Filed pursuant to Rule 497(c) and (h) under
the Securities Act of 1933, as Amended
File no. 333-154254
Prospectus Supplement
(To Prospectus dated April 9, 2010)
Energy Income and Growth Fund
1,700,000 Common Shares
Energy Income and Growth Fund (the "Fund") is offering 1,700,000 of its
common shares of beneficial interest, par value $0.01 per share, pursuant to
this prospectus supplement and the accompanying prospectus dated April 9, 2010
("Common Shares"). The Fund is a non-diversified, closed-end management
investment company which commenced investment operations in June 2004. The
Fund's investment objective is to seek a high level of after-tax total return
with an emphasis on current distributions paid to shareholders. The Fund seeks
to provide its common shareholders with an efficient vehicle to invest in a
portfolio of cash-generating securities of publicly traded master limited
partnerships ("MLPs") and related public entities in the energy sector. This
prospectus supplement, together with the accompanying prospectus, sets forth the
information that you should know before investing.
The Fund's currently outstanding common shares of beneficial interest
are, and the Common Shares offered by this prospectus supplement and
accompanying prospectus, subject to notice of issuance, will be, listed on the
NYSE Amex (formerly the American Stock Exchange) under the symbol "FEN." The
last reported sale price of the Fund's common shares on April 28, 2010 was
$25.58 per share. The net asset value per share of the Fund's common shares at
the close of business on April 28, 2010 was $22.69.
This investment involves risks. See "Risks" beginning on page 37 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 any Common Shares.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus supplement or the accompanying
prospectus. Any representation to the contrary is a criminal offense.
Per Share Total
Public offering price $24.200 $41,140,000
Underwriting discount(1) $0.968 $1,645,600
Proceeds, before expenses, to us(2) $23.232 $39,494,400
-----------
(1) The Fund has also agreed to reimburse the underwriters for certain
out-of-pocket legal expenses incurred by them up to an aggregate of $60,000 with
respect to this offering.
(2) The aggregate offering expenses, including expenses agreed to be paid by the
Fund in footnote (1) above, are estimated to be approximately $200,000, all of
which will be borne by the Fund.
The underwriters may also purchase up to an additional 255,000 Common
Shares at the public offering price, less the underwriting discount to cover
over-allotments, if any, within 30 days from the date of this prospectus
supplement. If the underwriters exercise the option in full, the total public
offering price will be $47,311,000, the total underwriting discount will be
$1,892,440, and the total proceeds, before expenses, to the Fund will be
$45,418,560.
The underwriters are offering the Common Shares as set forth under
"Underwriting" beginning on page S-9 of this prospectus supplement. Delivery of
the Common Shares is expected to be made on or about May 5, 2010.
Sole Book-Running Manager
RBC Capital Markets Oppenheimer & Co.
Co-Managers
BB&T Capital Markets, Janney Montgomery Scott Ladenburg Thalmann & Co. Inc.
a division of Scott & Stringfellow, LLC
Maxim Group LLC Wedbush Securities Inc. Wunderlich Securities
Prospectus Supplement dated April 30, 2010
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. The Statement of
Additional Information (the "SAI"), dated April 9, 2010, 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 66 of the
accompanying 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 (as
defined herein) website (http://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 this prospectus supplement, the
accompanying 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 (http://www.sec.gov).
- i -
TABLE OF CONTENTS
PAGE
PROSPECTUS SUPPLEMENT
PROSPECTUS SUPPLEMENT SUMMARY..................................................................S-1
SUMMARY OF FUND EXPENSES.......................................................................S-5
CAPITALIZATION.................................................................................S-7
MARKET AND NET ASSET VALUE INFORMATION.........................................................S-8
USE OF PROCEEDS................................................................................S-9
UNDERWRITING...................................................................................S-9
EXPERTS ......................................................................................S-12
LEGAL MATTERS.................................................................................S-12
AVAILABLE INFORMATION.........................................................................S-12
INDEX TO FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED NOVEMBER 30, 2009...................F-1
PROSPECTUS
PROSPECTUS SUMMARY...............................................................................1
SUMMARY OF FUND EXPENSES........................................................................22
FINANCIAL HIGHLIGHTS............................................................................24
SENIOR SECURITIES...............................................................................26
MARKET AND NET ASSET VALUE INFORMATION..........................................................27
THE FUND........................................................................................28
USE OF PROCEEDS.................................................................................28
THE FUND'S INVESTMENTS..........................................................................28
USE OF FINANCIAL LEVERAGE.......................................................................33
RISKS 37
MANAGEMENT OF THE FUND..........................................................................50
NET ASSET VALUE.................................................................................52
DISTRIBUTIONS...................................................................................53
DIVIDEND REINVESTMENT PLAN......................................................................53
PLAN OF DISTRIBUTION............................................................................54
DESCRIPTION OF SHARES...........................................................................55
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST AND BY-LAWS......................................58
STRUCTURE OF THE FUND; COMMON SHARE REPURCHASES AND CHANGE IN FUND STRUCTURE....................59
TAX MATTERS.....................................................................................61
CORPORATE FINANCE SERVICES AND CONSULTING FEE...................................................65
CUSTODIAN, ADMINISTRATOR AND TRANSFER AGENT.....................................................65
LEGAL OPINIONS..................................................................................65
TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION...................................66
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.
- ii -
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus supplement, the accompanying prospectus 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," "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. Many 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, petroleum, energy and other
markets, the price at which the Fund's common shares will trade in the public
markets and other factors discussed in the Fund's periodic filings with the SEC.
Although the Fund believes that the expectations expressed in any
forward-looking statements are reasonable, actual results could differ
materially from those expressed or implied in such 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 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 Securities Act of 1933, as amended (the
"Securities 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" section of the accompanying prospectus. The
Fund urges you to review carefully this section for a more detailed discussion
of the risks of an investment in its securities.
- iii -
PROSPECTUS SUPPLEMENT SUMMARY
The following summary contains basic information about the Fund and the
securities offered hereby. 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 37 of the accompanying prospectus.
The Fund
Energy Income and Growth Fund is a non-diversified, closed-end
management investment company. The Fund's investment objective is to seek a high
level of after-tax total return with an emphasis on current distributions paid
to shareholders. The Fund seeks to provide its common shareholders with an
efficient vehicle to invest in a portfolio of cash-generating securities of
publicly traded MLPs and related public entities in the energy sector. The Fund
commenced operations upon completion of its initial public offering of common
shares in June 2004, raising approximately $122 million in equity after the
payment of offering expenses. As of April 28, 2010, the Fund had 7,609,755
common shares outstanding and net assets applicable to common shares of
approximately $172.7 million.
Investment Advisor and Sub-Advisor
First Trust Advisors L.P. ("First Trust Advisors" or the "Advisor") is
the Fund's investment advisor, 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 Fund's
sub-advisor, is also 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-advisor and is
primarily responsible for the day-to-day supervision and investment strategy of
the Fund.
First Trust Advisors, a registered investment advisor, is an Illinois
limited partnership formed in 1991. First Trust Advisors serves as investment
advisor or portfolio supervisor to investment portfolios with approximately $30
billion in assets which it managed or supervised as of March 31, 2010.
Energy Income Partners is a Delaware limited liability company and a
registered investment advisor, 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 advisor to
investment portfolios with approximately $433 million in assets among three
separate funds which it managed as of March 31, 2010.
Pursuant to an 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 leverage),
minus the sum of the Fund's accrued and unpaid dividends on any outstanding
preferred shares and accrued liabilities (other than debt representing
leverage).
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 50 of the
accompanying prospectus.
Investment in Sub-Advisor Entities
First Trust Portfolios L.P., an affiliate of the Advisor, is in
negotiations to purchase, through one or more affiliates or wholly-owned
subsidiaries, up to a 20% ownership interest in each of the Sub-Advisor and EIP
Partners, LLC, a Delaware limited liability company and affiliate of the
Sub-Advisor. The completion of these transactions are subject to a number of
conditions, including entering into definitive agreements with regard to each
transaction and closing of such transactions contemporaneously. There can be no
assurance that the transactions will be completed.
S-1
Portfolio Investments
The Fund's investments consist of equity and/or debt securities issued
by energy companies and energy sector MLPs and MLP-related entities. The
companies in which the Fund invests are generally involved in the business of
transporting, processing, storing, distributing or marketing natural gas,
natural gas liquids (including propane), crude oil, refined petroleum products,
coal or electricity, or exploring, developing, managing or producing such
commodities or products, or in supplying energy-related products and services.
Under normal market conditions, as a non-fundamental policy, the Fund
invests at least 85% of its Managed Assets (including assets obtained through
leverage) in securities of energy companies and energy sector MLPs and
MLP-related entities, and invests at least 65% of its Managed Assets in equity
securities of such MLPs and MLP-related entities.
The Fund has adopted the following additional non-fundamental
investment policies:
o The Fund may invest up to 35% of its Managed Assets in
unregistered or otherwise restricted securities (including up to
10% of its Managed Assets in securities issued by private
companies). 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 companies.
o The Fund may invest up to 25% of its Managed Assets in debt
securities of energy companies, MLPs and MLP-related entities,
including below investment grade securities, which are commonly
referred to as "junk bonds." Below investment grade debt
securities will be rated at least "B3" by Moody's Investors
Service, Inc. and at least "B-" by Standard & Poor's Ratings
Group at the time of purchase, or comparably rated by another
nationally recognized statistical rating organization or, if
unrated, determined to be of comparable quality by the
Sub-Advisor.
o The Fund will not invest more than 10% 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 financial
leverage or market risks associated with the Fund's portfolio.
o The Fund may invest up to 15% of its Managed Assets in non-U.S.
securities as well as hedge the currency risk of the non-U.S.
securities using derivative instruments.
To generate additional income, the Fund writes (or sells) covered call
options on the common stock of energy companies held in the Fund's portfolio.
See "The Fund's Investments" beginning on page 28 of the accompanying
prospectus.
As of March 31, 2010, the Fund's top 10 holdings by issuer were:
Percentage of
Name Total Investments*
---------------------------------------- -----------------------
Magellan Midstream Partners, L.P. 9.4%
Enterprise Products Partners, L.P. 6.9
Plains All American Pipeline, L.P. 6.2
NuStar Energy, L.P. 5.2
Kinder Morgan Energy Partners, L.P. 5.0
ONEOK Partners, L.P. 4.0
Kinder Morgan Management, LLC. 3.9
William Cos., Inc. 3.9
Enterprise GP Holdings, L.P. 3.7
UGI Corp. 3.7
-----------------------
Total 51.9%
_______________________
* As of March 31, 2010, the value of the Fund's investment portfolio
was $268,074,694.
S-2
Recent Equity Sales
In February 2010, the Fund sold 805,000 Fund common shares in an
underwritten public offering. Net proceeds of the offering were used to acquire
portfolio securities in accordance with the Fund's investment objective and
policies and for general corporate purposes.
On May 19, 2009, the Fund entered into an equity sales agreement with a
registered broker-dealer, whereby the Fund may offer and sell up to 1,000,000 of
the Fund's common shares from time to time through such broker-dealer, as agent
for the offer and sale of the Fund's common shares (the "Equity Sales
Agreement"). Under the Equity Sales Agreement, upon written instructions from
the Fund, the broker-dealer has agreed to use its commercially reasonable
efforts to sell, as agent for the Fund, Fund common shares by means of ordinary
brokers' transactions on the NYSE Amex at market prices prevailing at the time
of the sale or at negotiated prices. While the Equity Sales Agreement
contemplates an offering of up to 1,000,000 common shares, the precise number of
common shares to be sold will depend primarily on future market conditions. The
Fund will suspend sales of common shares under the Equity Sales Agreement during
the offering of the Common Shares and may resume sales on the 45th day following
the date of the prospectus supplement, which 45-day period may be extended in
the event the Fund, during the last 17 days of such period, issues an earnings
release or material news or a material event relating to the Fund, the Advisor
or the Sub-Advisor occurs. See "Underwriting" beginning on page S-9. As of April
28, 2010, the Fund had sold 259,962 common shares pursuant to the Equity Sales
Agreement.
Financial Leverage
The Fund has entered into a $70,000,000 committed facility agreement
with BNP Paribas Prime Brokerage Inc. (the "Commitment Facility"). As of April
20, 2010, the principal amount of borrowings under the Commitment Facility was
$61,300,000, representing approximately 25.7% of the Fund's Managed Assets. As
of April 20, 2010, the Fund had $8,700,000 of unutilized funds available for
borrowing under the Commitment Facility. Outstanding balances under the
Commitment Facility generally accrue interest at a variable annual rate equal to
the three-month LIBOR plus 1.50%. As of April 20, 2010, the rate was 1.80%. The
Commitment Facility also has an annual unused fee of 0.80% on the unutilized
funds available for borrowing. The total annual interest and fee rate as of
April 20, 2010 was 1.68%, based on the total commitment of $70,000,000. Assuming
that the Fund's leverage costs remain as described above (at an assumed average
annual cost of 1.68%) and leverage as a percentage of the Fund's Managed Assets
remains at 25.7%, the annual return that the Fund's portfolio must experience
(net of expenses) in order to cover its leverage costs would be 0.49%.
Adjusted to reflect the impact of 1,700,000 Common Shares issued in the
offering contemplated by this prospectus supplement and accompanying prospectus
and an anticipated leverage percentage of approximately 26.9% of the Fund's
Managed Assets, the total annual interest and fee rate as of April 20, 2010
would be 1.80% and the annual return that the Fund's portfolio must experience
(net of expenses) in order to cover its leverage costs would be 0.49%. The
following table is designed to illustrate the effect of leverage on common share
total return after the issuance of Common Shares contemplated by this prospectus
supplement and 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 42 of the accompanying
prospectus. The table further assumes leverage representing 26.9% of the Fund's
Managed Assets, net of expenses, and the Fund's current annual leverage interest
and fee rate of 1.80%. Prior approval from the Commitment Facility lender will
be required for borrowings above $70,000,000 under the Commitment Facility.
There is no assurance that such approval will be obtained.
Assumed Portfolio Total Return (Net of Expenses).......... -10% -5% 0% 5% 10%
Common Share Total Return................................. -14.35% -7.51% -0.66% 6.18% 13.02%
Distributions
The Fund has paid distributions to common shareholders every quarter
since inception. Payment of future distributions is subject to approval by the
Fund's Board of Trustees, as well as meeting the covenants of any senior debt
and the asset coverage requirements of the Investment Company Act of 1940, as
amended (the "1940 Act"), including covenants contained in the Commitment
Facility. The Fund's next regularly scheduled quarterly distribution will be for
the quarter ending July 31, 2010 and, if approved by the Board of Trustees, will
be paid to common shareholders on or about July 30, 2010. The distributions the
Fund has paid since inception are as follows:
S-3
Payment Date Distribution Per Share ($)
October 29, 2004 0.3250
January 31, 2005 0.3300
April 29, 2005 0.3300
July 29, 2005 0.3300
October 31, 2005 0.3350
January 31, 2006 0.3350
April 28, 2006 0.3400
July 31, 2006 0.3450
October 31, 2006 0.3550
January 31, 2007 0.3750
April 30, 2007 0.3800
July 31, 2007 0.3850
October 31, 2007 0.3850
January 31, 2008 0.3850
April 30, 2008 0.3950
July 31, 2008 0.4400
October 31, 2008 0.4400
January 30, 2009 0.4400
April 30, 2009 0.4400
July 31, 2009 0.4400
October 30, 2009 0.4400
January 29, 2010 0.4400
April 30, 2010 0.4450*
_______________________
* The Common Shares offered hereby will not be entitled to
receive such distribution.
The Offering
Common Shares offered 1,700,000 shares(1)
Fund common shares outstanding
after this offering 9,309,755 shares(1)
Use of proceeds The Fund estimates that the net proceeds
from this offering after expenses without
exercise of the overallotment option will
be approximately $39.3 million.(2) The
Fund intends to use these net proceeds to
acquire portfolio securities in pursuit
of its investment objective and policies
and for general corporate purposes. See
"Use of Proceeds" on page S-9.
Risk factors See the section entitled "Risks" and
other information included in the
accompanying prospectus for a discussion
of factors you should carefully consider
before deciding to invest in the Common
Shares.
NYSE Amex symbol "FEN"
____________________
(1) The number of common shares of the Fund outstanding after the offering
assumes the underwriters' over-allotment option is not exercised. If the
over-allotment option is exercised in full, the Fund will issue and sell
an additional 255,000 Common Shares.
(2) If the over-allotment option is exercised in full, the Fund estimates
that the net proceeds from this offering after expenses will be
approximately $45.2 million.
S-4
SUMMARY OF FUND EXPENSES
The following table 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 April 20, 2010. As of that
date, the Fund had $61,300,000 of leverage outstanding pursuant to the
Commitment Facility. Such leverage represented 25.7% of Managed Assets as of
April 20, 2010. Additionally, the following table and example contain
information assuming the issuance of the 1,700,000 Common Shares offered hereby
and anticipated leverage of $80,000,000, or 26.9% of the Fund's Managed Assets.
Shareholder Transaction Expenses:
Underwriting Discount (as a percentage of offering price)(1)........ 4.00%
Offering Expenses Borne by the Fund
(as a percentage of offering price).............................. 0.11%
Dividend Reinvestment Plan Fees..................................... None(2)
Percentage of Net
Percentage of Net Assets Attributable
Assets Attributable to to Common
Common Shareholders Shareholders at April
at 20, 2010, (Assuming
April 20, 2010 the issuance of
(25.7% Leverage 1,700,000 Common
Outstanding as of Shares and 26.9%
April 20, 2010) Leverage Outstanding)
------------------------------------------------
Annual Expenses:
Management Fees(3).................................................. 1.35% 1.37%
Interest and Fees on Leverage(4).................................... 0.67% 0.66%
Offering Costs(5)................................................... 0.25% 0.02%
Other Expenses (exclusive of current and deferred income tax
expense (benefit))(6)............................................... 0.47% 0.47%
------ ------
Total Annual Expenses............................................... 2.74% 2.52%
Fee and Expense Reimbursement....................................... - -
------ ------
Total Net Annual Expenses........................................... 2.74% 2.52%
====== ======
----------------------------------------------------------------------------------------------------------------------
(1) The Fund will pay all offering costs of the Fund. The Fund has also agreed
to reimburse the underwriters for certain out-of-pocket legal expenses
incurred by them up to an aggregate of $60,000 with respect to this
offering.
(2) You will pay brokerage charges if you direct PNC Global Investment
Servicing (U.S.) 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 (and by the Advisor to
the Sub-Advisor).
(4) Interest and fees on leverage in the first column of the table reflect the
actual cost to the Fund of borrowing, expressed as a percentage of the
Fund's average daily net assets as of April 20, 2010. Interest and fees on
leverage in the second column reflect the cost to the Fund of borrowing,
expressed as a percentage of the Fund's net assets as of April 20, 2010,
assuming the issuance of the 1,700,000 Common Shares offered hereby and
leverage of 26.9% of the Fund's Managed Assets, based upon interest rates
in effect as of April 20, 2010.
(5) Offering costs in the first column of the table represent amortized
offering costs associated with the Equity Sales Agreement. Offering costs
in the second column represent the remaining unamortized offering costs
associated with the Equity Sales Agreement.
S-5
(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 November 30, 2009
has been as follows:
Period June 24, 2004 (commencement of operations)
Through November 30, 2004.............................. 16.18%
Year Ended November 30, 2005................................ 5.98%
Year Ended November 30, 2006................................ 10.84%
Year Ended November 30, 2007................................ 4.58%
Year Ended November 30, 2008................................ (24.83)%
Year Ended November 30, 2009................................ 22.47%
The purpose of the tables above and the example below is to help you
understand all fees and expenses that you, as a holder of Common Shares, would
bear directly or indirectly. The following example illustrates the expenses that
you would pay on a $1,000 investment in Common Shares, assuming: (i) an
underwriting discount of 4.00% and offering expenses of 0.11% of the offering
price, (ii) total annual expenses of 2.52% of net assets attributable to common
shares through year 10 (excluding deferred income tax expense (benefit)), (iii)
a 5% annual return and (iv) all distributions are reinvested at net asset
value.(1)
1 Year 3 Years 5 Years 10 Years
$66 $116 $170 $315
--------------------------------------------------------------------------------
(1) The example should not be considered a representation of future expenses.
The example assumes 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 26.9% of Managed Assets, assuming interest and fees on leverage of
1.80%. The interest and fees on leverage is expressed as an interest rate
and represents interest and fees payable on its current credit 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
CAPITALIZATION
The following table sets forth the Fund's capitalization at April 20, 2010:
o on a historical basis; and
o as adjusted to reflect (1) the issuance of 1,700,000 Common Shares
at $24.20 per share, in the offering contemplated by this
prospectus supplement, after deducting the underwriting discount
of $1,645,600 and offering expenses payable by the Fund of
approximately $200,000 and (2) an adjusted leverage percentage of
approximately 26.9% of the Fund's Managed Assets.
