normal operations
on an exchange; (5) the facilities of an exchange or the Options Clearing
Corporation may not at all times be adequate to handle current trading volume;
or (6) one or more exchanges could, for economic or other reasons, decide or be
compelled at some future date to discontinue the trading of options (or a
particular class or series of options). If trading were discontinued, the
secondary market on that exchange (or in that class or series of options) would
cease to exist. However, outstanding options on that exchange that had been
issued by the Options Clearing Corporation as a result of trades on that
exchange would continue to be exercisable in accordance with their terms.
The Fund's ability to terminate over-the-counter options is more limited
than with exchange-traded options and may involve the risk that broker-dealers
participating in such transactions will not fulfill their obligations. The
Sub-Advisor will determine the liquidity of each over-the-counter option in
accordance with guidelines adopted by the Board of Trustees.
The writing and purchase of options is a highly specialized activity which
involves investment techniques and risks different from those associated with
ordinary portfolio securities transactions. Generally, the successful use of
options depends in part on the Sub-Advisor's ability to predict future price
fluctuations and, for hedging transactions, the degree of correlation between
the options and securities or currency markets. Imperfect correlation between
the options and securities markets may detract from the effectiveness of
attempted hedging.
Futures Contracts and Options on Futures Contracts. The Fund may purchase
and sell futures contracts based on various securities (such as U.S. government
securities) and securities indices, and any other financial instruments and
indices and purchase and write call and put options on these futures contracts.
The Fund may also enter into closing purchase and sale transactions with respect
to any of these contracts and options. All futures contracts entered into by the
Fund are traded on U.S. or foreign exchanges or boards of trade that are
licensed, regulated or approved by the Commodity Futures Trading Commission
("CFTC").
Futures Contracts. A futures contract may generally be described as an
agreement between two parties to buy and sell particular financial instruments
or currencies for an agreed price during a designated month (or to deliver the
final cash settlement price, in the case of a contract relating to an index or
otherwise not calling for physical delivery at the end of trading in the
contract).
Positions taken in the futures markets are not normally held to maturity
but are instead liquidated through offsetting transactions which may result in a
profit or a loss. While futures contracts on securities will usually be
liquidated in this manner, the Fund may instead make, or take, delivery of the
27
underlying securities or currency whenever it appears economically advantageous
to do so. A clearing organization associated with the exchange on which futures
contracts are traded guarantees that, if still open, the sale or purchase will
be performed on the settlement date.
The Fund may, for example, take a "short" position in the futures market
by selling futures contracts in an attempt to hedge against an anticipated
decline in market prices that would adversely affect the value of the Fund's
portfolio securities. Such futures contracts may include contracts for the
future delivery of securities held by the Fund or securities with
characteristics similar to those of the Fund's portfolio securities. See "Other
Investment Policies and Techniques--Hedging Strategies--Futures Contracts"
below.
Margin Requirements for Futures Contracts and Associated Risks. If the
price of an open futures contract changes (by increase in the case of a sale or
by decrease in the case of a purchase) so that the loss on the futures contract
reaches a point at which the margin on deposit does not satisfy margin
requirements, the broker will require an increase in the margin. However, if the
value of a position increases because of favorable price changes in the futures
contract so that the margin deposit exceeds the required margin, the broker will
pay the excess to the Fund. In computing daily NAV, the Fund will mark to market
the current value of its open futures contract. The Fund expects to earn
interest income on its margin deposits.
Because of the low margin deposits required, Futures Contracts trading
involves an extremely high degree of leverage. As a result, a relatively small
price movement in a Futures Contract may result in immediate and substantial
loss, as well as gain, to the investor. For example, if at the time of purchase,
10% of the value of the Futures Contract is deposited as margin, a subsequent
10% decrease in the value of the Futures Contract would result in a total loss
of the margin deposit, before any deduction for the transaction costs, if the
account were then closed out. A 15% decrease would result in a loss equal to
150% of the original margin deposit, if the Futures Contracts were closed out.
Thus, a purchase or sale of a Futures Contract may result in losses in excess of
the amount initially invested in the Futures Contract. However, the Fund would
presumably have sustained comparable losses if, instead of the Futures Contract,
it had invested in the underlying financial instrument and sold it after the
decline.
Hedging and Other Strategies. Hedging is an attempt to establish with more
certainty than would otherwise be possible the effective price or rate of return
on portfolio securities or securities that the Fund proposes to acquire or the
exchange rate of currencies in which the portfolio securities are quoted or
denominated. When securities prices are falling, the Fund can seek to offset a
decline in the value of its current portfolio securities through the sale of
futures contracts. When securities prices are rising, the Fund, through the
purchase of futures contracts, can attempt to secure better rates or prices than
might later be available in the market when it effects anticipated purchases.
If, in the opinion of the Sub-Advisor, there is a sufficient degree of
correlation between price trends for the Fund's portfolio securities and futures
contracts based on other financial instruments, securities indices or other
indices, the Fund may also enter into such futures contracts as part of its
hedging strategy. Although under some circumstances prices of securities in the
28
Fund's portfolio may be more or less volatile than prices of such futures
contracts, the Sub-Advisor will attempt to estimate the extent of this
volatility difference based on historical patterns and compensate for any
differential by having the Fund enter into a greater or lesser number of futures
contracts or by attempting to achieve only a partial hedge against price changes
affecting the Fund's portfolio securities.
When a short hedging position is successful, any depreciation in the value
of portfolio securities will be substantially offset by appreciation in the
value of the futures position. On the other hand, any unanticipated appreciation
in the value of the Fund's portfolio securities would be substantially offset by
a decline in the value of the futures position. On other occasions, the Fund may
take a "long" position by purchasing futures contracts.
Options on Futures Contracts. The purchase of put and call options on
futures contracts will give the Fund the right (but not the obligation) for a
specified price to sell or to purchase, respectively, the underlying futures
contract at any time during the option period. As the purchaser of an option on
a futures contract, the Fund obtains the benefit of the futures position if
prices move in a favorable direction but limits its risk of loss in the event of
an unfavorable price movement to the loss of the premium and transaction costs.
The writing of a call option on a futures contract generates a premium
which may partially offset a decline in the value of the Fund's assets. By
writing a call option, the Fund becomes obligated, in exchange for the premium
(upon exercise of the option) to sell a futures contract if the option is
exercised, which may have a value higher than the exercise price. Conversely,
the writing of a put option on a futures contract generates a premium which may
partially offset an increase in the price of securities that the Fund purchases.
However, the Fund becomes obligated (upon exercise of the option) to purchase a
futures contract if the option is exercised, which may have a value lower than
the exercise price. The loss incurred by the Fund in writing options on futures
is potentially unlimited and may exceed the amount of the premium received.
The holder or writer of an option on a futures contract may terminate its
position by selling or purchasing an offsetting option of the same series. There
is no guarantee that such closing transactions can be effected. The Fund's
ability to establish and close out positions on such options will be subject to
the development and maintenance of a liquid market.
Other Considerations. The Fund will engage in futures and related options
transactions either for bona fide hedging or for other purposes as permitted by
the CFTC. These purposes may include using futures and options on futures as a
substitute for the purchase or sale of securities to increase or reduce exposure
to particular markets. To the extent that the Fund is using futures and related
options for hedging purposes, futures contracts will be sold to protect against
a decline in the price of securities that the Fund owns or futures contracts
will be purchased to protect the Fund against an increase in the price of
securities it purchases. The Fund will determine that the price fluctuations in
the futures contracts and options on futures used for hedging purposes are
substantially related to price fluctuations in securities held by the Fund or
securities or instruments which it expects to purchase. As evidence of its
hedging intent, the Fund expects that on occasions on which it takes a long
futures or option position (involving the purchase of futures contracts), the
29
Fund generally will have purchased, or will be in the process of purchasing,
equivalent amounts of related securities in the cash market at the time when the
futures or option position is closed out. However, in particular cases, when it
is economically advantageous for the Fund to do so, a long futures position may
be terminated or an option may expire without the corresponding purchase of
securities or other assets.
Risks Associated with Futures Contracts and Options on Futures Contracts.
While transactions in futures contracts and options on futures may reduce
certain risks, these transactions themselves entail certain other risks. For
example, unanticipated changes in interest rates or securities prices may result
in a poorer overall performance for the Fund than if it had not entered into any
futures contracts or options transactions. Perfect correlation between the
Fund's futures positions and portfolio positions will be impossible to achieve.
In the event of an imperfect correlation between a futures position and a
portfolio position which is intended to be protected, the desired protection may
not be obtained and the Fund may be exposed to risk of loss. Under certain
market conditions, the prices of security futures contracts may not maintain
their customary or anticipated relationships to the prices of the underlying
security or index. These pricing disparities could occur, for example, when the
market for the security futures contract is illiquid, when the primary market
for the underlying security is closed, or when the reporting of transactions in
the underlying security has been delayed.
Under certain market conditions, it may also be difficult or impossible to
manage the risk from open security futures positions by entering into an
equivalent but opposite position in another contract month, on another market,
or in the underlying security. This inability to take positions to limit the
risk could occur, for example, if trading is halted across markets due to
unusual trading activity in the security futures contract or the underlying
security or due to recent news events involving the issuer of the underlying
security.
There can be no assurance that a liquid market will exist at a time when
the Fund seeks to close out a futures contract position. The Fund would continue
to be required to meet margin requirements until the position is closed,
possibly resulting in a decline in the Fund's NAV. In addition, many of the
contracts discussed above are relatively new instruments without a significant
trading history. As a result, there can be no assurance that an active secondary
market will develop or continue to exist.
Some futures contracts or options on futures may become illiquid under
adverse market conditions. In addition, the value of a position in security
futures contracts could be affected if trading is halted in either the futures
contract or the underlying security. In certain circumstances, such as during
periods of market volatility, a commodity exchange may suspend or limit trading
in a futures contract or related option, which may make the instrument
temporarily illiquid and difficult to price and, thus, expose the Fund to a
potential loss. The regulated exchanges may also have discretion under their
rules to halt trading in other circumstances, such as when the exchange
determines that the halt would be advisable in maintaining a fair and orderly
market. Commodity exchanges also may establish daily limits on the amount that
the price of a futures contract or related option can vary from the previous
day's settlement price. Once the daily limit is reached, no trades may be made
that day at a price beyond the limit. This may prevent the Fund from closing out
positions and limiting its losses.
30
Each regulated exchange trading a security futures contract may also open
and close for trading at different times than other regulated exchanges trading
security futures contracts or markets trading the underlying security or
securities. Trading in security futures contracts prior to the opening or after
the close of the primary market for the underlying security may be less liquid
than trading during regular market hours.
As further discussed in this Statement of Additional Information,
transactions in futures contracts and options on futures involve brokerage
costs, require margin deposits and, in the case of contracts and options
obligating the Fund to purchase securities, require the Fund to establish a
segregated account consisting of cash or liquid securities in an amount equal to
the underlying value of such contracts and options.
Currency Exchange Transactions. The Fund may enter into currency exchange
transactions to hedge the Fund's exposure to foreign currency exchange rate risk
to the extent the Fund invests in non-U.S. denominated securities of non-U.S.
issuers. The Fund's currency transactions will be limited to portfolio hedging
involving portfolio positions. Portfolio hedging is the use of a forward
contract with respect to a portfolio security position denominated or quoted in
a particular currency. A currency forward contract is an agreement to purchase
or sell a specified currency at a specified future date (or within a specified
time period) and price set at the time of the contract. Currency forward
contracts are usually entered into with banks, foreign exchange dealers or
broker-dealers, are not exchange-traded, and are usually for less than one year,
but may be renewed.
At the maturity of a forward contract to deliver a particular currency,
the Fund may either sell the portfolio security related to such contract and
make delivery of the currency, or it may retain the security and either acquire
the currency on the spot market or terminate its contractual obligation to
deliver the currency by purchasing an offsetting contract with the same currency
trader obligating it to purchase on the same maturity date the same amount of
the currency.
It is impossible to forecast with absolute precision the market value of
portfolio securities at the expiration of a forward contract. Accordingly, it
may be necessary for the Fund to purchase additional currency on the spot market
(and bear the expense of such purchase) if the market value of the security is
less than the amount of currency that the Fund is obligated to deliver and if a
decision is made to sell the security and make delivery of the currency.
Conversely, it may be necessary to sell on the spot market some of the currency
received upon the sale of the portfolio security if its market value exceeds the
amount of currency the Fund is obligated to deliver.
If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward contract to sell the
currency. Should forward prices decline during the period between the Fund's
entering into a forward contract for the sale of a currency and the date it
enters into an offsetting contract for the purchase of the currency, the Fund
will realize a gain to the extent the price of the currency it has agreed to
sell exceeds the price of the currency it has agreed to purchase. Should forward
prices increase, the Fund will suffer a loss to the extent the price of the
31
currency it has agreed to purchase exceeds the price of the currency it has
agreed to sell. A default on the contract would deprive the Fund of unrealized
profits or force the Fund to cover its commitments for purchase or sale of
currency, if any, at the current market price.
Hedging against a decline in the value of a currency does not eliminate
fluctuations in the prices of portfolio securities or prevent losses if the
prices of such securities decline. Such transactions also preclude the
opportunity for gain if the value of the hedged currency should rise. Moreover,
it may not be possible for the Fund to hedge against a devaluation that is so
generally anticipated that the Fund is not able to contract to sell the currency
at a price above the devaluation level it anticipates. The cost to the Fund of
engaging in currency exchange transactions varies with such factors as the
currency involved, the length of the contract period, and prevailing market
conditions. Since currency exchange transactions are usually conducted on a
principal basis, no fees or commissions are involved.
Equity Swaps and Interest Rate Swaps, Collars, Caps and Floors. In order
to hedge the value of the Fund's portfolio against fluctuations in the market
value of equity securities, interest rates or commodity prices or to enhance the
Fund's income, the Fund may, but is not required to, enter into equity swaps and
various interest rate or commodity transactions such as interest rate swaps and
the purchase or sale of interest rate or commodity caps and floors. To the
extent that the Fund enters into these transactions, the Fund expects to do so
primarily to preserve a return or spread on a particular investment or portion
of its portfolio, to protect against any increase in the price of securities the
Fund anticipates purchasing at a later date, to protect against increasing
commodity prices or to manage the Fund's interest rate exposure, including, for
example, on any debt securities, including notes, or Preferred Shares issued by
the Fund for leverage purposes. The Fund uses these transactions primarily as a
hedge. However, the Fund also may invest in equity and interest rate swaps to
enhance income or to increase the Fund's yield, for example, during periods of
steep interest rate yield curves (i.e., wide differences between short-term and
long-term interest rates). The Fund is not required to hedge its portfolio and
may choose not to do so. The Fund cannot guarantee that any hedging strategies
it uses will work.
In an equity swap, the cash flows exchanged by the Fund and the
counterparty are based on the total return on some stock market index and an
interest rate (either a fixed rate or a floating rate). In an interest rate
swap, the Fund exchanges with another party their respective commitments to pay
or receive interest (e.g., an exchange of fixed rate payments for floating rate
payments). For example, if the Fund holds a debt instrument with an interest
rate that is reset only once each year, it may swap the right to receive
interest at this fixed rate for the right to receive interest at a rate that is
reset every week. This would enable the Fund to offset a decline in the value of
the debt instrument due to rising interest rates but would also limit its
ability to benefit from falling interest rates. Conversely, if the Fund holds a
debt instrument with an interest rate that is reset every week and it would like
to lock in what it believes to be a high interest rate for one year, it may swap
the right to receive interest at this variable weekly rate for the right to
receive interest at a rate that is fixed for one year. Such a swap would protect
the Fund from a reduction in yield due to falling interest rates and may permit
the Fund to enhance its income through the positive differential between one
week and one year interest rates, but would preclude it from taking full
advantage of rising interest rates.
32
The Fund usually will enter into equity and interest rate swaps on a net
basis (i.e., the two payment streams are netted out with the Fund receiving or
paying, as the case may be, only the net amount of the two payments). The net
amount of the excess, if any, of the Fund's obligations over its entitlements
with respect to each swap contract is accrued on a daily basis, and an amount of
cash or liquid instruments having an aggregate NAV at least equal to the accrued
excess is maintained in a segregated account by the Fund's custodian. If the
swap transaction is entered into on other than a net basis, the full amount of
the Fund's obligations is accrued on a daily basis, and the full amount of the
Fund's obligations will be maintained in a segregated account by the Fund's
custodian.
The Fund also may engage in interest rate or commodity transactions in the
form of purchasing or selling interest rate or commodity caps or floors. The
Fund will not sell uncovered interest rate or commodity caps or floors. The
purchase of an interest rate or commodity cap entitles the purchaser, to the
extent that a specified index exceeds a predetermined interest rate or commodity
price, to receive payments equal to the difference of the index and the
predetermined rate on a notional principal amount (i.e., the reference amount
with respect to which interest obligations are determined although no actual
exchange of principal occurs) from the party selling such interest rate or
commodity cap. The purchase of an interest rate or commodity floor entitles the
purchaser, to the extent that a specified index falls below a predetermined
interest rate or commodity price, to receive payments at the difference of the
index and the predetermined rate on a notional principal amount from the party
selling such interest rate or commodity floor.
Typically, the parties with which the Fund enters into equity and interest
rate or commodity transactions are broker-dealers and other financial
institutions. The Fund may not enter into any equity swap or interest rate swap,
cap or floor transaction unless the unsecured senior debt or the claims-paying
ability of the other party thereto is rated investment grade by at least one
NRSRO at the time of entering into such transaction or whose creditworthiness is
believed by the Sub-Advisor to be equivalent to such rating. If there is a
default by the other party to such a transaction, the Fund will have contractual
remedies pursuant to the agreements related to the transaction. The swap market
has grown substantially in recent years with a large number of banks and
investment banking firms acting both as principals and as agents utilizing
standardized swap documentation. As a result, the swap market has become
relatively liquid in comparison with other similar instruments traded in the
interbank market. Caps and floors, however, are less liquid than swaps. See
"Other Investment Policies and Techniques--Swap Agreements" below.
Credit Default Swap Agreements. The Fund may enter into credit default
swap agreements. The "buyer" in a credit default contract is obligated to pay
the "seller" a periodic stream of payments over the term of the contract
provided that no event of default on an underlying reference obligation has
occurred. If an event of default occurs, the seller must pay the buyer the "par
value" (full notional value) of the reference obligation in exchange for the
reference obligation. The Fund may be either the buyer or seller in the
transaction. If the Fund is a buyer and no event of default occurs, the Fund
loses its investment and recovers nothing. However, if an event of default
occurs, the buyer receives full notional value for a reference obligation that
may have little or no value. As a seller, the Fund receives a fixed rate of
33
income throughout the term of the contract, which typically is between six
months and three years, provided that there is no default event. If an event of
default occurs, the seller must pay the buyer the full notional value of the
reference obligation.
Credit default swaps involve greater risks than if the Fund had invested
in the reference obligation directly. In addition to general market risks,
credit default swaps are subject to illiquidity risk, counterparty risk and
credit risks. The Fund will enter into swap agreements only with counterparties
who are rated investment grade by at least one NRSRO at the time of entering
into such transaction or whose creditworthiness is believed by the Sub-Advisor
to be equivalent to such rating. A buyer also will lose its investment and
recover nothing should no event of default occur. If an event of default were to
occur, the value of the reference obligation received by the seller, coupled
with the periodic payments previously received, may be less than the full
notional value it pays to the buyer, resulting in a loss of value to the Fund.
When the Fund acts as a seller of a credit default swap agreement it is exposed
to the risks of leverage since if an event of default occurs the seller must pay
the buyer the full notional value of the reference obligation. See "Other
Investment Policies and Techniques--Swap Agreements" below.
The Fund may in the future employ new or additional investment strategies
and hedging instruments if those strategies and instruments are consistent with
the Fund's investment objective and are permissible under applicable regulations
governing the Fund.
OVER-THE-COUNTER MARKET RISK
The Fund may invest in over-the-counter securities. In contrast to the
securities exchanges, the over-the-counter market is not a centralized facility
that limits trading activity to securities of companies which initially satisfy
certain defined standards. Generally, the volume of trading in an unlisted or
over-the-counter security is less than the volume of trading in a listed
security. This means that the depth of market liquidity of some securities in
which the Fund invests may not be as great as that of other securities and, if
the Fund were to dispose of such a security, it might have to offer the
securities at a discount from recent prices, or sell the securities in small
lots over an extended period of time.
LEGISLATION RISK
At any time after the date of this Statement of Additional Information,
legislation may be enacted that could negatively affect the assets of the Fund
or the issuers of such assets. Changing approaches to regulation may have a
negative impact on entities in which the Fund invests. There can be no assurance
that future legislation, regulation or deregulation will not have a material
adverse effect on the Fund or will not impair the ability of the issuers of the
assets held in the Fund to achieve their business goals, and hence, for the Fund
to achieve its investment objective.
34
OTHER INVESTMENT POLICIES AND TECHNIQUES
HEDGING STRATEGIES
General Description of Hedging Strategies. As more fully described above,
the Fund may use derivatives or other transactions for the purpose of hedging
the Fund's exposure to an increase in the price of a security prior to its
anticipated purchase or a decrease in the price of a security prior to its
anticipated sale, to seek to reduce interest rate risks arising from the use of
any leverage by the Fund and to mitigate risks. The specific derivative
instruments to be used, or other transactions to be entered into, for such
hedging purposes may include options on currencies, common equities,
energy-related commodities, equity, fixed income and interest rate indices,
futures contracts (hereinafter referred to as "Futures" or "Futures Contracts"),
swap agreements and related instruments.
Hedging or derivative instruments on securities generally are used to
hedge against price movements in one or more particular securities positions
that the Fund owns or acquires. Such instruments may also be used to "lock-in"
recognized but unrealized gains in the value of portfolio securities. Hedging
strategies, if successful, can reduce the risk of loss by wholly or partially
offsetting the negative effect of unfavorable price movements in the investments
being hedged. However, hedging strategies also can reduce the opportunity for
gain by offsetting the positive effect of favorable price movements in the
hedged investments. The use of hedging instruments is subject to applicable
regulations of the SEC, the several options and futures exchanges upon which
they are traded, the CFTC and various state regulatory authorities.