Actual As Adjusted(1)(2)(3)
__________________ ____________________
Borrowings $61,300,000 $80,000,000
------------------ ------------------
Shareholders' equity
Common Shares, $0.01 par value per share, unlimited shares
authorized, 7,609,755 shares outstanding (actual) and
9,309,755 shares outstanding (as adjusted) 124,146,049 163,440,449
Accumulated net investment income (loss), net
of income taxes (17,820,502) (17,820,502)
Accumulated net realized gain (loss) on investments
and written options, net of income taxes 2,399,720 2,399,720
Net unrealized appreciation (depreciation) of investments
and written options, net of income taxes 68,883,665 68,883,665
------------------ ------------------
Net assets applicable to common shareholders 177,608,932 216,903,332
------------------ ------------------
Total Capitalization $238,908,932 $296,903,332
================== ==================
------------------------------------------------------------------------------------------------------------
(1) No additional common shares have been sold under the Equity Sales Agreement
since December 28, 2009.
(2) Does not include the underwriters' over-allotment option of 255,000 Common
Shares.
(3) Prior Commitment Facility lender approval will be required for borrowings
above $70,000,000 under the Commitment Facility. There is no assurance that
such approval will be obtained.
S-7
MARKET AND NET ASSET VALUE INFORMATION
The Fund's currently outstanding common shares are, and the Common
Shares offered by this prospectus supplement and accompanying prospectus,
subject to notice of issuance, will be, listed on the NYSE Amex. The Fund's
common shares commenced trading on the NYSE Amex (formerly the American Stock
Exchange) on June 25, 2004.
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. The continued
development of alternatives as vehicles for investing in a portfolio of energy
infrastructure MLPs, including other publicly traded investment companies and
private funds, may reduce or eliminate any tendency of the Fund's common shares
to trade at a premium in the future. See "Risks - Market Discount From Net Asset
Value," beginning on page 49 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
Amex (formerly the American Stock Exchange), 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). Prior to August 1, 2008, net asset value was determined on each Friday
and as of the end of each month. See "Net Asset Value" on page 52 of the
accompanying prospectus 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
Quarter Ended High Low High Low High Low
March 31, 2008....................... $24.60 $21.16 $26.18 $24.49 (6.04)% (13.60)%
June 30, 2008........................ $25.80 $22.36 $25.46 $23.91 1.34% (6.48)%
September 30, 2008................... $23.33 $18.26 $22.18 $20.71 5.18% (11.83)%
December 31, 2008.................... $20.20 $11.21 $19.14 $12.71 5.54% (11.80)%
March 31, 2009....................... $19.04 $14.02 $15.89 $13.76 19.82% 1.89%
June 30, 2009........................ $20.75 $16.83 $18.04 $15.95 15.02% 5.52%
September 30, 2009................... $22.31 $18.40 $18.48 $16.95 20.73% 8.55%
December 31, 2009.................... $25.20 $21.17 $21.00 $19.69 20.00% 7.52%
March 31, 2010....................... $24.59 $21.69 $22.64 $21.03 8.61% 3.14%
--------------------------------------------------------------------------------------------------------------
(1) Based on high and low closing market price for the respective quarter.
(2) Based on the net asset value calculated daily as of the close of regular
trading on the NYSE (normally 4:00 p.m. eastern time). Prior to August 1,
2008, net asset value was determined on each Friday and as of the end of
each month.
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 April 28, 2010
were $25.58, $22.69 and 12.74%, respectively. As of April 28, 2010, the Fund
had 7,609,755 common shares outstanding and Managed Assets of the Fund were
$237,488,393.
S-8
USE OF PROCEEDS
The Fund estimates that the net proceeds from this offering will be
approximately $39.3 million, after deducting the underwriting discount and
estimated offering expenses payable by the Fund. If the underwriters exercise
their over-allotment option in full, the Fund estimates that net proceeds from
this offering will be approximately $45.2 million, after deducting the
underwriting discount and estimated offering expenses payable by the Fund.
The Fund intends to use the net proceeds of this offering to acquire
portfolio securities in accordance with its investment objective and policies
and for general corporate purposes. Pending such investments, the Fund
anticipates either investing the proceeds in short-term securities issued by the
U.S. government or its agencies or instrumentalities or in high quality,
short-term or long-term debt obligations or money market instruments. A delay in
the anticipated use of proceeds could lower returns and reduce the Fund's
distribution to common shareholders.
UNDERWRITING
RBC Capital Markets Corporation is acting as the representative of the
underwriters of this offering. Under the terms of an underwriting agreement
dated the date of this prospectus supplement, the underwriters set forth below
have agreed to purchase from the Fund the number of Common Shares set forth
opposite their name.
Number of
Name Common Shares
---------------
RBC Capital Markets Corporation ..................................... 453,000
Oppenheimer & Co. Inc. .............................................. 329,000
BB&T Capital Markets, a division of Scott & Stringfellow, LLC ....... 123,000
Janney Montgomery Scott LLC ......................................... 58,000
Ladenburg Thalmann & Co. Inc. ....................................... 350,000
Maxim Group LLC ..................................................... 206,000
Wedbush Securities Inc. ............................................. 99,000
Wunderlich Securities, Inc. ......................................... 82,000
---------------
Total 1,700,000
===============
The underwriting agreement provides that the underwriters' obligations
to purchase the Common Shares depend on the satisfaction of the conditions
contained in the underwriting agreement and that if any of the Common Shares are
purchased by the underwriters, all of the Common Shares must be purchased. The
conditions contained in the underwriting agreement include the condition that
all the representations and warranties made by the Fund to the underwriters are
true, that there has been no material adverse change in the condition of the
Fund or in the financial markets and that the Fund deliver to the underwriters
customary closing documents.
The following table summarizes the underwriting discount the Fund will
pay to the underwriters in connection with this offering. These amounts are
shown assuming both no exercise and full exercise of the underwriters' option to
purchase additional Common Shares. The underwriting discount is the difference
between the initial price to the public and the amount the underwriters pay the
Fund to purchase the Common Shares.
Full
No Exercise Exercise
Per Common Share $0.968 $0.968
Total $1,645,600 $1,892,440
S-9
The Fund will pay all expenses of the offering that it incurs. Total
expenses of the offering payable by the Fund, other than the underwriting
discount, will be approximately $200,000. As a part of these expenses, the Fund
has agreed to reimburse the underwriters for certain out-of-pocket legal
expenses incurred by them up to an aggregate of $60,000 with respect to this
offering.
The Fund has been advised by the underwriters that the underwriters
propose to offer the Common Shares directly to the public at the initial price
to the public set forth on the cover page of this prospectus supplement and to
selected dealers at this price to the public less a concession not to exceed
$0.5808 per Common Share.
The Fund has agreed to indemnify the underwriters against certain
liabilities, including liabilities under the Securities Act or to contribute to
payments that may be required to be made with respect to these liabilities.
The Fund has granted to the underwriters an option to purchase up to an
aggregate of 255,000 additional Common Shares at the initial price to the public
less the underwriting discount set forth on the cover page of this prospectus
supplement exercisable solely to cover over-allotments, if any. Such option may
be exercised in whole or in part at any time until 30 days after the date of
this prospectus supplement. If this option is exercised, each underwriter will
be committed, subject to satisfaction of the conditions specified in the
underwriting agreement, to purchase a number of additional Common Shares
proportionate to each underwriter's initial commitment as indicated in the
preceding table, and the Fund will be obligated, pursuant to the option, to sell
these shares to the underwriters.
During a period of 60 days from the date of the prospectus supplement,
the Fund, the Advisor and the Sub-Advisor have agreed that subject to certain
exceptions, they will not, without the prior written consent of RBC Capital
Markets Corporation, directly or indirectly, (1) offer, pledge, sell, contract
to sell, sell any option, rights or warrant to purchase, purchase any option or
contract to sell, grant any option, right or warrant to purchase or otherwise
transfer or dispose of the Fund's common shares or any securities convertible
into or exercisable or exchangeable for the Fund's common shares or file any
registration statement under the Securities Act with respect to any of the
foregoing or (2) enter into any swap or any other agreement or any transaction
that transfers, in whole or in part, directly or indirectly, the economic
consequence of ownership of the Fund's common shares, whether any such swap or
transaction described in clause (1) or (2) above is to be settled by delivery of
common shares or such other securities, in cash or otherwise. The restrictions
described above will apply to certain of the Fund's trustees and the sale of
common shares under the Equity Sales Agreement for a period of 45 days after the
date of this Prospectus Supplement. In connection with such Equity Sales
Agreement, the Fund will be permitted to file an amendment to its registration
statement notwithstanding the restrictions set forth in this paragraph for
purposes of updating necessary disclosure relating to the sale of common shares
from time to time under the Equity Sales Agreement. The restrictions described
in this paragraph do not apply to the sale of the Common Shares to the
underwriters or common shares issued (or purchased in the open market) pursuant
to the Fund's dividend reinvestment plan. In the event that either: (x) during
the last 17 days of the 60-day period, or the 45-day period, as applicable,
referred to above ("Lock-Up Period"), the Fund issues an earnings release or
material news or a material event relating to the Fund, the Advisor or the
Sub-Advisor occurs, or (y) prior to the expiration of such Lock-Up Period, the
Fund announces that it will release earnings results or becomes aware that
material news or a material event will occur during the 16-day period beginning
on the last day of such Lock-Up Period, the restrictions described above shall
continue to apply until the expiration of the 18-day period beginning on the
date of the earnings release or the occurrence of the material news or material
event, as applicable, unless the underwriters waive such extensions.
RBC Capital Markets Corporation, in its sole discretion, may release
the common shares subject to lock-up agreements in whole or in part at any time
with or without notice. When determining whether or not to release common shares
from lock-up agreements, RBC Capital Markets Corporation will consider, among
other factors, the reasons for requesting the release, the number of common
shares for which the release is being requested and market conditions at the
time.
In connection with this offering, the underwriters may engage in
stabilizing transactions, over-allotment transactions, syndicate covering
transactions and penalty bids in accordance with Regulation M under the
Securities Exchange Act of 1934, as amended (the "Exchange Act").
o Stabilizing transactions permit bids to purchase the underlying
security so long as the stabilizing bids do not exceed a
specified maximum.
S-10
o Over-allotment transactions involve sales by the underwriters of
Common Shares in excess of the number of Common Shares the
underwriters are obligated to purchase, which creates a syndicate
short position. The short position may be either a covered short
position or a naked short position. In a covered short position,
the number of Common Shares over-allotted by the underwriters is
not greater than the number of shares they may purchase in their
option to purchase additional Common Shares. In a naked short
position, the number of Common Shares involved is greater than
the number of Common Shares in the underwriters' option to
purchase additional Common Shares. The underwriters may close out
any short position by either exercising their option and/or
purchasing Common Shares in the open market.
o Syndicate covering transactions involve purchases of the Common
Shares in the open market after the distribution has been
completed in order to cover syndicate short positions. In
determining the source of the Common Shares to close out the
short position, the underwriters will consider, among other
things, the price of Common Shares available for purchase in the
open market as compared to the price at which they may purchase
Common Shares through their option. If the underwriters sell more
Common Shares than could be covered by their option to purchase
additional Common Shares, which is referred to in this prospectus
supplement as a naked short position, the position can only be
closed out by buying Common Shares in the open market. A naked
short position is more likely to be created if the underwriters
are concerned that there could be downward pressure on the price
of the Common Shares in the open market after pricing that could
adversely affect investors who purchase in the offering.
o Penalty bids permit the representatives to reclaim a selling
concession from a syndicate member when the Common Shares
originally sold by the syndicate member are purchased in a
stabilizing or syndicate covering transaction to cover syndicate
short positions.
Similar to other purchase transactions, the underwriters' purchases to
cover the syndicate short sales may have the effect of raising or maintaining
the market price of the Common Shares or preventing or retarding a decline in
the market price of the Common Shares. As a result, the price of the Common
Shares may be higher than the price that might otherwise exist in the open
market.
These stabilizing transactions, syndicate covering transactions and
penalty bids may have the effect of raising or maintaining the market price of
the Common Shares or preventing or retarding a decline in the market price of
the Common Shares. As a result, the price of the Common Shares may be higher
than the price that might otherwise exist in the open market. These transactions
may be effected on the NYSE Amex or otherwise and, if commenced, may be
discontinued at any time.
Neither the Fund, the Advisor, the Sub-Advisor nor any of the
underwriters make any representation or prediction as to the direction or
magnitude of any effect that the transactions described above may have on the
price of the Common Shares. In addition, neither the Fund, the Advisor, the
Sub-Advisor nor any of the underwriters make any representation that the
underwriters will engage in these stabilizing transactions or that any
transaction, if commenced, will not be discontinued without notice.
The underwriters and their affiliates have provided in the past to the
Fund, and may from time to time in the future provide, certain commercial
banking, financial advisory, investment banking and other services, for which
they will be entitled to receive separate fees. The underwriters and their
affiliates may from time to time in the future engage in transactions with the
Fund and perform services for the Fund or its portfolio companies in the
ordinary course of business.
The principal business address of RBC Capital Markets Corporation is
Three World Financial Center, 200 Vesey Street, 8th Floor, New York, NY 10281.
S-11
EXPERTS
The financial statements and financial highlights in this prospectus
supplement and the accompanying SAI have been audited by Deloitte & Touche LLP,
an independent registered public accounting firm, as stated in their reports
appearing herein and elsewhere in the Registration Statement. Such financial
statements and financial highlights are included in reliance upon the reports of
such firm given upon their authority as experts in accounting and auditing.
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 and for
the underwriters by Troutman Sanders LLP. Chapman and Cutler LLP and Troutman
Sanders LLP may rely as to certain matters of Massachusetts law on the opinion
of Bingham McCutchen LLP.
AVAILABLE INFORMATION
The Fund is subject to the informational requirements of 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 annual shareholder report filed with the SEC is for the
period ended November 30, 2009. This document is 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 (http://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-12
INDEX TO FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED NOVEMBER 30, 2009
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM....................F-3
PORTFOLIO OF INVESTMENTS...................................................F-4
STATEMENT OF ASSETS AND LIABILITIES........................................F-8
STATEMENT OF OPERATIONS....................................................F-9
STATEMENTS OF CHANGES IN NET ASSETS........................................F-10
STATEMENT OF CASH FLOWS....................................................F-11
FINANCIAL HIGHLIGHTS.......................................................F-12
NOTES TO FINANCIAL STATEMENTS..............................................F-13
F-1
This page is intentionally left blank.
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees and Shareholders of Energy Income and Growth Fund:
We have audited the accompanying statement of assets and liabilities, including
the portfolio of investments, of Energy Income and Growth Fund (the "Fund") as
of November 30, 2009, and the related statements of operations and cash flows
for the year then ended, the statements of changes in net assets for each of the
two years in the period then ended, and the financial highlights for the periods
presented. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements and financial highlights are free of material misstatement.
The Fund is not required to have, nor were we engaged to perform, an audit of
its internal control over financial reporting. Our audits included consideration
of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of November 30, 2009 by correspondence with the Fund's
custodian and brokers. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Energy
Income and Growth Fund as of November 30, 2009, the results of its operations
and its cash flows for the year then ended, the changes in its net assets for
each of the two years in the period then ended, and the financial highlights for
the periods presented, in conformity with accounting principles generally
accepted in the United States of America.
/s/ Deloitte & Touche LLP
Chicago, Illinois
January 27, 2010
ENERGY INCOME AND GROWTH FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
NOVEMBER 30, 2009
SHARES/
UNITS DESCRIPTION VALUE
--------- ----------- ------------
MASTER LIMITED PARTNERSHIPS - 116.4%
OIL, GAS & CONSUMABLE FUELS - 114.8%
74,500 AmeriGas Partners, L.P. ................................... $ 2,795,240
110,000 Buckeye GP Holdings, L.P. (b) ............................. 3,081,100
25,000 Buckeye Partners, L.P. .................................... 1,317,500
465,471 Clearwater Natural Resources, L.P. (c) (d) (e) (f) ........ 0
124,300 Duncan Energy Partners, L.P. (b) .......................... 2,793,021
153,600 El Paso Pipeline Partners, L.P. (b) ....................... 3,640,320
150,947 Enbridge Energy Partners, L.P. (b) ........................ 7,440,178
7,582 Encore Energy Partners, L.P. (b) .......................... 134,429
159,000 Energy Transfer Equity, L.P. (b) .......................... 4,690,500
173,870 Energy Transfer Partners, L.P. (b) ........................ 7,526,832
267,803 Enterprise GP Holdings, L.P. (b) .......................... 9,908,711
515,998 Enterprise Products Partners, L.P. (b) .................... 15,371,580
40,709 EV Energy Partners, L.P. (b) .............................. 1,052,328
6,751 Exterran Partners, L.P. ................................... 130,497
74,874 Global Partners, L.P. (b) ................................. 1,758,790
100,700 Holly Energy Partners, L.P. (b) ........................... 3,695,690
112,836 Inergy Holdings, L.P. ..................................... 6,036,726
205,771 Kinder Morgan Energy Partners, L.P. (b) ................... 11,988,218
528,642 Magellan Midstream Partners, L.P. (b) ..................... 21,727,186
142,788 Natural Resource Partners, L.P. (b) ....................... 3,399,782
145,126 NuStar Energy, L.P. (b) ................................... 7,611,859
229,100 NuStar GP Holdings, LLC (b) ............................... 5,718,336
149,130 ONEOK Partners, L.P. (b) .................................. 8,752,440
70,000 Penn Virginia Resource Partners, L.P. (b) ................. 1,358,700
255,921 Plains All American Pipeline, L.P. (b) .................... 12,949,603
57,505 Quicksilver Gas Services, L.P. (b) ........................ 1,207,605
105,454 Sunoco Logistics Partners, L.P. (b) ....................... 6,511,785
27,000 TC Pipelines, L.P. ........................................ 977,130
70,000 TransMontaigne Partners, L.P. (b) ......................... 1,820,000
60,000 Williams Pipeline Partners, L.P. (b) ...................... 1,311,000
-------------
156,707,086
-------------
GAS UTILITIES - 1.6%
30,000 Spectra Energy Partners, L.P. ............................. 831,900
30,000 Suburban Propane Partners, L.P. ........................... 1,317,000
-------------
2,148,900
-------------
TOTAL MASTER LIMITED PARTNERSHIPS
(Cost $97,948,559) ..................................... 158,855,986
-------------
CANADIAN INCOME TRUSTS - 3.4%
OIL, GAS & CONSUMABLE FUELS - 2.7%
171,680 Keyera Facilities Income Fund ............................. 3,716,959
INDEPENDENT POWER PRODUCERS & ENERGY TRADERS - 0.7%
90,000 Northland Power Income Fund ............................... 937,180
-------------
TOTAL CANADIAN INCOME TRUSTS
(Cost $3,266,024) ...................................... 4,654,139
-------------
See Notes to Financial Statements
F-4
ENERGY INCOME AND GROWTH FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
NOVEMBER 30, 2009
SHARES DESCRIPTION VALUE
--------- ----------- -------------
COMMON STOCKS - 24.5%
OIL, GAS & CONSUMABLE FUELS - 17.4%
65,470 Enbridge Energy Management, LLC (b) (g) ................... $ 3,197,535
22,000 Enbridge, Inc. (h) ........................................ 940,720
119,037 Kinder Morgan Management, LLC (b) (g) ..................... 5,984,007
179,500 Spectra Energy Corp. (i) .................................. 3,484,095
160,000 TransCanada Corp. (i) ..................................... 5,163,200
250,000 Williams Cos., Inc. (h) ................................... 4,972,500
-------------
23,742,057
-------------
GAS UTILITIES - 7.0%
118,000 ONEOK, Inc. (i) ........................................... 4,722,360
205,000 UGI Corp. (i) ............................................. 4,813,400
-------------
9,535,760
-------------
CAPITAL MARKETS - 0.1%
20,000 NGP Capital Resources Co. (b) ............................. 153,800
-------------
TOTAL COMMON STOCKS
(Cost $28,604,923) ..................................... 33,431,617
-------------
RIGHTS - 0.0%
OIL, GAS & CONSUMABLE FUELS - 0.0%
17 Clearwater Natural Resources, L.P. (c) (d) (e) (f) ........ 0
-------------
TOTAL RIGHTS
(Cost $0) .............................................. 0
-------------
WARRANTS - 0.0%
OIL, GAS & CONSUMABLE FUELS - 0.0%
48,956 Abraxas Petroleum Corp., Expiration 05/25/12 (c) (d) (e) .. 23,034
-------------
TOTAL WARRANTS
(Cost $0) .............................................. 23,034
-------------
TOTAL INVESTMENTS - 144.3%
(Cost $129,819,506) (j) ................................ 196,964,776
-------------
NUMBER OF
CONTRACTS DESCRIPTION VALUE
--------- ----------- -------------
CALL OPTIONS WRITTEN - (0.8%)
Enbridge, Inc.
220 @ 45 due Apr 10 ........................................... (24,200)
-------------
ONEOK, Inc.
800 @ 35 due Jan 10 ........................................... (412,000)
-------------
Spectra Energy Corp.
900 @ 20 due Dec 09 ........................................... (13,500)
195 @ 22.5 due Mar 10 ........................................ (1,950)
-------------
(15,450)
-------------
See Notes to Financial Statements
F-5
ENERGY INCOME AND GROWTH FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
NOVEMBER 30, 2009
NUMBER OF
CONTRACTS DESCRIPTION VALUE
--------- ----------- -------------
CALL OPTIONS WRITTEN - (CONTINUED)
TransCanada Corp.
600 @ 30 due Feb 10 ........................................... $ (192,000)
800 @ 35 due May 10 ........................................... (32,000)
-------------
(224,000)
-------------
UGI Corp.
800 @ 25 due Jan 10 ........................................... (10,000)
500 @ 30 due Jan 10 ........................................... (7,500)
-------------
(17,500)
-------------
Williams Cos., Inc.
800 @ 17.5 due Feb 10 ......................................... (228,000)
300 @ 20 due Dec 09 ........................................... (12,000)
600 @ 20 due Jan 10 ........................................... (48,000)
800 @ 22.5 due May 10 ......................................... (68,000)
-------------
(356,000)
-------------
TOTAL CALL OPTIONS WRITTEN
(Premiums received $722,982) ........................... (1,049,150)
-------------
OUTSTANDING LOAN - (33.0)% ................................ (45,000,000)
NET OTHER ASSETS AND LIABILITIES - (10.5%) ................ (14,395,137)
-------------
NET ASSETS - 100.0% ....................................... $ 136,520,489
=============
----------
(a) All percentages shown in the Portfolio of Investments are based on net
assets.
(b) All or a portion of this security is serving as collateral on the
outstanding loan.
(c) This security is restricted and cannot be offered for public sale without
first being registered under the Securities Act of 1933, as amended. Prior
to registration, restricted securities may only be resold in transactions
exempt from registration (see Note 2D - Restricted Securities in the Notes
to Financial Statements).
(d) This security is fair valued in accordance with procedures adopted by the
Fund's Board of Trustees.
(e) Non-income producing security.
(f) This partnership filed for protection in federal bankruptcy court on
January 7, 2009.
(g) Non-income producing security which pays regular in-kind distributions.
(h) Call options were written on this entire Common Stock position and are
fully covered by the Common Stock position.
(i) Call options were written on a portion of this Common Stock position and
are fully covered by the Common Stock position.
(j) Aggregate cost for federal income tax purposes is $117,713,175. As of
November 30, 2009, the aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost was
$84,659,592 and the aggregate gross unrealized depreciation for all
securities in which there was an excess of tax cost over value was
$5,407,991.
See Notes to Financial Statements
F-6
ENERGY INCOME AND GROWTH FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
NOVEMBER 30, 2009
VALUATION INPUTS
A summary of the inputs used to value the Fund's investments as of November 30,
2009 is as follows (see Note 2A - Portfolio Valuation in the Notes to Financial
Statements):
ASSETS TABLE
LEVEL 2 LEVEL 3
TOTAL MARKET LEVEL 1 SIGNIFICANT SIGNIFICANT
VALUE AT QUOTED OBSERVABLE UNOBSERVABLE
11/30/09 PRICES INPUTS INPUTS
------------ ------------ ----------- ------------
Master Limited Partnerships* .. $158,855,986 $158,855,986 $ -- $--
Canadian Income Trusts* ....... 4,654,139 4,654,139 -- --
Common Stocks* ................ 33,431,617 33,431,617 -- --
Warrants* ..................... 23,034 -- 23,034 --
------------ ------------ ------- ---
Total Investments ............. $196,964,776 $196,941,742 $23,034 $--
============ ============ ======= ===
LIABILITIES TABLE
LEVEL 2 LEVEL 3
TOTAL MARKET LEVEL 1 SIGNIFICANT SIGNIFICANT
VALUE AT QUOTED OBSERVABLE UNOBSERVABLE
11/30/09 PRICES INPUTS INPUTS
------------ ----------- ----------- ------------
Call Options Written .......... $(1,049,150) $(1,049,150) $-- $--
=========== =========== === ===
* See the Portfolio of Investments for industry breakout.
The following table presents the Fund's investments measured at fair value on a
recurring basis using significant unobservable inputs (Level 3) for the period
presented.
INVESTMENTS AT FAIR VALUE TRANSFERS NET UNREALIZED
USING SIGNIFICANT UNOBSERVABLE BALANCE AS OF IN (OUT) APPRECIATION NET REALIZED BALANCE AS OF
INPUTS (LEVEL 3) NOVEMBER 30, 2008 OF LEVEL 3 (DEPRECIATION) GAINS (LOSSES) NOVEMBER 30, 2009
------------------------------ ----------------- ---------- -------------- -------------- -----------------
Master Limited Partnerships $2,792,826 $ -- $(2,792,826) $-- $--
Warrants 13,879 (23,034) 9,155 -- --
---------- -------- ----------- --- ---
Total Investments $2,806,705 $(23,034) $(2,783,671) $-- $--
========== ======== =========== === ===
Net change in unrealized depreciation from Level 3 investments held as of
November 30, 2009 was $2,792,826 and is included in "Net change in unrealized
appreciation (depreciation) before taxes on investments" on the Statement of
Operations.
See Notes to Financial Statements
F-7
ENERGY INCOME AND GROWTH FUND
STATEMENT OF ASSETS AND LIABILITIES
NOVEMBER 30, 2009
ASSETS:
Investments, at value
(Cost $129,819,506) ................................................ $196,964,776
Cash .................................................................. 9,702,492
Prepaid expenses ...................................................... 180,131
Receivables:
Income taxes ....................................................... 1,875,113
Fund shares sold ................................................... 140,295
Dividends .......................................................... 111,183
Investment securities sold ......................................... 39,233
Interest ........................................................... 158
------------
Total Assets .................................................... 209,013,381
------------
LIABILITIES:
Outstanding loan ...................................................... 45,000,000
Deferred income taxes ................................................. 26,095,391
Options written, at value (Premiums received $722,982) ................ 1,049,150
Payables:
Investment advisory fees ........................................... 145,856
Audit and tax fees ................................................. 113,240
Printing fees ...................................................... 26,128
Legal fees ......................................................... 18,267
Administrative fees ................................................ 13,857
Interest and fees on loan .......................................... 8,778
Trustees' fees and expenses ........................................ 6,712
Custodian fees ..................................................... 3,775
Income taxes ....................................................... 3,342
Transfer agent fees ................................................ 2,532
Other liabilities ..................................................... 5,864
------------
Total Liabilities ............................................... 72,492,892
------------
NET ASSETS ............................................................ $136,520,489
============
NET ASSETS CONSIST OF:
Paid-in capital ....................................................... $106,182,584
Par value ............................................................. 67,583
Net unrealized appreciation (depreciation) on investments, written
options and foreign currency translation, net of income taxes ...... 44,282,176
Accumulated net realized gain (loss) on investments, written options
and foreign currency transactions, net of income taxes ............. (1,117,184)
Accumulated net investment income (loss), net of income taxes ......... (12,894,670)
------------
NET ASSETS ............................................................ $136,520,489
============
NET ASSET VALUE, per Common Share (par value $0.01 per Common Share) .. $ 20.20
============
Number of Common Shares outstanding (unlimited number of Common Shares
has been authorized) ............................................... 6,758,270
============
See Notes to Financial Statements
F-8
ENERGY INCOME AND GROWTH FUND
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED NOVEMBER 30, 2009
INVESTMENT INCOME:
Dividends (net of foreign withholding tax of $58,864) ............... $ 1,047,431
Interest ............................................................ 1,710
------------
Total investment income .......................................... 1,049,141
------------
EXPENSES:
Investment advisory fees ............................................ 1,489,058
Interest and fees on loan ........................................... 1,105,915
Energy Notes offering costs ......................................... 324,047
Shelf offering costs ................................................ 170,391
Administrative fees ................................................. 141,460
Audit and tax fees .................................................. 106,963
Legal fees .......................................................... 94,348
Printing fees ....................................................... 75,929
Trustees' fees and expenses ......................................... 38,396
Transfer agent fees ................................................. 35,260
Insurance expense ................................................... 31,448
Custodian fees ...................................................... 22,475
Auction fees ........................................................ 19,965
Other ............................................................... 23,754
------------
Total expenses ................................................... 3,679,409
------------
NET INVESTMENT INCOME (LOSS) BEFORE TAXES ........................... (2,630,268)
------------
Current income tax benefit (expense) - foreign ................... 167,032
Current income tax benefit (expense) - state ..................... 24,119
Current federal income tax benefit (expense) ..................... (2,028,313)
Deferred federal income tax benefit (expense) .................... 2,867,200
-----------
Total income tax benefit (expense) ............................... 1,030,038
------------
NET INVESTMENT INCOME (LOSS) ........................................ (1,600,230)
------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain (loss) before taxes on:
Investments ...................................................... 3,213,323
Written options .................................................. 1,196,354
Foreign currency transactions .................................... 2,129
------------
Net realized gain (loss) before taxes ............................... 4,411,806
------------
Deferred federal income tax benefit (expense) .................... (1,525,524)
-----------
Total income tax benefit (expense) ............................... (1,525,524)
------------
Net realized gain (loss) on investments, written options and foreign
currency transactions ............................................ 2,886,282
------------
Net change in unrealized appreciation (depreciation) before taxes on:
Investments ...................................................... 70,922,148
Written options .................................................. (706,893)
Foreign currency translations .................................... 632
------------
Net change in unrealized appreciation (depreciation) before taxes ... 70,215,887
------------
Deferred federal income tax benefit (expense) .................... (24,242,951)
Deferred income tax benefit (expense) - state .................... (156,991)
-----------
Total income tax benefit (expense) ............................... (24,399,942)
------------
Net change in unrealized appreciation (depreciation) on investments,
written options and foreign currency translations ................ 45,815,945
------------
NET REALIZED AND UNREALIZED GAIN (LOSS) ............................. 48,702,227
------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS ..... $ 47,101,997
============
See Notes to Financial Statements
F-9
ENERGY INCOME AND GROWTH FUND
STATEMENTS OF CHANGES IN NET ASSETS
YEAR YEAR
ENDED ENDED
11/30/2009 11/30/2008
------------ ------------
OPERATIONS:
Net investment income (loss) ............................................... $ (1,600,230) $ (3,714,353)
Net realized gain (loss) ................................................... 2,886,282 8,261,568
Net change in unrealized appreciation (depreciation) ....................... 45,815,945 (71,654,830)
------------ ------------
Net increase (decrease) in net assets resulting from operations ............ 47,101,997 (67,107,615)
------------ ------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net realized gain .......................................................... (2,319,211) (10,702,017)
Return of capital .......................................................... (9,207,189) --
------------ ------------
Total distributions to shareholders ........................................ (11,526,400) (10,702,017)
------------ ------------
CAPITAL TRANSACTIONS:
Proceeds from Common Shares sold through shelf offering .................... 4,804,981 --
Proceeds from Common Shares reinvested ..................................... 1,259,581 269,029
------------ ------------
Net increase (decrease) in net assets resulting from capital transactions .. 6,064,562 269,029
------------ ------------
Total increase (decrease) in net assets .................................... 41,640,159 (77,540,603)
NET ASSETS:
Beginning of period ........................................................ 94,880,330 172,420,933
------------ ------------
End of period .............................................................. $136,520,489 $ 94,880,330
============ ============
Accumulated net investment income (loss), net of income taxes .............. $(12,894,670) $(11,294,440)
============ ============
CAPITAL SHARE TRANSACTIONS WERE AS FOLLOWS:
Common Shares at beginning of period ....................................... 6,462,221 6,446,995
Common Shares sold through shelf offering .................................. 227,636 --
Common Shares issued as reinvestment under the Dividend Reinvestment Plan .. 68,413 15,226
------------ ------------
Common Shares at end of period ............................................. 6,758,270 6,462,221
============ ============
See Notes to Financial Statements
F-10
ENERGY INCOME AND GROWTH FUND
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED NOVEMBER 30, 2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net increase (decrease) in net assets resulting from operations ...... $ 47,101,997
Adjustments to reconcile net increase (decrease) in net assets
resulting from operations to net cash used by operating activities:
Purchases of investments .......................................... (81,776,452)
Sales of investments .............................................. 68,439,475
Proceeds from written options ..................................... 1,395,514
Cost to close written options ..................................... (11,046)
Return of capital received from investments in MLPs ............... 11,496,906
Net realized gain/loss on investments and options ................. (4,409,677)
Net change in unrealized appreciation/depreciation on investments
and options .................................................... (70,215,255)
CHANGES IN ASSETS AND LIABILITIES:
Decrease in income tax receivable ................................. 1,636,598
Decrease in interest receivable ................................... 227
Increase in dividends receivable (a) .............................. (38,408)
Decrease in prepaid expenses ...................................... 156,112
Decrease in interest and fees on loan payable ..................... (93,637)
Decrease in income tax payable .................................... (260,949)
Increase in investment advisory fees payable ...................... 36,062
Increase in audit and tax fees payable ............................ 6,240
Decrease in legal fees payable .................................... (23,739)
Increase in printing fees payable ................................. 4,040
Increase in administrative fees payable ........................... 3,427
Decrease in transfer agent fees payable ........................... (236)
Decrease in custodian fees payable ................................ (1,698)
Decrease in Trustees' fees and expenses payable ................... (785)
Increase in accrued expenses ...................................... 3,364
Increase in deferred income taxes ................................. 23,058,264
------------
CASH USED IN OPERATING ACTIVITIES .................................... $(3,493,656)
-----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Distributions to Common Shareholders from net realized gain ....... (2,319,211)
Return of capital distributions ................................... (9,207,189)
Proceeds of Common Shares sold .................................... 4,664,686
Proceeds of Common Shares reinvested .............................. 1,259,581
Issuance of loan .................................................. 47,850,000
Repayment of loan ................................................. (8,500,000)
Redemption of Series B Energy Notes ............................... (25,000,000)
------------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES .......................... 8,747,867
-----------
Increase in cash ..................................................... 5,254,211
Cash at beginning of period .......................................... 4,448,281
-----------
CASH AT END OF PERIOD ................................................ $ 9,702,492
===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest and fees .................... $ 1,221,333
===========
Cash paid during the period for taxes ................................ $ 461,515
===========
----------
(a) Includes net change in unrealized appreciation (depreciation) on foreign
currency of $632.
See Notes to Financial Statements
F-11
ENERGY INCOME AND GROWTH FUND
FINANCIAL HIGHLIGHTS
FOR A COMMON SHARE OUTSTANDING THROUGHOUT EACH PERIOD
YEAR YEAR YEAR YEAR YEAR
ENDED ENDED ENDED ENDED ENDED
11/30/2009 11/30/2008 11/30/2007(a) 11/30/2006 11/30/2005
---------- ---------- ------------- ---------- ----------
Net asset value, beginning of period ................. $ 14.68 $ 26.74 $ 25.88 $ 22.53 $ 21.34
-------- -------- -------- -------- --------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) ......................... (0.24)(b) (0.57) (0.67) (0.50) (0.34)
Net realized and unrealized gain (loss) .............. 7.43 (9.83) 3.06 5.23 2.86
-------- -------- -------- -------- --------
Total from investment operations after income tax .... 7.19 (10.40) 2.39 4.73 2.52
-------- -------- -------- -------- --------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net realized gain .................................... (0.35) (1.66) (1.53) -- (0.88)
Return of capital .................................... (1.41) -- -- (1.38) (0.45)
-------- -------- -------- -------- --------
Total from distributions ............................. (1.76) (1.66) (1.53) (1.38) (1.33)
-------- -------- -------- -------- --------
Premiums from shares sold in at the market offering .. 0.09 -- -- -- --
-------- -------- -------- -------- --------
Net asset value, end of period ....................... $ 20.20 $ 14.68 $ 26.74 $ 25.88 $ 22.53
======== ======== ======== ======== ========
Market value, end of period .......................... $ 22.30 $ 14.40 $ 23.82 $ 24.49 $ 20.92
======== ======== ======== ======== ========
TOTAL RETURN BASED ON NET ASSET VALUE (c) ............ 51.03% (40.70)% 9.38% 22.23% 11.96%(e)
======== ======== ======== ======== ========
TOTAL RETURN BASED ON MARKET VALUE (d) ............... 70.20% (34.74)% 2.96% 24.57% 0.29%
======== ======== ======== ======== ========
Net assets, end of period (in 000's) ................. $136,520 $ 94,880 $172,421 $166,850 $145,230
------------------------------------------------------------------------
RATIOS OF EXPENSES TO AVERAGE NET ASSETS:
Including current and deferred income taxes before
waiver (f) ........................................ 25.79% (20.03)% 8.52% 14.47% 8.62%
Including current and deferred income taxes after
waiver (f) ........................................ 25.79% (20.03)% 8.52% 14.29% 8.31%
Excluding current and deferred income taxes before
waiver ............................................ 3.32% 4.80% 3.94% 3.63% 2.64%
Excluding current and deferred income taxes after
waiver ............................................ 3.32% 4.80% 3.94% 3.45% 2.33%
Excluding current and deferred income taxes and
interest expense after waiver ..................... 2.32% 2.55% 1.89% 1.76% 1.57%
RATIOS OF NET INVESTMENT INCOME (LOSS) TO AVERAGE
NET ASSETS:
Net investment income (loss) ratio before tax
expenses .......................................... (2.37)% (3.83)% (3.83)% (3.26)% (2.29)%
Net investment income (loss) ratio including tax
expenses (f) ...................................... (24.84)% 21.00% (8.41)% (14.10)% (8.27)%
Portfolio turnover rate .............................. 43% 38% 16% 17% 38%
SENIOR SECURITIES:
Total Energy Notes outstanding ($25,000 per note) .... N/A 1,000 2,360 2,360 1,360
Principal amount and market value per
Energy Note (g) ................................... N/A $ 25,006 $ 25,004 $ 25,069 $ 25,074
Asset coverage per Energy Note (h) ................... N/A $119,880 $ 98,060 $ 95,699 $131,786
Total loan outstanding (in 000's) .................... $ 45,000 $ 5,650 $ 15,250 N/A N/A
Asset coverage per $1,000 senior indebtedness ........ $ 4,034(j) $ 22,218(j) $ 12,306(i) N/A N/A
----------
(a) On September 14, 2007, the Fund's Board of Trustees approved an interim
sub-advisory agreement with Energy Income Partners, LLC ("EIP"), and on
September 24, 2007, the Board of Trustees voted to approve EIP as
investment sub-advisor.
(b) Based on average shares outstanding.
(c) Total return based on net asset value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan, and changes in net
asset value per share and does not reflect sales load.
(d) Total return based on market value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan, and changes in Common
Share price.
(e) In 2005, the Fund received reimbursements from the investment advisor and
former sub-advisor. This reimbursement had no effect on the Fund's total
return.
(f) Includes current and deferred income taxes associated with each component
of the Statement of Operations.
(g) Includes accumulated and unpaid interest.
(h) Calculated by taking the Fund's total assets less the Fund's total
liabilities (not including the Energy Notes) and dividing by the
outstanding Energy Notes in 000's.
(i) 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.
(j) Calculated by taking the Fund's total assets less the Fund's total
liabilities (not including the loan outstanding and the Energy Notes) and
dividing by the loan outstanding in 000's. If this methodology had been
used historically, fiscal year 2007 would have been $16,175.
N/A Not applicable.
See Notes to Financial Statements
F-12
NOTES TO FINANCIAL STATEMENTS
ENERGY INCOME AND GROWTH FUND
NOVEMBER 30, 2009
1. FUND DESCRIPTION
Energy Income and Growth Fund (the "Fund") is a non-diversified, closed-end
management investment company organized as a Massachusetts business trust on
March 25, 2004, and is registered with the Securities and Exchange Commission
("SEC") under the Investment Company Act of 1940, as amended (the "1940 Act").
The Fund trades under the ticker symbol FEN on the NYSE Amex (formerly the
American Stock Exchange).
The Fund's investment objective is to seek a high level of after-tax total
return with an emphasis on current distributions paid to shareholders. The Fund
seeks to provide its shareholders with an efficient vehicle to invest in a
portfolio of cash-generating securities of energy companies. The Fund focuses on
investing in publicly-traded master limited partnerships ("MLPs") and related
public entities in the energy sector, which Energy Income Partners, LLC ("EIP"
or the "Sub-Advisor") believes offer opportunities for income and growth. Due to
the tax treatment of cash distributions made by MLPs to their investors, a
portion of the distributions received may be tax deferred, thereby maximizing
cash available for distribution by the Fund to its shareholders. There can be no
assurance that the Fund's investment objective will be achieved.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts and disclosures in
the financial statements. Actual results could differ from those estimates.
A. PORTFOLIO VALUATION:
The net asset value ("NAV") of the Fund's Common Shares is determined daily as
of the close of regular trading on the New York Stock Exchange ("NYSE"),
normally 4:00 p.m. Eastern time, on each day the NYSE is open for trading. The
NAV per Common Share is calculated by dividing the value of all assets of the
Fund (including accrued dividends and interest), less all liabilities (including
accrued expenses, dividends declared but unpaid and deferred income taxes and
any borrowings of the Fund) by the total number of shares outstanding.
The Fund's investments are valued daily at market value or, in the absence of
market value with respect to any portfolio securities, at fair value according
to procedures adopted by the Fund's Board of Trustees. A majority of the Fund's
assets are 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, or the valuations are deemed
unreliable, the Fund's Board of Trustees has designated First Trust Advisors
L.P. ("First Trust") to use a fair value method to value the Fund's securities
and other investments. Additionally, if events occur after the close of the
principal markets for particular securities (e.g., domestic debt and foreign
securities), but before the Fund values its assets, that could materially affect
NAV, First Trust may use a fair value method to value the Fund's securities and
other investments. The use of fair value pricing by the Fund is governed by
valuation procedures adopted by the Fund's Board of Trustees, and in accordance
with the provisions of the 1940 Act.