Regulation as a "Commodity Pool." CFTC Rule 4.5 requires operators of
registered investment companies to either limit such investment companies' use
of futures, options on futures and swaps or register as a "commodity pool
operator" ("CPO") and submit to dual regulation by the CFTC and the SEC. In
order to be able to comply with the exclusion from the CPO definition pursuant
to CFTC Rule 4.5 with respect to the Fund, the Advisor must limit the Fund's
transactions in commodity futures, commodity option contracts and swaps for
non-bona fide hedging purposes by either (a) limiting the aggregate initial
margin and premiums required to establish non-bona fide hedging commodities
positions to not more than 5% of the liquidation value of the Fund's portfolio
after taking into account unrealized profits and losses on any such contract or
(b) limiting the aggregate net notional value of non-bona fide hedging
commodities positions to not more than 100% of the liquidation value of the
Fund's portfolio after taking into account unrealized profits and losses on such
positions. In the event that the Fund's investments in such instruments exceed
one of these thresholds, the Advisor would no longer be excluded from the CPO
definition and may be required to register as a CPO, and the Sub-Advisor may be
required to register as a commodity trading advisor ("CTA"). In the event the
Advisor or the Sub-Advisor is required to register as a CPO or CTA, as
applicable, it will become subject to additional recordkeeping and reporting
requirements with respect to the Fund and the Fund may incur additional expenses
as a result of the CFTC's regulatory requirements. The Advisor has claimed an
exclusion from the definition of a CPO with respect to the Fund under the
amended rules. The Sub-Advisor has also relied on an exclusion from the
definition of CTA with respect to the Fund. If, in the future, the Advisor or
Sub-Advisor is not able to rely on an exclusion from the definition of CPO or
CTA, as applicable, it will register as a CPO or CTA, as applicable, with
35
respect to the Fund. The Fund reserves the right to engage in transactions
involving futures, options thereon and swaps in accordance with the Fund's
policies.
Asset Coverage for Futures and Options Positions. The Fund complies with
the regulatory requirements of the SEC and the CFTC with respect to coverage of
options and futures positions by registered investment companies and, if the
guidelines so require, earmarks or sets aside cash, U.S. government securities,
high grade liquid debt securities and/or other liquid assets permitted by the
SEC and CFTC in a segregated custodial account in the amount prescribed.
Securities held in a segregated account cannot be sold while the futures or
options position is outstanding, unless replaced with other permissible assets,
and will be marked-to-market daily.
Futures Contracts. The Fund may enter into securities-related Futures
Contracts, including security futures contracts as an anticipatory hedge. The
Fund's hedging may include sales of Futures as an offset against the effect of
expected declines in securities prices and purchases of Futures as an offset
against the effect of expected increases in securities prices. The Fund will not
enter into Futures Contracts which are prohibited under the CEA and will, to the
extent required by regulatory authorities, enter only into Futures Contracts
that are traded on exchanges and are standardized as to maturity date and
underlying financial instrument. A security futures contract is a legally
binding agreement between two parties to purchase or sell in the future a
specific quantity of shares of a security or of the component securities of a
narrow-based security index, at a certain price. A person who buys a security
Futures Contract enters into a contract to purchase an underlying security and
is said to be "long" the contract. A person who sells a security futures contact
enters into a contract to sell the underlying security and is said to be "short"
the contract. The price at which the contract trades (the "contract price") is
determined by relative buying and selling interest on a regulated exchange.
Transaction costs are incurred when a Futures Contract is bought or sold
and margin deposits must be maintained. In order to enter into a Futures
Contract, the Fund must deposit funds with its custodian in the name of the
futures commodities merchant equal to a specified percentage of the current
market value of the contract as a performance bond. Moreover, all security
futures contracts are marked-to-market at least daily, usually after the close
of trading. At that time, the account of each buyer and seller reflects the
amount of any gain or loss on the security futures contract based on the
contract price established at the end of the day for settlement purposes.
An open position, either a long or short position, is closed or liquidated
by entering into an offsetting transaction (i.e., an equal and opposite
transaction to the one that opened the position) prior to the contract
expiration. Traditionally, most Futures Contracts are liquidated prior to
expiration through an offsetting transaction and, thus, holders do not incur a
settlement obligation. If the offsetting purchase price is less than the
original sale price, a gain will be realized. Conversely, if the offsetting sale
price is more than the original purchase price, a gain will be realized; if it
is less, a loss will be realized. The transaction costs must also be included in
these calculations. There can be no assurance, however, that the Fund will be
able to enter into an offsetting transaction with respect to a particular
Futures Contract at a particular time. If the Fund is not able to enter into an
offsetting transaction, the Fund will continue to be required to maintain the
36
margin deposits on the Futures Contract and the Fund may not be able to realize
a gain in the value of its future position or prevent losses from mounting. This
inability to liquidate could occur, for example, if trading is halted due to
unusual trading activity in either the security futures contract or the
underlying security; if trading is halted due to recent news events involving
the issuer of the underlying security; if systems failures occur on an exchange
or at the firm carrying the position; or, if the position is on an illiquid
market. Even if the Fund can liquidate its position, it may be forced to do so
at a price that involves a large loss.
Security futures contracts that are not liquidated prior to expiration
must be settled in accordance with the terms of the contract. Some security
futures contracts are settled by physical delivery of the underlying security.
At the expiration of a security futures contract that is settled through
physical delivery, a person who is long the contract must pay the final
settlement price set by the regulated exchange or the clearing organization and
take delivery of the underlying shares. Conversely, a person who is short the
contract must make delivery of the underlying shares in exchange for the final
settlement price. Settlement with physical delivery may involve additional
costs.
Other security futures contracts are settled through cash settlement. In
this case, the underlying security is not delivered. Instead, any positions in
such security futures contracts that are open at the end of the last trading day
are settled through a final cash payment based on a final settlement price
determined by the exchange or clearing organization. Once this payment is made,
neither party has any further obligations on the contract.
As noted above, margin is the amount of funds that must be deposited by
the Fund in order to initiate futures trading and to maintain the Fund's open
positions in Futures Contracts. A margin deposit is intended to ensure the
Fund's performance of the Futures Contract. The margin required for a particular
Futures Contract is set by the exchange on which the Futures Contract is traded
and may be significantly modified from time to time by the exchange during the
term of the Futures Contract.
In addition to the foregoing, imperfect correlation between the Futures
Contracts and the underlying securities may prevent the Fund from achieving the
intended hedge or expose the Fund to risk of loss. Under certain market
conditions, the prices of security futures contracts may not maintain their
customary or anticipated relationships to the prices of the underlying security
or index. These pricing disparities could occur, for example, when the market
for the security futures contract is illiquid, when the primary market for the
underlying security is closed, or when the reporting of transactions in the
underlying security has been delayed.
In addition, the value of a position in Futures Contracts could be
affected if trading is halted in either the security futures contract or the
underlying security. In certain circumstances, regulated exchanges are required
by law to halt trading in security futures contracts. For example, trading on a
particular security futures contract must be halted if trading is halted on the
listed market for the underlying security as a result of pending news,
regulatory concerns, or market volatility. Similarly, trading of a security
futures contract on a narrow-based security index must be halted under
circumstances such as where trading is halted on securities accounting for at
least 50% of the market capitalization of the index. In addition, regulated
37
exchanges are required to halt trading in all security futures contracts for a
specified period of time when the Dow Jones Industrial Average ("DJIA")
experiences one-day declines of 10%, 20% and 30%. The regulated exchanges may
also have discretion under their rules to halt trading in other circumstances -
such as when the exchange determines that the halt would be advisable in
maintaining a fair and orderly market.
A trading halt, either by a regulated exchange that trades security
futures or an exchange trading the underlying security or instrument, could
prevent the Fund from liquidating a position in security futures contracts in a
timely manner, which could expose the Fund to a loss.
Risks and Special Considerations Concerning Derivatives. In addition to
the risks described above, the use of Strategic Transactions involves certain
general risks and considerations, including the imperfect correlation between
the value of such instruments and the underlying assets of the Fund, which
creates the possibility that the loss on such instruments may be greater than
the gain in the value of the underlying assets in the Fund's portfolio; the loss
of principal; the possible default and insolvency of the other party to the
transaction; and illiquidity of the derivative instruments. Certain of the
Strategic Transactions in which the Fund may invest may, in certain
circumstances, give rise to a form of financial leverage, which may magnify the
risk of owning such instruments. See "Risks--Leverage Risk" in the Prospectus.
Furthermore, the ability to successfully use Strategic Transactions
depends on the ability of the Sub-Advisor to predict pertinent market movements,
which cannot be assured. Thus, the use of Strategic Transactions to generate
income, for hedging, for currency or interest rate management or other purposes
may result in losses greater than if they had not been used, may require the
Fund to sell or purchase portfolio securities at inopportune times or for prices
other than current market values, may limit the amount of appreciation the Fund
can realize on an investment or may cause the Fund to hold a security that it
might otherwise sell. In addition, there may be situations in which the
Sub-Advisor elects not to use Strategic Transactions that result in losses
greater than if they had been used. Amounts paid by the Fund as premiums and
cash or other assets held in margin accounts with respect to the Fund's
Strategic Transactions are not otherwise available to the Fund for investment
purposes.
38
With respect to some of its derivative positions, if any, the Fund will
segregate or earmark an amount of cash, cash equivalents or liquid securities on
the Fund's records in an amount equal to the face value of those positions or
otherwise in accordance with SEC staff guidance. The Fund also may offset
derivatives positions against one another or against other assets to manage the
effective market exposure resulting from derivatives in its portfolio. To the
extent that the Fund does not segregate or earmark liquid assets or otherwise
cover its obligations under any such transactions (e.g., through offsetting
positions), certain types of these transactions will be treated as senior
securities representing leverage for purposes of the requirements under the 1940
Act; and therefore, the Fund may not enter into any such transactions if the
Fund's leverage would thereby exceed the limits of the 1940 Act. In addition, to
the extent that any offsetting positions do not perform in relation to one
another as expected, the Fund may perform as if it were leveraged. The foregoing
risks concerning Strategic Transactions are more fully described below.
(1) Market Risk. Market risk is the risk that the value of the
underlying assets may go up or down. Adverse movements in the value of an
underlying asset can expose the Fund to losses. Derivative instruments may
include elements of leverage and, accordingly, fluctuations in the value
of the derivative instrument in relation to the underlying asset may be
magnified. The successful use of derivative instruments depends upon a
variety of factors, particularly the Sub-Advisor's ability to predict
correctly market movements or changes in the relationships of such hedge
instruments to the Fund's portfolio holdings, and there can be no
assurance the Sub-Advisor's judgment in this respect will be accurate.
Consequently, the use of derivatives for investment or hedging purposes
might result in a poorer overall performance for the Fund, whether or not
adjusted for risk, than if the Fund had not used derivatives.
(2) Credit/Counterparty Risk. Credit risk is the risk that a loss
is sustained as a result of the failure of a counterparty to comply with
the terms of a derivative instrument. The counterparty risk for
exchange-traded derivatives is generally lower than for over-the-counter
derivatives not cleared through a central counterparty, since generally a
clearing organization provides a guarantee of performance and cleared
derivative transactions benefit from daily mark-to-market and settlement
as well as from segregation and minimum capital requirements applicable to
intermediaries. For privately-negotiated instruments not cleared through a
central counterparty, there are no similar protections. In all
transactions, the Fund will bear the risk that the counterparty will
default, and this could result in a loss of the expected benefit of the
derivative transactions and possibly other losses to the Fund. Such
counterparty risk is accentuated in the case of contracts with longer
maturities where there is a greater risk that a specific event may prevent
or delay settlement, or where the Fund has concentrated its transactions
with a single or small group of counterparties. The Fund is not restricted
from dealing with any particular counterparty or from concentrating any or
all of its transactions with one counterparty. The Fund will enter into
transactions in derivative instruments only with counterparties that the
Sub-Advisor reasonably believes are capable of performing under the
contract.
39
(3) Correlation Risk. Correlation risk is the risk that there might
be an imperfect correlation, or even no correlation, between price
movements of a derivative instrument and price movements of investments
being hedged. When a derivative transaction is used to completely hedge
another position, changes in the market value of the combined position
(the derivative instrument plus the position being hedged) result from an
imperfect correlation between the price movements of the two instruments.
With a perfect hedge, the value of the combined position remains unchanged
with any change in the price of the underlying asset. With an imperfect
hedge, the value of the derivative instrument and its hedge are not
perfectly correlated. For example, if the value of a derivative instrument
used in a short hedge (such as buying a put option or selling a futures
contract) increased by less than the decline in value of the hedged
investments, the hedge would not be perfectly correlated. This might occur
due to factors unrelated to the value of the investments being hedged,
such as speculative or other pressures on the markets in which these
instruments are traded. In addition, the Fund's success in using hedging
instruments is subject to the Sub-Advisor's ability to correctly predict
changes in relationships of such hedge instruments to the Fund's portfolio
holdings, and there can be no assurance that the Sub-Advisor's judgment in
this respect will be accurate. An imperfect correlation may prevent the
Fund from achieving the intended hedge or expose the Fund to a risk of
loss.
(4) Liquidity Risk. Liquidity risk is the risk that a derivative
instrument cannot be sold, closed out, or replaced quickly at or very
close to its fundamental value. Generally, exchange contracts are more
liquid than over-the-counter transactions. The illiquidity of the
derivatives markets may be due to various factors, including congestion,
disorderly markets, limitations on deliverable supplies, the participation
of speculators, government regulation and intervention, and technical and
operational or system failures. In addition, daily limits on price
fluctuations and speculative position limits on exchanges on which the
Fund may conduct its transactions in derivative instruments may prevent
prompt liquidation of positions, subjecting the Fund to the potential of
greater losses. The Fund might be required by applicable regulatory
requirements to maintain assets as "cover," maintain segregated accounts
and/or make margin payments when it takes positions in derivative
instruments involving obligations to third parties (i.e., instruments
other than purchase options). If the Fund is unable to close out its
positions in such instruments, it might be required to continue to
maintain such accounts or make such payments until the position expires,
matures, or is closed out. These requirements might impair the Fund's
ability to sell a security or make an investment at a time when it would
otherwise be favorable to do so, or require that the Fund sell a portfolio
security at a disadvantageous time. The Fund's ability to sell or close
out a position in an instrument prior to expiration or maturity depends
upon the existence of a liquid secondary market or, in the absence of such
a market, the ability and willingness of the counterparty to enter into a
transaction closing out the position. Due to liquidity risk, there is no
assurance that any derivatives position can be sold or closed out at a
time and price that is favorable to the Fund.
(5) Legal Risk. Legal risk is the risk of loss caused by the
unenforceability of a party's obligations under the derivative. While a
party seeking price certainty agrees to surrender the potential upside in
40
exchange for downside protection, the party taking the risk is looking for
a positive payoff. Despite this voluntary assumption of risk, a
counterparty that has lost money in a derivative transaction may try to
avoid payment by exploiting various legal uncertainties about certain
derivative products.
(6) Volatility. The prices of many derivative instruments,
including many options and swaps, are highly volatile. Price movements of
options contracts and payments pursuant to swap agreements are influenced
by, among other things, interest rates, changing supply and demand
relationships, trade, fiscal, monetary and exchange control programs and
policies of governments, and national and international political and
economic events and policies. The value of options and swap agreements
also depends upon the price of the securities or currencies underlying
them.
(7) Systemic or "Interconnection" Risk. Systemic or interconnection
risk is the risk that a disruption in the financial markets will cause
difficulties for all market participants. In other words, a disruption in
one market will spill over into other markets, perhaps creating a chain
reaction. Much of the OTC derivatives market takes place among the OTC
dealers themselves, thus creating a large interconnected web of financial
obligations. This interconnectedness raises the possibility that a default
by one large dealer could create losses for other dealers and destabilize
the entire market for OTC derivative instruments.
SWAP AGREEMENTS
The Fund may enter into swap agreements. A swap is a financial instrument
that typically involves the exchange of cash flows between two parties on
specified dates (settlement dates), where the cash flows are based on
agreed-upon prices, rates, indices, etc. The nominal amount on which the cash
flows are calculated is called the notional amount. Swaps are individually
negotiated and structured to include exposure to a variety of different types of
investments or market factors, such as interest rates, commodity prices,
non-U.S. currency rates, mortgage securities, corporate borrowing rates,
security prices, indexes or inflation rates.
Swap agreements may increase or decrease the overall volatility of the
investments of the Fund and its share price. The performance of swap agreements
may be affected by a change in the specific interest rate, currency, or other
factors that determine the amounts of payments due to and from the Fund. If a
swap agreement calls for payments by the Fund, the Fund must be prepared to make
such payments when due. In addition, if the counterparty's creditworthiness
declines, the value of a swap agreement would be likely to decline, potentially
resulting in losses.
Generally, swap agreements have fixed maturity dates that are agreed upon
by the parties to the swap. The agreement can be terminated before the maturity
date only under limited circumstances, such as default by one of the parties or
insolvency, among others, and can be transferred by a party only with the prior
written consent of the other party. The Fund may be able to eliminate its
exposure under a swap agreement either by assignment or by other disposition, or
by entering into an offsetting swap agreement with the same party or a similarly
creditworthy party. If the counterparty is unable to meet its obligations under
41
the contract, declares bankruptcy, defaults or becomes insolvent, the Fund may
not be able to recover the money it expected to receive under the contract.
A swap agreement can be a form of leverage, which can magnify the Fund's
gains or losses. In order to reduce the risk associated with leveraging, the
Fund may cover its current obligations under swap agreements according to
guidelines established by the SEC. If the Fund enters into a swap agreement on a
net basis, it will be required to segregate assets with a daily value at least
equal to the excess, if any, of the Fund's accrued obligations under the swap
agreement over the accrued amount the Fund is entitled to receive under the
agreement. If the Fund enters into a swap agreement on other than a net basis,
it will be required to segregate assets with a value equal to the full amount of
the Fund's accrued obligations under the agreement.
Equity Swaps. In a typical equity swap, one party agrees to pay another
party the return on a security, security index or basket of securities in return
for a specified interest rate. By entering into an equity index swap, for
example, the index receiver can gain exposure to securities making up the index
of securities without actually purchasing those securities. Equity index swaps
involve not only the risk associated with investment in the securities
represented in the index, but also the risk that the performance of such
securities, including dividends, will not exceed the interest that the Fund will
be committed to pay under the swap.
WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS
The Fund may buy and sell securities on a when-issued or delayed delivery
basis, making payment or taking delivery at a later date, normally within 15-45
days of the trade date. On such transactions, the payment obligation and the
interest rate are fixed at the time the buyer enters into the commitment.
Beginning on the date the Fund enters into a commitment to purchase securities
on a when-issued or delayed delivery basis, the Fund is required under rules of
the SEC to maintain in a separate account liquid assets, consisting of cash,
cash equivalents or liquid securities having a market value at all times of at
least equal to the amount of the commitment. Income generated by any such assets
which provide taxable income for U.S. federal income tax purposes is includable
in the taxable income of the Fund. The Fund may enter into contracts to purchase
securities on a forward basis (i.e., where settlement will occur more than 60
days from the date of the transaction) only to the extent that the Fund
specifically collateralizes such obligations with a security that is expected to
be called or mature within sixty days before or after the settlement date of the
forward transaction. The commitment to purchase securities on a when-issued,
delayed delivery or forward basis may involve an element of risk because at the
time of delivery the market value may be less than cost.
REPURCHASE AGREEMENTS
As temporary investments, the Fund may invest in repurchase agreements. A
repurchase agreement is a contractual agreement whereby the seller of securities
agrees to repurchase the same security at a specified price on a future date
agreed upon by the parties. The agreed-upon repurchase price determines the
yield during the Fund's holding period. Repurchase agreements are considered to
be loans collateralized by the underlying security that is the subject of the
42
repurchase contract. The Fund will only enter into repurchase agreements with
registered securities dealers or domestic banks that, in the opinion of the
Sub-Advisor, present minimal credit risk. The risk to the Fund is limited to the
ability of the issuer to pay the agreed-upon repurchase price on the delivery
date; however, although the value of the underlying collateral at the time the
transaction is entered into always equals or exceeds the agreed-upon repurchase
price, if the value of the collateral declines there is a risk of loss of both
principal and interest. In the event of default, the collateral may be sold, but
the Fund may incur a loss if the value of the collateral declines, and may incur
disposition costs or experience delays in connection with liquidating the
collateral. In addition, if bankruptcy proceedings are commenced with respect to
the seller of the security, realization upon the collateral by the Fund may be
delayed or limited. The Sub-Advisor will monitor the value of the collateral at
the time the transaction is entered into and at all times subsequent during the
term of the repurchase agreement in an effort to determine that such value
always equals or exceeds the agreed-upon repurchase price. In the event the
value of the collateral declines below the repurchase price, the Fund will
demand additional collateral from the issuer to increase the value of the
collateral to at least that of the repurchase price, including interest.
LENDING OF PORTFOLIO SECURITIES
Although it is not the Fund's current intention, the Fund may lend its
portfolio securities to broker-dealers and banks. Any such loan must be
continuously secured by collateral in cash or cash equivalents maintained on a
current basis in an amount at least equal to the market value of the securities
loaned by the Fund. The Fund would continue to receive the equivalent of the
interest or dividends paid by the issuer on the securities loaned, and would
also receive an additional return that may be in the form of a fixed fee or a
percentage of the collateral. The Fund may pay reasonable fees to persons
unaffiliated with the Fund for services in arranging these loans. The Fund would
have the right to call the loan and obtain the securities loaned at any time on
notice of not more than five business days. The Fund would not have the right to
vote the securities during the existence of the loan but would call the loan to
permit voting of the securities, if, in the Sub-Advisor's judgment, a material
event requiring a stockholder vote would otherwise occur before the loan was
repaid. In the event of bankruptcy or other default of the borrower, the Fund
could experience both delays in liquidating the loan collateral or recovering
the loaned securities and/or incur losses, including possible decline in the
value of the collateral or in the value of the securities loaned during the
period while the Fund seeks to enforce its rights thereto, possible subnormal
levels of income and lack of access to income during this period, and expenses
of enforcing its rights. As with other extensions of credit, there are risks of
delay in the recovery or even loss of rights in the collateral should a borrower
default or fail financially.
PORTFOLIO TRADING AND TURNOVER RATE
Portfolio trading will be undertaken as determined by the Fund's
Sub-Advisor. There are no limits on the rate of portfolio turnover. Although the
Fund cannot accurately predict its annual portfolio turnover rate, it is not
expected to exceed 20% under normal circumstances, but may be higher or lower in
certain periods. For the fiscal year ended October 31, 2017, the Fund's
portfolio turnover rate was approximately 50%. A higher portfolio turnover rate
43
results in correspondingly greater brokerage commissions and other transactional
expenses that are borne by the Fund. High portfolio turnover may also result in
the Fund's recognition of gains that will increase the Fund's tax liability and
thereby lower the after-tax dividends of the Fund. A high portfolio turnover may
also increase the Fund's current and accumulated earnings and profits, resulting
in a greater portion of the Fund's distributions being treated as a taxable
dividend to the Fund's common shareholders. See "Tax Matters" in the Fund's
Prospectus and "Federal Tax Matters" in this Statement of Additional
Information.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The general supervision of the duties performed for the Fund under the
Investment Management Agreement (as defined below) is the responsibility of the
Board of Trustees. There are five trustees of the Fund (each, a "Trustee", or
collectively, the "Trustees"), one of whom is an "interested person" (as the
term is defined in the 1940 Act) ("Interested Trustee") and four of whom are
Trustees who are not officers or employees of First Trust Advisors L.P. or
Energy Income Partners, LLC, which are the investment advisor and sub-advisor,
respectively, to the Fund, or any of their affiliates ("Independent Trustees").