Portfolio securities listed on any exchange other than the NASDAQ National
Market ("NASDAQ") are valued 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 traded on the 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. Portfolio securities
traded in the over-the-counter market, but excluding securities traded on the
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. Short-term investments that mature in less than 60 days when purchased
are valued at amortized cost.
The Fund is subject to fair value accounting standards that define fair value,
establish the framework for measuring fair value and provide a three-level
hierarchy for fair valuation based upon the inputs to the valuation as of the
measurement date. The three levels of the fair value hierarchy are as follows:
- Level 1 - Level 1 inputs are quoted prices in active markets for
identical securities. An active market is a market in which
transactions for the security occur with sufficient frequency and
volume to provide pricing information on an ongoing basis.
- Level 2 - Level 2 inputs are observable inputs, either directly or
indirectly, and include the following:
- Quoted prices for similar securities in active markets.
F-13
- Quoted prices for identical or similar securities in markets that
are non-active. A non-active market is a market where
there are few transactions for the security, the prices are not
current, or price quotations vary substantially either over time
or among market makers, or in which little information is
released publicly.
- Inputs other than quoted prices that are observable for the
security (for example, interest rates and yield curves observable
at commonly quoted intervals, volatilities, prepayment speeds,
loss severities, credit risks, and default rates).
- Inputs that are derived principally from or corroborated by
observable market data by correlation or other means.
- Level 3 - Level 3 inputs are unobservable inputs. Unobservable inputs
reflect the reporting entity's own assumptions about the assumptions
that market participants would use in pricing the security.
The inputs or methodology used for valuing securities are not necessarily an
indication of the risk associated with investing in those securities. A summary
of the inputs used to value the Fund's net assets as of November 30, 2009 is
included with the Fund's Portfolio of Investments.
B. OPTION CONTRACTS:
COVERED OPTIONS. The Fund is subject to equity price risk in the normal course
of pursuing its investment objective and may enter into options written to hedge
against changes in the value of equities. The Fund may write (sell) covered call
or put options ("options") on all or a portion of the common stock of energy
companies held in the Fund's portfolio as determined to be appropriate by the
Sub-Advisor. The number of options the Fund can write (sell) is limited by the
amount of common stock of energy companies the Fund holds in its portfolio. The
Fund will not write (sell) "naked" or uncovered options. By writing (selling)
options, the Fund seeks to generate additional income, in the form of premiums
received for writing (selling) the options, and may provide a partial hedge
against a market decline in the underlying equity security. Options are
marked-to-market daily and their value will be affected by changes in the value
and dividend rates of the underlying equity securities, changes in interest
rates, changes in the actual or perceived volatility of the securities markets
and the underlying equity securities and the remaining time to the options'
expiration. The value of options may also be adversely affected if the market
for the options becomes less liquid or smaller.
Options the Fund writes (sells) will either be exercised, expire or be cancelled
pursuant to a closing transaction. If the price of the underlying equity
security exceeds the option's exercise price, it is likely that the option
holder will exercise the option. If an option written (sold) by the Fund is
exercised, the Fund would be obligated to deliver the underlying equity security
to the option holder upon payment of the strike price. In this case, the option
premium received by the Fund will be added to the amount realized on the sale of
the underlying security for purposes of determining gain or loss. If the price
of the underlying equity security is less than the option's strike price, the
option will likely expire without being exercised. The option premium received
by the Fund will, in this case, be treated as short-term capital gain on the
expiration date of the option. The Fund may also elect to close out its position
in an option prior to its expiration by purchasing an option of the same series
as the option written (sold) by the Fund.
The options that the Fund writes (sells) give the option holder the right, but
not the obligation, to purchase a security from the Fund at the strike price on
or prior to the option's expiration date. The ability to successfully implement
the writing (selling) of covered call options depends on the ability of the
Sub-Advisor to predict pertinent market movements, which cannot be assured.
Thus, the use of options may require the Fund to sell portfolio securities at
inopportune times or for prices other than current market value, which 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. As the writer (seller)
of a covered option, the Fund foregoes, during the option's life, the
opportunity to profit from increases in the market value of the security
covering the option above the sum of the premium and the strike price of the
option, but has retained the risk of loss should the price of the underlying
security decline. The writer (seller) of an option has no control over the time
when it may be required to fulfill its obligation as a writer (seller) of the
option. Once an option writer (seller) has received an exercise notice, it
cannot effect a closing purchase transaction in order to terminate its
obligation under the option and must deliver the underlying security to the
option holder at the exercise price.
Over-the-counter ("OTC") options have the risk of the potential inability of
counterparties to meet the terms of their contracts. The Fund's maximum equity
price risk for purchased options is limited to the premium initially paid. In
addition, certain risks may arise upon entering into option contracts including
the risk that an illiquid secondary market will limit the Fund's ability to
close out an option contract prior to the expiration date and that a change in
the value of the option contract may not correlate exactly with changes in the
value of the securities hedged.
C. SECURITIES TRANSACTIONS AND INVESTMENT INCOME:
Securities transactions are recorded as of the trade date. Realized gains and
losses from securities transactions are recorded on the identified cost basis.
Dividend income is recorded on the ex-dividend date. Interest income is
recognized and recorded on the accrual basis, including amortization of premiums
and accretion of discounts. The Fund will rely to some extent on information
provided by the MLPs, which is not necessarily timely, to estimate taxable
income allocable to the MLP units held in the Fund's portfolio and to estimate
the associated deferred tax asset or liability. From time to time, the Fund will
F-14
modify its estimates and/or assumptions regarding its deferred tax liability as
new information becomes available. To the extent the Fund modifies its estimates
and/or assumptions, the NAV of the Fund will likely fluctuate.
Distributions received from the Fund's investments in MLPs generally are
comprised of return of capital from the MLP to the extent of the cost basis of
such MLP investments. Cumulative distributions received in excess of the Fund's
cost basis in an MLP generally are recorded as capital gain.
D. RESTRICTED SECURITIES:
The Fund may invest up to 35% of its Managed Assets, which is the gross asset
value of the Fund minus accrued liabilities (excluding the principal amount of
any borrowings), in restricted securities. Restricted securities are securities
that cannot be offered for public sale without first being registered under the
Securities Act of 1933, as amended. Prior to registration, restricted securities
may only be resold in transactions exempt from registration. The Fund holds the
restricted securities at November 30, 2009 shown in the following table. The
Fund does not have the right to demand that such securities be registered. These
securities are valued according to the valuation procedures as stated in the
Portfolio Valuation footnote (Note 2A) and are not expressed as a discount to
the value of a comparable unrestricted security.
ACQUISITION SHARES/ CARRYING % OF
SECURITY DATE UNITS PRICE COST VALUE NET ASSETS
-------- ----------- ------- ----- ---------- ------- ----------
Abraxas Petroleum Corp. - Warrants 05/25/07 48,956 $0.47 $ -- $23,034 0.02%
Clearwater Natural Resources, L.P. 08/01/05 465,471 -- 8,601,560 -- --
Clearwater Natural Resources, L.P. - Rights 08/01/05 17 -- -- -- --
---------- ------- ----
$8,601,560 $23,034 0.02%
========== ======= ====
E. DISTRIBUTIONS TO SHAREHOLDERS:
The Fund intends to make quarterly distributions to Common Shareholders. On
December 11, 2006, the Board of Trustees approved a managed distribution policy
to better align the Fund with its after-tax total return investment objective.
The Fund's distributions generally will consist of 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
Fund less operating expenses, including taxes. Distributions to Common
Shareholders are recorded on the ex-date and are based on U.S. generally
accepted accounting principles, which may differ from their ultimate
characterization for federal income tax purposes.
Distributions made from current and accumulated earnings and profits of the Fund
will be 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 tax-deferred 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.
Distributions of $2,319,211 paid during the year ended November 30, 2009, are
anticipated to be characterized as taxable dividends for federal income tax
purposes. The remaining $9,207,189 in distributions paid during the year ended
November 30, 2009 is expected to be return of capital. However, the ultimate
determination of the character of the distributions will be made after the 2009
calendar year. Distributions of $10,702,017 paid during the year ended November
30, 2008, were characterized as taxable dividends for federal income tax
purposes. Distributions will automatically be reinvested in additional Common
Shares pursuant to the Fund's Dividend Reinvestment Plan unless cash
distributions are elected by the shareholder.
F. INCOME TAXES:
The Fund is treated as a regular C corporation for U.S. federal income tax
purposes and as such will be obligated to pay federal and applicable state and
foreign corporate taxes on its taxable income. The Fund's tax expense or benefit
is included in the Statement of Operations based on the component of income or
gains (losses) to which such expense or benefit relates. The current U.S.
federal maximum graduated income tax rate for corporations is 35%. In addition,
the U.S. imposes a 20% alternative minimum tax on the recalculated alternative
minimum taxable income of an entity treated as a corporation. This differs from
most investment companies, which elect to be treated as "regulated investment
companies" under the U.S. Internal Revenue Code of 1986, as amended. The various
investments of the Fund may cause the Fund to be subject to state income taxes
on a portion of its income at various rates.
The tax deferral benefit the Fund derives from its investment in MLPs results
largely because the MLPs are treated as partnerships for federal income tax
purposes. As a partnership, an MLP has no income tax liability at the entity
level. As a limited partner in the MLPs in which it invests, the Fund will be
allocated its pro rata share of income, gains, losses, deductions and credits
from the MLPs, regardless of whether or not any cash is distributed from the
MLPs.
F-15
To the extent that the distributions received from the MLPs exceed the net
taxable income realized by the Fund from its investment, a tax liability
results. This tax liability is a deferred liability to the extent that MLP
distributions received have not exceeded the Fund's adjusted tax basis in the
respective MLPs. To the extent that distributions from an MLP exceed the Fund's
adjusted tax basis, the Fund will recognize a taxable capital gain. For the year
ended November 30, 2009, distributions of $11,496,906 received from MLPs have
been reclassified as a return of capital. The cost basis of applicable MLPs has
been reduced accordingly.
The Fund's provision for income taxes consists of the following:
Current federal income tax benefit (expense) ..... $ (2,028,313)
Current state tax expense benefit (expense) ...... 24,119
Current foreign tax benefit (expense) ............ 167,032
Deferred federal income tax benefit (expense) .... (22,901,275)
Deferred state income tax benefit (expense) ...... (156,991)
------------
Total income tax benefit (expense) ............... $(24,895,428)
============
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for tax purposes. At November 30, 2009, the Fund
had a net operating loss carry forward for federal and state income tax purposes
of $4,014,426 and $11,433,639, respectively. The Fund's 2009 income tax
provision includes a full valuation allowance against the deferred tax assets
associated with this state net operating loss. Components of the Fund's deferred
tax assets and liabilities as of November 30, 2009 are as follows:
DEFERRED TAX ASSETS:
Federal net operating loss ....................... $ 1,405,049
State net operating loss ......................... 659,574
State income taxes ............................... 53,474
Other ............................................ 181,656
------------
Total deferred tax assets ........................ 2,299,753
Less: valuation allowance ........................ (659,574)
------------
Net deferred tax assets .......................... $ 1,640,179
============
DEFERRED TAX LIABILITIES:
Unrealized gains on investment securities ........ $(27,735,570)
------------
Total deferred tax liabilities ................... (27,735,570)
------------
Total net deferred tax liabilities ............... $(26,095,391)
============
Total income taxes differ from the amount computed by applying the maximum
graduated federal income tax rate of 35% to net investment income and realized
and unrealized gains on investments.
Application of statutory income tax rate ......... $25,199,099
State income taxes, net .......................... (173,245)
Change in valuation allowance .................... 337,413
Other ............................................ (467,839)
-----------
Total ............................................ $24,895,428
===========
The Fund is subject to accounting standards that establish a minimum threshold
for recognizing, and a system for measuring, the benefits of a tax position
taken or expected to be taken in a tax return. Taxable years ending 2004, 2005,
2006, 2007 and 2008 remain open to federal and state audit. The Internal Revenue
Service initiated a corporate income tax audit during the first quarter of 2008
for the Fund's 2004 tax year. Subsequently, the audit was expanded to include
the 2005 and 2006 tax years. The audit is still ongoing and the Fund expects the
audit to last through the second quarter of 2010. As of November 30, 2009,
management has evaluated the application of these standards to the Fund, and has
determined that no provision for income tax is required in the Fund's financial
statements for uncertain tax provisions.
G. EXPENSES:
The Fund will pay all expenses directly related to its operations.
H. FOREIGN CURRENCY:
The books and records of the Fund are maintained in U.S. dollars. Foreign
currencies, investments and other assets and liabilities are translated into
U.S. dollars at the exchange rates prevailing at the end of the period.
Purchases and sales of investment securities and items of income and expense are
translated on the respective dates of such transactions. Unrealized gains and
losses on assets and liabilities, other than investments in securities, which
result from changes in foreign currency exchange rates have been included in
"Net change in unrealized appreciation (depreciation) on foreign currency
translation" on the Statement of Operations. Unrealized gains and losses on
F-16
investments in securities which result from changes in foreign exchange rates
are included with fluctuations arising from changes in market price and are
shown in "Net change in unrealized appreciation (depreciation) on investments"
on the Statement of Operations. Net realized foreign currency gains and losses
include the effect of changes in exchange rates between trade date and
settlement date on investment security transactions, foreign currency
transactions and interest and dividends received. The portion of foreign
currency gains and losses related to fluctuation in exchange rates between the
initial purchase trade date and subsequent sale trade date is included in "Net
realized gain (loss) on foreign currency transactions" on the Statement of
Operations.
3. INVESTMENT ADVISORY FEE, AFFILIATED TRANSACTIONS AND OTHER FEE ARRANGEMENTS
First Trust is a limited partnership with one limited partner, Grace Partners of
DuPage L.P., and one general partner, The Charger Corporation. First Trust
serves as investment advisor to the Fund pursuant to an Investment Management
Agreement. First Trust is responsible for the ongoing monitoring of the Fund's
investment portfolio, managing the Fund's business affairs and providing certain
administrative services necessary for the management of the Fund. For these
services, First Trust is entitled to a monthly fee calculated at an annual rate
of 1.00% of the Fund's Managed Assets (the value of the securities and other
investments the Fund holds plus cash or other assets, including interest accrued
but not yet received, minus accrued liabilities other than the principal amount
of any borrowings).
EIP serves as the Fund's sub-advisor and manages the Fund's portfolio subject to
First Trust's supervision. The Sub-Advisor receives a monthly portfolio
management fee calculated at an annual rate of 0.50% of Managed Assets that is
paid by First Trust out of its investment advisory fee.
PNC Global Investment Servicing (U.S.) Inc., an indirect majority-owned
subsidiary of The PNC Financial Services Group, serves as the Fund's
Administrator, Fund Accountant and Transfer Agent in accordance with certain fee
arrangements. PFPC Trust Company, also an indirect, majority-owned subsidiary of
The PNC Financial Services Group, Inc., serves as the Fund's Custodian in
accordance with certain fee arrangements.
Each Trustee who is not an officer or employee of First Trust, any sub-advisor
or any of their affiliates ("Independent Trustees") is paid an annual retainer
of $10,000 per trust for the first 14 trusts of the First Trust Fund Complex and
an annual retainer of $7,500 per trust for each additional trust in the First
Trust Fund Complex. The annual retainer is allocated equally among each of the
trusts. No additional meeting fees are paid in connection with board or
committee meetings.
Additionally, the Lead Independent Trustee is paid $10,000 annually, the
Chairman of the Audit Committee is paid $5,000 annually, and each of the
Chairmen of the Nominating and Governance Committee and Valuation Committee is
paid $2,500 annually to serve in such capacities, with such compensation paid by
the trusts in the First Trust Fund Complex and divided among those trusts.
Trustees are also reimbursed by the trusts in the First Trust Fund Complex for
travel and out-of-pocket expenses in connection with all meetings.The Lead
Independent Trustee and each Committee chairman served two-year terms which
ended on December 31, 2009, before rotating to serve as a chairman of another
committee or as Lead Independent Trustee. The officers and the "Interested"
Trustee receive no compensation from the Fund for serving in such capacities.
4. PURCHASES AND SALES OF SECURITIES AND OPTIONS
Cost of purchases and proceeds from sales of investment securities, excluding
short-term investments, for the year ended November 30, 2009, were $79,897,822
and $66,886,196, respectively.
Written option activity for the Fund was as follows:
NUMBER
OF
WRITTEN OPTIONS CONTRACTS PREMIUMS
--------------- --------- ------------
Options outstanding at November 30, 2008 .. 4,546 $ 534,868
Options Written ........................... 20,069 2,808,613
Options Expired ........................... (7,173) (992,882)
Options Exercised ......................... (8,549) (1,413,099)
Options Closed ............................ (1,578) (214,518)
------ -----------
Options outstanding at November 30, 2009 .. 7,315 $ 722,982
====== ===========
5. ENERGY NOTES
The 1,000 Series B Energy Notes, at a principal value of $25,000 per note, were
redeemed in full on February 26, 2009 in the amount of $25,000,000. The high and
the low annual interest rates during the period December 1, 2008 through
February 26, 2009 were 3.75% and 0.74%, respectively, and the average interest
rate was 1.34%. The redemption of Series B Energy Notes was financed through a
credit agreement with BNP Paribas Prime Brokerage Inc. ("BNP") (see Note 7
below). At the time of the refinancing, the Fund had unamortized offering costs
F-17
of $92,378 and commissions of $231,669. Because the Series B Energy Notes were
redeemed prior to the maturity date of March 30, 2046, the combined amount of
$324,047 was expensed on February 26, 2009. This is shown on the Statement of
Operations under "Energy Notes offering costs."
6. CREDIT AGREEMENT WITH THE BANK OF NOVA SCOTIA
The Fund had a credit agreement with The Bank of Nova Scotia that had a maximum
commitment amount of $55,000,000. This credit agreement was scheduled to
terminate on March 26, 2009. On January 23, 2009, all outstanding borrowings, in
the amount of $8,150,000, were paid in full through a credit agreement with BNP
(see Note 7 below).
The average amount outstanding between December 1, 2008 and January 23, 2009 was
$6,734,906 with a weighted average interest rate of 3.05%. The high and low
annual interest rates during the period December 1, 2008 through January 23,
2009 were 4.81% and 2.17%, respectively.
7. COMMITTED FACILITY AGREEMENT WITH BNP PARIBAS PRIME BROKERAGE INC.
On January 23, 2009, the Fund entered into a committed facility agreement with
BNP that has a maximum commitment amount of $60,000,000. The committed facility
required an upfront payment from the Fund equal to $150,000. Absent certain
events of default or failure to maintain certain collateral requirements, BNP
may not terminate the committed facility agreement except upon 180 calendar days
prior notice. The borrowing rate under the facility is equal to the 3-month
LIBOR plus 150 basis points. In addition, under the facility, the Fund pays a
commitment fee of 0.80% on the undrawn amount of such facility.
On January 23, 2009, the committed facility was used to pay in full outstanding
borrowings under a credit agreement with The Bank of Nova Scotia in the amount
of $8,150,000. This committed facility was also used to redeem in full the
Series B Energy Notes in the principal amount of $25,000,000 on February 26,
2009.
The average amount outstanding between January 23, 2009 and November 30, 2009
was $36,554,521, with a weighted average interest rate of 2.11%. As of November
30, 2009, the Fund had outstanding borrowings of $45,000,000 under this
committed facility agreement. The high and low annual interest rates during the
period January 23, 2009 through November 30, 2009 were 2.83% and 1.76%,
respectively. The interest rate at November 30, 2009 was 1.76%.
8. AT THE MARKET OFFERING
On May 19, 2009, the Fund, Advisor and Sub-Advisor entered into a sales
agreement with JonesTrading Institutional Services LLC ("JonesTrading") whereby
the Fund may offer and sell up to 1,000,000 Common Shares from time to time
through JonesTrading as agent for the offer and sale of the Common Shares. Sales
of Common Shares pursuant to the sales agreement 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, including sales made
directly on the NYSE Amex or sales made through a market maker other than on an
exchange, at an offering price equal to or in excess of the net asset value per
share of the Funds Common Shares at the time such Common Shares are initially
sold.
The Fund has used the net proceeds from the sale of the Common Shares in
accordance with it's investment objective and policies. Please see the
prospectus and the prospectus supplement related to this offering for additional
information. Transactions for the fiscal year ended November 30, 2009 related to
offerings under such sales agreement are as follows:
COMMON
SHARES NET PROCEEDS NET ASSET VALUE PROCEEDS RECEIVED IN
SOLD RECEIVED OF SHARES SOLD EXCESS OF NET ASSET VALUE
------ ------------ --------------- -------------------------
227,636 $4,804,981 $4,215,868 $589,113
Additionally, estimated offering costs of $319,000 related to this offering have
been recorded as a prepaid asset and are being amortized to expense by the Fund
on a straight line basis over the lesser of one year or until the fund sells all
1,000,000 Common Shares related to this offering.
9. INDEMNIFICATION
The Fund has a variety of indemnification obligations under contracts with its
service providers. The Fund's maximum exposure under these arrangements is
unknown. However, the Fund has not had prior claims or losses pursuant to these
contracts and expects the risk of loss to be remote.
10. RISK CONSIDERATIONS
Risks are inherent in all investing. The following summarizes some of the risks
that should be considered for the Fund. For additional information about the
risks associated with investing in the Fund, please see the Fund's prospectus
and statement of additional information, as well as other Fund regulatory
filings.
F-18
INVESTMENT AND MARKET RISK: An investment in the Fund's Common Shares is subject
to investment risk, including the possible loss of the entire principal
invested. An investment in Common Shares represents an indirect investment in
the securities owned by the Fund. The value of these securities, like other
market investments, may move up or down, sometimes rapidly and unpredictably.
Common Shares at any point in time may be worth less than the original
investment, even after taking into account the reinvestment of Fund dividends
and distributions. Security prices can fluctuate for several reasons including
the general condition of the securities markets, or when political or economic
events affecting the issuers occur. When the Advisor or Sub-Advisor determines
that it is temporarily unable to follow the Fund's investment strategy or that
it is impractical to do so (such as when a market disruption event has occurred
and trading in the securities is extremely limited or absent), the Fund may take
temporary defensive positions.
INDUSTRY CONCENTRATION RISK: The Fund invests at least 85% of its Managed Assets
in securities issued by energy companies, energy sector MLPs and MLP-related
entities. Given this industry concentration, the Fund is more susceptible to
adverse economic or regulatory occurrences affecting that industry than an
investment company that is not concentrated in a single industry. Energy issuers
may be subject to a variety of factors that may adversely affect their business
or operations, including high interest costs in connection with capital
construction programs, high leverage costs associated with environmental and
other regulations, the effects of economic slowdown, surplus capacity, increased
competition from other providers of services, uncertainties concerning the
availability of fuel at reasonable prices, the effects of energy conservation
policies and other factors.
MLP RISK: 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. In addition,
there are certain tax risks associated with an investment in MLP units and
conflicts of interest exist between common unit holders and the general partner,
including those arising from incentive distribution payments.
LEVERAGE RISK: The use of leverage results in additional risks and can magnify
the effect of any losses. The funds borrowed pursuant to a leverage borrowing
program constitute a substantial lien and burden by reason of their prior claim
against the income of the Fund and against the net assets of the Fund in
liquidation. If the Fund is not in compliance with certain credit facility
provisions, the Fund may not be permitted to declare dividends or other
distributions.
RESTRICTED SECURITIES RISK: The Fund may invest in unregistered or otherwise
restricted securities. The term "restricted securities" refers to securities
that are unregistered or are 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. 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.
NON-DIVERSIFICATION RISK: Because the Fund is non-diversified, it is only
limited as to the percentage of its assets which may be invested in the
securities of any one issuer by the diversification requirements imposed by the
Internal Revenue Code of 1986, as amended. Because the Fund may invest a
relatively high percentage of its assets in a limited number of issuers, the
Fund may be more susceptible to any single economic, political or regulatory
occurrence and to the financial conditions of the issuers in which it invests.
11. SUBSEQUENT EVENT
Management has evaluated the impact of all subsequent events on the Fund through
January 27, 2010, the date the financial statements were issued, and has
determined that there was the following subsequent event:
On January 12, 2010, the Fund declared a dividend of $0.44 per share to Common
Shareholders of record January 25, 2010, payable January 29, 2010.
F-19
[BLANK BACK COVER]
BASE PROSPECTUS
Energy Income and Growth Fund
Up to 3,348,960 Common Shares
-------------------------------------------------------------------------------
The Fund. Energy Income and Growth Fund (the "Fund") is a non-diversified,
closed-end management investment company which commenced operations in June
2004.
Investment Objective. The Fund's investment objective is to seek a high
level of after-tax total return with an emphasis on current distributions paid
to shareholders. The Fund seeks to provide its common shareholders with an
efficient vehicle to invest in a portfolio of cash-generating securities of
energy companies. The Fund focuses on investing in publicly traded master
limited partnerships ("MLPs") and related public entities in the energy sector,
which the Fund's Sub-Advisor (as defined below) believes offer opportunities for
income and growth. As used in this prospectus, unless the context requires
otherwise, MLPs are those MLPs in the energy sector. Due to the tax treatment
under current law of cash distributions made by MLPs to their investors (such as
the Fund), the Fund believes that a portion of its income may be tax deferred,
thereby increasing cash available for distribution by the Fund to its
shareholders. There can be no assurance that the Fund's investment objective
will be achieved.
Investment Strategy. Under normal market conditions, the Fund invests at
least 85% of its Managed Assets (as defined below) (including assets obtained
through leverage) in securities of energy companies and energy sector MLPs and
MLP-related entities and invests at least 65% of its Managed Assets in equity
securities of such MLPs and MLP-related entities. The Fund may also invest up to
35% of its Managed Assets in unregistered or otherwise restricted securities
(including up to 10% of its Managed Assets in securities issued by private
companies) and up to 25% of its Managed Assets in debt securities of energy
companies, MLPs and MLP-related entities, including securities rated below
investment grade (commonly referred to as "junk bonds"). To generate additional
income, the Fund writes (or sells) covered call options on the common stock of
energy companies held in the Fund's portfolio. The Fund anticipates that it will
be able to invest substantially all of the net proceeds of any offering of
common shares pursuant to this prospectus in securities that meet the Fund's
investment objective and policies within one month after the completion of any
offering. See "Risks" for a discussion of the risks involved in investing in
both MLPs and junk bonds.
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 Amex (formerly the American Stock Exchange) under the trading or "ticker"
symbol "FEN." The net asset value of the Fund's common shares on March 3, 2010
was $22.03 per common share, and the last sale price of the common shares on the
NYSE Amex on such date was $23.12.
The Fund may offer, on an immediate, continuous or delayed basis, up to
3,348,960 of the Fund's 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. 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.
Investing in common shares involves certain risks. You could lose some or
all of your investment. See "Risks" beginning on page 37.
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.
(continued on the following page)
(continued from previous page)
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 (the "Internal Revenue Code"), 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 will be subject to corporate income tax to
the extent the Fund recognizes taxable income.
Investment Advisor and Sub-Advisor. First Trust Advisors L.P. ("First Trust
Advisors" or the "Advisor") is the Fund's investment advisor, 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,
LLC ("Energy Income Partners" or the "Sub-Advisor") is the Fund's sub-advisor
and is primarily responsible for the day-to-day supervision and investment
strategy of the Fund.
First Trust Advisors serves as investment advisor or portfolio supervisor to
investment portfolios with approximately $28 billion in assets which it managed
or supervised as of February 28, 2010. Energy Income Partners serves as
investment advisor or portfolio supervisor to investment portfolios with
approximately $408 million in assets, which it managed or supervised as of
February 28, 2010. See "Management of the Fund."
Use of Financial Leverage. The Fund is currently engaged in, and may in the
future engage in, the use of financial leverage to seek to enhance the level of
its current distributions to common shareholders. The Fund may use leverage
through the issuance of preferred shares ("Preferred Shares") and/or through the
issuance of commercial paper or notes and/or other borrowings ("Borrowings") by
the Fund. As of March 3, 2010, aggregate financial leverage through Borrowings
(collectively, "Financial Leverage") was approximately 26% of the Fund's Managed
Assets (as defined below) (including the proceeds of the Financial Leverage).
The term "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 and the liquidation
preference of any outstanding Preferred Shares). The determination to use
Financial Leverage is subject to the approval of the Fund's Board of Trustees
("Board of Trustees").
You should read this prospectus and any prospectus supplement, which
contains important information about the Fund, before deciding whether to invest
in the common shares, and retain it 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
Statement of Additional Information (the "SAI"), dated April 9, 2010, containing
additional information about the Fund, has been filed with the Securities and
Exchange Commission 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 66 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 or from the Fund's
website (http://www.ftportfolios.com). Please note that the information
contained in the Fund'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 Securities and Exchange Commission's
web site (http://www.sec.gov).
Shares of common stock of closed-end investment companies, like the Fund,
frequently trade at discounts to their net asset values. If the Fund's common
shares trade at a discount to net asset value, the risk of loss may increase for
purchasers in this offering, especially for those investors who expect to sell
their common shares in a relatively short period after purchasing shares in this
offering. See "Risks - Market Discount From Net Asset Value." 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 April 9, 2010
--ii--
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," "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, petroleum and other markets,
the price at which the Fund's common shares will trade in the public markets and
other factors discussed in the Fund's periodic filings with the Securities and
Exchange Commission (the "SEC").
Although we believe that 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 any 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 (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" section of this prospectus. We urge you to
review carefully that section for a more detailed discussion of the risks of an
investment in the Fund's securities.
--iii--
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 SAI, including the
documents incorporated by reference, particularly the section entitled "Risks"
beginning on page 37.
The Fund................... Energy Income and Growth Fund is a non-
diversified, closed-end management investment
company which commenced operations in June 2004.
The Fund's investment objective is to seek a high
level of after-tax total return with an emphasis on
current distributions paid to common shareholders.
The Fund seeks to provide its common shareholders
with an efficient vehicle to invest in a portfolio
of cash-generating securities of energy companies.
The Fund completed its initial public offering of
common shares in June 2004, raising approximately
$122 million in equity after the payment of
offering expenses. As of March 3, 2010, the Fund
had 7,609,755 common shares outstanding and net
assets applicable to common shares of $167,612,407.
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."
Investment Advisor
and Sub-Advisor............ First Trust Advisors L.P. ("First Trust Advisors"
or the "Advisor") is the Fund's investment advisor,
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, is
also 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-advisor and is primarily responsible
for the day-to-day supervision and investment
strategy of the Fund.
First Trust Advisors, a registered investment
advisor, is an Illinois limited partnership formed
in 1991. First Trust Advisors serves as investment
advisor or portfolio supervisor to investment
portfolios with approximately $28 billion in assets
which it managed or supervised as of February 28,
2010.
Energy Income Partners is a limited liability
company and a registered investment advisor, 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 advisor to
investment portfolios with approximately $408
million of assets which it managed as of February
28, 2010.
The Offering................ The Fund may offer, on an immediate, continuous or
delayed basis, up to 3,348,960 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 a company's common
stock (calculated within 48 hours of pricing),
absent shareholder approval or under certain other
circumstances. The Fund has received shareholder
approval to engage in offerings at a price less
than net asset value under certain conditions. 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 us 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 May 19, 2009, the Fund entered into a sales
agreement with the Advisor, Sub-Advisor, and
JonesTrading Institutional Services LLC
("JonesTrading") pursuant to which the Fund may
offer and sell up to 1,000,000 Common Shares
through JonesTrading as its agent. As of March 3,
2010, 259,962 Common Shares have been sold under
this sales agreement. In addition, on February 12,
2010, the Fund entered into an underwriting
agreement with the Advisor, the Sub-Advisor, RBC
Capital Markets Corporation and other underwriters
named in the agreement pursuant to which 805,000
Common Shares were sold (including 105,000 pursuant
to an overallotment option), on February 18, 2010
and February 25, 2010, respectively.
Use of Proceeds............ Unless otherwise specified in a prospectus
supplement, the Fund will 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.
Distributions.............. The Fund's distributions generally consist 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 Fund less (ii)
current or accrued operating expenses of the Fund,
including taxes on Fund taxable income and leverage
costs. Due to the tax treatment under current law
of cash distributions made by MLPs in which the
Fund invests, a portion of distributions the Fund
makes to common shareholders may consist of a
tax-deferred return of capital. The Fund intends to
make quarterly distributions to common
shareholders. There is no assurance that the Fund
will continue to make regular distributions. See
"Tax Considerations" in this Summary and "Tax
Matters."
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."
Investment Objective
and Policies............... The Fund's investment objective is to seek a high
level of after-tax 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 an efficient vehicle to
invest in a portfolio of cash-generating
securities of energy companies. The Fund focuses
on investing in MLPs and related public entities
-2-
in the energy sector which the Sub-Advisor
believes offer opportunities for income and
growth. As used in this prospectus, unless the
context requires otherwise, MLPs are those MLPs in
the energy sector. Due to the tax treatment under
current law of cash distributions made by MLPs to
their investors (such as the Fund), the Fund
believes that a portion of its income may be tax
deferred, thereby increasing cash available for
distribution by the Fund to its common
shareholders. There can be no assurance that the
Fund's investment objective will be achieved.
Under normal market conditions, as a
non-fundamental policy, the Fund invests at least
85% of its Managed Assets (including assets
obtained through leverage) in securities of energy
companies and energy sector MLPs and MLP-related
entities, and invests at least 65% of its Managed
Assets in equity securities of such MLPs and
MLP-related entities.
The Fund has adopted the following additional
non-fundamental investment policies:
o The Fund may invest up to 35% of its Managed
Assets in unregistered or otherwise restricted
securities (including up to 10% of its Managed
Assets in securities issued by private
companies). 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 companies.
o The Fund may invest up to 25% of its Managed
Assets in debt securities of energy companies,
MLPs and MLP-related entities, including below
investment grade securities, which are
commonly referred to as "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 Group ("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.
o The Fund will not invest more than 10% 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 Financial Leverage or market
risks associated with the Fund's portfolio.
o The Fund may invest up to 15% of its Managed
Assets in non-U.S. securities as well as hedge
the currency risk of the non-U.S. securities
using derivative instruments.
To generate additional income, the Fund writes (or
sells) covered call options on the common stock of
energy companies held in the Fund's portfolio. The
Fund anticipates that it will be able to invest
substantially all of the net proceeds of any
offering of Common Shares pursuant to this
prospectus and applicable prospectus supplement in
securities that meet the Fund's investment
objective and policies within one month after the
completion of any such offering.
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
-3-
investment strategy, are considered non-fundamental
and may be changed by the Board of Trustees without
shareholder approval. The Fund will provide
investors with at least 60 days prior notice of any
change in the Fund's investment strategy. 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
fluctuations. There can be no assurance that the
Fund's investment objective will be achieved. See
"The Fund's Investments" and "Risks" in this
prospectus and "Investment Policies and Techniques"
in the Fund's SAI.
The Fund's Investments..... The Fund's investments consist of equity and/or
debt securities issued by energy companies and
energy sector MLPs and MLP-related entities. The
companies in which the Fund invests are generally
involved in the business of transporting,
processing, storing, distributing or marketing
natural gas, natural gas liquids ("NGLs")
(including propane), crude oil, refined petroleum
products, coal or electricity, or exploring,
developing, managing or producing such commodities
or products, or in supplying energy-related
products and services.
The types of MLP and MLP-related entity equity
securities the Fund purchases include common units,
subordinated units and I-Shares. Unlike the holders
of common stock of a corporation, investors in MLP
common units, including the Fund, have limited
control and voting rights on matters affecting the
partnership. Investors in MLP common units are
generally entitled to minimum quarterly
distributions ("MQD") from the MLP, including
arrearage rights, which must be satisfied before
any distributions are paid to subordinated unit
holders or incentive payments are made to the MLP's
general partner. MLP common units are typically
listed and traded on a U.S. securities exchange.
While the Fund anticipates that it will generally
purchase MLP common units in open market
transactions, the Fund has purchased in the past,
and may purchase in the future, MLP common units
through direct placements. MLP subordinated units
provide for distributions to be made to holders
once the MQD payable to common unit holders have
been satisfied but prior to incentive payments to
the MLP's general partner. MLP subordinated units
do not provide for arrearage rights and are
typically convertible into common units after a
specified period of time or upon the achievement of
specified financial goals. As MLP subordinated
units are not typically listed or publicly traded,
the Fund anticipates that it will purchase MLP
subordinated units directly from MLP affiliates or
holders of such shares. I-Shares are similar in
most respects to common units except that
distributions payable on I-Shares are in the form
of additional I-Shares rather than cash
distributions. As a result, the Fund will consider
its own distribution targets and cash holdings when
making a determination as to whether to purchase
I-Shares.
The Fund may also invest in equity and debt
securities of MLP-related entities, such as general
partners or other affiliates of MLPs and equity and
debt securities of energy companies that are
organized and/or taxed as corporations.
The Fund may invest up to 35% of its Managed Assets
in equity securities issued by energy companies.
The Fund intends to purchase these equity
securities in market transactions but may also
purchase securities directly from the issuers in
private placements. To generate additional income,
the Fund sells covered call options on the common
stock of energy companies held in the Fund's
portfolio.
-4-
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
Financial Leverage, to facilitate portfolio
management and to mitigate risks, including
interest rate, currency and credit risks. The Fund
also may write (or sell) covered call options on
the common stock of energy companies held in the
Fund's portfolio. 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 will write call
options only if they are "covered." In the case of
a call option on a common stock or other security,
the option is "covered" if the Fund owns the
security underlying the call or has an absolute and
immediate right to acquire that security without
additional cash consideration (or, if additional
cash consideration is required, cash or other
assets determined to be liquid by the Sub-Advisor
(in accordance with procedures established by the
Board of Trustees) in such amount are segregated by
the Fund's custodian) upon conversion or exchange
of other securities held by the Fund. The Fund may
purchase and sell derivative investments such as
exchange-listed and over-the-counter put and call
options on securities, energy-related commodities,
equity, fixed income and interest rate indices,
currencies, and other financial instruments,
purchase and sell financial futures contracts and
options thereon, and enter into various interest
rate transactions such as swaps, caps, floors or
collars or credit transactions and credit default
swaps. The Fund also may purchase derivative
investments that combine features of these
instruments. Collectively, all of the above are
referred to as "Strategic Transactions." The Fund
generally seeks to use these instruments and
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.
Use of Financial Leverage.. The Fund is currently engaged in, and may in the
future engage in, the use of Financial Leverage to
seek to enhance the level of its current
distributions to common shareholders. On January
28, 2005, the Fund issued $34 million principal
amount of auction rate senior notes due March 2,
2045 (the "Series A Notes") and on March 26, 2006,
issued $25 million principal amount of auction rate
senior notes due March 20, 2046 (the "Series B
Notes"), which were rated "Aaa" and "AAA" by
Moody's and Fitch Ratings Services, Inc. ("Fitch"),
respectively. On March 26, 2008, the Fund entered
into a $55 million senior revolving credit facility
with The Bank of Nova Scotia (the "Credit
Facility"), of which $34 million was utilized to
redeem the issued and outstanding Series A Notes.
On January 23, 2009, the Fund entered into a
$60,000,000 commitment facility agreement with BNP
Paribas Prime Brokerage Inc. (the "Commitment
Facility"), which was used to repay in full
outstanding borrowings under the Credit Facility
and, on February 26, 2009, to deposit funds to
redeem the issued and outstanding Series B Notes.
All of the issued and outstanding Series B Notes
were redeemed on March 13, 2009. On March 2, 2010,
the Fund and BNP Paribas Prime Brokerage Inc.
amended the Commitment Facility to increase the
commitment amount to $70,000,000. As of March 3,
2010, the principal amount of Borrowings under the
Commitment Facility was $59,300,000, representing
-5-
approximately 26% of the Fund's Managed Assets. As
of March 3, 2010, the Fund had $10,700,000 of
unutilized funds available for Borrowing under
the Commitment Facility.
The Fund's common shares are junior in liquidation
and distribution rights to amounts owed pursuant to
the Commitment Facility. The issuance of Preferred
Shares and/or Borrowings (each a "Leverage
Instrument" and collectively, the "Leverage
Instruments"), represent the leveraging of the
Fund's common shares. The issuance of additional
Common Shares offered by this prospectus will
enable the Fund to increase the aggregate amount of
its leverage. The use of Financial Leverage creates
an opportunity for increased income and capital
appreciation for common shareholders, but at the
same time, it creates special risks that may
adversely affect common shareholders. Because both
the Advisor's and Sub-Advisor's fees are based on
Managed Assets (including assets obtained through
leverage), both the Advisor's and Sub-Advisor's
fees are higher when the Fund is leveraged. There
can be no assurance that a leveraging strategy will
be successful during any period in which it is
used. 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
determination to use Financial Leverage is subject
to the Board of Trustees' approval and the ability
of the Fund to obtain Financial Leverage. Leverage
Instruments will have seniority over the common
shares. The use of Leverage Instruments will
leverage your investment in the Common Shares. The
Fund expects to issue additional Leverage
Instruments to extent such Financial Leverage is
available. If the Fund uses additional Leverage
Instruments, associated costs, if any, will be
borne immediately by common shareholders and result
in a reduction of the net asset value of the common
shares.
Preferred Shares, if any, may pay dividends based
on short-term rates, which may be reset frequently.
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
Instruments, 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 distributions to common
shareholders. Conversely, if the income or gains
from the securities and investments purchased with
such proceeds does not cover the cost of leverage,
the return to the common shares will be less than
if leverage had not been used. When leverage is
employed, the net asset value and market prices of
the common shares and the yield to common
shareholders will be more volatile.
There is no assurance that the Fund will utilize
Financial Leverage in addition to the Commitment
Facility or, if additional Financial Leverage is
utilized, that it will be successful in enhancing
the level of the Fund's current distributions.
The Fund may make further use of Financial Leverage
through the issuance of notes or other senior
securities to the extent permitted by the 1940 Act.