The Trustees set broad policies for the Fund, choose the Fund's officers and
hire the Fund's investment advisor and other service providers. The Board of
Trustees is divided into three classes: Class I, Class II and Class III. In
connection with the organization of the Fund, each Trustee was elected for one
initial term, the length of which depends on the class, as more fully described
below. Subsequently, the Trustees in each class will be elected to serve for a
term expiring at the third succeeding annual shareholder meeting subsequent to
their election at an annual meeting, in each case until their respective
successors are duly elected and qualified, as described below. Mr. Bowen is an
Interested Trustee due to his position as Chief Executive Officer of First Trust
Advisors. The officers of the Fund manage the day-to-day operations and are
responsible to the Board of Trustees. The officers of the Fund serve indefinite
terms. The following is a list of the Trustees and executive officers of the
Fund and a statement of their present positions and principal occupations during
the past five years, the number of portfolios each Trustee oversees and the
other directorships they hold, if applicable.
44
NUMBER OF
PORTFOLIOS IN OTHER
THE FIRST TRUSTEESHIPS OR
TERM OF OFFICE(2) TRUST DIRECTORSHIPS
AND YEAR FIRST PRINCIPAL OCCUPATIONS FUND COMPLEX HELD BY
NAME, ADDRESS AND POSITION AND OFFICES ELECTED OR DURING THE OVERSEEN BY TRUSTEE DURING THE
DATE OF BIRTH WITH FUND APPOINTED PAST 5 YEARS TRUSTEE PAST 5 YEARS
Trustee who is an Interested
Person of the Fund
----------------------------
James A. Bowen(1) Chairman of the o Class III(3)(4) Chief Executive Officer, 153 None
120 East Liberty Drive, Board and Trustee First Trust Advisors Portfolios
Suite 400 o 2013 L.P. and First Trust
Wheaton, IL 60187 Portfolios L.P.;
D.O.B.: 09/55 Chairman of the Board of
Directors, BondWave LLC
(Software Development
Company) and Stonebridge
Advisors LLC (Investment
Advisor)
Independent Trustees
----------------------------
Richard E. Erickson Trustee o Class II(3)(4) Physician and Officer, 153 None
c/o First Trust Advisors L.P. Wheaton Orthopedics; Portfolios
120 East Liberty Drive, o 2013 Limited Partner,
Suite 400 Gundersen Real Estate
Wheaton, IL 60187 Limited Partnership
D.O.B.: 04/51 (June 1992 to December
2016); Member, Sportsmed
LLC (April 2007 to
November 2015)
Thomas R. Kadlec Trustee o Class II(3)(4) President, ADM Investor 153 Director of ADM
c/o First Trust Advisors L.P. Services, Inc. (Futures Portfolios Investor Services,
120 East Liberty Drive, o 2013 Commission Merchant) Inc.; ADM Investor
Suite 400 Services
Wheaton, IL 60187 International; and
D.O.B.: 11/57 Futures Industry
Association
Robert F. Keith Trustee o Class I(3)(4) President, Hibs 153 Director of Trust
c/o First Trust Advisors L.P. Enterprises (Financial Portfolios Company of
120 East Liberty Drive, o 2013 and Management Illinois
Suite 400 Consulting)
Wheaton, IL 60187
D.O.B.: 11/56
45
NUMBER OF
PORTFOLIOS IN OTHER
THE FIRST TRUSTEESHIPS OR
TERM OF OFFICE(2) TRUST DIRECTORSHIPS
AND YEAR FIRST PRINCIPAL OCCUPATIONS FUND COMPLEX HELD BY
NAME, ADDRESS AND POSITION AND OFFICES ELECTED OR DURING THE OVERSEEN BY TRUSTEE DURING THE
DATE OF BIRTH WITH FUND APPOINTED PAST 5 YEARS TRUSTEE PAST 5 YEARS
Niel B. Nielson Trustee o Class III(3)(4) Managing Director and 153 Director of
c/o First Trust Advisors L.P. Chief Operating Officer Portfolios Covenant Transport
120 East Liberty Drive, o 2013 (January 2015 to Inc. (May 2003 to
Suite 400 present), Pelita Harapan May 2014)
Wheaton, IL 60187 Educational Foundation
D.O.B.: 03/54 (Educational Products
and Services); President
and Chief Executive
Officer (June 2012 to
September 2014), Servant
Interactive LLC
(Educational Products
and Services); President
and Chief Executive
Officer (June 2012 to
September 2014), Dew
Learning LLC
(Educational Products
and Services); President
(June 2002 to June
2012), Covenant College
Officers of the Fund
----------------------------
James M. Dykas President and Chief o Indefinite term Managing Director and N/A N/A
120 East Liberty Drive, Executive Officer Chief Financial Officer
Suite 400 o 2016 (January 2016 to
Wheaton, IL 60187 present), Controller
D.O.B.: 01/66 (January 2011 to January
2016), Senior Vice
President (April 2007 to
January 2016), First
Trust Advisors L.P. and
First Trust Portfolios
L.P.; Chief Financial
Officer, BondWave LLC
(Software Development
Company) (January 2016
to present) and
Stonebridge Advisors LLC
(Investment Advisor)
(January 2016 to
present)
W. Scott Jardine Secretary and Chief o Indefinite term General Counsel, First N/A N/A
120 East Liberty Drive Legal Officer Trust Advisors L.P. and
Suite 400 o 2013 First Trust Portfolios
Wheaton, IL 60187 L.P.; Secretary and
D.O.B.: 05/60 General Counsel,
BondWave LLC (Software
Development Company) and
Secretary, Stonebridge
Advisors LLC (Investment
Advisor)
46
NUMBER OF
PORTFOLIOS IN OTHER
THE FIRST TRUSTEESHIPS OR
TERM OF OFFICE(2) TRUST DIRECTORSHIPS
AND YEAR FIRST PRINCIPAL OCCUPATIONS FUND COMPLEX HELD BY
NAME, ADDRESS AND POSITION AND OFFICES ELECTED OR DURING THE OVERSEEN BY TRUSTEE DURING THE
DATE OF BIRTH WITH FUND APPOINTED PAST 5 YEARS TRUSTEE PAST 5 YEARS
Daniel J. Lindquist Vice President o Indefinite term Managing Director (July N/A N/A
120 East Liberty Drive, 2012 to present), Senior
Suite 400 o 2013 Vice President
Wheaton, IL 60187 (September 2005 to July
D.O.B.: 02/70 2012), First Trust
Advisors L.P. and First
Trust Portfolios L.P.
Kristi A. Maher Assistant Secretary o Indefinite term Deputy General Counsel, N/A N/A
120 East Liberty Drive, and Chief Compliance First Trust Advisors
Suite 400 Officer o 2013 L.P. and First Trust
Wheaton, IL 60187 Portfolios L.P.
D.O.B.: 12/66
Donald Swade Treasurer, Chief o Indefinite term Senior Vice President N/A N/A
120 East Liberty Drive, Financial Officer (July 2016 to present),
Suite 400 and Chief Accounting o Since January Vice President (April
Wheaton, IL 60187 Officer 2016 2012 to July 2016),
D.O.B.: 08/72 First Trust Advisors
L.P. and First Trust
Portfolios L.P., Vice
President (September
2006 to April 2012),
Guggenheim Funds
Investment Advisors,
LLC/Claymore Securities,
Inc.
--------------------
(1) Mr. Bowen is deemed an "interested person" of the Fund due to his position
as Chief Executive Officer of First Trust Advisors, investment advisor of
the Fund.
(2) Officer positions with the Fund have an indefinite term.
(3) Currently, Robert F. Keith, as a Class I Trustee, is serving a term until
the Fund's 2020 annual meeting. Richard E. Erickson and Thomas R. Kadlec,
as Class II Trustees, are each serving a term until the Fund's 2018 annual
meeting. James A. Bowen and Niel B. Nielson, as Class III Trustees, are
each serving a term until the Fund's 2019 annual meeting.
(4) Each Trustee has served in such capacity since the Fund's inception.
Unitary Board Leadership Structure
Each Trustee serves as a trustee of all open-end and closed-end funds in
the First Trust Fund Complex (as defined below), which is known as a "unitary"
board leadership structure. Each Trustee currently serves as a trustee of the
Fund; First Trust Series Fund and First Trust Variable Insurance Trust, open-end
funds with seven portfolios advised by First Trust Advisors; First Trust Senior
Floating Rate Income Fund II, Macquarie/First Trust Global Infrastructure/
Utilities Dividend & Income Fund, First Trust Energy Income and Growth Fund,
First Trust Enhanced Equity Income Fund, First Trust/Aberdeen Global Opportunity
Income Fund, First Trust Mortgage Income Fund, First Trust Strategic High Income
Fund II, First Trust/Aberdeen Emerging Opportunity Fund, First Trust Specialty
47
Finance and Financial Opportunities Fund, and First Trust High Income Long/Short
Fund, First Trust Energy Infrastructure Fund, First Trust Dynamic Europe Equity
Income Fund, First Trust New Opportunities MLP & Energy Fund, First Trust
Intermediate Duration Preferred & Income Fund and First Trust Senior Floating
Rate 2022 Target Term Fund, closed-end funds advised by First Trust Advisors;
and First Trust Exchange-Traded Fund, First Trust Exchange-Traded Fund II, First
Trust Exchange-Traded Fund III, First Trust Exchange-Traded Fund IV, First Trust
Exchange-Traded Fund V, First Trust Exchange-Traded Fund VI, First Trust
Exchange-Traded Fund VII, First Trust Exchange-Traded Fund VIII, First Trust
Exchange-Traded AlphaDEX(R) Fund and First Trust Exchange-Traded AlphaDEX(R)
Fund II, exchange-traded funds with 130 portfolios advised by First Trust
Advisors (each a "First Trust Fund" and collectively, the "First Trust Fund
Complex"). None of the Trustees who are not "interested persons" of the Fund,
nor any of their immediate family members, has ever been a director, officer or
employee of, or consultant to, First Trust Advisors, First Trust Portfolios L.P.
or their affiliates. Mr. Bowen serves as the Chairman of the Board of each Fund
in the First Trust Fund Complex. The officers of the Fund listed above hold the
same positions with the other funds in the First Trust Fund Complex as they hold
with the Fund.
The same five persons serve as Trustees on the Fund's Board of Trustees
and on the boards of all other First Trust Funds. The unitary board structure
was adopted for the First Trust Funds because of the efficiencies it achieves
with respect to the governance and oversight of the First Trust Funds. Each
First Trust Fund is subject to the rules and regulations of the 1940 Act (and
other applicable securities laws), which means that many of the First Trust
Funds face similar issues with respect to certain of their fundamental
activities, including risk management, portfolio liquidity, portfolio valuation
and financial reporting. In addition, all of the First Trust closed-end funds
are managed by the Advisor and all but two of the First Trust closed-end funds
employ common service providers for custody, fund accounting, administration and
transfer agency that provide substantially similar services to these closed-end
funds pursuant to substantially similar contractual arrangements. Because of the
similar and often overlapping issues facing the First Trust Funds, including the
Fund, the Board of the First Trust Funds believes that maintaining a unitary
board structure promotes efficiency and consistency in the governance and
oversight of all First Trust Funds and reduces the costs, administrative burdens
and possible conflicts that may result from having multiple boards. In adopting
a unitary board structure, the Trustees seek to provide effective governance
through establishing a board, the overall composition of which, as a body,
possesses the appropriate skills, diversity, independence and experience to
oversee the business of the First Trust Funds.
Annually, the Board of Trustees will review its governance structure and
the committee structures, their performance and functions and any processes that
would enhance Board governance over the business of the First Trust Funds. The
Board of Trustees has determined that its leadership structure, including the
unitary board and committee structure, is appropriate based on the
characteristics of the funds it serves and the characteristics of the First
Trust Fund Complex as a whole.
In order to streamline communication between the Advisor and the
Independent Trustees and create certain efficiencies, the Board of Trustees has
a Lead Independent Trustee who is responsible for: (i) coordinating activities
of the Independent Trustees; (ii) working with the Advisor, Fund counsel and the
48
independent legal counsel to the Independent Trustees to determine the agenda
for Board meetings; (iii) serving as the principal contact for and facilitating
communication between the Independent Trustees and the service providers of the
First Trust Funds, particularly the Advisor; and (iv) any other duties that the
Independent Trustees may delegate to the Lead Independent Trustee. The Lead
Independent Trustee is selected by the Independent Trustees and serves a
three-year term or until his successor is selected.
The Board of Trustees has established four standing committees (as
described below) and has delegated certain of its responsibilities to those
committees. The Board and its committees meet frequently throughout the year to
oversee the activities of the First Trust Funds, review contractual arrangements
with and performance of service providers, oversee compliance with regulatory
requirements and review the performance of the First Trust Funds. The
Independent Trustees are represented by independent legal counsel at all Board
and committee meetings (other than meetings of the Executive Committee).
Generally, the Board of Trustees acts by majority vote of all the Trustees,
including a majority vote of the Independent Trustees if required by applicable
law.
The three committee chairs and the Lead Independent Trustee rotate every
three years in serving as chair of the Audit Committee, the Nominating and
Governance Committee or the Valuation Committee, or as Lead Independent Trustee.
The Lead Independent Trustee and immediate past Lead Independent Trustee also
serve on the Executive Committee with the Interested Trustee.
The four standing committees of the Board of Trustees are: the Executive
Committee (and Pricing and Dividend Committee), the Nominating and Governance
Committee, the Valuation Committee and the Audit Committee. The Executive
Committee, which meets between Board meetings, is authorized to exercise all
powers of and to act in the place of the Board of Trustees to the extent
permitted by the Fund's Declaration of Trust and By-Laws. The members of the
Executive Committee also serve as a special committee of the Board of Trustees
known as the Pricing and Dividend Committee, which is authorized to exercise all
of the powers and authority of the Board of Trustees in respect of the issuance
and sale, through an underwritten public offering, of the Common Shares of the
Fund and all other such matters relating to such financing, including
determining the price at which such Common Shares are to be sold, approval of
the final terms of the underwriting agreement, and approval of the members of
the underwriting syndicate. Such committee is also responsible for the
declaration and setting of dividends. Mr. Kadlec, Mr. Bowen and Mr. Erickson are
members of the Executive Committee. During the last fiscal year, the Executive
Committee held twelve meetings.
The Nominating and Governance Committee is responsible for appointing and
nominating non-interested persons to the Trust's Board of Trustees. Messrs.
Erickson, Kadlec, Keith and Nielson are members of the Nominating and Governance
Committee, and each is an Independent Trustee who is also an "independent
director" within the meaning of the listing standards of the NYSE. The
Nominating and Governance Committee operates under a written charter adopted and
approved by the Board. If there is no vacancy on the Board of Trustees, the
Board will not actively seek recommendations from other parties, including
shareholders. The Board of Trustees adopted a mandatory retirement age of 75 for
49
Trustees, beyond which age Trustees are ineligible to serve. The Committee will
not consider new trustee candidates who are 72 years of age or older. When a
vacancy on the Board of Trustees occurs and nominations are sought to fill such
vacancy, the Nominating and Governance Committee may seek nominations from those
sources it deems appropriate in its discretion, including shareholders of Fund.
To submit a recommendation for nomination as a candidate for a position on the
Board of Trustees, shareholders of the Fund should mail such recommendation to
W. Scott Jardine, Secretary, 120 East Liberty Drive, Suite 400, Wheaton,
Illinois 60187. Such recommendation shall include the following information: (i)
evidence of Fund ownership of the person or entity recommending the candidate
(if a Fund shareholder); (ii) a full description of the proposed candidate's
background, including education, experience, current employment and date of
birth; (iii) names and addresses of at least three professional references for
the candidate; (iv) information as to whether the candidate is an "interested
person" in relation to the Fund, as such term is defined in the 1940 Act, and
such other information that may be considered to impair the candidate's
independence; and (v) any other information that may be helpful to the Committee
in evaluating the candidate. If a recommendation is received with satisfactorily
completed information regarding a candidate during a time when a vacancy exists
on the Board or during such other time as the Nominating and Governance
Committee is accepting recommendations, the recommendation will be forwarded to
the Chair of the Nominating and Governance Committee and to counsel to the
Independent Trustees. Recommendations received at any other time will be kept on
file until such time as the Nominating and Governance Committee is accepting
recommendations, at which point they may be considered for nomination. During
the last fiscal year, the Nominating and Governance Committee held four
meetings.
The Valuation Committee is responsible for the oversight of the valuation
procedures of the Fund (the "Valuation Procedures"), for determining the fair
value of the Fund's securities or other assets under certain circumstances as
described in the Valuation Procedures and for evaluating the performance of any
pricing service for the Fund. Messrs. Erickson, Kadlec, Keith and Nielson are
members of the Valuation Committee. During the last fiscal year, the Valuation
Committee held four meetings.
The Audit Committee is responsible for overseeing the Fund's accounting
and financial reporting process, the system of internal controls and audit
process and for evaluating and appointing independent auditors (subject also to
Board approval). Messrs Erickson, Kadlec, Keith and Nielson serve on the Audit
Committee. Messrs. Erickson, Kadlec, Keith and Nielson, all of whom are
"independent" as defined in the listing standards of the NYSE, serve on the
Audit Committee. Messrs. Kadlec and Keith each has been determined to qualify as
an "Audit Committee Financial Expert" as such term is defined in Form N-CSR.
During the last fiscal year, the Audit Committee held six meetings.
RISK OVERSIGHT
As part of the general oversight of the Fund, the Board of Trustees is
involved in the risk oversight of the Fund. The Board of Trustees has adopted
and periodically reviews policies and procedures designed to address the Fund's
risks. Oversight of investment and compliance risk, including oversight of the
Sub-Advisor, is performed primarily at the Board level in conjunction with the
Advisor's investment oversight group and the Fund's Chief Compliance Officer
50
("CCO"). Oversight of other risks also occurs at the committee level. The
Advisor's investment oversight group reports to the Board of Trustees at
quarterly meetings regarding, among other things, Fund performance and the
various drivers of such performance as well as information related to the
Sub-Advisor and its operations and processes. The Board of Trustees reviews
reports on the Fund's and the service providers' compliance policies and
procedures at each quarterly Board meeting and receives an annual report from
the CCO regarding the operations of the Fund's and the service providers'
compliance programs. In addition, the Independent Trustees meet privately each
quarter with the CCO. The Audit Committee reviews with the Advisor the Fund's
major financial risk exposures and the steps the Advisor has taken to monitor
and control these exposures, including the Fund's risk assessment and risk
management policies and guidelines. The Audit Committee also, as appropriate,
reviews in a general manner the processes other Board committees have in place
with respect to risk assessment and risk management. The Nominating and
Governance Committee monitors all matters related to the corporate governance of
the Fund. The Valuation Committee monitors valuation risk and compliance with
the Fund's Valuation Procedures and oversees the pricing agents and actions by
the Advisor's Pricing Committee with respect to the valuation of portfolio
securities.
Not all risks that may affect the Fund can be identified nor can controls
be developed to eliminate or mitigate their occurrence or effects. It may not be
practical or cost-effective to eliminate or mitigate certain risks, the
processes and controls employed to address certain risks may be limited in their
effectiveness, and some risks are simply beyond the reasonable control of the
Fund or the Advisor or other service providers. For instance, as the use of
Internet technology has become more prevalent, the Fund and its service
providers have become more susceptible to potential operational risks through
breaches in cyber security (generally, intentional and unintentional events that
may cause the Fund or a service provider to lose proprietary information, suffer
data corruption or lose operational capacity). There can be no guarantee that
any risk management systems established by the Fund, its service providers, or
issuers of the securities in which the Fund invests to reduce cyber security
risks will succeed, and the Fund cannot control such systems put in place by
service providers, issuers or other third parties whose operations may affect
the Fund and/or its shareholders. Moreover, it is necessary to bear certain
risks (such as investment related risks) to achieve the Fund's goals. As a
result of the foregoing and other factors, the Fund's ability to manage risk is
subject to substantial limitations.
BOARD DIVERSIFICATION AND TRUSTEE QUALIFICATIONS
As described above, the Nominating and Governance Committee of the Board
of Trustees oversees matters related to the nomination of Trustees. The
Nominating and Governance Committee seeks to establish an effective Board with
an appropriate range of skills and diversity, including, as appropriate,
differences in background, professional experience, education, vocations, and
other individual characteristics and traits in the aggregate. Each Trustee must
meet certain basic requirements, including relevant skills and experience, time
availability, and if qualifying as an Independent Trustee, independence from the
Advisor, Sub-Advisor, underwriters or other service providers, including any
affiliates of these entities.
51
Listed below for each current Trustee are the experiences, qualifications
and attributes that led to the conclusion, as of the date of this Statement of
Additional Information, that each current Trustee should serve as a Trustee in
light of the Trust's business and structure.
Independent Trustees. Richard E. Erickson, M.D., is an orthopedic surgeon.
He also has been President of Wheaton Orthopedics, a co-owner and directors of a
fitness center and a limited partner of two real estate companies. Dr. Erickson
has served as a Trustee of each First Trust Fund since its inception. Dr.
Erickson has also served as the Lead Independent Trustee and on the Executive
Committee (2008 - 2009), Chairman of the Nominating and Governance Committee
(2003 - 2007 and 2014 - 2016), Chairman of the Audit Committee (2012 - 2013) and
Chairman of the Valuation Committee (June 2006 - 2007 and 2010 - 2011) of the
First Trust Funds. He currently serves as Lead Independent Trustee and on the
Executive Committee (since January 1, 2017) of the First Trust Funds.
Thomas R. Kadlec is President of ADM Investor Services Inc. ("ADMIS"), a
futures commission merchant and wholly-owned subsidiary of the Archer Daniels
Midland Company ("ADM"). Mr. Kadlec has been employed by ADMIS and its
affiliates since 1990 in various accounting, financial, operations and risk
management capacities. Mr. Kadlec serves on the boards of several international
affiliates of ADMIS and is a member of ADM's Integrated Risk Committee, which is
tasked with the duty of implementing and communicating enterprise-wide risk
management. In 2014, Mr. Kadlec was elected to the board of the Futures Industry
Association. Mr. Kadlec has served as a Trustee of each First Trust closed-end
fund since its inception. Mr. Kadlec has also served on the Executive Committee
since the organization of the first First Trust closed-end fund in 2003 until he
was elected as the first Lead Independent Trustee in December 2005, serving as
such through 2007. He also served as Chairman of the Valuation Committee (2008 -
2009) and Chairman of the Audit Committee (2010 - 2011) and Chairman of the
Nominating and Governance Committee (2012 - 2013). He currently serves as
Chairman of the Valuation Committee and on the Executive Committee (since
January 1, 2017) of the First Trust Funds.
Robert F. Keith is President of Hibs Enterprises, a financial and
management consulting firm. Mr. Keith has been with Hibs Enterprises since 2004.
Prior thereto, Mr. Keith spent 18 years with ServiceMaster and Aramark,
including three years as President and COO of ServiceMaster Consumer Services,
where he led the initial expansion of certain products overseas, five years as
President and COO of ServiceMaster Management Services and two years as
President of Aramark ServiceMaster Management Services. Mr. Keith is a certified
public accountant and also has held the positions of Treasurer and Chief
Financial Officer of ServiceMaster, at which time he oversaw the financial
aspects of ServiceMaster's expansion of its Management Services division into
Europe, the Middle East and Asia. Mr. Keith has served as a Trustee of the First
Trust Funds since June 2006. Mr. Keith has also served as the Chairman of the
Audit Committee (2008 - 2009), Chairman of the Nominating and Governance
Committee (2010 - 2011) and Chairman of the Valuation Committee (2014 - 2016) of
the First Trust Funds. He served as Lead Independent Trustee and on the
Executive Committee (2012 - 2016) and currently serves as Chairman of the Audit
Committee (since January 1, 2017) of the First Trust Funds.
52
Niel B. Nielson, Ph.D., has been the Managing Director and Chief Operating
Officer of Pelita Harapan Educational Foundation, a global provider of
educational products and services since January, 2015. Mr. Nielson formerly
served as the President and Chief Executive Officer of Dew Learning LLC from
June 2012 through September 2014, President of Covenant College (2002 - 2012),
and as a partner and trader (of options and futures contracts for hedging
options) for Ritchie Capital Markets Group (1996 - 1997), where he held an
administrative management position at this proprietary derivatives trading
company. He also held prior positions in new business development for
ServiceMaster Management Services Company, and in personnel and human resources
for NationsBank of North Carolina, N.A. and Chicago Research and Trading Group,
Ltd. ("CRT"). His international experience includes serving as a director of CRT
Europe, Inc. for two years, directing out of London all aspects of business
conducted by the U.K. and European subsidiary of CRT. Prior to that, Mr. Nielson
was a trader and manager at CRT in Chicago. Mr. Nielson has served as a Trustee
of each First Trust Fund since its inception and of the First Trust Funds since
1999. Mr. Nielson has also served as the Chairman of the Audit Committee (2003 -
2006), Chairman of the Valuation Committee (2007 - 2008), Chairman of the
Nominating and Governance Committee (2008 - 2009) and Lead Independent Trustee
and a member of the Executive Committee (2010 - 2011). He currently serves as
Chairman of the Nominating and Governance Committee (since January 1, 2017) of
the First Trust Funds.
Interested Trustee. James A. Bowen is Chief Executive Officer of First
Trust Advisors L.P. and First Trust Portfolios L.P. Mr. Bowen is involved in the
day-to-day management of the First Trust Funds and serves on the Executive
Committee. He has over 26 years of experience in the investment company business
in sales, sales management and executive management. Mr. Bowen has served as a
Trustee of each First Trust Fund since its inception and of the First Trust
Funds since 1999.
As described above, the Board of Trustees is divided into three classes
and, in connection with the organization of the Fund, Trustees were elected for
an initial term. The Class I Trustee will serve until the second succeeding
annual meeting subsequent to his initial election; Class II Trustees will serve
until the third succeeding annual meeting subsequent to their initial election;
and Class III Trustees will serve until the first succeeding annual meeting
subsequent to their initial election. At each annual meeting, the Trustees
chosen to succeed those whose terms are expiring shall be identified as being of
the same class as the Trustees whom they succeed and shall be elected for a term
expiring at the time of the third succeeding annual meeting subsequent to their
election, in each case until their respective successors are duly elected and
qualified. Holders of any Preferred Shares will be entitled to elect a majority
of the Fund's Trustees under certain circumstances. See "Description of Shares -
Preferred Shares - Voting Rights" in the Prospectus.
Effective January 1, 2016, the fixed annual retainer paid to the
Independent Trustees is $230,000 per year and an annual per fund fee is $2,500
for each closed-end fund and actively managed fund and $250 for each index fund.
The fixed annual retainer is allocated equally among each fund in the First
Trust Fund Complex rather than being allocated on a pro rata basis based on each
fund's net assets. Additionally, the Lead Independent Trustee is paid $30,000
annually, the Chairman of the Audit Committee and the Chairman of the Valuation
Committee are each paid $20,000 annually and the Chairman of the Nominating and
53
Governance Committee is paid $10,000 annually to serve in such capacities with
compensation allocated pro rata among each fund in the First Trust Fund Complex
based on its net assets.
The following table sets forth compensation (including reimbursement for
travel and out-of-pocket expenses) paid by the Fund during the Fund's last
fiscal year ended October 31, 2017 to each of the Independent Trustees and the
total compensation paid to each of the Independent Trustees by the First Trust
Fund Complex for the calendar year ended December 31, 2017. The Fund has no
retirement or pension plans. The officers and the Trustee who is an "interested
person" as designated above serve without any compensation from the Fund. The
Fund's officers are compensated by First Trust Advisors.
TOTAL COMPENSATION
AGGREGATE COMPENSATION FROM THE FIRST TRUST
NAME OF TRUSTEE FROM THE FUND(1) FUND COMPLEX(2)
Richard E. Erickson $4,477 $414,011
Thomas R. Kadlec $4,478 $403,267
Robert F. Keith $4,409 $403,163
Niel B. Nielson $4,312 $392,987
--------------------
(1) The compensation paid by the Fund to the Independent Trustees for the last
fiscal year for services to the Fund.
(2) The total compensation paid to the Independent Trustees for the calendar
year ended December 31, 2017 for services to the 151 portfolios existing
in 2017, which consisted of 7 open-end mutual funds, 16 closed-end funds
and 128 exchange-traded funds.
As of the date of this Statement of Additional Information, the Fund has
three employees. The shareholders of the Fund will be asked to vote on the
election of Trustees for a three-year term at the next annual meeting of
shareholders.
The following table sets forth the dollar range of equity securities
beneficially owned by the Trustees in the Fund and in other funds overseen by
the Trustees in the First Trust Fund Complex as of December 31, 2017:
AGGREGATE DOLLAR RANGE OF
EQUITY SECURITIES IN
ALL REGISTERED
DOLLAR RANGE OF INVESTMENT COMPANIES
EQUITY SECURITIES OVERSEEN BY TRUSTEE IN THE
TRUSTEE IN THE FUND FIRST TRUST FUND COMPLEX
James A. Bowen None Over $100,000
Richard E. Erickson None Over $100,000
Thomas R. Kadlec None Over $100,000
Robert F. Keith None Over $100,000
Niel B. Nielson None Over $100,000
As of December 31, 2017, the Independent Trustees of the Fund and
immediate family members do not own beneficially or of record any class of
securities of an investment advisor or principal underwriter of the Fund or any
person directly or indirectly controlling, controlled by, or under common
control with an investment advisor or principal underwriter of the Fund.
54
As of the date of this Statement of Additional Information, the officers
and Trustees, in the aggregate, owned less than 1% of the common shares of the
Fund.
CONTROL PERSONS
To the knowledge of the Fund, as of November 30, 2017, no single
shareholder or "group" (as that term is used in Section 13(d) of the Securities
Exchange Act of 1934, as amended (the "1934 Act")) beneficially owned more than
5% of the Fund's outstanding common shares, except as described in the following
table. Information as to the beneficial ownership of common shares of the Fund,
including the percentage of common shares beneficially owned, is based on
reports filed with the SEC by such holders and a securities position listing
report from The Depository Trust & Clearing Corporation as of November 30, 2017.
The Fund does not have any knowledge of the identity of the ultimate
beneficiaries of the common shares of beneficial interest listed below. A
control person is one who owns, either directly or indirectly, more than 25% of
the voting securities of the Fund or acknowledges the existence of control.
PERCENT NUMBER OF
SHAREHOLDER AND ADDRESS OWNERSHIP SHARES HELD
----------------------- --------- -----------
Morgan Stanley Smith Barney LLC
1300 Thames St., 6th Floor
Baltimore, Maryland 21231 43.42% 20,301,533
Wells Fargo Clearing Services, LLC
2801 Market Street, H0006-09B
St. Louis, Missouri 63103 5.88% 2,750,695
RBC Capital Markets, LLC
60 S. 6th Street - P09
Minneapolis, Minnesota 55402 5.75% 2,687,739
National Financial Services LLC
499 Washington Blvd.
Jersey City, New Jersey 07310 5.68% 2,656,348
INVESTMENT ADVISOR
First Trust Advisors L.P., 120 East Liberty Drive, Suite 400, Wheaton,
Illinois 60187, is the investment advisor to the Fund. First Trust Advisors
serves as investment advisor or portfolio supervisor to investment portfolios
with approximately $117.3 billion in assets which it managed or supervised as of
55
November 30, 2017. As investment advisor, First Trust Advisors provides the Fund
with professional investment supervision and selects the Fund's Sub-Advisor
(with the approval of the Board of Trustees) and permits any of its officers or
employees to serve without compensation as Trustees or officers of the Fund if
elected to such positions. First Trust Advisors supervises the activities of the
Fund's Sub-Advisor and provides the Fund with certain other services necessary
with the management of the portfolio.
First Trust Advisors is an Illinois limited partnership formed in 1991 and
an investment advisor registered with the SEC under the Investment Advisers Act
of 1940 (the "Advisers Act"). First Trust Advisors has one limited partner,
Grace Partners of DuPage L.P. ("Grace Partners"), and one general partner, The
Charger Corporation. Grace Partners is a limited partnership with one general
partner, The Charger Corporation, and a number of limited partners. Grace
Partners' and The Charger Corporation's primary business is investment advisory
and broker/dealer services through their ownership interests. The Charger
Corporation is an Illinois corporation controlled by James A. Bowen, Chief
Executive Officer of the Advisor. First Trust Advisors is controlled by Grace
Partners and The Charger Corporation.
First Trust Advisors is advisor or sub-advisor to seven mutual funds, 10
exchange-traded funds consisting of 130 series and 16 closed-end funds
(including the Fund) and is the portfolio supervisor of certain unit investment
trusts sponsored by First Trust Portfolios L.P. First Trust Portfolios L.P.
specializes in the underwriting, trading and distribution of unit investment
trusts and other securities. First Trust Portfolios L.P., an Illinois limited
partnership formed in 1991, took over the First Trust product line and acts as
sponsor for successive series of The First Trust Combined Series, FT Series
(formerly known as The First Trust Special Situations Trust), The First Trust
Insured Corporate Trust, The First Trust of Insured Municipal Bonds and The
First Trust GNMA. The First Trust product line commenced with the first insured
unit investment trust in 1974, and as of November 30, 2017, more than $355
billion in gross assets have been deposited in First Trust Portfolios L.P. unit
investment trusts.
First Trust Advisors acts as investment advisor to the Fund pursuant to an
Investment Management Agreement. The Investment Management Agreement continues
in effect from year to year after its initial two-year term so long as its
continuation is approved at least annually by the Trustees including a majority
of the Independent Trustees, or the vote of a majority of the outstanding voting
securities of the Fund. It may be terminated at any time without the payment of
any penalty upon 60 days' written notice by either party, or by a majority vote
of the outstanding voting securities of the Fund or by the Board of Trustees
(accompanied by appropriate notice), and will terminate automatically upon its
assignment. The Investment Management Agreement may also be terminated, at any
time, without payment of any penalty, by the Board or by vote of a majority of
the outstanding voting securities of the Fund, in the event that it shall have
been established by a court of competent jurisdiction that the Advisor, or any
officer or director of the Advisor, has taken any action which results in a
breach of the material covenants of the Advisor set forth in the Investment
Management Agreement. The Investment Management Agreement provides that First
Trust Advisors shall not be liable for any loss sustained by reason of the
purchase, sale or retention of any security, whether or not such purchase, sale
or retention shall have been based upon the investigation and research made by
any other individual, firm or corporation, if the recommendation shall have been
56
selected with due care and in good faith, except loss resulting from willful
misfeasance, bad faith or gross negligence on the part of the Advisor in
performance of its obligations and duties, or by reason of its reckless
disregard of its obligations and duties under the Investment Management
Agreement.
The Investment Management Agreement between the Advisor and the Fund has
been approved by the Board of Trustees of the Fund, including a majority of the
Independent Trustees, and the sole shareholder of the Fund. Information
regarding the Board of Trustees' approval of the Investment Management and
Sub-Advisory Agreements is available in the Fund's annual report for the fiscal
year ended October 31, 2017. Pursuant to the Investment Management Agreement,
the Fund has agreed to pay for the services and facilities provided by the
Advisor an annual management fee, payable on a monthly basis, equal to 1.00% of
the Fund's Managed Assets. For purposes of calculation of the management fee,
the Fund's "Managed Assets" means the average daily gross asset value of the
Fund (which includes assets attributable to the Fund's Preferred Shares, if any,
and the principal amount of borrowings), minus the sum of the Fund's accrued and
unpaid dividends on any outstanding Preferred Shares and accrued liabilities
(other than the principal amount of any borrowings incurred, commercial paper or
notes or other forms of indebtedness issued by the Fund and the liquidation
preference of any outstanding Preferred Shares).
In addition to the fee of the Advisor, the Fund pays all other costs and
expenses of its operations except the Sub-Advisor's fee, which is paid by the
Advisor out of the Advisor's management fee. The costs and expenses paid by the
Fund include: compensation of its Trustees (other than the Trustee affiliated
with the Advisor), custodian, transfer agent, administrative, accounting and
dividend disbursing expenses, legal fees, leverage expenses, expenses of
independent auditors, expenses of repurchasing shares, expenses of preparing,
printing and distributing shareholder reports, notices, proxy statements and
reports to governmental agencies, and taxes, if any. All fees and expenses are
accrued daily and deducted before payment of dividends to investors.
Pursuant to a sub-advisory agreement among the Fund, the Advisor and the
Sub-Advisor, (the "Sub-Advisory Agreement"), the Sub-Advisor receives a
portfolio management fee equal to 0.50% of the Fund's Managed Assets. The
Sub-Advisor's fee is paid by the Advisor out of the Advisor's management fee.
Because the fee paid to the Advisor and by the Advisor to the Sub-Advisor will
be calculated on the basis of the Fund's Managed Assets, which include the
proceeds of leverage, the dollar amount of the Advisor's and Sub-Advisor's fees
will be higher (and the Advisor and Sub-Advisor will be benefited to that
extent) when leverage is utilized. In this regard, if the Fund uses leverage in
the amount equal to 25.15% of the Fund's Managed Assets (after their issuance),
the Fund's management fee would be 1.34% of net assets attributable to common
shares. See "Summary of Fund Expenses" in the Fund's Prospectus.
CODE OF ETHICS
The Fund, the Advisor and the Sub-Advisor have each adopted codes of
ethics under Rule 17j-1 under the 1940 Act. These codes permit personnel subject
to the code to invest in securities, including securities that may be purchased
or held by the Fund. These codes can be reviewed and copied at the SEC's Public
57
Reference Room in Washington, D.C. Information on the operation of the Public
Reference Room may be obtained by calling the SEC at (202) 942-8090. The codes
of ethics are available on the EDGAR Database on the SEC's website
(http://www.sec.gov), and copies of these codes may be obtained, after paying a
duplicating fee, by electronic request at the following e-mail address:
publicinfo@sec.gov, or by writing the SEC Public Reference Section, Washington,
D.C. 20549-0102.
SUB-ADVISOR
Energy Income Partners serves as the Fund's Sub-Advisor. In this capacity,
Energy Income Partners is responsible for the selection and on-going monitoring
of the securities in the Fund's investment portfolio.
Energy Income Partners, located at 10 Wright Street, Westport, Connecticut
06880, is a registered investment advisor and serves as investment advisor or
portfolio supervisor to investment portfolios with approximately $6.0 billion of
assets as of November 30, 2017.
Energy Income Partners is a Delaware limited liability company and an
SEC-registered investment advisor, founded in October 2003 by James J. Murchie
to provide professional asset management services in the area of energy related
master limited partnerships and other high payout securities in the energy
sector. In addition to serving as Sub-Advisor to the Fund, Energy Income
Partners serves as the investment manager to separately managed accounts,
unregistered investment companies, a registered investment company and provides
a model portfolio to unified managed accounts. Energy Income Partners also
serves as the sub-adviser to three other registered investment companies advised
by First Trust Advisors, an actively managed exchange traded fund, a sleeve of
an actively managed exchange-traded fund, a sleeve of a variable insurance trust
and an Irish Domiciled UCITs fund. Energy Income Partners mainly focuses on
portfolio companies that operate infrastructure assets such as pipelines,
storage and terminals that receive fee-based or regulated income from their
customers. Energy Income Partners currently has a staff of 13 full-time and 4
part-time/contract persons.
First Trust Capital Partners, LLC, an affiliate of the Advisor, owns,
through a wholly-owned subsidiary, a 15% ownership interest in each of the
Sub-Advisor and EIP Partners, LLC, a Delaware limited liability company and
affiliate of the Sub-Advisor.
James J. Murchie is the Founder, Chief Executive Officer, Principal of
Energy Income Partners and a co-portfolio manager. After founding Energy Income
Partners in October 2003, Mr. Murchie and the Energy Income Partners investment
team joined Pequot Capital Management Inc. ("Pequot Capital") in December 2004.
In August 2006, Mr. Murchie and the Energy Income Partners investment team left
Pequot Capital and re-established Energy Income Partners. Prior to founding
Energy Income Partners, Mr. Murchie was a Portfolio Manager at Lawhill Capital
Partners, LLC ("Lawhill Capital"), a long/short equity hedge fund investing in
commodities and equities in the energy and basic industry sectors. Before
Lawhill Capital, Mr. Murchie was a Managing Director at Tiger Management, LLC,
where his primary responsibility was managing a portfolio of investments in
commodities and related equities. Mr. Murchie was also a Principal at Sanford C.
58
Bernstein. He began his career at British Petroleum, PLC. Mr. Murchie holds a BA
from Rice University and an MA from Harvard University.
Eva Pao is a Principal of Energy Income Partners and a co-portfolio
manager. She has been with Energy Income Partners since inception in 2003. From
2005 to mid-2006, Ms. Pao joined Pequot Capital Management during Energy Income
Partners' affiliation with Pequot. Prior to Harvard Business School, Ms. Pao was
a Manager at Enron Corp where she managed a portfolio in Canadian oil and gas
equities for Enron's internal hedge fund that specialized in energy-related
equities and managed a natural gas trading book. Ms. Pao holds degrees from Rice
University and Harvard Business School.
John K. Tysseland is a Principal of Energy Income Partners, LLC and a
co-portfolio manager. Mr. Tysseland has been a portfolio manager of the Fund
since 2016. Prior to joining Energy Income Partners in 2014, he worked at Citi
Research, most recently serving as a Managing Director where he covered
midstream energy companies and MLPs. From 1998 to 2005, he worked at Raymond
James & Associates as a Vice President who covered the oilfield service industry
and established the firm's initial coverage of MLPs in 2001. Prior to that, he
was an Equity Trader at Momentum Securities from 1997 to 1998 and an Assistant
Executive Director at Sumar Enterprises from 1996 to 1997. He graduated from The
University of Texas at Austin with a BA in economics.
Linda Longville is the Research Director and a Principal of Energy Income
Partners. Ms. Longville has been with Energy Income Partners since its inception
in 2003, including the time the Energy Income Partners investment team spent at
Pequot Capital between December 2004 and July 2006. From April 2001 through
September 2003, she was a research analyst for Lawhill Capital. Prior to Lawhill
Capital, Ms. Longville held positions in finance and business development at
British Petroleum, PLC and Advanced Satellite Communications, Inc. She has a BAS
from Miami University (Ohio) and an MA from Case Western Reserve University.
Saul Ballesteros is the Head of Trading and Operations and a Principal of
Energy Income Partners. Mr. Ballesteros joined Energy Income Partners in 2006
after six years as a proprietary trader at FPL Group and Mirant Corp. From 1994
through 1999, he was with Enron's internal hedge fund in various positions of
increased responsibility, and, from 1991 through 1994, Mr. Ballesteros was a
manager of financial planning at IBM. Mr. Ballesteros holds a BS from Duke
University and an MBA from Northwestern University.
59
------------------------------------------------------------------------------------------------------------------------------------
NUMBER OF OTHER ACCOUNTS MANAGED AND ASSETS BY ACCOUNT TYPE
AS OF OCTOBER 31, 2017
------------------------------------------------------------------------------------------------------------------------------------
REGISTERED OTHER POOLED
REGISTERED INVESTMENT INVESTMENT
INVESTMENT COMPANIES VEHICLES OTHER ACCOUNTS
COMPANIES SUBJECT TO OTHER POOLED SUBJECT TO SUBJECT TO
PORTFOLIO (OTHER THAN PERFORMANCE-BASED INVESTMENT PERFORMANCE-BASED PERFORMANCE-BASED
MANAGER THE FUND) ADVISORY FEES VEHICLES ADVISORY FEES OTHER ACCOUNTS ADVISORY FEES
------------------------------------------------------------------------------------------------------------------------------------
James J. Murchie Number: 7 Number: 0 Number: 3 Number: 2 Number: 532 Number: 1
Assets: $3,431 Assets: $0 Assets: $246 Assets: $235.8 Assets: $1,351 Assets: $2.1
------------------------------------------------------------------------------------------------------------------------------------
Eva Pao Number: 7 Number: 0 Number: 3 Number: 2 Number: 532 Number: 1
Assets: $3,431 Assets: $0 Assets: $246 Assets: $235.8 Assets: $1,351 Assets: $2.1
------------------------------------------------------------------------------------------------------------------------------------
John K. Number: 7 Number: 0 Number: 3 Number: 1 Number: 532 Number: 1
Tysseland Assets: $3,431 Assets: $0 Assets: $246 Assets: $235.8 Assets: $1,351 Assets: $2.1
------------------------------------------------------------------------------------------------------------------------------------
The portfolio managers are compensated by a competitive minimum base
salary and share in the profits of Energy Income Partners in relationship to
their ownership of Energy Income Partners.
The following table sets forth the dollar range of equity securities
beneficially owned by the portfolio managers in the Fund as of October 31, 2017:
DOLLAR RANGE OF
EQUITY SECURITIES
PORTFOLIO MANAGER IN THE FUND
James J. Murchie None
Eva Pao None
John K. Tysseland None
Actual or apparent conflicts of interest may arise when a portfolio
manager has day-to-day management responsibilities with respect to more than one
fund or other account. More specifically, portfolio managers who manage multiple
funds and/or other accounts may be presented with one or more of the potential
conflicts described below.
The management of multiple funds and/or other accounts may result in a
portfolio manager devoting unequal time and attention to the management of each
fund and/or other account. The Sub-Advisor seeks to manage such competing
interests for the time and attention of a portfolio manager by having the
portfolio manager focus on a particular investment discipline. Most other
accounts managed by a portfolio manager are managed using the same investment
models that are used in connection with the management of the Fund.
If a portfolio manager identifies a limited investment opportunity which
may be suitable for more than one fund or other account, a fund may not be able
to take full advantage of that opportunity due to an allocation of filled
60
purchase or sale orders across all eligible funds and other accounts. To deal
with these situations, the Sub-Advisor has adopted procedures for allocating
portfolio transactions across multiple accounts. In addition, Section 17(d) of
the 1940 Act may limit or prevent the Fund from participating in certain joint
transactions with affiliated persons.