However, it is possible that the Fund will be
unable to obtain additional Financial Leverage. In
the current economic environment, it has become
more difficult for borrowers, including the Fund,
to find third parties willing to extend credit or
purchase securities that would constitute Financial
Leverage. If the Fund is unable to increase
Financial Leverage after the issuance of additional
Common Shares pursuant to this prospectus, there
could be an adverse impact on the return to common
-6-
shareholders. In addition, to the extent additional
Financial Leverage is utilized, the Fund may
consequently be subject to certain financial
covenants and restrictions that are not currently
imposed on the Fund. See "Use of Financial
Leverage" and "Risks -- Leverage Risk."
Tax Considerations......... 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 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 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. However, as discussed below, the Fund
expects that a portion of the distributions it
receives from MLPs may be treated as a tax-deferred
return of capital, thus reducing the Fund's current
tax liability. 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
tax-deferred return of capital as well as capital
appreciation of its investments. The Fund relies to
some extent on information provided by 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. 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.
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
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 tax
deductions. In this situation, the Fund will
incur a current tax liability on that portion
of the income from an MLP not offset by tax
deductions with a portion of any distribution
being treated as a tax-deferred return of
capital. The Fund's tax basis in its MLP units
would be reduced by amounts treated as
tax-deferred return of capital, which would
either increase the Fund's taxable gain or
reduce the Fund's loss recognized upon the
sale of an MLP. 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.
Certain energy related deductions are also not
allowed for alternative minimum tax purposes,
which may cause the Fund to be subject to the
alternative minimum tax depending upon the
nature of the assets of the MLPs. A reduction
in the percentage of income offset by tax
deductions or an increase in the Fund's
portfolio turnover will reduce that portion of
the Fund's distribution treated as a
tax-deferred return of capital and increase
that portion treated as income, and may result
-7-
in reduced Fund distributions and 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
energy 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.
Shareholder Tax Aspects.
o Current Distributions on Shares. Common
shareholders of the Fund hold common shares 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.
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. Prior to 2011, dividend
income generally will qualify for treatment
as "qualified dividend income" for federal
income tax purposes if holding period and
other requirements are satisfied by the common
shareholder receiving such dividend income.
Qualified dividend income received by
individual shareholders is taxed at long-term
capital gains rates, which reach a maximum of
15%. The special tax treatment afforded to
qualified dividend income is set to end as of
December 31, 2010 (assuming such special tax
treatment is not repealed by Congress before
then). After December 31, 2010, dividends will
be taxed at ordinary income rates. Currently,
the highest federal income tax rate applicable
to individuals as ordinary income is 35%. This
rate is scheduled to increase to 39.6% after
2010. Distributions that are in an amount
greater than the Fund's current and
accumulated earnings and profits will
represent a tax-deferred 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
significant portion of the Fund's
distributions to common shareholders will
likely represent a tax-deferred return of
capital. 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."
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
-8-
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."
Comparison with Direct
Investments in MLPs........ The Fund seeks to provide an efficient method for
investing in MLPs, MLP-related entities and other
energy 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 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 of the Fund will
receive a single Form 1099 and will only be
required to file income tax returns in states
in which they would ordinarily file;
o Direct investors in MLPs are limited in their
ability to use losses to offset other gains by
the passive activity income and loss rules,
whereas common shareholders of the Fund are
not so limited; 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.
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 NYSE
Amex under the trading or "ticker" symbol "FEN."
The net asset value of the Fund's common shares at
the close of business on March 3, 2010 was $22.03
per common share, and the last sale price of the
common shares on the NYSE Amex on such date was
$23.12.
Corporate Finance Services
and Consulting Agent....... Wells Fargo Advisors, LLC, as successor to A.G.
Edwards, serves as corporate finance services and
consulting agent to the Advisor, pursuant to a
Corporate Finance Services and Consulting Agreement
between A.G. Edwards and the Advisor. See
"Corporate Finance Services and Consulting Fee."
Custodian, Administrator
and Transfer Agent......... PNC Global Investment Servicing (U.S.) Inc.,
formerly known as PFPC Inc., an indirect,
majority-owned subsidiary of The PNC Financial
Services Group, Inc., serves as the Fund's
Administrator, Fund Accountant, Transfer Agent and
Board Administrator in accordance with certain fee
arrangements. PFPC Trust Company (which will be
renamed PNC Trust Company effective June 7, 2010),
also an indirect, majority-owned subsidiary of The
PNC Financial Services Group, Inc., serves as the
Fund's Custodian in accordance with certain fee
arrangements.
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,
-9-
mutual funds issue securities redeemable at net
asset value 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 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 net asset value, but in
some cases trade at a premium. The market price may
be affected by net asset value, 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,
net asset value. 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
Fund's common shares with respect to their net
asset value 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 net asset value 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 net asset value per
common share. In addition, as noted above, the
Board of Trustees determined in connection with the
initial offering of common shares of the Fund that
the closed-end structure is desirable, 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
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............. Investment and Market Risk. An investment in the
Fund's 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, substantially all of which are
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's performance was adversely impacted by
the weakness in the credit markets and broad stock
market, and the resulting rapid and dramatic
declines in the value of MLPs that occurred
beginning in late 2008, and may again be adversely
affected due to weaknesses in the credit and stock
markets. If the Fund's net asset value declines or
remains volatile, there is an increased risk that
the Fund may be required to reduce outstanding
leverage, which could adversely affect the price of
the Fund's common shares and ability to pay
distributions at historical levels. A sustained
-10-
economic slowdown may adversely affect the ability
of MLPs to sustain their historical distribution
levels, which in turn, may adversely affect the
Fund's ability to sustain distributions at
historical levels. MLPs that have historically
relied heavily on outside capital to fund their
growth have been impacted by the slowdown in the
capital markets. The recovery of the MLP sector is
dependent on several factors, including the
recovery of the financial sector, the general
economy and the commodity markets.
In response to the financial crises affecting the
banking system and financial markets, the U.S. and
foreign governments have intervened to an
unprecedented degree in the financial and credit
markets. Among other things, U.S. government
regulators have encouraged, and in some cases
structured and provided financial assistance for,
banks, securities firms, insurers and other
financial companies. Additional intervention
programs have been adopted and proposed which will
have a further impact on the securities markets.
Many of the recently enacted or proposed government
measures are far-reaching and without historical
precedent. Furthermore, the U.S. government has
stated its willingness to implement additional
measures as it may see fit to address changes in
market conditions. There can be no assurance that
any or all of these measures will succeed in
stabilizing and providing liquidity to the U.S.
financial markets, including the extreme levels of
volatility recently experienced. Such volatility
could materially and adversely affect the financial
condition of the Fund, the performance of the
Fund's investments and the trading price of the
Fund's common shares.
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 by 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. 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.
Energy Sector Risk. The Fund's investments are
generally concentrated in the energy sector, with a
particular concentration in energy sector MLPs and
MLP-related entities. Certain risks inherent in
investing in the energy business of these types of
securities include the following:
o Commodity Pricing Risk. MLPs, MLP-related
entities and energy companies may be directly
affected by energy commodity prices,
especially those MLPs, MLP-related entities
and energy companies which own the underlying
energy commodity. Commodity prices fluctuate
for several reasons, including changes in
market and economic conditions, the impact of
weather on demand, levels of domestic
production and imported commodities, energy
conservation, domestic and foreign
governmental regulation and taxation and the
availability of local, intrastate and
interstate transportation systems. Volatility
of commodity prices which leads to a reduction
in production or supply may also impact the
performance of MLPs, MLP-related entities and
energy companies that are solely involved in
the transportation, processing, storing,
distribution or marketing of commodities.
Volatility of commodity prices may also make
it more difficult for MLPs, MLP-related
-11-
entities and energy companies to raise capital
to the extent the market perceives that their
performance may be directly tied to commodity
prices.
o Supply and Demand Risk. 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
financial performance of MLPs, MLP-related
entities and energy 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 or
depressed commodity prices. Alternatively, a
sustained decline in demand for such
commodities could also impact the financial
performance of MLPs, MLP-related entities and
energy 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. A
continuation of reduced demand for energy
commodities as a result of the economic
recession may further reduce the financial
performance of the entities in which the Fund
invests.
o Depletion and Exploration Risk. MLPs,
MLP-related entities and energy companies
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. MLPs,
MLP-related entities and energy companies
generally increase reserves 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 energy companies.
o Regulatory Risk. MLPs, MLP-related entities
and energy companies are subject to
significant federal, state and local
government regulation in virtually every
aspect of their operations, including how
facilities are constructed, maintained and
operated, environmental and safety controls,
and the prices they may charge for products
and services. 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 energy
companies.
o Interest Rate Risk. Rising interest rates
could adversely impact the financial
performance of MLPs, MLP-related entities and
-12-
energy companies. Rising interest rates may
increase an MLP's, MLP-related entity's or
energy company's cost of capital, which would
increase operating costs and may reduce an
MLP's, MLP-related entity's or energy
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 company shares as the
yields on alternative investments increase.
o Acquisition or Reinvestment Risk. The ability
of MLPs to grow and to increase distributions
to unitholders is dependent in part on their
ability to make acquisitions or find organic
projects that result in an increase in
adjusted operating surplus per unit. In the
event that MLPs 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 do consummate
acquisitions/projects that they believe will
be accretive, the acquisitions may in fact
turn out to result in a decrease in adjusted
operating surplus per unit. As MLP general
partners typically receive a greater
percentage of increased cash distributions, in
an effort to increase cash distributions the
general partner may make acquisitions which,
due to various factors, including increased
debt obligations as well as the factors set
forth below, may adversely affect the MLP. 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. A few of the midstream
MLPs are dependent on their parents or
sponsors for a majority of their revenues. Any
failure by the parents or sponsors to satisfy
their payments or obligations would impact the
MLPs' revenues and cash flows and ability to
make distributions.
o Catastrophe Risk. The operations of MLPs,
MLP-related entities and energy 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;
fires 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 energy 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.
-13-
o Terrorism/Market Disruption Risk. The
terrorist attacks in the United States on
September 11, 2001 had a disruptive effect on
the securities markets. U.S. military and
related action in Iraq is ongoing and events
in the Middle East could have significant
adverse effects on the U.S. economy and the
stock market. Uncertainty surrounding
retaliatory military strikes or a sustained
military campaign may affect energy company
operations in unpredictable ways, including
disruptions of fuel supplies and markets, and
transmission and distribution facilities could
be direct targets, or indirect casualties, of
an act of terror. Since the September 11th
attacks, the U.S. government has issued
warnings that energy assets, specifically the
U.S. pipeline infrastructure, may be the
future target of terrorist organizations. In
addition, changes in the insurance markets
attributable to the September 11th attacks
have made certain types of insurance more
difficult, if not impossible, to obtain and
have generally resulted in increased premium
costs.
o 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. In
addition, there are certain tax risks
associated with an investment in MLP units and
conflicts of interest exist between common
unit holders and the general partner,
including those arising from incentive
distribution payments.
o Industry Specific Risk. MLPs, MLP-related
entities and energy companies are also subject
to risks that are specific to the industry
they serve.
o Midstream MLPs, MLP-related entities and
energy 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 Propane MLPs and MLP-related entities 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 energy
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.
Cash Flow Risk. A substantial portion of the cash
flow received by the Fund is derived from its
investment in equity securities of MLPs and
MLP-related entities. The amount of cash an MLP or
MLP-related entity has available for distributions
and the tax character of such distributions is
dependent upon the amount of cash generated by the
MLP's or MLP-related entity's operations. Cash
available for distribution varies from quarter to
quarter and is largely dependent on factors
-14-
affecting the MLP's or MLP-related entity's
operations and factors affecting the energy
industry in general. In addition to the risk
factors described above, other factors which may
reduce the amount of cash an MLP or MLP-related
entity has available for distribution include
increased operating costs, capital expenditures,
acquisition costs, expansion, construction or
exploration costs and borrowing costs.
Tax Risk. The Fund's ability to meet its investment
objective depends on the level of taxable income
and distributions it receives from the MLP,
MLP-related entities and energy company securities
in which the Fund invests, a factor over which the
Fund has no control. The benefit the Fund derives
from its investment in MLPs is largely dependent on
their being treated as partnerships for federal
income tax purposes. As a partnership, an MLP has
no income tax liability at the entity level. If, as
a result of a change in an MLP's business, an MLP
were treated as a corporation for federal income
tax purposes, such MLP would be obligated to pay
federal income tax on its income at the applicable
corporate tax rate. If an MLP was classified as a
corporation for federal income tax purposes, the
amount of cash available for distribution with
respect to its units would be reduced and any such
distributions received by the Fund would be taxed
entirely as dividend income if paid out of the
earnings of the MLP. Therefore, treatment of an MLP
as a corporation for federal income tax purposes
would result in a material reduction in the
after-tax return to the Fund, likely causing a
substantial reduction in 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
in which it invests. Any such changes could
negatively impact the Fund and its common
shareholders. For example, if, by reason of a
change in law or otherwise, an MLP in which the
Fund invests is treated as a corporation rather
than a partnership, the MLP would be subject to
entity level corporate taxation and any
distributions received by the Fund would be treated
as dividend income. This would negatively impact
the amount and tax characterization of
distributions received by common shareholders.
Deferred Tax Risk. 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 tax
deductions. The Fund will incur a current tax
liability on that portion of a distribution that is
not offset by tax deductions, with the remaining
portion of the distribution being treated as a
tax-deferred return of capital. 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 in the Fund's
portfolio 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 the income from an
MLP offset by tax deductions or gains as a result
of the sale of portfolio securities will reduce
that portion, if any, of the Fund's distribution
treated as a tax-deferred return of capital and
increase that portion treated as dividend income,
resulting in reduced Fund distributions and lower
after-tax distributions to the Fund's common
shareholders. For purposes of computing net asset
value, the Fund will accrue deferred income taxes
for its future tax liability associated with that
portion of MLP distributions considered to be
tax-deferred return of capital as well as capital
appreciation of its investments. The Fund will rely
to some extent on information provided by MLPs,
which is usually not timely, to estimate deferred
tax liability for purposes of financial statement
reporting and
-15-
determining the Fund's net asset value. From time
to time the Fund will modify its estimates and/or
assumptions regarding its deferred tax liability
as new information becomes available.
Delay in Investing the Proceeds of this Offering.
Although the Fund currently intends to invest the
proceeds from any sale of the Common Shares as soon
as practicable following the completion of such
offering, such investments may be delayed if
suitable investments are unavailable at the time.
The trading market and volumes for MLP, MLP-related
entity and energy 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 energy
company securities. Income received by the Fund
from these securities would subject the Fund to
corporate tax before any distributions to Common
Shareholders. As a result, the return and yield on
the Common Shares in the year following any
offering pursuant to this prospectus and an
applicable prospectus supplement 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 energy
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 MLP units and other equity securities may be
particularly sensitive to rising interest rates, as
the cost of capital rises and borrowing costs
increase.
Certain of the energy 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 energy 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 energy companies and
may be more vulnerable to adverse general market or
economic developments. Stocks of smaller MLPs,
MLP-related entities and energy companies may be
less liquid than those of larger MLPs, MLP-related
entities and energy companies and may experience
greater price fluctuations than larger MLPs,
MLP-related entities and energy 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 invests
and may in the future invest 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.
The Fund invests, and may in the future invest, in
I-Shares which represent an indirect investment in
MLP i-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.
-16-
Leverage Risk. The Fund currently utilizes leverage
in the form of Borrowings under the Commitment
Facility, and may in the future use additional
leverage for investment purposes, to finance the
repurchase of its common shares, and to meet cash
requirements. Although the use of leverage by the
Fund creates an opportunity for increased return
for the common shares, it also results in
additional risks and 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 or gains from the securities and investments
purchased with such proceeds does not cover the
cost of leverage, the return to the common shares
will be less than if leverage had not been used.
There is no assurance that a leveraging strategy
will be successful. In addition, certain types of
leverage may result in the Fund being subject to
covenants relating to asset coverage and the Fund's
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. Under the
Commitment Facility, the Fund is also required to
pledge assets to the lenders. Leverage involves
risks and special considerations for common
shareholders including:
o the likelihood of greater volatility of net
asset value 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 distributions paid on the
common shares;
o the effect of leverage in a declining market,
which is likely to cause a greater decline in
the net asset value 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 leverage, the investment
advisory fee payable to the Advisor, and the
sub-advisory fee payable by the Advisor to the
Sub-Advisor, will be higher than if the Fund
did not use leverage.
The issuance of Leverage Instruments by the Fund,
in addition to Borrowings under the Commitment
Facility, involve offering expenses and other
costs, including interest or dividend payments,
which would be borne indirectly by the common
shareholders. Increased operating costs, including
the financing cost associated with any leverage,
may reduce the Fund's total return.
Certain types of Borrowings may result in the Fund
being subject to covenants in credit agreements
relating to asset coverage and portfolio
composition requirements. The Fund may be subject
to certain restrictions on investments imposed by
guidelines of one or more rating agencies, which
may issue ratings for the short-term corporate 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. In
addition, the loan documents under the Commitment
Facility include customary provisions including a
restriction on the Fund's ability to pledge its
assets and contains customary events of default
including failure of the Fund to meet the asset
coverage test of the 1940 Act. There is no
assurance that the Fund will not violate financial
covenants relating to the Commitment Facility or
other 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
-17-
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.
It is possible that the Fund will be unable to
obtain additional leverage. If the Fund is unable
to increase Financial Leverage after the issuance
of additional Common Shares, there could be an
adverse impact on the return to common
shareholders.
Derivatives Risk. The Fund's Strategic Transactions
have risks, including the imperfect correlation
between the value of such instruments and the
underlying assets of the Fund, the possible default
of the other party to the transaction or
illiquidity of the derivative investments.
Furthermore, the ability to successfully use
hedging and interest rate transactions depends on
the Sub-Advisor's ability to predict pertinent
market movements, which cannot be assured. Thus,
the use of derivatives 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 hedging and
strategic transactions are not otherwise available
to the Fund for investment purposes. As the writer
of a covered call option, the Fund forgoes, during
the option's life, the opportunity to profit from
increases in the market value of the security
covering the call option above the sum of the
premium and the strike price of the call, but has
retained the risk of loss should the price of the
underlying security decline. The writer of an
option has no control over the time when it may be
required to fulfill its obligation as a writer of
the option. Once an option writer has received an
exercise notice, it cannot effect a closing
purchase transaction in order to terminate its
obligation under the option and must deliver the
underlying security at the exercise price. See
"Risks-Derivatives Risk."
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 30% under normal
circumstances, but may be higher or lower in
certain periods. For the fiscal year ended November
30, 2009, portfolio turnover was approximately 43%.
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 to the Fund. A 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 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."
Restricted Securities. The Fund invests, and may in
the future invest, in unregistered or otherwise
restricted securities. The term "restricted
securities" refers to securities that have not been
registered under the 1933 Act or are 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
-18-
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 energy companies trade on the New York
Stock Exchange ("NYSE"), NYSE Amex, and The NASDAQ
Stock Market, 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,
derivatives 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 lowest 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,
MLP-related entities or private companies, 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 will rely on information
provided by the MLPs, which is usually not timely,
to calculate taxable income allocable to the MLP
units held in the Fund's portfolio and to calculate
associated deferred tax liability for purposes of
financial statement reporting and determining the
Fund's net asset value. From time to time the Fund
will modify its estimates and/or assumptions
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.
See "Net Asset Value."
Interest Rate Risk. Interest rate risk is the risk
that equity and debt 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 net asset value and
market price of the common shares will tend to
decline if market interest rates rise. Interest
rates are at or near historic lows, and as a
result, they are likely to rise over time. Certain
debt instruments, particularly below investment
grade securities, may contain call or redemption
-19-
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 the Fund's debt securities
are called or redeemed, the Fund may be forced to
reinvest in lower yielding securities.
Below Investment Grade Securities. Below investment
grade debt securities are commonly referred to as
"junk bonds." Below investment grade quality
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 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.
As of February 28, 2010, the Fund did not invest in
any below investment grade debt securities.
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 Internal Revenue Code. Accordingly, there are
no regulatory requirements under the 1940 Act or
the Internal Revenue Code on the minimum number or
size of securities held by the Fund. As of February
28, 2010, there were approximately sixty-seven
(67) publicly traded MLPs, approximately 80% of
which operate energy assets. The Fund intends to
select its MLP investments from this small pool of
issuers. The Fund may invest in securities of
MLP-related entities and non-MLP securities of
other energy companies, consistent with its
investment objective and policies. As of February
28, 2010 the Fund held investments in thirty-four
(34) MLP issuers.
Market Disruption Risk. The terrorist attacks in
the United States on September 11, 2001 had a
disruptive effect on the securities markets. U.S.
military and related action in Iraq is ongoing and
events in the Middle East, as well as the
continuing threat of terrorist attacks, could have
significant adverse effects on the U.S. economy and
the stock market. The Fund cannot predict the
effects of similar events in the future on the U.S.
economy.
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" and "Risks-Anti-Takeover Provisions."
-20-
Competition Risk. There exist other alternatives to
the Fund as a vehicle for investment in a portfolio
of MLPs, including other publicly traded investment
companies and private funds. In addition, recent
tax law changes or future tax law changes may
increase the ability of regulated investment
companies or other institutions to invest in MLPs.