With respect to securities transactions for the Fund, the Sub-Advisor
determines which broker to use to execute each order, consistent with its duty
to seek best execution of the transaction. However, with respect to certain
other accounts (such as mutual funds for which the Sub-Advisor acts as
sub-advisor, other pooled investment vehicles that are not registered mutual
funds, and other accounts managed for organizations and individuals), the
Sub-Advisor may be limited by the client with respect to the selection of
brokers or may be instructed to direct trades through a particular broker. In
these cases, trades for a fund in a particular security may be placed separately
from, rather than aggregated with, such other accounts. Having separate
transactions with respect to a security may temporarily affect the market price
of the security or the execution of the transaction, or both, to the possible
detriment of such fund or other account(s) involved.
The Sub-Advisor, the Advisor and the Fund have adopted certain compliance
procedures which are designed to address these types of conflicts. However,
there is no guarantee that such procedures will detect each and every situation
in which a conflict arises.
The Sub-Advisor, subject to the Board of Trustees' and Advisor's
supervision, provides the Fund with discretionary investment services.
Specifically, the Sub-Advisor is responsible for managing the investments of the
Fund in accordance with the Fund's investment objective, policies and
restrictions as provided in the Prospectus and this Statement of Additional
Information, as may be subsequently changed by the Board of Trustees and
communicated to the Sub-Advisor in writing. The Sub-Advisor further agrees to
conform to all applicable laws and regulations of the SEC in all material
respects and to conduct its activities under the Sub-Advisory Agreement in all
material respects in accordance with applicable regulations of any governmental
authority pertaining to its investment advisory services. In the performance of
its duties, the Sub-Advisor will in all material respects satisfy any applicable
fiduciary duties it may have to the Fund, will monitor the Fund's investments,
and will comply with the provisions of the Fund's Declaration of Trust and
By-laws, as amended from time to time, and the stated investment objective,
policies and restrictions of the Fund. The Sub-Advisor is responsible for
effecting all security transactions for the Fund's assets. The Sub-Advisory
Agreement provides that the Sub-Advisor shall not be liable for any loss
suffered by the Fund or the Advisor (including, without limitation, by reason of
the purchase, sale or retention of any security) in connection with the
performance of the Sub-Advisor's duties under the Sub-Advisory Agreement, except
for a loss resulting from willful misfeasance, bad faith or gross negligence on
the part of the Sub-Advisor in performance of its duties under such Sub-Advisory
Agreement, or by reason of its reckless disregard of its obligations and duties
under such Sub-Advisory Agreement.
Pursuant to a sub-advisory agreement among the Fund, the Advisor and the
Sub-Advisor, (the "Sub-Advisory Agreement"), the Sub-Advisor receives a
portfolio management fee equal to 0.50% of the Fund's Managed Assets. The
61
Sub-Advisor's fee is paid by the Advisor out of the Advisor's management fee.
Because the fee paid to the Advisor and by the Advisor to the Sub-Advisor will
be calculated on the basis of the Fund's Managed Assets, which include the
proceeds of leverage, the dollar amount of the Advisor's and Sub-Advisor's fees
will be higher (and the Advisor and Sub-Advisor will be benefited to that
extent) when leverage is utilized.
The following table sets for the advisory fee paid by the Fund to the
Advisor for the periods indicated in the table below.
-------------------------------------------- ---------------------------------
Fiscal Year ended October 31, 2017 $9,383,858
-------------------------------------------- ---------------------------------
Fiscal Year ended October 31, 2016 $8,952,394
-------------------------------------------- ---------------------------------
Fiscal Year ended October 31, 2015 $12,777,010
-------------------------------------------- ---------------------------------
The following table sets for the advisory fee paid by the Advisor to the
Sub-Advisor for the periods indicated in the table below.
-------------------------------------------- ---------------------------------
Fiscal Year ended October 31, 2017 $4,691,929
-------------------------------------------- ---------------------------------
Fiscal Year ended October 31, 2016 $4,476,197
-------------------------------------------- ---------------------------------
Fiscal Year ended October 31, 2015 $6,388,505
-------------------------------------------- ---------------------------------
The Sub-Advisory Agreement may be terminated without the payment of any
penalty by First Trust Advisors, the Fund's Board of Trustees, or a majority of
the outstanding voting securities of the Fund (as defined in the 1940 Act), upon
60 days' written notice to the Sub-Advisor.
All fees and expenses are accrued daily and deducted before payment of
dividends to investors. The Sub-Advisory Agreement has been approved by the
Board of Trustees, including a majority of the Independent Trustees of the Fund,
and the common shareholders of the Fund.
PROXY VOTING POLICIES AND PROCEDURES
The Fund has adopted a proxy voting policy that seeks to ensure that
proxies for securities held by the Fund are voted consistently and solely in the
best interests of the Fund.
The Board of Trustees is responsible for oversight of the Fund's proxy
voting process. The Board has delegated day-to-day proxy voting responsibility
to the Sub-Advisor. The Proxy Voting Guidelines of the Sub-Advisor are set forth
in Appendix B to this Statement of Additional Information.
Information regarding how the Fund voted proxies (if any) relating to
portfolio securities during the most recent 12-month period ended June 30 will
be available: (i) without charge, upon request, by calling (800) 621-1675; (ii)
62
on the Fund's website at http://www.ftportfolios.com; and (iii) by accessing the
SEC's website at http://www.sec.gov.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the supervision of the Board of Trustees, the Sub-Advisor shall
have authority and discretion to select brokers and dealers to execute
transactions initiated by the Sub-Advisor and to select the market in which the
transactions will be executed. In placing orders for the sale and purchase of
securities for the Fund, the Sub-Advisor's primary responsibility shall be to
seek the best execution of orders at the most favorable prices. However, this
responsibility shall not obligate the Sub-Advisor to solicit competitive bids
for each transaction or to seek the lowest available commission cost to the
Fund, so long as the Sub-Advisor reasonably believes that the broker or dealer
selected by it can be expected to obtain a "best execution" market price on the
particular transaction and determines in good faith that the commission cost is
reasonable in relation to the value of the brokerage and research services
(within the meaning of Section 28(e)(3) of the 1934 Act) provided by such broker
or dealer to the Sub-Advisor, viewed in terms of either that particular
transaction or of the overall responsibilities with respect to its clients,
including the Fund, as to which the Sub-Advisor exercises investment discretion,
notwithstanding that the Fund may not be the direct or exclusive beneficiary of
any such services or that another broker may be willing to charge the Fund a
lower commission on the particular transaction.
The Sub-Advisor's objective in selecting brokers and dealers and in
effecting portfolio transactions is to seek to obtain the best combination of
price and execution with respect to its clients' portfolio transactions. Steps
associated with seeking best execution include, but are not limited to, the
following: (i) determine each client's trading requirements; (ii) select
appropriate trading methods, venues, and agents to execute the trades under the
circumstances; (iii) evaluate market liquidity of each security and take
appropriate steps to avoid excessive market impact; (iv) maintain client
confidentiality and proprietary information inherent in the decision to trade;
and (v) review the results on a periodic basis.
In arranging for the purchase and sale of clients' portfolio securities,
the Sub-Advisor takes numerous factors into consideration. The best net price,
giving effect to brokerage commissions, spreads and other costs, is normally an
important factor in this decision, but a number of other judgmental factors are
considered as they are deemed relevant. The factors include, but are not limited
to: the execution capabilities required by the transactions; the ability and
willingness of the broker or dealer to facilitate the accounts' portfolio
transactions by participating therein for its own account; the importance to the
account of speed, efficiency and confidentiality; the broker or dealer's
apparent familiarity with sources from or to whom particular securities might be
purchased or sold; the reputation and perceived soundness of the broker or
dealer; the Sub-Advisor's knowledge of negotiated commission rates and spreads
currently available; the nature of the security being traded; the size and type
of the transaction; the nature and character of the markets for the security to
be purchased or sold; the desired timing of the trade; the activity existing and
expected in the market for the particular security; confidentiality; the
execution, clearance and settlement capabilities as well as the reputation and
perceived soundness of the broker-dealer selected and others which are
63
considered; the Sub-Advisor's knowledge of actual or apparent operational
problems of any broker-dealer; the broker-dealer's execution services rendered
on a continuing basis and in other transactions; the reasonableness of spreads
or commissions; as well as other matters relevant to the selection of a broker
or dealer for portfolio transactions for any account. The Sub-Advisor does not
adhere to any rigid formula in making the selection of the applicable broker or
dealer for portfolio transactions, but weighs a combination of the preceding
factors.
When buying or selling securities in dealer markets, the Sub-Advisor
generally prefers to deal directly with market makers in the securities. The
Sub-Advisor will typically effect these trades on a "net" basis, and will not
pay the market maker any commission, commission equivalent or markup/markdown
other than the "spread." Usually, the market maker profits from the "spread,"
that is, the difference between the price paid (or received) by the Sub-Advisor
and the price received (or paid) by the market maker in trades with other
broker-dealers or other customers.
The Sub-Advisor may use Electronic Communications Networks ("ECN") or
Alternative Trading Systems ("ATS") to effect such over-the-counter trades for
equity securities when, in the Sub-Advisor's judgment, the use of an ECN or ATS
may result in equal or more favorable overall executions for the transactions.
Portfolio transactions for each client account will generally be completed
independently, except when the Sub-Advisor is in the position of buying or
selling the same security for a number of clients at approximately the same
time. Because of market fluctuations, the prices obtained on such transactions
within a single day may vary substantially. In order to avoid having clients
receive different prices for the same security on the same day, the Sub-Advisor
endeavors, when possible, to use an "averaging" procedure.
Under this procedure, purchases or sales of a particular security for
clients' accounts will at times be combined or "batched" with purchases or sales
for other advisory clients by the Sub-Advisor unless the client has expressly
directed otherwise. Such batched trades may be used to facilitate best
execution, including negotiating more favorable prices, obtaining more timely or
equitable execution or reducing overall commission charges. In such cases, the
price shown on confirmations of clients' purchases or sales will be the average
execution price on all of the purchases and sales that are aggregated for this
purpose.
The Sub-Advisor may also consider the following when deciding on
allocations: (i) cash flow changes (including available cash, redemptions,
exchanges, capital additions and capital withdrawals) may provide a basis to
deviate from a pre-established allocation as long as it does not result in an
unfair advantage to specific accounts or types of accounts over time; (ii)
accounts with specialized investment objectives or restrictions emphasizing
investment in a specific category of securities may be given priority over other
accounts in allocating such securities; and (iii) for bond trades, street
convention and good delivery often dictate the minimum size and par amounts and
may result in deviations from pro rata distribution.
The following table sets forth the aggregate amount of brokerage
commissions paid by the Fund for the specified periods
64
-------------------------------------------- ---------------------------------
Fiscal Year ended October 31, 2017 $658,962
-------------------------------------------- ---------------------------------
Fiscal Year ended October 31, 2016 $1,004,419
-------------------------------------------- ---------------------------------
Fiscal Period ended October 31, 2015 $724,939
-------------------------------------------- ---------------------------------
The Fund did not pay any brokerage commissions to any affiliated persons of the
Fund.
During the fiscal year ended October 31, 2017, the Fund paid $150,076 in
commissions to brokers in return for research services. During the fiscal year
ended October 31, 2016, the Fund did not acquire any securities of its regular
brokers or dealers as defined in Rule 10b-1 under the 1940 Act or the parents of
the brokers or dealers.
DESCRIPTION OF SHARES
COMMON SHARES
The beneficial interest of the Fund may be divided from time to time into
shares of beneficial interest of such classes and of such designations and par
values (if any) and with such rights, preferences, privileges and restrictions
as shall be determined by the Trustees from time to time in their sole
discretion, without shareholder vote. The Fund's Declaration of Trust initially
authorizes the issuance of an unlimited number of common shares. The Common
Shares being offered have a par value of $0.01 per share and, subject to the
rights of holders of Preferred Shares, if issued, have equal rights as to the
payment of dividends and the distribution of assets upon liquidation of the
Fund. The Common Shares being offered will, when issued, be fully paid and,
subject to matters discussed in "Certain Provisions in the Declaration of Trust
and By-Laws," non-assessable, and currently have no pre-emptive or conversion
rights (except as may otherwise be determined by the Trustees in their sole
discretion) or rights to cumulative voting in the election of Trustees.
Shares of closed-end investment companies may frequently trade at prices
lower than NAV. NAV will be reduced immediately following an offering of the
Fund after payment of the sales load and organization and offering expenses.
Although the value of the Fund's net assets is generally considered by market
participants in determining whether to purchase or sell shares, whether
investors will realize gains or losses upon the sale of common shares will
depend entirely upon whether the market price of the common shares at the time
of sale is above or below the original purchase price for the shares. Since the
market price of the Fund's common shares will be determined by factors beyond
the control of the Fund, the Fund cannot predict whether the common shares will
trade at, below, or above NAV or at, below or above the initial public offering
price. Accordingly, the common shares are designed primarily for long-term
investors, and investors in the common shares should not view the Fund as a
vehicle for trading purposes. See "Repurchase of Fund Shares; Conversion to
Open-End Fund" below and "The Fund's Investments" in the Fund's Prospectus.
65
PREFERRED SHARE AUTHORIZATION
Under the terms of the Declaration of Trust, the Board of Trustees has the
authority in its sole discretion, without prior approval of the common
shareholders, to authorize the issuance of Preferred Shares in one or more
classes or series with such rights and terms, including voting rights, dividend
rates, redemption provisions, liquidation preferences and conversion provisions,
as determined by the Board of Trustees.
BORROWINGS
The Declaration of Trust authorizes the Fund, without prior approval of
the common shareholders, to borrow money. In this connection, the Fund may issue
notes or other evidence of indebtedness (including bank borrowings or commercial
paper) ("Borrowings") and may secure any such Borrowings by mortgaging, pledging
or otherwise subjecting as security the Fund's assets. In connection with such
Borrowings, the Fund may be required to maintain average balances with the
lender or to pay a commitment or other fee to maintain a line of credit. Any
such requirements will increase the cost of borrowing over the borrowing
instrument's stated interest rate. The Fund may borrow from banks and other
financial institutions.
Limitations on Borrowings. Under the requirements of the 1940 Act, the
Fund, immediately after any Borrowings, must have an "asset coverage" of at
least 300% (33 1/3% of Managed Assets after Borrowings). With respect to such
Borrowings, "asset coverage" means the ratio which the value of the total assets
of the Fund, less all liabilities and indebtedness not represented by senior
securities (as defined in the 1940 Act), bears to the aggregate amount of such
Borrowings represented by senior securities issued by the Fund. Certain types of
Borrowings may result in the Fund being subject to covenants in credit
agreements relating to asset coverage or portfolio composition or otherwise. In
addition, the Fund may be subject to certain restrictions imposed by the
guidelines of one or more NRSROs which may issue ratings for short-term
corporate debt securities and/or Preferred Shares issued by the Fund. Such
restrictions may be more stringent than those imposed by the 1940 Act.
Distribution Preference. The rights of lenders to the Fund to receive
interest on and repayment of principal of any such Borrowings will be senior to
those of the common shareholders, and the terms of any such Borrowings may
contain provisions which limit certain activities of the Fund, including the
payment of dividends to common shareholders in certain circumstances.
Voting Rights. The 1940 Act grants (in certain circumstances) to the
lenders to the Fund certain voting rights in the event the asset coverage falls
below specified levels. In the event that the Fund elects to be treated as a
regulated investment company under the Code and such provisions would impair the
Fund's status as a regulated investment company, the Fund, subject to its
ability to liquidate its portfolio, repays the Borrowings as soon as
practicable. Any Borrowings will likely be ranked senior or equal to all other
existing and future borrowings of the Fund.
66
The discussion above describes the Fund's Board of Trustees' present
intention with respect to Borrowings. If authorized by the Board of Trustees,
the terms of any Borrowings may be the same as, or different from, the terms
described above, subject to applicable law and the Fund's Declaration of Trust.
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST AND BY-LAWS
Under Massachusetts law, shareholders could, in certain circumstances, be
held personally liable for the obligations of the Fund. However, the Declaration
of Trust (the "Declaration") contains an express disclaimer of shareholder
liability for debts or obligations of the Fund and requires that notice of such
limited liability be given in each agreement, obligation or instrument entered
into or executed by the Fund or the Trustees. The Declaration further provides
for indemnification out of the assets and property of the Fund for all loss and
expense of any shareholder held personally liable for the obligations of the
Fund solely by reason of his or her being a shareholder. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which the Fund would be unable to meet its
obligations. The Fund believes that the likelihood of such circumstances is
remote.
The Declaration and By-Laws include provisions that could limit the
ability of other entities or persons to acquire control of the Fund or to
convert the Fund to open-end status. The number of trustees is currently five,
but by action of two-thirds of the trustees, the Board of Trustees may from time
to time be increased or decreased. The Board of Trustees is divided into three
classes of trustees serving staggered three-year terms, with the terms of one
class expiring at each annual meeting of shareholders. If the Fund issues
Preferred Shares, the Fund may establish a separate class for the trustees
elected by the holders of the Preferred Shares. Subject to applicable provisions
of the 1940 Act, vacancies on the Board of Trustees may be filled by a majority
action of the remaining trustees. Such provisions may work to delay a change in
the majority of the Board of Trustees. The provisions of the Declaration of
Trust relating to the election and removal of trustees may be amended only by a
vote of two-thirds of the trustees then in office. The By-Laws may be amended
only by the Board of Trustees.
The Declaration of Trust requires a common shareholder vote only on those
matters where the 1940 Act or the Fund's listing with an exchange require a
common shareholder vote, but otherwise permits the Board of Trustees to take
action without seeking the consent of common shareholders. For example, the
Declaration of Trust gives the Board of Trustees broad authority to approve
reorganizations between the Fund and another entity, such as another closed-end
fund, and the sale of all or substantially all of its assets without common
shareholder approval if the 1940 Act would not require such approval. The
Declaration of Trust further provides that the Board of Trustees may amend the
Declaration of Trust in any respect without common shareholder approval. The
Declaration of Trust, however, prohibits amendments that impair the exemption
from personal liability granted in the Declaration of Trust to persons who are
or have been shareholders, trustees, officers or employees of the Fund or that
limit the rights to indemnification or insurance provided in the Declaration of
Trust with respect to actions or omissions of persons entitled to
indemnification under the Declaration of Trust prior to the amendment.
67
Generally, the Declaration requires the affirmative vote or consent by
holders of at least two-thirds of the shares outstanding and entitled to vote,
except as described below, to authorize (1) a conversion of the Fund from a
closed-end to an open-end investment company, (2) a merger or consolidation of
the Fund with any corporation, association, trust or other organization,
including a series or class of such other organization (in the limited
circumstances where a vote by shareholders is otherwise required under the
Declaration of Trust), (3) a sale, lease or exchange of all or substantially all
of the Fund's assets (in the limited circumstances where a vote by shareholders
is otherwise required under the Declaration of Trust), (4) in certain
circumstances, a termination of the Fund, (5) removal of Trustees by
shareholders, or (6) certain transactions in which a Principal Shareholder (as
defined below) is a party to the transactions. However, with respect to items
(1), (2) and (3) above, if the applicable transaction has been already approved
by the affirmative vote of two-thirds of the Trustees, then the majority of the
outstanding voting securities as defined in the 1940 Act (a "Majority
Shareholder Vote") is required. In addition, if there are then Preferred Shares
outstanding, with respect to (1) above, two-thirds of the Preferred Shares
voting as a separate class shall also be required unless the action has already
been approved by two-thirds of the Trustees, in which case then a Majority
Shareholder Vote is required. Such affirmative vote or consent shall be in
addition to the vote or consent of the holders of the shares otherwise required
by law or by the terms of any class or series of Preferred Shares, whether now
or hereafter authorized, or any agreement between the Fund and any national
securities exchange. Further, in the case of items (2) or (3) that constitute a
plan of reorganization (as such term is used in the 1940 Act) which adversely
affects the Preferred Shares within the meaning of section 18(a)(2)(D) of the
1940 Act, except as may otherwise be required by law, the approval of the action
in question will also require the affirmative vote of two thirds of the
Preferred Shares voting as a separate class provided, however, that such
separate class vote shall be by a Majority Shareholder Vote if the action in
question has previously been approved by the affirmative vote of two-thirds of
the Trustees.
As noted above, pursuant to the Declaration of Trust, the affirmative
approval of two-thirds of the Shares outstanding and entitled to vote, subject
to certain exceptions, shall be required for the following transactions in which
a Principal Shareholder (as defined below) is a party: (1) the merger or
consolidation of the Fund or any subsidiary of the Fund with or into any
Principal Shareholder; (2) the issuance of any securities of the Fund to any
Principal Shareholder for cash other than pursuant to a dividend reinvestment or
similar plan available to all shareholders; (3) the sale, lease or exchange of
all or any substantial part of the assets of the Fund to any Principal
Shareholder (except assets having an aggregate fair market value of less than
$1,000,000, aggregating for the purpose of such computation all assets sold,
leased or exchanged in any series of similar transactions within a twelve-month
period); (4) the sale, lease or exchange to the Fund or any subsidiary thereof,
in exchange for securities of the Fund, of any assets of any Principal
Shareholder (except assets having an aggregate fair market value of less than
$1,000,000, aggregating for the purposes of such computation all assets sold,
leased or exchanged in any series of similar transactions within a twelve-month
period). However, shareholder approval for the foregoing transactions shall not
be applicable to (1) any transaction, including, without limitation, any rights
offering, made available on a pro rata basis to all shareholders of the Fund or
class thereof unless the Trustees specifically make such transaction subject to
this voting provision, (2) any transaction if two-thirds of the Trustees shall
by resolution have approved a memorandum of understanding with such Principal
68
Shareholder with respect to and substantially consistent with such transaction
or (3) any such transaction with any corporation of which a majority of the
outstanding shares of all classes of stock normally entitled to vote in
elections of directors is owned of record or beneficially by the Fund and its
subsidiaries. As described in the Declaration of Trust, a Principal Shareholder
shall mean any corporation, person or other entity which is the beneficial
owner, directly or indirectly, of more than 5% of the outstanding shares and
shall include any affiliate or associate (as such terms are defined in the
Declaration of Trust) of a Principal Shareholder or persons acting in concert.
The above affirmative vote shall be in addition to the vote of the shareholders
otherwise required by law or by the terms of any class or series of Preferred
Shares, whether now or hereafter authorized, or any agreement between the Fund
and any national securities exchange.
The provisions of the Declaration described above could have the effect of
depriving the common shareholders of opportunities to sell their common shares
at a premium over market value by discouraging a third party from seeking to
obtain control of the Fund in a tender offer or similar transaction. The overall
effect of these provisions is to render more difficult the accomplishment of a
merger or the assumption of control by a third party. They provide, however, the
advantage of potentially requiring persons seeking control of a Fund to
negotiate with its management regarding the price to be paid and facilitating
the continuity of the Fund's investment objective and policies. The Board of
Trustees of the Fund has considered the foregoing anti-takeover provisions and
concluded that they are in the best interests of the Fund and its common
shareholders.
The Declaration provides that the obligations of the Fund are not binding
upon the Trustees of the Fund individually, but only upon the assets and
property of the Fund, and that the Trustees shall not be liable to any person in
connection with the Fund property or the affairs of the Fund or for any neglect
or wrongdoing of any officer, employee or agent of the Fund or for the act or
omission of any other Trustee. Nothing in the Declaration, however, protects a
Trustee against any liability to which he or she would otherwise be subject by
reason of willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of his office with or on behalf of the
Fund.
Reference should be made to the Declaration on file with the SEC for the
full text of these provisions.
REPURCHASE OF FUND SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its shareholders
will not have the right to cause the Fund to redeem their shares. Instead, the
Fund's common shares trade in the open market at a price that will be a function
of several factors, including dividend levels (which are in turn affected by
expenses), NAV, price, dividend stability, relative demand for and supply of
such shares in the market, general market and economic conditions and other
factors. Because shares of a closed-end investment company may frequently trade
at prices lower than NAV, the Trustees, in consultation with the Fund's Advisor,
Sub-Advisor and the corporate finance services and consulting agent that the
Advisor may retain from time to time, may review possible actions to reduce any
such discount. Actions may include the repurchase of such shares in the open
market or in private transactions, the making of a tender offer for such shares,
69
or the conversion of the Fund to an open-end investment company. There can be no
assurance, however, that the Trustees will decide to take any of these actions,
or that share repurchases or tender offers, if undertaken, will reduce a market
discount. After any consideration of potential actions to seek to reduce any
significant market discount, the Trustees may, subject to their fiduciary
obligations and compliance with applicable state and federal laws, authorize the
commencement of a share-repurchase program or tender offer. The size and timing
of any such share repurchase program or tender offer will be determined by the
Trustees in light of the market discount of the common shares, trading volume of
the common shares, information presented to the Trustees regarding the potential
impact of any such share repurchase program or tender offer, and general market
and economic conditions. There can be no assurance that the Fund will in fact
effect repurchases of or tender offers for any of its common shares. Before
deciding whether to take any action if the Fund's common shares trade below NAV,
the Trustees would consider all relevant factors, including the extent and
duration of the discount, the liquidity of the Fund's portfolio, the impact of
any action that might be taken on the Fund or its shareholders and market
considerations. Based on these considerations, even if the Fund's shares should
trade at a discount, the Trustees may determine that, in the interest of the
Fund and its shareholders, no action should be taken.
Further, the staff of the SEC currently requires that any tender offer
made by a closed-end investment company for its shares must be at a price equal
to the NAV of such shares on the close of business on the last day of the tender
offer. Any service fees incurred in connection with any tender offer made by the
Fund will be borne by the Fund and will not reduce the stated consideration to
be paid to tendering shareholders.
Subject to its investment limitations, the Fund may borrow to finance the
repurchase of shares or to make a tender offer. Interest on any borrowings to
finance share repurchase transactions or the accumulation of cash by the Fund in
anticipation of share repurchases or tenders will increase the Fund's expenses
and reduce the Fund's net income. Any share repurchase, tender offer or
borrowing that might be approved by the Trustees would have to comply with the
Securities Exchange Act of 1934, as amended, and the 1940 Act and the rules and
regulations thereunder.
Although the decision to take action in response to a discount from NAV
will be made by the Trustees at the time they consider such issue, it is the
Trustees' present policy, which may be changed by the Trustees, not to authorize
repurchases of common shares or a tender offer for such shares if (1) such
transactions, if consummated, would (a) result in the delisting of the common
shares from the NYSE, or (b) impair status as a registered closed-end investment
company under the 1940 Act; (2) the Fund would not be able to liquidate
portfolio securities in an orderly manner and consistent with the Fund's
investment objective and policies in order to repurchase shares; or (3) there
is, in the Board of Trustees' judgment, any (a) material legal action or
proceeding instituted or threatened challenging such transactions or otherwise
materially adversely affecting the Fund, (b) general suspension of or limitation
on prices for trading securities on the NYSE, (c) declaration of a banking
moratorium by Federal or state authorities or any suspension of payment by
United States or state banks in which the Fund invests, (d) material limitation
affecting the Fund or the issuers of its portfolio securities by Federal or
state authorities on the extension of credit by lending institutions or on the
70
exchange of non-U.S. currency, (e) commencement of war, armed hostilities or
other international or national calamity directly or indirectly involving the
United States, or (f) other event or condition which would have a material
adverse effect (including any adverse tax effect) on the Fund or its
shareholders if shares were repurchased. The Trustees may in the future modify
these conditions in light of experience with respect to the Fund.
Conversion to an open-end company would require the approval of the
holders of at least two-thirds of the Fund's shares outstanding and entitled to
vote; provided, however, that unless otherwise provided by law, if there are
Preferred Shares outstanding, the affirmative vote of two-thirds of the
Preferred Shares voting as a separate class shall be required; provided,
however, that such votes shall be by the affirmative vote of the majority of the
outstanding voting securities, as defined in the 1940 Act, if the action in
question was previously approved by the affirmative vote of two-thirds of the
Trustees. Such affirmative vote or consent shall be in addition to the vote or
consent of the holders of the shares otherwise required by law or by the terms
of any class or series of Preferred Shares, whether now or hereafter authorized,
or any agreement between the Fund and any national securities exchange. See the
Prospectus under "Closed-End Fund Structure" for a discussion of voting
requirements applicable to conversion of the Fund to an open-end company. If the
Fund converted to an open-end company, the Fund's common shares would no longer
be listed on the NYSE. Any Preferred Shares would need to be redeemed and any
Borrowings may need to be repaid upon conversion to an open-end investment
company. Additionally, the 1940 Act imposes limitations on open-end funds'
investments in illiquid securities, which could restrict the Fund's ability to
invest in certain securities discussed in the Prospectus to the extent discussed
therein. Such limitations could adversely affect distributions to Fund common
shareholders in the event of conversion to an open-end fund. Shareholders of an
open-end investment company may require the company to redeem their shares on
any business day (except in certain circumstances as authorized by or under the
1940 Act) at their NAV, less such redemption charge, if any, as might be in
effect at the time of redemption. In order to avoid maintaining large cash
positions or liquidating favorable investments to meet redemptions, open-end
companies typically engage in a continuous offering of their shares. Open-end
companies are thus subject to periodic asset in-flows and out-flows that can
complicate portfolio management. The Trustees may at any time propose conversion
of the Fund to an open-end company depending upon their judgment as to the
advisability of such action in light of circumstances then prevailing.
The repurchase by the Fund of its shares at prices below NAV will result
in an increase in the NAV of those shares that remain outstanding. However,
there can be no assurance that share repurchases or tenders at or below NAV will
result in the Fund's shares trading at a price equal to their NAV. Nevertheless,
the fact that the Fund's shares may be the subject of repurchase or tender
offers from time to time may reduce any spread between market price and NAV that
might otherwise exist.
In addition, a purchase by the Fund of its common shares will decrease the
Fund's Managed Assets which would likely have the effect of increasing the
Fund's expense ratio.
71
NET ASSET VALUE
The NAV of the common shares of the Fund is computed based upon the value
of the Fund's portfolio securities and other assets. The NAV is determined daily
as of the close of regular session trading on the NYSE (normally 4:00 p.m.
eastern time). U.S. debt securities will normally be priced using data
reflecting the earlier closing of the principal markets for those securities.
The Fund calculates NAV per common share by subtracting the Fund's liabilities
(including accrued expenses, dividends payable, current and deferred income
taxes, any borrowings of the Fund and the market value of written call options)
and the liquidation value of any outstanding Preferred Shares from 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 and
option premiums) and dividing the result by the total number of common shares
outstanding. The Fund relies to some extent on information provided by MLPs,
which is not necessarily timely, to estimate taxable income allocable to MLP
units held by the Fund and to estimate associated deferred tax liability. From
time to time the Fund will modify its estimates and/or assumption regarding its
deferred tax liability as new information becomes available. To the extent the
Fund modifies its estimates and/or assumptions, the net asset value of the Fund
would likely fluctuate.
The assets in the Fund's portfolio are valued daily in accordance with
Valuation Procedures (as defined below) adopted by the Trustees. The Sub-Advisor
anticipates that a majority of the Fund's assets will be valued using market
information supplied by third parties. In the event that market quotations are
not readily available, the pricing service does not provide a valuation for a
particular asset (as is the case for unlisted investments), or the valuations
are deemed unreliable, or if events occurring after the close of the principal
markets for particular securities (e.g., U.S. debt securities), but before the
Fund values its assets, would materially affect NAV, the Fund may use a fair
value method in good faith to value the Fund's securities and investments. The
use of fair value pricing by the Fund is governed by Valuation Procedures
adopted by the Trustees, and in accordance with the provisions of the 1940 Act.
For purposes of determining the NAV of the Fund, readily marketable
portfolio securities listed on any U.S. exchange other than Nasdaq are valued,
except as indicated below, at the last sale price on the business day as of
which such value is being determined. If there has been no sale on such day, the
securities are valued at the mean of the most recent bid and asked prices on
such day. Securities admitted to trade on Nasdaq are valued at the Nasdaq
Official Closing Price as determined by Nasdaq. Portfolio securities traded on
more than one securities exchange are valued at the last sale price on the
business day as of which such value is being determined at the close of the
exchange representing the principal market for such securities.
Equity securities traded in the over-the-counter market, but excluding
securities admitted to trading on Nasdaq, are valued at the closing bid prices.
Fixed income securities with a remaining maturity of 60 days or more will be
valued by the Fund using a pricing service. When price quotes are not available,
fair market value is based on prices of comparable securities. Fixed income
securities maturing within 60 days are valued by the Fund on an amortized cost
basis.
72
Any derivative transaction that the Fund enters into may, depending on the
applicable market environment, have a positive or negative value for purposes of
calculating NAV. Any option transaction that the Fund enters into may, depending
on the applicable market environment, have no value or a positive value.
Exchange traded options and futures contracts are valued at the closing price in
the market where such contracts are principally traded.
The value of any portfolio security held by the Fund for which reliable
market quotations are not readily available, including illiquid securities, or
if a valuation is deemed inappropriate, will be determined under procedures
adopted by the Board of Trustees in a manner that reflects fair market value of
the security on the valuation date.
Unlisted Investments--Fair Value. When applicable, fair value is
determined by the Board of Trustees or its designee. In fair valuing the Fund's
investments, consideration is given to several factors, which may include, among
others, the following:
o the fundamental business data relating to the issuer;
o an evaluation of the forces which influence the market in which the
securities of the issuer are purchased and sold;
o the type, size and cost of the security;
o the financial statements of the issuer;
o the credit quality and cash flow of the issuer, based on the
Sub-Advisor's or external analysis;
o the information as to any transactions in or offers for the security;
o the price and extent of public trading in similar securities (or
equity securities) of the issuer, or comparable companies;
o the coupon payments;
o the quality, value and saleability of collateral, if any, securing the
security;
o the business prospects of the issuer, including any ability to obtain
money or resources from a parent or affiliate and an assessment of the
issuer's management;
o the prospects for the issuer's industry, and multiples (of earnings
and/or cash flow) being paid for similar businesses in that industry;
o the issuer's competitive position within the industry;
o the issuer's ability to access additional liquidity through public and
private markets; and
73
o other relevant factors.
If the Board of Trustees or its designee cannot obtain a market value or
the Board of Trustees or its designee determines that the value of a security as
so obtained does not represent a fair value as of the valuation time (due to a
significant development subsequent to the time its price is determined or
otherwise), fair value for the security shall be determined pursuant to
methodologies established by the Board of Trustees (the "Valuation Procedures").
The Valuation Procedures provide that direct placements of securities of private
companies (i.e., companies with no outstanding public securities) will be valued
based upon a fair value methodology, which has typically been at cost. The
Valuation Procedures provide that securities that are convertible into publicly
traded securities (i.e., subordinated units) ordinarily will be valued at the
market value of the publicly traded security less a discount equal in amount to
the discount negotiated at the time of purchase. A report of any prices
determined pursuant to such fair value methodologies will be presented to the
Board of Trustees or a designated committee thereof no less frequently than
quarterly.
The Valuation Procedures also provide that the Board of Trustees or its
designee will review the valuation of the obligation for income taxes separately
for current taxes and deferred taxes due to the differing impact of each on the
anticipated timing of distributions by the Fund to its shareholders.
The allocation between current and deferred income taxes is determined
based upon the value of assets reported for book purposes compared to the
respective net tax bases of assets as determined for federal income tax
purposes. It is anticipated that cash distributions from MLPs in which the Fund
invests will not equal the amount of taxable income allocable to the Fund,
primarily due to non-cash deductions such as depreciation and amortization
recorded by MLPs, which generally results in a portion of the cash distribution
received by an MLP investor to not be taxable income. The relative portion of
such non-taxable distributions will vary among the MLPs, and will also vary year
by year for each MLP. The Board of Trustees or its designee will be able to
directly confirm the taxable income allocated from each MLP when it receives
annual tax reporting information from each MLP. The allocation between current
and deferred income taxes also impacts the determination of the Fund's earnings
and profits, as described in Section 312 of the Internal Revenue Code of 1986,
as amended (the "Code").
FEDERAL TAX MATTERS
The following discussion of federal income tax matters is based on the
advice of Chapman and Cutler LLP, counsel to the Fund.
MATTERS ADDRESSED
This section and the discussion in the Prospectus provide a general
summary of the material U.S. federal income tax consequences to the persons who
purchase, own and dispose of the common shares. It does not address all federal
income tax consequences that may apply to investment in the common shares.
Unless otherwise indicated, this discussion is limited to taxpayers who are U.S.
74
persons, as defined herein. The discussion that follows is based on the
provisions of the Code, on Treasury regulations promulgated thereunder as in
effect on the date hereof and on existing judicial and administrative
interpretations thereof. These authorities are subject to change and to
differing interpretations, which could apply retroactively. Potential investors
should consult their own tax advisors in determining the federal, state, local,
foreign and any other tax consequences to them of the purchase, ownership and
disposition of the common shares. This discussion does not address all tax
consequences that may be applicable to a U.S. person that is a beneficial owner
of common shares, nor does it address, unless specifically indicated, the tax
consequences to, among others, (i) persons that may be subject to special
treatment under U.S. federal income tax law, including, but not limited to,
banks, insurance companies, thrift institutions, regulated investment companies,
real estate investment trusts, tax-exempt organizations, partnerships and other
pass-through entities, United States expatriates, and dealers in securities or
currencies, (ii) persons that will hold common shares as part of a position in a
"straddle" or as part of a "hedging," "conversion" or other integrated
investment transaction for U.S. federal income tax purposes and traders that
have elected the mark-to-market method of accounting, (iii) persons whose
functional currency is not the U.S. dollar or (iv) persons that do not hold
common shares as capital assets within the meaning of Section 1221 of the Code.
For purposes of this discussion, a "U.S. person" is (i) an individual
citizen or resident of the United States, (ii) a corporation or partnership
organized in or under the laws of the United States or any state thereof or the
District of Columbia (other than a partnership that is not treated as a U.S.
person under any applicable Treasury regulations), (iii) an estate the income of
which is subject to U.S. federal income taxation regardless of its source, or
(iv) a trust if a court within the United States is able to exercise primary
supervision over the administration of such trust and one or more U.S. persons
have the authority to control all the substantial decisions of such trust.
Notwithstanding clause (iv) above, to the extent provided in regulations,
certain trusts in existence on August 20, 1996 and treated as U.S. persons prior
to such date that elect to continue to be so treated also shall be considered
U.S. persons.
TAX CHARACTERIZATION OF THE FUND FOR U.S. FEDERAL INCOME TAX PURPOSES
The Fund has elected to as a regular C corporation for U.S. federal income
tax purposes. Thus, the Fund is subject to U.S. corporate income tax on its U.S.
taxable income. Such taxable income generally would include all of the Fund's
net income from the MLPs. The current U.S. federal maximum graduated income tax
rate for corporations is 21%. However, certain ordinary income dividends
received by the Fund that are attributable to qualifying dividends from certain
corporations may be eligible for the dividends received deduction. However, the
presence of covered call options in the portfolio may reduce the amount of
dividends that are treated as qualifying dividends. The Fund will also be
obligated to pay state income tax on its taxable income.
The MLPs in which the Fund invests generally are treated as partnerships
for U.S. federal income tax purposes. As a partner in the MLPs, the Fund will be
required to report its allocable share of MLP income, gain, loss, deduction and
expense, whether or not any cash is distributed from the MLPs.
75
The Fund invests in energy MLPs, so the Fund anticipates that the majority
of the Fund's items of income, gain, loss, deduction and expense will be related
to energy ventures. However, some items are likely to relate to the temporary
investment of the Fund's capital, which may be unrelated to energy ventures.
Although the Fund holds the interests in the MLPs for investment, the Fund
is likely to sell interests in a particular MLP from time to time. On any such
sale, the Fund generally will recognize gain or loss based upon the difference
between the consideration received for tax purposes on the sale and the Fund's
tax basis in the interest sold. The consideration received is generally the
amount paid by the purchaser plus any debt of the MLP allocated to the Fund that
will shift to the purchaser on the sale. The Fund's tax basis in an MLP is the
amount paid for the interest, increased by the Fund's allocable share of net
income and gains and the MLP's debt, if any, and capital contributions to the
MLP, and decreased for any distributions of cash received by the Fund by
reductions in the Fund's allocable share of the MLP's debt, if any, and by the
Fund's allocable share of net losses. Thus, although cash distributions in
excess of taxable income and net tax losses may create a temporary economic
benefit to the Fund, they will increase the amount of gain (or decrease the
amount of loss) on the sale of an interest in an MLP. No favorable federal
income tax rate applies to long-term capital gains for entities treated as
corporations for federal income tax purposes, such as the Fund. Thus, the Fund
will be subject to federal income tax on its long-term capital gains, like
ordinary income, at rates of up to 21%.
The Fund is not treated as a regulated investment company for federal
income tax purposes. In order to qualify as a regulated investment company, the
income and assets of the company must meet certain minimum threshold tests.
Because the Fund invests a substantial portion of its Managed Assets in MLPs
that invest in energy ventures, the Fund does not meet such tests under current
law. In contrast to the tax rules that will apply to the Fund, a regulated
investment company generally does not pay corporate income tax. Thus, the
regulated investment company taxation rules have no application to the Fund or
common shareholders of the Fund.
TAXATION OF THE SHAREHOLDERS
Distributions. The Fund's distributions will be treated as dividends to
common shareholders to the extent of the Fund's current or accumulated earnings
and profits as determined for federal income tax purposes.
The portion of the Fund's distributions treated as a dividend for federal
income tax purposes should be treated as qualified dividend income for federal
income tax purposes, subject to certain holding period and other requirements.
The practice of the Fund to sell or buy offsetting positions may redirect the
portion of the distributions that are treated as qualified dividends. The
maximum federal income tax rate for individuals on qualified dividend income is
currently generally 20%. The current maximum rate for individuals on ordinary
income is 37%. Corporations are generally subject to tax on dividends at a
maximum 21% rate, but, for the tax years beginning after December 31, 2017,
corporations may be eligible to exclude 50% of the dividends if certain holding
period requirements are met.
76
If a Fund distribution exceeds the Fund's current and accumulated earnings
and profits, the distribution will be treated as a non-taxable adjustment to the
basis of the common shares to the extent of such basis, and then as capital gain
to the extent the distribution exceeds the basis of the common shares. Such gain
will be long-term capital gain if the holding period for the common shares is
more than one year. Individuals are generally subject to a maximum tax rate of
20% on long-term capital gains. Corporations are taxed on capital gains at their
ordinary income rates.
A corporation's earnings and profits are generally calculated by making
certain adjustments to the corporation's reported taxable income. Based upon the
historic performance of similar MLPs, the Fund anticipates that the distributed
cash from the MLPs in its portfolio will exceed the Fund's earnings and profits
derived from its investments in the MLPs in its portfolio. Thus, the Fund
anticipates that only a portion of its distributions will be treated as
dividends to its common shareholders for federal income tax purposes.
Special rules apply to the calculation of earnings and profits for
corporations invested in energy ventures. The Fund's earnings and profits will
be calculated using (i) straight-line depreciation rather than a percentage
depletion method and (ii) five-year and ten-year amortization of drilling costs
and exploration and development costs, respectively. Thus, these deductions may
be significantly lower for purposes of calculating earnings and profits than
they are for purposes of calculating taxable income. Because of these
differences, the Fund may make distributions out of earnings and profits,
treated as dividends, in years in which Fund distributions exceed the Fund's
taxable income.
A common shareholder participating in the Fund's automatic dividend
reinvestment plan will be taxed upon the reinvested amount as if actually
received by the participating common shareholder and the participating
reinvested such amount in additional Fund common shares.
The Fund will notify common shareholders annually as to the federal income
tax status of Fund distributions to them.
Distributions from the Fund may be subject to a U.S. withholding tax of
30% in the case of distributions to (i) certain non-U.S. financial institutions
that either (A) have not entered into an agreement with the U.S. Treasury to
collect and disclose certain information or (B) are not resident for tax
purposes in a jurisdiction that has entered into an agreement with the IRS to
collect and provide the information otherwise required, and (ii) certain other
non-U.S. entities that do not provide certain certifications and information
about the entity's U.S. owners.
Sale of Shares. Upon the sale of common shares, a common shareholder will
generally recognize capital gain or loss measured by the difference between the
amount received on the sale and the common shareholder's tax basis of common
shares sold. As discussed above, such tax basis may be less than the price paid
for the common shares as a result of prior Fund distributions in excess of the
Fund's earnings and profits. Such capital gain or loss will generally be
long-term capital gain or loss, if such common shares were capital assets held
for more than one year. The federal income tax treatment of long-term capital
gains is described above. The deductibility of capital losses is subject to
limitations. In addition, the gross proceeds from dispositions of interests in
77
the Fund after December 31, 2018 may be subject to a U.S. withholding tax of 30%
in the case of payments to (i) certain non-U.S. financial institutions that
either (A) have not entered into an agreement with the U.S. Treasury to collect
and disclose certain information or (B) are not resident for tax purposes in a
jurisdiction that has entered into an agreement with the IRS to collect and
provide the information otherwise required, and (ii) certain other non-U.S.
entities that do not provide certain certifications and information about the
entity's U.S. owners.
Medicare Tax. Income from the Fund may also be subject to a 3.8% "Medicare
tax." This tax will generally apply to the net investment income (such as
interest and dividends, including dividends paid with respect to the common
shares) of a shareholder who is an individual if such shareholder's adjusted
gross income exceeds certain threshold amounts, which are $250,000 in the case
of a married couple filing joint returns and $200,000 in the case of single
individuals.