Because of the limited number of MLP issuers, these
competitive conditions may adversely impact the
Fund's ability to make investments in the MLP
market and could adversely impact the Fund's
distributions to common shareholders.
Market Discount From Net Asset Value. The Fund's
common shares have been publicly traded since June
24, 2004 and have traded both at a premium and at a
discount relative to net asset value. There is no
assurance that any premium of the public offering
price for the Common Shares over net asset value
with respect to any offering hereunder will
continue after such offering or that the common
shares will not again trade at a discount. Shares
of closed-end investment companies frequently trade
at a discount from their net asset value. This
characteristic is a risk separate and distinct from
the risk that the Fund's net asset value 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 any offering hereunder.
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 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 will
be affected by factors such as net asset value,
dividend or distribution levels (which are
dependent, in part, on expenses), supply of and
demand for the common shares, stability of
dividends or distributions, trading volume of the
common shares, general market and economic
conditions, and other factors beyond the control of
the Fund, the Fund cannot predict whether the
Common Shares will trade at, below or above net
asset value or at, below or above the public
offering price with respect to any offering
hereunder.
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.
Certain Affiliations. Certain broker-dealers may be
considered to be affiliated persons of the Fund,
First Trust Advisors or Energy Income Partners.
Absent an exemption from the SEC or other
regulatory relief, the Fund is generally precluded
from effecting certain principal transactions with
affiliated brokers, and its ability to utilize
affiliated brokers for agency transactions, is
subject to restrictions. This could limit the
Fund's ability to engage in securities transactions
and take advantage of market opportunities.
-21-
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 March
3, 2010, 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 are based
on the Fund's capital structure as of March 3, 2010. As of that date, the Fund
had $59,300,000 of leverage outstanding pursuant to the Commitment Facility.
Such leverage represented 26% of total assets as of March 3, 2010.
Shareholder Transaction Expenses:
Sales Load (as a percentage of offering price) ........................................-- %*
Offering Expenses Borne by the Fund (as a percentage of offering price)(1).............-- %*
Dividend Reinvestment Plan Fees.....................................................None(2)
Percentage of Net Assets
Attributable to Common Shares,
(Assumes 26% Leverage is Outstanding)
Annual Expenses:
Management Fees(3)............................................................... 1.35%
Interest and Fees on Leverage(4)................................................. 0.68%
Other Expenses (exclusive of current and deferred income tax expense (benefit))(5) 0.57%
Total Annual Expenses............................................................ 2.60%
------
Fee and Expense Reimbursement.................................................... -- %
------
Total Net Annual Expenses................................................... 2.60%
======
-------------------------------------------------------------------------------
* 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 PNC Global Investment Servicing
(U.S.) 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 (and 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 March 3, 2010, based on interest
rates in effect as of March 3, 2010. The table assumes total Borrowings of
$59.3 million, which reflects leverage in an amount representing 26% of
total 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 November 30, 2009 has been as
follows:
Period June 24, 2004 (commencement of
operations)
Through November 30, 2004 16.18%
Year Ended November 30, 2005 5.98%
Year Ended November 30, 2006 10.84%
Year Ended November 30, 2007 4.58%
Year Ended November 30, 2008 (24.83)%
Year Ended November 30, 2009 22.47%
The purpose of the tables above and the example 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 Net Annual Expenses" are based on estimated amounts for the
Fund's 12 months of operations after March 3, 2010 unless otherwise indicated
and assumes that the Fund has not issued any additional common shares.
-22-
The following examples illustrate the expenses that you would pay on a
$1,000 investment in Common Shares, assuming: (i) total annual expenses of 2.60%
of net assets attributable to Common Shares through year 10, (ii) a 5% annual
return and (iii) all distributions are reinvested at net asset value:(1)
1 Year 3 years 5 Years 10 Years
$26 $81 $138 $293
-------------------------------------------------------------------------------
(1) This example does not include sales load or estimated offering costs. The
example should not be considered a representation of future expenses. The
example assumes 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
26% of total assets, assuming interest and fees on leverage of 0.68%. The
interest and fees on leverage is expressed as an interest rate and
represents interest and fees payable on the Commitment 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.
-23-
FINANCIAL HIGHLIGHTS
The information in this table is derived from the Fund's financial
statements audited by Deloitte & Touche LLP, whose report on certain of such
financial statements is contained in the Fund's 2009 Annual Report and is
incorporated by reference into the Fund's SAI, both of which are available from
the Fund upon request.
Year Year Year Year Year Period
Ended Ended Ended Ended Ended Ended
November 30, November 30, November 30, November 30, November 30, November 30,
2009 2008 2007 (a) 2006 2005 2004 (k)
Net asset value, beginning of period.... $ 14.68 $ 26.74 $ 25.88 $ 22.53 $ 21.34 $ 19.10(l)
--------- ---------- ------- ---------- ----------- ----------
Income from investment operations:
Net investment loss..................... (0.24)(b) (0.57) (0.67) (0.50) (0.34) (0.13)
Net realized and unrealized gain
(loss).................................. 7.43 (9.83) 3.06 5.23 2.86 2.74
--------- ---------- ------- ---------- ----------- ----------
Total from investment operations
after income tax........................ 7.19 (10.40) 2.39 4.73 2.52 2.61
--------- ---------- ------- ---------- ----------- ----------
Distributions paid to shareholders from:
Net realized gain....................... (0.35) (1.66) (1.53) -- (0.88) --
Return of capital....................... (1.41) -- -- (1.38) (0.45) (0.33)
--------- ---------- -------- ---------- ----------- -----------
Total from distributions................ (1.76) (1.66) (1.53) (1.38) (1.33) (0.33)
--------- ---------- -------- ---------- ----------- -----------
Premiums from shares sold in at the
market offering......................... 0.09 -- -- -- -- --
Common share offering costs charges to
paid-in capital......................... -- -- -- -- -- (0.04)
--------- ---------- -------- ---------- ----------- -----------
Net asset value, end of period.......... $ 20.20 $ 14.68 $ 26.74 $ 25.88 $ 22.53 $ 21.34
========= ========== ========= ========== =========== ===========
Market value, end of period............. $ 22.30 $ 14.40 $ 23.82 $ 24.49 $ 20.92 $ 22.12
========= ========== ========= ========== =========== ===========
Total return based on net asset
value (c)............................... 51.03% (40.70)% 9.38% 22.23% 11.96%(e) 13.53%
========= ========== ========= ========== =========== ===========
Total return based on market value (d).. 70.20% (34.74)% 2.96% 24.57% 0.29% 12.38%
========= ========== ========= ========== =========== ===========
Net assets, end of period (in 000's).... $136,520 $ 94,880 $172,421 $ 166,850 $ 145.230 $ 136,993
Ratios of expenses to average net assets:
Including current and deferred income
taxes before waiver (f)................. 25.79 % (20.03) % 8.52% 14.47 % 8.62 % 18.38%(m)
Including current and deferred income
taxes after waiver (f).................. 25.79 % (20.03) % 8.52% 14.29 % 8.31 % 18.09%(m)
Excluding current and deferred income
taxes before waiver..................... 3.32 % 4.80 % 3.94% 3.63 % 2.64 % 2.20%(m)
Excluding current and deferred income
taxes after waiver...................... 3.32 % 4.80 % 3.94% 3.45 % 2.33 % 1.91%(m)
Excluding current and deferred income
taxes and interest expense after
waiver.................................. 2.32 % 2.55 % 1.89% 1.76 % 1.57 % 1.36%(m)
Ratios of net investment income (loss)
to average net assets:
Net investment income (loss) ratio
before tax expenses..................... (2.73) % (3.83) % (3.83)% (3.26) % (2.29) % (1.49)%(m)
Net investment income (loss) ratio
including tax expenses (f).............. (24.84) % 21.00 % (8.41)% (14.10) % (8.27) % (17.67)%(m)
Portfolio turnover rate................. 43 % 38 % 16 % 17 % 38 % 35%
Senior Securities:
Total Energy Notes outstanding
($25,000 per note) ..................... N/A 1,000 2,360 2,360 1,360 N/A
Principal amount and market value per
Energy Note (g)......................... N/A $ 25,006 $ 25,004 $ 25,069 $ 25,074 N/A
Asset coverage per Energy Note (h)...... N/A $ 119,880 $ 98,060 $ 95,699 $ 131,786 N/A
Total loan outstanding (in 000's)....... $45,000 $ 5,650 $ 15,250 N/A N/A $30,000
Asset coverage per $1,000 senior $ 4,034(j) $ 22,218(j) $ 12,306(i) N/A N/A $ 5,566 (i)
indebtedness ...........................
See notes to this table on the next page.
-24-
(a) On September 14, 2007, the Fund's Board of Trustees approved an interim
sub-advisory agreement with Energy Income Partners, LLC ("EIP"), and on
September 24, 2007, the Board of Trustees voted to approve EIP as investment
sub-advisor.
(b) Based on average shares outstanding.
(c) Total return based on net asset value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan, and changes in net
asset value per share and does not reflect sales load.
(d) Total return based on market value is the combination of reinvested dividend
distributions and reinvested capital gains distributions, if any, at prices
obtained by the Dividend Reinvestment Plan, and changes in Common Share
price.
(e) In 2005, the Fund received reimbursements from the investment advisor and
former sub-advisor. This reimbursement had no effect on the Fund's total
return.
(f) Includes current and deferred income taxes associated with each component of
the Statement of Operations. (g) Includes accumulated and unpaid interest.
(h) Calculated by taking the Fund's total assets less the Fund's total
liabilities (not including the Energy
Notes) and dividing by the outstanding Energy Notes in 000's.
(i) 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.
(j) Calculated by taking the Fund's total assets less the Fund's total
liabilities (not including the loan outstanding and the Energy Notes) and
dividing by the loan outstanding in 000's. If this methodology had been used
historically, fiscal year 2007 would have been $16,175 and fiscal year 2004
would remain unchanged.
(k) Initial seed date of June 17, 2004. The Fund commenced operations on June
24, 2004.
(l) Net of sales load of $0.90 per common share on initial
offering.
(m) Annualized.
N/A Not applicable.
-25-
SENIOR SECURITIES
The following table sets forth information about the Fund's outstanding
senior securities as of each fiscal year ended November 30 since the Fund's
inception:
Principal
Total Amount
Principal Asset Coverage Asset and Market
Amount/Liquidation per $1,000 Coverage per Value
Preference Senior Energy Per Energy
Year Title of Security Outstanding Indebtedness Note (b) Note (d)
2004 Borrowings
Total Loan $30,000,000 $ 5,566(a) ____ ____
Outstanding
2005 Energy Notes
Series A (1,360 Notes) $34,000,000 ____ $131,786 $ 25,074
2006 Energy Notes
Series A (1,360 Notes)
Series B (1,000 Notes) $59,000,000 ____ $ 95,699 $ 25,069
2007 Energy Notes
Series A (1,360 Notes)(e) $59,000,000 ____ $ 98,060 $ 25,004
Series B (1,000
Notes) Borrowings
Credit Facility $15,250,000 $ 12,306(a) ____ ____
2008 Energy Notes
Series B (1,000 $25,000,000 ____ $119,880 $ 25,006
Notes)(f)
Borrowings
Credit Facility (g) $ 5,650,000 $ 22,218(c) ____ ____
2009 Borrowings
Credit Facility $45,000,000 $ 4,034(c) ____ ____
(a) 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 000s).
(b) Calculated by taking the Fund's total assets less the Fund's total
liabilities (not including the Energy Notes) and dividing by the outstanding
Energy Notes (in 000s).
(c) Calculated by taking the Fund's total assets less the Fund's total
liabilities (not including the loan outstanding and the Energy Notes) and
dividing by the loan outstanding in 000's. If this methodology had been used
historically, fiscal year 2007 would have been $16,175.
(d) Includes accumulated and unpaid interest.
(e) On April 18, 2008, the Fund redeemed all of the issued and outstanding
Series A Notes.
(f) On March 13, 2009, the Fund redeemed all of the issued and outstanding
Series B Notes.
(g) On January 23, 2009, the Fund repaid in full outstanding borrowings under
the Credit Facility with borrowings under the Commitment Facility.
-26-
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 NYSE Amex (formerly the American Stock
Exchange). The Fund's common shares commenced trading on NYSE Amex on June 25,
2004.
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. The continued development of alternatives as vehicles for investing in a
portfolio of energy infrastructure MLPs, including other publicly traded
investment companies and private funds, may reduce or eliminate any tendency of
the Fund's common shares to trade at a premium in the future. 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 NYSE Amex, 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). Prior to August 1, 2008, net asset value was determined on
each Friday and as of the end of each month. 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
Quarter Ended High Low High Low High Low
September 30, 2004.....................$22.20 $19.60 $20.44 $19.06 8.61% 2.83%
December 31, 2004......................$22.98 $20.60 $21.01 $20.16 9.38% 2.18%
March 31, 2005.........................$24.05 $21.50 $23.12 $21.68 4.02% (0.83)%
June 30, 2005..........................$23.69 $21.49 $22.35 $21.46 6.00% 0.14%
September 30, 2005.....................$24.77 $22.74 $24.23 $24.09 2.23% (5.60)%
December 30, 2005......................$23.85 $20.82 $23.99 $23.34 (0.58)% (10.80)%
March 31, 2006.........................$22.42 $20.40 $23.01 $22.86 (2.56)% (10.76)%
June 30, 2006..........................$21.36 $20.15 $23.33 $23.16 (8.44)% (13.00)%
September 30, 2006.....................$22.56 $20.50 $24.38 $23.41 (7.47)% (12.43)%
December 30, 2006......................$25.55 $21.70 $26.39 $23.92 (3.18)% (9.28)%
March 31, 2007.........................$29.26 $24.22 $28.99 $26.04 0.93% (6.99)%
June 29, 2007..........................$29.90 $27.00 $29.70 $29.82 0.67% (9.46)%
September 28, 2007.....................$29.55 $22.65 $31.27 $27.01 (5.50)% (16.14)%
December 31, 2007......................$26.45 $21.71 $27.82 $25.57 (4.92)% (15.10)%
March 31, 2008.........................$24.60 $21.16 $26.18 $24.49 (6.04)% (13.60)%
June 30, 2008..........................$25.80 $22.36 $25.46 $23.91 1.34% (6.48)%
September 30, 2008.....................$23.33 $18.26 $22.18 $20.71 5.18% (11.83)%
December 31, 2008......................$20.20 $11.21 $19.14 $12.71 5.54% (11.80)%
March 31, 2009.........................$19.04 $14.02 $15.89 $13.76 19.82% 1.89%
June 30, 2009..........................$20.75 $16.83 $18.04 $15.95 15.02% 5.52%
September 30, 2009.....................$22.31 $18.40 $18.48 $16.95 20.73% 8.55%
December 31, 2009......................$25.20 $21.17 $21.00 $19.69 20.00% 7.52%
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 March 3, 2010
were $23.12, $22.03 and 4.95%, respectively. As of March 3, 2010, the Fund had
7,609,755 common shares outstanding and net assets of the Fund were
$167,612,407.
-------------------------------------------------------------------------------
(1) Based on high and low closing market price for the respective quarter.
(2) Based on the net asset value calculated daily as of the close of regular
trading on the NYSE (normally 4:00 p.m. eastern time). Prior to August 1,
2008, net asset value was determined on each Friday and as of the end of
each month.
-27-
THE FUND
The Fund is a non-diversified, closed-end management investment company
registered under the 1940 Act. The Fund was organized as a Massachusetts
business trust on March 25, 2004, pursuant to a Declaration of Trust governed by
the laws of the Commonwealth of Massachusetts. The Fund's investment objective
is to seek a high level of after-tax total return with an emphasis on current
distributions paid to common shareholders. The Fund seeks to provide its common
shareholders with an efficient vehicle to invest in a portfolio of cash-
generating securities of energy companies. On June 29, 2004, the Fund issued
an aggregate of 6,400,000 common shares in its initial public offering.
On May 19, 2009, the Fund entered into a sales agreement with the Advisor,
Sub-Advisor, and JonesTrading pursuant to which the Fund may offer and sell up
to 1,000,000 Common Shares through JonesTrading as its agent. As of March 3,
2010, 259,962 Common Shares have been sold under this sales agreement. In
addition, on February 12, 2010, the Fund entered into an underwriting agreement
with the Advisor, the Sub-Advisor, RBC Capital Markets Corporation and other
underwriters named in the agreement pursuant to which 805,000 Common Shares were
sold (including 105,000 pursuant to an overallotment option), on February 18,
2010 and February 25, 2010, respectively. The Fund's currently outstanding
common shares are, and the Common Shares offered in this prospectus and
applicable prospectus supplement will be, listed on the NYSE Amex under the
symbol "FEN." The Fund's principal office is located at 120 East Liberty Drive,
Suite 400, Wheaton, Illinois 60187.
The following table provides information about the Fund's outstanding
securities as of March 3, 2010:
Amount Held by
Amount the Fund or for Amount
Title of Class Authorized Its Account Outstanding
Common shares................... Unlimited 0 7,609,755
USE OF PROCEEDS
Unless otherwise specified in a prospectus supplement, the Fund will 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. 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 after-tax 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 will invest regardless of the tax character of the distributions. The Fund
seeks to provide its common shareholders with an efficient vehicle to invest in
a portfolio of cash-generating securities of energy companies. The Fund focuses
on investing in publicly traded MLPs and related public entities in the energy
sector which the Fund's Sub-Advisor believes offer opportunities for income and
growth. As used in this prospectus, unless the context requires otherwise, MLPs
are those MLPs in the energy sector. Due to the tax treatment under current law
of cash distributions made by MLPs to their investors (such as the Fund), the
Fund believes that a portion of its income may be tax deferred thereby
increasing cash available for distribution by the Fund to its common
shareholders. There can be no assurance that the Fund will achieve its
investment objective.
The Fund's investment objective is considered fundamental and may not be
changed without common shareholder approval. 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 without the approval
of the holders of a "majority of the outstanding" common shares, provided that
common shareholders 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" shares 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.
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The Fund seeks to achieve its investment objective by investing primarily in
securities of MLPs and MLP-related entities in the energy sector that the
Sub-Advisor believes offer attractive distribution rates and capital
appreciation potential. The Fund also may invest in other securities set forth
below if the Sub-Advisor expects to achieve the Fund's objective with such
investments.
The Fund's policy of investing at least 85% of its Managed Assets (including
assets obtained through leverage) in securities of energy companies, MLPs and
MLP-related entities in the energy sector is non-fundamental.
The Fund has adopted the following additional non-fundamental policies:
o Under normal market conditions, the Fund invests at least 65% and up
to 100% of its Managed Assets in equity securities issued by energy
sector MLPs and MLP-related entities. Equity securities currently
consist of 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.
o The Fund may invest 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
companies. The Fund does not intend to invest more than 35% of its
Managed Assets in such restricted securities, including up to 10% of
its Managed Assets in private companies.
o The Fund may invest up to 25% of its Managed Assets in debt
securities of energy companies, MLPs and MLP related entities,
including certain securities rated below investment grade. Below
investment grade debt securities will be rated at least "B3" by
Moody's and at least "B-" by S&P at the time of purchase, or
comparably rated by another NRSRO or, if unrated, determined to be of
comparable quality by the Sub-Advisor.
o The Fund will not invest more than 10% 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 Financial
Leverage or market risks associated with the Fund's portfolio.
o The Fund may invest up to 15% of its Managed Assets in non-U.S.
securities as well as hedge the currency risk of the non-U.S.
securities using derivative instruments.
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
Under normal market conditions, the Fund invests at least 85% of its Managed
Assets in securities of energy companies and energy sector MLPs and MLP-related
entities. 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, 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.
The Fund concentrates its investments in the energy sector. The Fund pursues
its objective by investing principally in a portfolio of equity securities
issued by MLPs and MLP-related entities. MLP common units historically have
generated higher average total returns than domestic common stock (as measured
by the S&P 500) and fixed income securities. A more detailed description of
investment policies and restrictions and more detailed information about
portfolio investments is contained in the Fund's SAI.
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Energy Companies. The Fund's investments consist of equity and debt
securities issued by energy companies and energy sector MLPs and MLP-related
entities. The companies in which the Fund invests are generally involved in the
business of transporting, processing, storing, distributing or marketing natural
gas, NGLs (including propane), crude oil, refined petroleum products, coal or
electricity, or exploring, developing, managing or producing such commodities or
products, or in supplying energy-related products and services.
Some energy companies operate as "public utilities" or "local distribution
companies," and are therefore subject to rate regulation by state or federal
utility commissions. However, other energy 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. Most Midstream MLPs with pipeline
assets are subject to government regulation concerning the construction, pricing
and operation of pipelines. In many cases, the rules and tariffs charged by
these pipelines are monitored by the Federal Energy Regulatory Commission
("FERC") or various state regulatory agencies.
Master Limited Partnerships. MLPs are limited partnerships whose shares (or
units) are listed and traded on a U.S. securities exchange, just like common
stock. To qualify as an MLP, a partnership must receive at least 90% of its
income from qualifying sources such as natural resource activities. Natural
resource activities include the exploration, development, mining, production,
processing, refining, transportation, storage and marketing of mineral or
natural resources. MLPs generally have two classes of owners, the general
partner and limited partners. The general partner, which is generally a major
energy company, investment fund or the management of the MLP, typically controls
the MLP through a 2% general partner equity interest in the MLP plus common
units and subordinated units. Limited partners own the remainder of the
partnership, through ownership of common units, and have a limited role in the
partnership's operations and management.