Information Reporting and Withholding. The Fund will be required to report
annually to the Internal Revenue Service (the "IRS"), and to each common
shareholder, the amount of distributions and consideration paid in redemptions,
and the amount withheld for federal income taxes, if any, for each calendar
year, except as to exempt holders (including certain corporations, tax-exempt
organizations, qualified pension and profit-sharing trusts, and individual
retirement accounts). Each common shareholder (other than common shareholders
who are not subject to the reporting requirements without supplying any
documentation) that is a U.S. person will be required to provide the Fund, under
penalties of perjury, an IRS Form W-9 or an equivalent form containing the
common shareholder's name, address, correct federal taxpayer identification
number and a statement that the common shareholder is not subject to backup
withholding. Should a non-exempt common shareholder fail to provide the required
certification, backup withholding will apply. The current backup withholding
rate is 24%. Backup withholding is not an additional tax. Any such withholding
will be allowed as a credit against the common shareholder's federal income tax
liability provided the required information is timely furnished to the IRS.
TAX CONSEQUENCES OF CERTAIN INVESTMENTS
Federal Income Taxation of MLPs. MLPs are generally intended to be taxed
as partnerships for federal income tax purposes. As a partnership, an MLP is
treated as a pass-through entity for federal income tax purposes. This means
that the federal income items of the MLP, though calculated and determined at
the partnership level, are allocated among the partners in the MLP and are
included directly in the calculation of the taxable income of the partners
whether or not cash flow is distributed from the MLP. The MLP files an
information return, but normally pays no federal income tax.
MLPs are often publicly traded. Publicly traded partnerships are generally
treated as corporations for federal income tax purposes. However, if an MLP
satisfies certain income character requirements, the MLP will generally continue
to be treated as partnership for federal income tax purposes. Under these
requirements, an MLP must receive at least 90% of its gross income from certain
"qualifying income" sources.
78
Qualifying income for this purpose generally includes interest, dividends,
real property rents, real property gains, and income and gain from the
exploration, development, mining or production, processing, refining,
transportation or marketing of any mineral or natural resource (including
fertilizer, geothermal energy, and timber). As discussed above, the Fund invests
in energy MLPs that derive income from such sources, so the income of the MLPs
in the Fund's portfolio should qualify as qualifying income. The IRS has
finalized regulations that limit the nature of qualifying income for MLPs. Some
MLPs may convert to corporations under the regulations or restructure their
activities to qualify under the regulations.
As discussed above, the tax items of an MLP are allocated through to the
partners of the MLP whether or not an MLP makes any distributions of cash. In
part because estimated tax payments are payable quarterly, partnerships often
make quarterly cash distributions. A distribution from a partnership will
generally be treated as a non-taxable adjustment to the basis of the Fund's
interest in the partnership to the extent of such basis, and then as gain to the
extent of the excess distribution. The gain will generally be capital gain, but
a variety of rules could potentially recharacterize the gain as ordinary income.
The Fund's initial tax basis is the price paid for the MLP interest plus any
debt of the MLP allocated to the Fund. The tax basis is decreased for
distributions received by the Fund, by reductions in the Fund's allocable share
of the MLP's debt, if any, and by the Fund's allocable share of net losses, and
increased for capital contributions and by the Fund's allocable share of net
income and gains.
When interests in a partnership are sold, the difference between (i) the
sum of the sales price and the Fund's share of debt of the partnership that will
be allocated to the purchaser and (ii) the Fund's adjusted tax basis will be
taxable gain or loss, as the case may be.
The Fund should receive a Form K-1 from each MLP, showing its share of
each item of MLP income, gain, loss, deductions and expense. The Fund will use
that information to calculate its taxable income and its earnings and profits.
Because the Fund has elected to be taxed as a corporation, the Fund will
report the tax items of the MLPs and any gain or loss on the sale of interests
in the MLPs on its own tax returns. The Fund's common shareholders will be
viewed for federal income tax purposes as having income or loss on their
investment in the Fund rather than in the underlying MLPs. Common shareholders
will receive a Form 1099 from the Fund based upon the distributions made (or
deemed to have been made) to the common shareholders rather than based upon the
income, gain, loss or deductions of the MLPs in which the Fund invests.
Foreign Investments. Dividends or other income (including, in some cases,
capital gains) received by the Fund from investments in non-U.S. securities may
be subject to withholding and other taxes imposed by foreign countries. Tax
conventions between certain countries and the United States may reduce or
eliminate such taxes in some cases. Foreign taxes paid by the Fund will reduce
the return from the Fund's investments. Common shareholders will not be entitled
to claim credits or deductions on their own tax returns for foreign taxes paid
by the Fund.
Other Investments. The Fund may attempt to generate premiums from the sale
of call options. These premiums typically will result in short-term capital
gains to the Fund. Transactions involving the disposition of the Fund's
79
underlying securities (whether pursuant to the exercise of a call option, put
option or otherwise) will give rise to capital gains or losses. Because the Fund
does not have control over the exercise of the call options it writes, such
exercises or other required sales of the underlying stocks may cause the Fund to
realize capital gains or losses at inopportune times.
Certain of the Fund's investment practices may be subject to special and
complex federal income tax provisions that may, among other things, (i)
disallow, suspend or otherwise limit the allowance of certain losses or
deductions, (ii) convert an ordinary loss or a deduction into a capital loss
(the deductibility of which is more limited) or (iii) cause the Fund to
recognize income or gain without a corresponding receipt of cash. The Fund will
monitor its transactions and may make certain tax elections in order to mitigate
the effect of these provisions, if possible.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Financial Statements of the Fund as of October 31, 2017, incorporated
by reference in this Statement of Additional Information, have been audited by
Deloitte & Touche LLP, an independent registered public accounting firm, as
stated in their report which is incorporated herein by reference. Such financial
statements have been so incorporated in reliance upon the report of such firm
given upon their authority as experts in accounting and auditing. Deloitte &
Touche LLP provides auditing services to the Fund. The principal business
address of Deloitte & Touche LLP is 111 South Wacker Drive, Chicago, Illinois
60606.
CUSTODIAN, ADMINISTRATOR AND TRANSFER AGENT
The Bank of New York Mellon, One Wall Street, New York, New York 10286
serves as custodian for the Fund. As such, The Bank of New York Mellon has
custody of all securities and cash of the Fund and attends to the collection of
principal and income and payment for and collection of proceeds of securities
bought and sold by the Fund. BNY Mellon Investment Servicing (US) Inc., 301
Bellevue Parkway, Wilmington, Delaware 19809, is the transfer agent, registrar,
dividend disbursing agent and shareholder servicing agent for the Fund and
provides certain clerical, bookkeeping, shareholder servicing and administrative
services necessary for the operation of the Fund and maintenance of shareholder
accounts. The Bank of New York also provides certain accounting and
administrative services to the Fund pursuant to an Administration and Accounting
Services Agreement, including maintaining the Fund's books of account, records
of the Fund's securities transactions, and certain other books and records;
acting as liaison with the Fund's independent registered public accounting firm
and providing the independent registered public accounting firm with certain
Fund accounting information; and providing other continuous accounting and
administrative services.
ADDITIONAL INFORMATION
A Registration Statement on Form N-2, including amendments thereto,
relating to the shares of the Fund offered hereby, has been filed by the Fund
with the SEC. The Fund's Prospectus and this Statement of Additional Information
do not contain all of the information set forth in the Registration Statement,
80
including any exhibits and schedules thereto. For further information with
respect to the Fund and the shares offered hereby, reference is made to the
Fund's Registration Statement. Statements contained in the Fund's Prospectus and
this Statement of Additional Information as to the contents of any contract or
other document referred to are not necessarily complete and in each instance
reference is made to the copy of such contract or other document filed as an
exhibit to the Registration Statement, each such statement being qualified in
all respects by such reference. Copies of the Registration Statement may be
inspected without charge at the SEC's principal office in Washington, D.C., and
copies of all or any part thereof may be obtained from the SEC upon the payment
of certain fees prescribed by the SEC.
81
FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Fund's financial statements and financial highlights and the report of
Deloitte & Touche LLP thereon, contained in the following documents filed by the
Fund with the SEC, are hereby incorporated by reference into, and are made part
of, this Statement of Additional Information: The Fund's Annual Report for the
year ended October 31, 2017 contained in the Fund's Form N-CSR filed with the
SEC on January 8, 2018. A copy of such Annual Report must accompany the delivery
of this Statement of Additional Information.
82
APPENDIX A
RATINGS OF INVESTMENTS
STANDARD & POOR'S RATINGS SERVICES-- A BRIEF DESCRIPTION OF CERTAIN
STANDARD & POOR'S RATINGS SERVICES, A DIVISION OF THE MCGRAW-HILL COMPANIES
("STANDARD & POOR'S" OR "S&P") RATING SYMBOLS AND THEIR MEANINGS (AS PUBLISHED
BY S&P) FOLLOWS:
A Standard & Poor's issue credit rating is a forward-looking opinion about
the creditworthiness of an obligor with respect to a specific financial
obligation, a specific class of financial obligations, or a specific financial
program (including ratings on medium-term note programs and commercial paper
programs). It takes into consideration the creditworthiness of guarantors,
insurers, or other forms of credit enhancement on the obligation and takes into
account the currency in which the obligation is denominated. The opinion
reflects Standard & Poor's view of the obligor's capacity and willingness to
meet its financial commitments as they become due, and may assess terms, such as
collateral security and subordination, which could affect ultimate payment in
the event of default.
Issue credit ratings can be either long term or short term. Short-term
ratings are generally assigned to those obligations considered short-term in the
relevant market. In the U.S., for example, that means obligations with an
original maturity of no more than 365 days--including commercial paper.
Short-term ratings are also used to indicate the creditworthiness of an obligor
with respect to put features on long-term obligations. Medium-term notes are
assigned long-term ratings.
LONG-TERM ISSUE CREDIT RATINGS
Issue credit ratings are based, in varying degrees, on Standard & Poor's
analysis of the following considerations:
o Likelihood of payment--capacity and willingness of the obligor to meet
its financial commitment on an obligation in accordance with the terms
of the obligation;
o Nature of and provisions of the obligation, and the promise we impute;
and
o Protection afforded by, and relative position of, the obligation in
the event of bankruptcy, reorganization, or other arrangement under
the laws of bankruptcy and other laws affecting creditors' rights.
Issue ratings are an assessment of default risk, but may incorporate an
assessment of relative seniority or ultimate recovery in the event of default.
Junior obligations are typically rated lower than senior obligations, to reflect
the lower priority in bankruptcy as noted above. (Such differentiation may apply
when an entity has both senior and subordinated obligations, secured and
unsecured obligations, or operating company and holding company obligations.)
A-1
AAA
An obligation rated 'AAA' has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA
An obligation rated 'AA' differs from the highest-rated obligations only
to a small degree. The obligor's capacity to meet its financial commitment on
the obligation is very strong.
A
An obligation rated 'A' is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations in
higher-rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB
An obligation rated 'BBB' exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
BB, B, CCC, CC, AND C
Obligations rated 'BB', 'B', 'CCC', 'CC', and 'C' are regarded as having
significant speculative characteristics. 'BB' indicates the least degree of
speculation and 'C' the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions.
BB
An obligation rated 'BB' is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions, which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B
An obligation rated 'B' is more vulnerable to nonpayment than obligations
rated 'BB', but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
A-2
CCC
An obligation rated 'CCC' is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC
An obligation rated 'CC' is currently highly vulnerable to nonpayment. The
'CC' rating is used when a default has not yet occurred, but Standard & Poor's
expects default to be a virtual certainty, regardless of the anticipated time to
default.
C
A 'C' rating is currently highly vulnerable to nonpayment, and the
obligation is expected to have lower relative seniority or lower ultimate
recovery compared to obligations that are rated higher.
D
An obligation rated 'D' is in default or in breach of an imputed promise.
For non-hybrid capital instruments, the 'D' rating category is used when
payments on an obligation are not made on the date due, unless Standard & Poor's
believes that such payments will be made within five business days in the
absence of a stated grace period or within the earlier of the stated grace
period or 30 calendar days. The 'D' rating also will be used upon the filing of
a bankruptcy petition or the taking of similar action and where default on an
obligation is a virtual certainty, for example due to automatic stay provisions.
An obligation's rating is lowered to 'D' if it is subject to a distressed
exchange offer.
PLUS (+) OR MINUS (-)
The ratings from 'AA' to 'CCC' may be modified by the addition of a plus
(+) or minus (-) sign to show relative standing within the major rating
categories.
NR
This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that Standard & Poor's
does not rate a particular obligation as a matter of policy.
A-3
SHORT-TERM ISSUE CREDIT RATINGS
A-1
A short-term obligation rated 'A-1' is rated in the highest category by
Standard & Poor's. The obligor's capacity to meet its financial commitment on
the obligation is strong. Within this category, certain obligations are
designated with a plus sign (+). This indicates that the obligor's capacity to
meet its financial commitment on these obligations is extremely strong.
A-2
A short-term obligation rated 'A-2' is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to meet
its financial commitment on the obligation is satisfactory.
A-3
A short-term obligation rated 'A-3' exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
B
A short-term obligation rated 'B' is regarded as having significant
speculative characteristics. Ratings of 'B-1', 'B-2', and 'B-3' may be assigned
to indicate finer distinctions within the 'B' category. The obligor currently
has the capacity to meet its financial commitment on the obligation; however, it
faces major ongoing uncertainties which could lead to the obligor's inadequate
capacity to meet its financial commitments.
B-1
A short-term obligation rated 'B-1' is regarded as having significant
speculative characteristics, but the obligor has a relatively stronger capacity
to meet its financial commitments over the short-term compared to other
speculative-grade obligors.
B-2
A short-term obligation rated 'B-2' is regarded as having significant
speculative characteristics, and the obligor has an average speculative-grade
capacity to meet its financial commitments over the short-term compared to other
speculative-grade obligors.
A-4
B-3
A short-term obligation rated 'B-3' is regarded as having significant
speculative characteristics, and the obligor has a relatively weaker capacity to
meet its financial commitments over the short-term compared to other
speculative-grade obligors.
C
A short-term obligation rated 'C' is currently vulnerable to nonpayment
and is dependent upon favorable business, financial, and economic conditions for
the obligor to meet its financial commitment on the obligation.
D
A short-term obligation rated 'D' is in default or in breach of an imputed
promise. For non-hybrid capital instruments, the 'D' rating category is used
when payments on an obligation are not made on the date due, unless Standard &
Poor's believes that such payments will be made within any stated grace period.
However, any stated grace period longer than five business days will be treated
as five business days. The 'D' rating also will be used upon the filing of a
bankruptcy petition or the taking of a similar action and where default on an
obligation is a virtual certainty, for example due to automatic stay provisions.
An obligation's rating is lowered to 'D' if it is subject to a distressed
exchange offer.
SPUR (STANDARD & POOR'S UNDERLYING RATING)
This is a rating of a stand-alone capacity of an issue to pay debt service
on a credit-enhanced debt issue, without giving effect to the enhancement that
applies to it. These ratings are published only at the request of the debt
issuer/obligor with the designation SPUR to distinguish them from the
credit-enhanced rating that applies to the debt issue. Standard & Poor's
maintains surveillance of an issue with a published SPUR.
MUNICIPAL SHORT-TERM NOTE RATINGS DEFINITIONS
A Standard & Poor's U.S. municipal note rating reflects Standard & Poor's
opinion about the liquidity factors and market access risks unique to the notes.
Notes due in three years or less will likely receive a note rating. Notes with
an original maturity of more than three years will most likely receive a
long-term debt rating. In determining which type of rating, if any, to assign,
Standard & Poor's analysis will review the following considerations:
o Amortization schedule--the larger the final maturity relative to other
maturities, the more likely it will be treated as a note; and
o Source of payment--the more dependent the issue is on the market for
its refinancing, the more likely it will be treated as a note.
A-5
Note rating symbols are as follows:
SP-1
Strong capacity to pay principal and interest. An issue determined to
possess a very strong capacity to pay debt service is given a plus (+)
designation.
SP-2
Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
SP-3
Speculative capacity to pay principal and interest.
DUAL RATINGS
Dual ratings may be assigned to debt issues that have a put option or
demand feature. The first component of the rating addresses the likelihood of
repayment of principal and interest as due, and the second component of the
rating addresses only the demand feature. The first component of the rating can
relate to either a short-term or long-term transaction and accordingly use
either short-term or long-term rating symbols. The second component of the
rating relates to the put option and is assigned a short-term rating symbol (for
example, 'AAA/A-1+' or 'A-1+/A- 1'). With U.S. municipal short-term demand debt,
the U.S. municipal short-term note rating symbols are used for the first
component of the rating (for example, 'SP-1+/A-1+').
ACTIVE QUALIFIERS (CURRENTLY APPLIED AND/OR OUTSTANDING)
Standard & Poor's uses five qualifiers that limit the scope of a rating.
The structure of the transaction can require the use of a qualifier such as a
'p' qualifier, which indicates the rating addressed the principal portion of the
obligation only. Likewise, the qualifier can indicate a limitation on the type
of information used, such as 'pi' for public information. A qualifier appears as
a suffix and is part of the rating.
L
Ratings qualified with 'L' apply only to amounts invested up to federal
deposit insurance limits.
P
This suffix is used for issues in which the credit factors, the terms, or
both, that determine the likelihood of receipt of payment of principal are
different from the credit factors, terms or both that determine the likelihood
of receipt of interest on the obligation. The 'p' suffix indicates that the
A-6
rating addresses the principal portion of the obligation only and that the
interest is not rated.
PI
Ratings with a 'pi' subscript are based on an analysis of an issuer's
published financial information, as well as additional information in the public
domain. They do not, however, reflect in-depth meetings with an issuer's
management and therefore may be based on less comprehensive information than
ratings without a 'pi' subscript. Ratings with a 'pi' subscript are reviewed
annually based on a new year's financial statement, but may be reviewed on an
interim basis if a major event occurs that may affect the issuer's credit
quality.
PRELIMINARY
Preliminary ratings, with the 'prelim' qualifier, may be assigned to
obligors or obligations, including financial programs, in the circumstances
described below. Assignment of a final rating is conditional on the receipt by
Standard & Poor's of appropriate documentation. Standard & Poor's reserves the
right not to issue a final rating. Moreover, if a final rating is issued, it may
differ from the preliminary rating.
o Preliminary ratings may be assigned to obligations, most commonly
structured and project finance issues, pending receipt of final
documentation and legal opinions.
o Preliminary ratings are assigned to Rule 415 Shelf Registrations. As
specific issues, with defined terms, are offered from the master
registration, a final rating may be assigned to them in accordance with
Standard & Poor's policies.
o Preliminary ratings may be assigned to obligations that will likely be
issued upon the obligor's emergence from bankruptcy or similar
reorganization, based on late-stage reorganization plans, documentation
and discussions with the obligor. Preliminary ratings may also be assigned
to the obligors. These ratings consider the anticipated general credit
quality of the reorganized or post-bankruptcy issuer as well as attributes
of the anticipated obligation(s).
o Preliminary ratings may be assigned to entities that are being formed or
that are in the process of being independently established when, in
Standard & Poor's opinion, documentation is close to final. Preliminary
ratings may also be assigned to the obligations of these entities'.
o Preliminary ratings may be assigned when a previously unrated entity is
undergoing a well-formulated restructuring, recapitalization, significant
financing or other transformative event, generally at the point that
investor or lender commitments are invited. The preliminary rating may be
assigned to the entity and to its proposed obligation(s). These
preliminary ratings consider the anticipated general credit quality of the
obligor, as well as attributes of the anticipated obligation(s) assuming
A-7
successful completion of the transformative event. Should the
transformative event not occur, Standard & Poor's would likely withdraw
these preliminary ratings.
o A preliminary recovery rating may be assigned to an obligation that has a
preliminary issue credit rating.
T
This symbol indicates termination structures that are designed to honor
their contracts to full maturity or, should certain events occur, to terminate
and cash settle all of their contracts before their final maturity date.
UNSOLICITED AND U
The "u" and 'unsolicited' designations are unsolicited credit ratings
assigned at the initiative of Standard & Poor's and not at the request of the
issuer or its agents.
INACTIVE QUALIFIERS (NO LONGER APPLIED OR OUTSTANDING)
*
This symbol indicated continuance of the ratings was contingent upon
Standard & Poor's receipt of an executed copy of the escrow agreement or closing
documentation confirming investments and cash flows. Discontinued use in August
1998.
C
This qualifier was used to provide additional information to investors
that the bank may terminate its obligation to purchase tendered bonds if the
long-term credit rating of the issuer was lowered below an investment-grade
level and/or the issuer's bonds are deemed taxable. Discontinued use in January
2001.
G
THE LETTER 'G' FOLLOWED THE RATING SYMBOL WHEN A FUND'S PORTFOLIO CONSISTED
PRIMARILY OF DIRECT U.S. GOVERNMENT SECURITIES.
PR
The letters 'pr' indicate that the rating is provisional. A provisional
rating assumes the successful completion of the project financed by the debt
being rated and indicates that payment of debt service requirements was largely
or entirely dependent upon the successful, timely completion of the project.
This rating, however, while addressing credit quality subsequent to completion
A-8
of the project, made no comment on the likelihood of or the risk of default upon
failure of such completion.
Q
A 'q' subscript indicates that the rating is based solely upon
quantitative analysis of publicly available information. Discontinued use in
April 2001.
R
The 'r' modifier was assigned to securities containing extraordinary
risks, particularly market risks, which are not covered in the credit rating.
The absence of an 'r' modifier should not be taken as an indication that an
obligation will not exhibit extraordinary non-credit related risks. Standard &
Poor's discontinued the use of the 'r' modifier for most obligations in June
2000 and for the balance of the obligations (mainly structured finance
transactions) in November 2002.
MOODY'S INVESTORS SERVICE, INC. -- A BRIEF DESCRIPTION OF CERTAIN MOODY'S
INVESTORS SERVICE, INC. ("MOODY'S") RATING SYMBOLS AND THEIR MEANINGS (AS
PUBLISHED BY MOODY'S) FOLLOWS:
LONG-TERM OBLIGATION RATINGS
Moody's long-term ratings are opinions of the relative credit risk of
financial obligations with an original maturity of one year or more. They
address the possibility that a financial obligation will not be honored as
promised. Such ratings use Moody's Global Scale and reflect both the likelihood
of default and any financial loss suffered in the event of default.
Aaa
Obligations rated Aaa are judged to be of the highest quality, with
minimal credit risk.
Aa
Obligations rated Aa are judged to be of high quality and are subject to
very low credit risk.
A
Obligations rated A are considered upper-medium grade and are subject to
low credit risk.
A-9
Baa
Obligations rated Baa are subject to moderate credit risk. They are
considered medium grade and as such may possess certain speculative
characteristics.
Ba
Obligations rated Ba are judged to have speculative elements and are
subject to substantial credit risk.
B
Obligations rated B are considered speculative and are subject to high
credit risk.
Caa
Obligations rated Caa are judged to be of poor standing and are subject to
very high credit risk.
Ca
Obligations rated Ca are highly speculative and are likely in, or very
near, default, with some prospect of recovery of principal and interest.
C
Obligations rated C are the lowest rated class and are typically in
default with little prospect for recovery of principal or interest.
Note: Moody's appends numerical modifiers 1, 2, and 3 in each generic rating
classification from Aa through Caa. The modifier 1 indicates that the obligation
ranks in the higher end of its generic rating category; the modifier 2 indicates
a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of
that generic rating category.
MEDIUM-TERM NOTE PROGRAM RATINGS
Moody's assigns provisional ratings to medium-term note (MTN) programs and
to the individual debt securities issued from them (referred to as drawdowns or
notes). These ratings may be expressed on Moody's general long-term or
short-term rating sale, depending upon the intended tenor of the notes to be
issued under the program.
MTN program ratings are intended to reflect the ratings likely to be
assigned to drawdowns issued from the program with the specific priority of
claim (e.g., senior or subordinated). However, the rating assigned to a drawdown
from a rated MTN program may differ from the program if the drawdown is exposed
to additional credit risks besides the issuer's default, such as links to the
A-10
defaults of other issuers, or has other structural features that warrant a
different rating. In some circumstances, no rating may be assigned to a
drawdown.
Market participants must determine whether any particular note is rated,
and if so, at what rating level. Moody's encourages market participants to
contact Moody's Ratings Desks or visit www.moody's.com directly if they have
questions regarding ratings for specific notes issued under a medium-term note
program. Unrated notes issued under an MTN program may be assigned an NR (not
rated) symbol.
SHORT-TERM OBLIGATION RATINGS
Moody's short-term ratings are opinions of the ability of issuers to honor
short-term financial obligations. Ratings may be assigned to issuers, short-term
programs or to individual short-term debt instruments. Such obligations
generally have an original maturity not exceeding thirteen months, unless
explicitly noted.
Moody's employs the following designations to indicate the relative
repayment ability of rated issuers:
P-1
Issuers (or supporting institutions) rated Prime-1 have a superior ability
to repay short-term debt obligations.
P-2
Issuers (or supporting institutions) rated Prime-2 have a strong ability
to repay short-term debt obligations.
P-3
Issuers (or supporting institutions) rated Prime-3 have an acceptable
ability to repay short-term obligations.
NP
Issuers (or supporting institutions) rated Not Prime do not fall within
any of the Prime rating categories.
U.S. MUNICIPAL SHORT-TERM OBLIGATION RATINGS
There are three rating categories for short-term municipal obligations
that are considered investment grade. These ratings are designated as Municipal
Investment Grade (MIG) and are divided into three levels -- MIG 1 through MIG 3.
A-11
In addition, those short-term obligations that are of speculative quality are
designated SG, or speculative grade. MIG ratings expire at the maturity of the
obligation.
MIG 1
This designation denotes superior credit quality. Excellent protection is
afforded by established cash flows, highly reliable liquidity support, or
demonstrated broad-based access to the market for refinancing.
MIG 2
This designation denotes strong credit quality. Margins of protection are
ample, although not as large as in the preceding group.
MIG 3
This designation denotes acceptable credit quality. Liquidity and
cash-flow protection may be narrow, and market access for refinancing is likely
to be less well-established.
SG
This designation denotes speculative-grade credit quality. Debt
instruments in this category may lack sufficient margins of protection.
U.S. MUNICIPAL DEMAND OBLIGATION RATINGS
In the case of variable rate demand obligations (VRDOs), a two-component
rating is assigned; a long or short-term debt rating and a demand obligation
rating. The first element represents Moody's evaluation of the degree of risk
associated with scheduled principal and interest payments. The second element
represents Moody's evaluation of the degree of risk associated with the ability
to receive purchase price upon demand ("demand feature"), using a variation of
the MIG rating scale, the Variable Municipal Investment Grade or VMIG rating.
When either the long- or short-term aspect of a VRDO is not rated, that piece is
designated NR, e.g., Aaa/NR or NR/VMIG 1. VMIG rating expirations are a function
of each issue's specific structural or credit features.
VMIG 1
This designation denotes superior credit quality. Excellent protection is
afforded by the superior short-term credit strength of the liquidity provider
and structural and legal protections that ensure the timely payment of purchase
price upon demand.
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VMIG 2
This designation denotes strong credit quality. Good protection is
afforded by the strong short-term credit strength of the liquidity provider and
structural and legal protections that ensure the timely payment of purchase
price upon demand.
VMIG 3
This designation denotes acceptable credit quality. Adequate protection is
afforded by the satisfactory short-term credit strength of the liquidity
provider and structural and legal protections that ensure the timely payment of
purchase price upon demand.
SG
This designation denotes speculative-grade credit quality. Demand features
rated in this category may supported by a liquidity provider that does not have
an investment grade short-term rating or may lack the structural and/or legal
protections necessary to ensure the timely payment of purchase price upon
demand.
FITCH RATINGS -- A BRIEF DESCRIPTION OF CERTAIN FITCH RATINGS, INC.
("FITCH") RATINGS SYMBOLS AND THEIR MEANINGS (AS PUBLISHED BY FITCH) FOLLOWS:
INTERNATIONAL ISSUER AND CREDIT RATING SCALES
The Primary Credit Rating Scales (those featuring the symbols 'AAA'-'D'
and 'F1'-'D') are used for debt and financial strength ratings.
LONG-TERM RATING SCALES--ISSUER CREDIT RATING SCALES
Rated entities in a number of sectors, including financial and
non-financial corporations, sovereigns and insurance companies, are generally
assigned Issuer Default Ratings (IDRs). IDRs opine on an entity's relative
vulnerability to default on financial obligations. The "threshold" default risk
addressed by the IDR is generally that of the financial obligations whose
non-payment would best reflect the uncured failure of that entity. As such, IDRs
also address relative vulnerability to bankruptcy, administrative receivership
or similar concepts, although the agency recognizes that issuers may also make
pre-emptive and therefore voluntary use of such mechanisms.
In aggregate, IDRs provide an ordinal ranking of issuers based on the
agency's view of their relative vulnerability to default, rather than a
prediction of a specific percentage likelihood of default.
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AAA
Highest credit quality. 'AAA' ratings denote the lowest expectation of
default risk. They are assigned only in cases of exceptionally strong capacity
for payment of financial commitments. This capacity is highly unlikely to be
adversely affected by foreseeable events.
AA
Very high credit quality. 'AA' ratings denote expectations of very low
default risk. They indicate very strong capacity for payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
A
High credit quality. 'A' ratings denote expectations of low default risk.
The capacity for payment of financial commitments is considered strong. This
capacity may, nevertheless, be more vulnerable to adverse business or economic
conditions than is the case for higher ratings.
BBB
Good credit quality. 'BBB' ratings indicate that expectations of default
risk are currently low. The capacity for payment of financial commitments is
considered adequate but adverse business or economic conditions are more likely
to impair this capacity.
BB
Speculative. 'BB' ratings indicate an elevated vulnerability to default
risk, particularly in the event of adverse changes in business or economic
conditions over time; however, business or financial flexibility exists which
supports the servicing of financial commitments.
B
Highly speculative. 'B' ratings indicate that material default risk is
present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is vulnerable to
deterioration in the business and economic environment.
CCC
Substantial credit risk. Default is a real possibility.
CC
Very high levels of credit risk. Default of some kind appears probable.
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C
Exceptionally high levels of credit risk. Default is imminent or
inevitable, or the issuer is in standstill. Conditions that are indicative of a
'C' category rating of an issuer include:
a. the issuer has entered into a grace or cure period following
non-payment of a material financial obligation;
b. the issuer has entered into a temporary negotiated waiver or
standstill agreement following a payment default on a material financial
obligation; or
c. Fitch Ratings otherwise believes a condition of 'RD' or 'D' to
be imminent or inevitable, including through the formal announcement of a
distressed debt exchange.
RD
Restricted default. 'RD' ratings indicate an issuer that in Fitch Ratings'
opinion has experienced an uncured payment default on a bond, loan or other
material financial obligation but which has not entered into bankruptcy filings,
administration, receivership, liquidation or other formal winding-up procedure,
and which has not otherwise ceased business. This would include:
a. the selective payment default on a specific class or currency
of debt;
b. the uncured expiry of any applicable grace period, cure period
or default forbearance period following a payment default on a bank loan,
capital markets security or other material financial obligation;
c. the extension of multiple waivers or forbearance periods upon a
payment default on one or more material financial obligations, either in
series or in parallel; or
d. execution of a coercive debt exchange on one or more material
financial obligations.
D
Default. 'D' ratings indicate an issuer that in Fitch Ratings' opinion has
entered into bankruptcy filings, administration, receivership, liquidation or
other formal winding-up procedure, or which has otherwise ceased business.
Default ratings are not assigned prospectively to entities or their
obligations; within this context, non-payment on an instrument that contains a
deferral feature or grace period will generally not be considered a default
until after the expiration of the deferral or grace period, unless a default is
otherwise driven by bankruptcy or other similar circumstance, or by a coercive
debt exchange.
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"Imminent" default typically refers to the occasion where a payment
default has been intimated by the issuer, and is all but inevitable. This may,
for example, be where an issuer has missed a scheduled payment, but (as is
typical) has a grace period during which it may cure the payment default.
Another alternative would be where an issuer has formally announced a coercive
debt exchange, but the date of the exchange still lies several days or weeks in
the immediate future.
In all cases, the assignment of a default rating reflects the agency's
opinion as to the most appropriate rating category consistent with the rest of
its universe of ratings, and may differ from the definition of default under the
terms of an issuer's financial obligations or local commercial practice.
Note: The modifiers "+" or "-" may be appended to a rating to denote relative
status within the major rating categories. Such suffixes are not added to the
'AAA' Long-Term IDR category, or to Long-Term IDR categories below 'B'.
Limitations of the Issuer Credit Rating Scale:
Specific limitations relevant to the issuer credit rating scale include:
o The ratings do not predict a specific percentage of default likelihood
over any given time period.
o The ratings do not opine on the market value of any issuer's
securities or stock, or the likelihood that this value may change.
o The ratings do not opine on the liquidity of the issuer's securities
or stock.
o The ratings do not opine on the possible loss severity on an
obligation should an issuer default.
o The ratings do not opine on the suitability of an issuer as
counterparty to trade credit.
o The ratings do not opine on any quality related to an issuer's
business, operational or financial profile other than the agency's
opinion on its relative vulnerability to default.
Ratings assigned by Fitch Ratings articulate an opinion on discrete and
specific areas of risk. The above list is not exhaustive, and is provided for
the reader's convenience.
SHORT-TERM RATINGS -- SHORT-TERM RATINGS ASSIGNED TO ISSUERS OR OBLIGATIONS IN
CORPORATE, PUBLIC AND STRUCTURED FINANCE
A short-term issuer or obligation rating is based in all cases on the
short-term vulnerability to default of the rated entity or security stream and
relates to the capacity to meet financial obligations in accordance with the
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documentation governing the relevant obligation. Short-Term Ratings are assigned
to obligations whose initial maturity is viewed as "short term" based on market
convention. Typically, this means up to 13 months for corporate, sovereign, and
structured obligations, and up to 36 months for obligations in U.S. public
finance markets.
F1
Highest short-term credit quality. Indicates the strongest intrinsic
capacity for timely payment of financial commitments; may have an added "+" to
denote any exceptionally strong credit feature.
F2
Good short-term credit quality. Good intrinsic capacity for timely payment
of financial commitments.
F3
Fair short-term credit quality. The intrinsic capacity for timely payment
of financial commitments is adequate.
B
Speculative short-term credit quality. Minimal capacity for timely payment
of financial commitments, plus heightened vulnerability to near term adverse
changes in financial and economic conditions.
C
High short-term default risk. Default is a real possibility.
RD
Restricted default. Indicates an entity that has defaulted on one or more
of its financial commitments, although it continues to meet other financial
obligations. Applicable to entity ratings only.
D
Default. Indicates a broad-based default event for an entity, or the
default of a short-term obligation.
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Limitations of the Short-Term Ratings Scale:
Specific limitations relevant to the Short-Term Ratings scale include:
o The ratings do not predict a specific percentage of default likelihood
over any given time period.
o The ratings do not opine on the market value of any issuer's
securities or stock, or the likelihood that this value may change.
o The ratings do not opine on the liquidity of the issuer's securities
or stock.
o The ratings do not opine on the possible loss severity on an
obligation should an obligation default.
o The ratings do not opine on any quality related to an issuer or
transaction's profile other than the agency's opinion on the relative
vulnerability to default of the rated issuer or obligation.
Ratings assigned by Fitch Ratings articulate an opinion on discrete and
specific areas of risk. The above list is not exhaustive, and is provided for
the reader's convenience.
ADDITIONAL INFORMATION
'Not Rated' or 'NR': A designation of 'Not Rated' or 'NR' is used to
denote securities not rated by Fitch where Fitch has rated some, but not all,
securities comprising an issuance capital structure.
'Withdrawn': The rating has been withdrawn and the issue or issuer is no
longer rated by Fitch. Indicated in rating databases with the symbol 'WD'.
RATING WATCHES AND RATING OUTLOOKS
Rating Watches and Outlooks form part of the Credit Rating and indicate
the likely direction of the rating.
Rating Watch
Rating Watches indicate that there is a heightened probability of a rating
change and the likely direction of such a change. These are designated as
"Positive", indicating a potential upgrade, "Negative", for a potential
downgrade, or "Evolving", if ratings may be raised, lowered or affirmed.
However, ratings that are not on Rating Watch can be raised or lowered without
being placed on Rating Watch first, if circumstances warrant such an action.
A Rating Watch is typically event-driven and, as such, it is generally
resolved over a relatively short period. The event driving the Watch may be
either anticipated or have already occurred, but in both cases, the exact rating
implications remain undetermined. The Watch period is typically used to gather
further information and/or subject the information to further analysis.
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Additionally, a Watch may be used where the rating implications are already
clear, but where a triggering event (e.g. shareholder or regulatory approval)
exists. The Watch will typically extend to cover the period until the triggering
event is resolved or its outcome is predictable with a high enough degree of
certainty to permit resolution of the Watch.
Rating Watches can be employed by all analytical groups and are applied to
the ratings of individual entities and/or individual instruments. At the lowest
categories of speculative grade ('CCC', 'CC' and 'C') the high volatility of
credit profiles may imply that almost all ratings should carry a Watch. Watches
are nonetheless only applied selectively in these categories, where a committee
decides that particular events or threats are best communicated by the addition
of the Watch designation.
Rating Outlook
Rating Outlooks indicate the direction a rating is likely to move over a
one- to two-year period. They reflect financial or other trends that have not
yet reached the level that would trigger a rating action, but which may do so if
such trends continue. The majority of Outlooks are generally Stable, which is
consistent with the historical migration experience of ratings over a one- to
two-year period. Positive or Negative rating Outlooks do not imply that a rating
change is inevitable and, similarly, ratings with Stable Outlooks can be raised
or lowered without a prior revision to the Outlook, if circumstances warrant
such an action. Occasionally, where the fundamental trend has strong,
conflicting elements of both positive and negative, the Rating Outlook may be
described as Evolving.
Outlooks are currently applied on the long-term scale to issuer ratings in
corporate finance (including sovereigns, industrials, utilities, financial
institutions and insurance companies) and public finance outside the U.S.; to
issue ratings in public finance in the U.S.; to certain issues in project
finance; to Insurer Financial Strength Ratings; to issuer and/or issue ratings
in a number of National Rating scales; and to the ratings of structured finance
transactions and covered bonds. Outlooks are not applied to ratings assigned on
the short-term scale and are applied selectively to ratings in the 'CCC', 'CC'
and 'C' categories. Defaulted ratings typically do not carry an Outlook.
Deciding When to Assign Rating Watch or Outlook
Timing is informative but not critical to the choice of a Watch rather
than an Outlook. A discrete event that is largely clear and the terms of which
are defined, but which will not happen for more than six months - such as a
lengthy regulatory approval process - would nonetheless likely see ratings
placed on Watch rather than a revision to the Outlook.
An Outlook revision may, however, be deemed more appropriate where a
series of potential event risks has been identified, none of which individually
warrants a Watch but which cumulatively indicate heightened probability of a
rating change over the following one to two years.
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A revision to the Outlook may also be appropriate where a specific event
has been identified, but where the conditions and implications of that event are
largely unclear and subject to high execution risk over an extended period - for
example a proposed, but politically controversial, privatization.
STANDARD RATING ACTIONS
Affirmed*
The rating has been reviewed with no change in rating. Ratings
affirmations may also include an affirmation of, or change to an Outlook when an
Outlook is used.
Confirmed
Action taken in response to an external request or change in terms. Rating
has been reviewed in either context, and no rating change has been deemed
necessary. For servicer ratings, action taken in response to change in financial
condition or IDR of servicer where servicer rating is reviewed in that context
exclusively, and no rating action has been deemed necessary.
Downgrade*
The rating has been lowered in the scale.
Matured*/Paid-In-Full
a. 'Matured' - This action is used when an issue has reached the end of
its repayment term and rating coverage is discontinued. Denoted as 'NR'.
b. 'Paid-In-Full' - This action indicates that the issue has been paid in
full. As the issue no longer exists, it is therefore no longer rated. Denoted as
'PIF'.
New Rating*
Rating has been assigned to a previously unrated issue primarily used in
cases of shelf issues such as MTNs or similar programs.
Pre-refunded*
Assigned to long-term US Public Finance issues after Fitch assesses
refunding escrow.
Publish*
Initial public announcement of rating on the agency's website, although
not necessarily the first rating assigned. This action denotes when a previously
private rating is published.
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Upgrade*
The rating has been raised in the scale.
Withdrawn*
The rating has been withdrawn and the issue or issuer is no longer rated
by Fitch Ratings. Indicated in the rating databases with symbol "WD."
* A rating action must be recorded for each rating in a required cycle to
be considered compliant with Fitch policy concerning aging of ratings. Not all
Ratings or Data Actions, or changes in rating modifiers, will meet this
requirement. Actions that meet this requirement are noted with an '*' in the
above definitions.
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APPENDIX B
ENERGY INCOME PARTNERS, LLC
PROXY VOTING POLICIES AND PROCEDURES
If an adviser exercises voting authority with respect to client
securities, Advisers Act Rule 206(4)-6 requires the adviser to adopt and
implement written policies and procedures reasonably designed to ensure that
client securities are voted in the best interest of the client. This is
consistent with legal interpretations which hold that an adviser's fiduciary
duty includes handling the voting of proxies on securities held in client
accounts over which the adviser exercises investment or voting discretion, in a
manner consistent with the best interest of the client.
Absent unusual circumstances, EIP exercises voting authority with respect
to securities held in client accounts pursuant to provisions in its advisory
agreements. Accordingly, EIP has adopted these policies and procedures with the
aim of meeting the following requirements of Rule 206(4)-6:
o ensuring that proxies are voted in the best interest of clients;
o addressing material conflicts that may arise between EIP's interests
and those of its clients in the voting of proxies;
o disclosing to clients how they may obtain information on how EIP voted
proxies with respect to the client's securities; and
o describing to clients EIP's proxy voting policies and procedures and,
upon request, furnishing a copy of the policies and procedures to the
requesting client.
ENGAGEMENT OF INSTITUTIONAL SHAREHOLDER SERVICES INC.
Group
With the aim of ensuring that proxies are voted in the best interest of
EIP clients, EIP has engaged Institutional Shareholder Services Inc. ("ISS"),
formerly known as RiskMetrics Group, as its independent proxy voting service to
provide EIP with proxy voting recommendations, as well as to handle the
administrative mechanics of proxy voting. EIP has directed ISS to utilize its
Proxy Voting Guidelines in making recommendations to vote, as those guidelines
may be amended from time to time.
Conflicts of Interest in Proxy Voting
There may be instances where EIP's interests conflict, or appear to
conflict, with client interests in the voting of proxies. For example, EIP may
provide services to, or have an investor who is a senior member of, a company
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whose management is soliciting proxies. There may be a concern that EIP would
vote in favor of management because of its relationship with the company or a
senior officer. Or, for example, EIP (or its senior executive officers) may have
business or personal relationships with corporate directors or candidates for
directorship.
EIP addresses these conflicts or appearances of conflicts by ensuring that
proxies are voted in accordance with the recommendations made by ISS, an
independent third party proxy voting service. As previously noted, in most
cases, proxies will be voted in accordance with ISS's own pre-existing proxy
voting guidelines.
Disclosure on How Proxies Were Voted
EIP will disclose to clients in its Form ADV how clients can obtain
information on how their proxies were voted, by contacting EIP at its office in
Westport, CT. EIP will also disclose in the ADV a summary of these proxy voting
policies and procedures and that upon request, clients will be furnished a full
copy of these policies and procedures.
It is the responsibility of the CCO to ensure that any requests made by
clients for proxy voting information are responded to in a timely fashion and
that a record of requests and responses are maintained in EIP's books and
records.
Proxy Materials
EIP personnel will instruct custodians to forward to ISS all proxy
materials received on securities held in EIP client accounts.
Limitations
In certain circumstances, where EIP has determined that it is consistent
with the client's best interest, EIP will not take steps to ensure that proxies
are voted on securities in the client's account. The following are circumstances
where this may occur:
* Limited Value: Proxies will not be required to be voted on securities
in a client's account if the value of the client's economic interest in
the securities is indeterminable or insignificant (less than $1,000).
Proxies will also not be required to be voted for any securities that
are no longer held by the client's account.
* Securities Lending Program: When securities are out on loan, they are
transferred into the borrower's name and are voted by the borrower, in
its discretion. In most cases, EIP will not take steps to see that
loaned securities are voted. However, where EIP determines that a proxy
vote, or other shareholder action, is materially important to the
client's account, EIP will make a good faith effort to recall the
security for purposes of voting, understanding that in certain cases,
the attempt to recall the security may not be effective in time for
voting deadlines to be met.
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* Unjustifiable Costs: In certain circumstances, after doing a
cost-benefit analysis, EIP may choose not to vote where the cost of
voting a client's proxy would exceed any anticipated benefits to the
client of the proxy proposal.
OVERSIGHT OF POLICY
The CCO is responsible for overseeing these proxy voting policies and
procedures. In addition, the CCO will review these policies and procedures not
less than annually with a view to determining whether their implementation has
been effective and that they are operating as intended and in such a fashion as
to maintaining EIP's compliance with all applicable requirements.
RECORDKEEPING ON PROXIES
It is the responsibility of EIP's CCO to ensure that the following proxy
voting records are maintained:
o a copy of EIP's proxy voting policies and procedures;
o a copy of all proxy statements received on securities in client
accounts (EIP may rely on ISS or the SEC's EDGAR system to satisfy
this requirement);
o a record of each vote cast on behalf of a client (EIP relies on ISS to
satisfy this requirement);
o a copy of any document prepared by EIP that was material to making a
voting decision or that memorializes the basis for that decision;
o a copy of each written client request for information on how proxies
were voted on the client's behalf or for a copy of EIP's proxy voting
policies and procedures; and
o a copy of any written response to any client request for information
on how proxies were voted on their behalf or furnishing a copy of
EIP's proxy voting policies and procedures.
The CCO will see that these books and records are made and maintained in
accordance with the requirements and time periods provided in Rule 204-2 of the
Advisers Act.
For any registered investment companies advised by EIP, votes made on its
behalf will be stored electronically or otherwise recorded so that they are
available for preparation of the Form N-PX, Annual Report of Proxy Voting Record
of Registered Management Investment Company.
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