MLPs are typically structured such that common units have first priority to
receive quarterly cash distributions up to an established MQD. 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, but 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. The general
partner is also eligible to receive incentive distributions if the general
partner operates the business in a manner which maximizes value to unit holders.
As the general partner increases cash distributions to the limited partners, the
general partner receives an increasingly higher percentage of the incremental
cash distributions. A common arrangement provides that the general partner can
reach a tier where the general partner is receiving 50% of every incremental
dollar paid to common and subordinated unit holders. By providing for incentive
distributions the general partner is encouraged to streamline costs and acquire
assets in order to grow the partnership, increase the partnership's cash flow,
and raise the quarterly cash distribution in order to reach higher tiers. Such
results benefit all security holders of the MLP.
Energy MLPs in which the Fund invests can generally be classified as
Midstream MLPs, Propane MLPs and Coal MLPs.
o Midstream MLP natural gas services include the 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 the 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 may also operate ancillary
businesses including the marketing of the products and logistical
services.
o Propane MLP services include the distribution of propane to
homeowners for space and water heating and to commercial, industrial
and agricultural customers. Propane serves approximately 3% of the
household energy needs in the United States, largely for homes beyond
the geographic reach of natural gas distribution pipelines. Volumes
are weather dependent and a majority of annual cash flow is earned
during the winter heating season (October through March).
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o 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
supply of alternative fuels to generators are the primary drivers of
coal demand.
The Fund also may invest in equity and debt securities of energy companies
that are organized and/or taxed as corporations, including Canadian income
trusts, and may invest in equity and debt securities of MLP-related entities,
such as general partners or other affiliates of MLPs, and in private companies
that operate energy assets.
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.
Equity Securities of MLPs and MLP-Related Entities. Consistent with its
investment objective, the Fund may invest up to 100% of its Managed Assets in
equity securities issued by energy sector 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.
MLP Common Units. MLP common units represent a limited partnership interest
in the MLP. Common units are listed and traded on U.S. securities exchanges or
over-the-counter, with their value fluctuating predominantly based on the
success of an MLP. The Fund intends to purchase 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 have limited voting rights and 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
a quarterly distribution. 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
units, but not debt holders or preferred unit holders, to the remaining assets
of the MLP.
MLP Subordinated Units. MLP subordinated units are typically issued by MLPs
to their original sponsors, such as their founders, corporate general partners
of MLPs, entities that sell assets to the MLP, and institutional investors. The
Fund expects to purchase subordinated units directly from these persons.
Subordinated units have similar voting rights as common units and are generally
not publicly traded. Once the MQD on the common units, including any arrearages,
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 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.
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 receives additional i-units in an amount equal to the
cash distributions received by 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 traded
on the NYSE and the AMEX.
Equity Securities of Energy Companies. The Fund may invest up to 35% of its
Managed Assets in equity securities issued by energy companies. The Fund intends
to purchase these equity securities in market transactions but may also purchase
securities directly from the issuers in private placements.
Debt Securities. The Fund may invest up to 25% of its Managed Assets in debt
securities of energy companies, MLPs and MLP-related entities, including
securities rated below investment grade. The debt securities in which the Fund
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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 obligation 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 or "B3" by Moody's or a
comparable rating by another NRSRO or, if unrated, 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 any offering of Common Shares
offered hereby 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
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
Covered Call Option Transactions. 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 option is
"covered" if the Fund owns the security underlying the call or has an absolute
and immediate right to acquire that security without additional cash
consideration (or, if additional cash consideration is required, cash or other
assets determined to be liquid by the Sub-Advisor (in accordance with procedures
approved by the Board of Trustees) in such amount are segregated by the Fund's
custodian) upon conversion or exchange of other securities held by the Fund.
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.
See "Tax Matters."
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 Financial Leverage by the Fund, to facilitate
portfolio management and mitigate risks, including interest rate, currency and
credit risks. The Fund may write (or sell) covered call options on the common
stock of energy companies held in the Fund's portfolio. Hedging and strategic
transactions are generally accepted under modern portfolio management theory and
are regularly used by many investment companies and other institutional
-32-
investors. Although the Sub-Advisor seeks to use such practices to further the
Fund's investment objective, no assurance can be given that these practices will
achieve this result.
The Fund may purchase and sell derivative investments 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 or collars or credit transactions and credit default
swaps. The Fund also may purchase derivative investments 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 Financial Leverage issued by the Fund, or establish
positions in the derivatives markets as a temporary substitute for purchasing or
selling particular securities.
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.
See "Risks - Derivatives Risk" in the prospectus and "Investment Policies
and Techniques" in the Fund's 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 30% under normal
circumstances, but may be higher or lower in certain periods. For the fiscal
year ended November 30, 2009, the Fund's portfolio turnover rate was
approximately 43%. However, 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 increase the Fund's tax
liability and thereby lower the after-tax dividends of the Fund. 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."
USE OF FINANCIAL LEVERAGE
The Fund is currently engaged in, and may in the future engage in, the use
of Financial Leverage to seek to enhance the level of its current distributions
to common shareholders. The Fund may borrow (by use of commercial paper, notes
and/or other Borrowings) an amount up to 33(1)/3% (or such other percentage to
the extent permitted by the 1940 Act) of its Managed Assets (including the
amount borrowed) less all liabilities other than borrowings. The Fund may also
issue Preferred Shares in an amount up to 50% of the Fund's Managed Assets
(including the proceeds of the Preferred Shares and any borrowings). As of March
3, 2010, the Fund utilized leverage in an amount equal to approximately 26% of
the Fund's Managed Assets. Borrowings, commercial paper or notes and Preferred
Shares are each considered a "Leverage Instrument" and collectively, the
"Leverage Instruments." Leverage Instruments have seniority in liquidation and
distribution rights over the Fund's common shares.
On January 28, 2005, the Fund issued $34 million principal amount of auction
rate senior notes due March 2, 2045 (the "Series A Notes") and on March 26,
2006, issued $25 million principal amount of auction rate senior notes due March
20, 2046 (the "Series B Notes") each of which were rated "Aaa" and "AAA" by
Moody's and Fitch, respectively. On March 26, 2008, the Fund established a
Credit Facility with The Bank of Nova Scotia, of which $34 million was used to
redeem the issued and outstanding Series A Notes. On January 23, 2009, the Fund
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entered into a $60,000,000 commitment facility agreement with BNP Paribas Prime
Brokerage Inc. (the "Commitment Facility"), which was used to repay in full
outstanding borrowings under the Credit Facility and, on February 26, 2009, to
deposit funds to redeem the issued and outstanding Series B Notes. All of the
issued and outstanding Series B Notes were redeemed on March 13, 2009. On March
2, 2010, the Fund and BNP Paribas Prime Brokerage, Inc. amended the Commitment
Facility to increase the commitment amount to $70,000,000.
The Fund may, in the future, incur additional Borrowings, issue additional
series of notes or other senior securities to the extent permitted by the 1940
Act. The Fund's common shares, including the Common Shares, are junior in
liquidation and distribution rights to Borrowings under the Commitment Facility.
The issuance of debt and Preferred Shares, including Borrowings under the
Commitment Facility, represent the leveraging of the Fund's common shares. The
issuance of additional Common Shares offered by this prospectus and an
applicable prospectus supplement will enable the Fund to increase the aggregate
amount of its leverage. The use of leverage creates an opportunity for increased
income and capital appreciation for common shareholders, but at the same time,
it creates special risks that may adversely affect common shareholders. Because
both the Advisor's and Sub-Advisor's fees are based on Managed Assets (including
assets obtained through leverage), both the Advisor's and Sub-Advisor's fees are
higher when the Fund is leveraged. There can be no assurance that a leveraging
strategy will be successful during any period in which it is used.
It is possible that the Fund will be unable to obtain additional Financial
Leverage. The capital and credit markets have recently experienced extreme
volatility and disruption. Such volatility and disruption generally reduces the
availability of credit. The availability of Financial Leverage will depend on a
variety of factors, such as market conditions, the general availability of
credit, the volume of trading activities, the overall availability of credit to
the closed-end management investment companies, the Fund's credit ratings and
credit capacity, the Fund's asset class, as well as the possibility that lenders
could develop a negative perception of the Fund's long- or short-term financial
prospects if the Fund incurs large investment losses due to a market downturn.
Similarly, the Fund's access to Financial Leverage may be impaired if regulatory
authorities or rating agencies take negative actions against the Fund. The Fund
may not be able to successfully obtain additional Financial Leverage on
favorable terms, or at all. In the current economic environment, it has become
more difficult for borrowers, including the Fund, to find third parties willing
to extend credit or purchase securities that would constitute Financial
Leverage. If the Fund is unable to increase Financial Leverage after the
issuance of additional Common Shares pursuant to this prospectus and an
applicable prospectus supplement, there could be an adverse impact on the return
to common shareholders.
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 Leverage Instruments
have complete priority upon distribution of assets over common shares. The
issuance of Leverage Instruments leverages the common shares. Although based on
recommendations by the Advisor and the Sub-Advisor, the determination of whether
to utilize Financial Leverage as well as timing and other terms of the offering
of Leverage Instruments and the terms of the Leverage Instruments, would be
determined by the Fund's Board of Trustees. The Fund expects to invest the net
proceeds derived from any future Leverage Instrument offering according to the
investment program described in this prospectus. 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 Leverage Instrument, after taking expenses into
consideration, the leverage will cause common shareholders to receive a higher
rate of income than if the Fund were not leveraged.
Leverage creates risk for holders of the common shares, 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 holders of the common shares or will result in fluctuations in the
dividends paid on the common shares. To the extent total return 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 Sub-Advisor 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 than the costs of leverage, which would
enhance returns to common shareholders. The fees paid to the Advisor and
-34-
Sub-Advisor will be calculated on the basis of the Fund's Managed Assets
including proceeds from Borrowings for leverage and the issuance of Preferred
Shares. During periods in which the Fund is utilizing Financial Leverage, the
investment advisory fee payable to the Advisor, and the sub-advisory fee payable
by the Advisor to the Sub-Advisor, will be higher than if the Fund did not
utilize a leveraged capital structure. The use of leverage creates risks and
involves special considerations. See "Risks-Leverage Risk."
The Fund's 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) 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% (33(1)/3% of
Managed Assets after borrowings). With respect to such borrowings, asset
coverage means the ratio which the value of the Managed 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
represented by senior securities issued by the Fund.
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. 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. In
the event that the Fund elects to be treated as a regulated investment company,
and that such provisions would impair the Fund's status as a regulated
investment company under the Internal Revenue Code, the Fund, subject to its
ability to liquidate its relatively illiquid portfolio, intends to repay the
borrowings.
Certain types of Borrowings may result in the Fund being subject to
covenants in credit agreements including covenants relating to asset coverage
and portfolio composition requirements. The Fund may be subject to certain
restrictions on investments imposed by guidelines of one or more rating
agencies, which may issue ratings for the short-term corporate 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. In addition, the loan documents under the
Commitment Facility include customary provisions including a restriction on the
Fund's ability to pledge its assets and contains customary events of default
including failure of the Fund to meet the asset coverage test of the 1940 Act
described below. There is no assurance that the Fund will not violate asset
coverage covenants relating to the Commitment 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.
The Commitment Facility can be used by the Fund for general corporate
purposes, including for financing a portion of the Fund's investments. The
Commitment Facility is secured by a first priority perfected security interest
in the assets of the Fund. In addition, the loan documents under the Commitment
Facility restrict the Fund's ability to change its investment advisor,
sub-advisor or custodian, amend its fundamental investment policies or
fundamental investment objectives, or take on additional indebtedness without
prior consent from the provider of the Commitment Facility.
If Preferred Shares are issued they could pay adjustable rate dividends
based on shorter-term interest rates or a fixed rate. In the event the dividends
are paid at adjustable rates, the adjustment period for Preferred Shares
dividends could be as short as one day or as long as a year or more.
Under the 1940 Act, the Fund is not permitted to issue Preferred Shares
unless immediately after such issuance the value of the Fund's managed assets 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 Managed 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 Managed Assets is at least 200% of such liquidation value.
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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 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, if any, 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 Commitment Facility
represented approximately 26% of Managed Assets as of March 3, 2010. Asset
coverage with respect to the Borrowings under the Commitment Facility was 383%
and the Fund had $10,700,000 of unutilized funds available for Borrowing under
the Commitment Facility as of that date. Outstanding balances under the
Commitment Facility generally accrue interest at a variable annual rate equal to
the three-month LIBOR plus 1.50%. As of March 3, 2010, the rate was 1.73%. As of
March 3, 2010, the Fund had $59,300,000 outstanding under the Commitment
Facility. The Commitment Facility also has an annual unused fee of 0.80% on the
unutilized funds available for borrowing. The total annual interest and fee rate
as of March 3, 2010 was 1.59%.
Assuming that the Fund's leverage costs remain as described above (at an
assumed average annual cost of 2.53%), the annual return that the Fund's
portfolio must experience (net of expenses) in order to cover its leverage costs
would be 0.50%.
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 26% of the Fund's Managed
Assets, net of expenses, and the Fund's current annual leverage interest and fee
rate of 1.59%.
Assumed Portfolio Total Return (Net of Expenses)........ -10% -5% 0% 5% 10%
Common Share Total Return .............................. -14.22% -7.45% -0.68% 6.09% 12.86%
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
Instruments) 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. For example, to
assume a total return of 0% the Fund must assume that the distributions it
receives on its investments is entirely offset by losses in the value of those
securities.
While the Fund is using leverage, the amount of the fees paid to both the
Advisor and 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 the Fund's Managed Assets, which include assets purchased
with leverage. 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
-36-
other. 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.
RISKS
General
Risk is inherent in all investing. The following discussion summarizes some
of the risks that a Common Shareholder should consider before deciding whether
to invest in the Fund. For additional information about the risks associated
with investing in the Fund, see "Additional Information About the Fund's
Investments and Investment Risks" in the Fund's SAI.
Investment and Market Risk
An investment in the Fund's Common Shares is subject to investment risk,
including the possible loss of the entire principal amount that you invest. Your
investment in Common Shares represents an indirect investment in the securities
owned by the Fund, substantially all of which are traded on a national
securities exchange or in the over-the-counter markets. An investment in the
Fund's Common Shares is not intended to constitute a complete investment program
and should not be viewed as such. 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.
The Fund's performance was adversely impacted by the weakness in the credit
markets and broad stock market, and the resulting rapid and dramatic declines in
the value of MLPs that occurred beginning in late 2008, and may again be
adversely affected due to weaknesses in the credit and stock markets. If the
Fund's net asset value declines or remains volatile, there is an increased risk
that the Fund may be required to reduce outstanding leverage, which could
adversely affect the price of the Fund's common shares and ability to pay
distributions at historical levels. A sustained economic slowdown may adversely
affect the ability of MLPs to sustain their historical distribution levels,
which in turn, may adversely affect the Fund's ability to sustain distributions
at historical levels. MLPs that have historically relied heavily on outside
capital to fund their growth have been impacted by the slowdown in the capital
markets. The sustained recovery of the MLP sector is dependent on several
factors, including the sustained recovery of the financial sector, the general
economy and the commodity markets.
In response to the financial crises affecting the banking system and
financial markets and going concern threats to investment banks and other
financial institutions, the U.S. and foreign governments have intervened to an
unprecedented degree in the financial and credit markets. Among other things,
U.S. government regulators have encouraged, and in some cases structured and
provided financial assistance for, banks, securities firms, insurers and other
financial companies. Additional intervention programs have been adopted and
proposed which will have a further impact on the securities markets.
Many of the recently enacted or proposed government measures are far-
reaching and without historical precedent. Furthermore, the U.S. government
has stated its willingness to implement additional measures as it may see fit to
address changes in market conditions. There can be no assurance that any or all
of these measures will succeed in stabilizing and providing liquidity to the
U.S. financial markets, including the extreme levels of volatility recently
experienced. Such volatility could materially and adversely affect the Fund's
financial condition, the performance of its investments and the trading price
of its common shares.
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 by increasing the number of shares available, which may put
-37-
downward pressure on the market price for the Fund's common shares. These sales
also might make it more difficult for us to sell additional equity securities in
the future at a time and price the Fund deems appropriate.
Management Risk
The Fund is subject to management risk because it is an actively managed
portfolio. The Advisor and Sub-Advisor will 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.
Energy Sector Risk
The Fund's investments will generally be concentrated in the energy sector,
with a particular concentration in energy sector MLPs and MLP-related entities.
Certain risks inherent in investing in the energy business of these types of
securities include the following:
o Commodity Pricing Risk. MLPs, MLP-related entities and energy
companies may be directly affected by energy commodity prices,
especially those energy companies who own the underlying energy
commodity. Commodity prices fluctuate for several reasons including,
changes in market and economic conditions, the impact of weather on
demand, levels of domestic production and imported commodities, energy
conservation, domestic and foreign governmental regulation and
taxation and the availability of local, intrastate and interstate
transportation systems. Volatility of commodity prices which leads to
a reduction in production or supply may also impact the performance of
MLPs, MLP-related entities and energy companies that are solely
involved in the transportation, processing, storing, distribution or
marketing of commodities. Volatility of commodity price may also make
it more difficult for MLPs, MLP-related entities and energy companies
to raise capital to the extent the market perceives that their
performance may be directly tied to commodity prices.
o Supply and Demand Risk. 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 financial performance
of MLPs, MLP-related entities and energy 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 or depressed commodity prices. Alternatively, a
sustained decline in demand for such commodities could also impact the
financial performance of MLPs, MLP-related entities and energy
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. A continuation of reduced demand for
energy commodities as a result of the economic recession may further
reduce the financial performance of the entities in which the Fund
invests.
o Depletion and Exploration Risk. MLPs, MLP-related entities and energy
companies 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. MLPs,
MLP-related entities and energy companies generally increase reserves
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 energy
companies.
o Regulatory Risk. MLPs, MLP-related entities and energy companies are
subject to significant federal, state and local government regulation
in virtually every aspect of their operations, including how
facilities are constructed, maintained and operated, environmental and
-38-
safety controls, and the prices they may charge for products and
services. 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 energy
companies.
o Interest Rate Risk. Rising interest rates could adversely impact the
financial performance of MLPs, MLP-related entities and energy
companies. Rising interest rates may increase an MLP's, MLP-related
entity's or energy company's cost of capital, which would increase
operating costs and may reduce an MLP's, MLP-related entity's or
energy 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 company
shares as the yields on alternative investments increase.
o Acquisition or Reinvestment Risk. The ability of MLPs to grow and to
increase distributions to unitholders is dependent in part on their
ability to make acquisitions or find organic projects that result in
an increase in adjusted operating surplus per unit. In the event that
MLPs 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 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 surplus per unit. As MLP general
partners typically receive a greater percentage of increased cash
distributions, in an effort to increase cash distributions the general
partner may make acquisitions/projects which, due to various factors,
including increased debt obligations as well as the factors set forth
below, may adversely affect the MLP. 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. A few of the Midstream MLPs are dependent on
their parents or sponsors for a majority of their revenues. Any
failure by the parents or sponsors to satisfy their payments or
obligations would impact the MLPs' revenues and cash flows and ability
to make distributions.
o Catastrophe Risk. The operations of MLPs, MLP-related entities and
energy 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 the
exploring, managing or producing of such commodities, 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; fires 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 energy 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. The terrorist attacks in the United
States on September 11, 2001 had a disruptive effect on the securities
markets. U.S. military and related action in Iraq is ongoing and
events in the Middle East could have significant adverse effects on
the U.S. economy and the stock market. Uncertainty surrounding
retaliatory military strikes or a sustained military campaign may
affect energy company operations in unpredictable ways, including
disruptions of fuel supplies and markets, and transmission and
distributions facilities could be direct targets, or indirect
casualties, of an act of terror. Since the September 11th attacks, the
U.S. government has issued warnings that energy assets, specifically
the U.S. pipeline infrastructure, may be the future target of
terrorist organizations. In addition, changes in the insurance markets
-39-
attributable to the September 11th attacks have made certain types of
insurance more difficult, if not impossible, to obtain and have
generally resulted in increased premium costs.
o 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. In addition, there are certain tax risks associated with
an investment in MLP units and conflicts of interest exist between
common unit holders and the general partner, including those arising
from incentive distribution payments.
Industry Specific Risk
MLPs, MLP-related entities and energy companies are also subject to risks
that are specific to the industry they serve.
o Midstream MLPs, MLP-related entities and energy 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 Propane MLPs and MLP-related entities 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 energy 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.
Cash Flow Risk
A substantial portion of the cash flow received by the Fund is derived from
its investment in equity securities of MLPs and MLP-related entities. The amount
of cash an MLP or MLP-related entity has available for distributions and the tax
character of such distributions is dependent upon the amount of cash generated
by the MLP's or MLP-related entity's operations. Cash available for distribution
will vary from quarter to quarter and is largely dependent on factors affecting
the MLP's or MLP-related entity's operations and factors affecting the energy
industry in general. In addition to the risk factors described above, other
factors which may reduce the amount of cash an MLP or MLP-related entity has
available for distribution include increased operating costs, capital
expenditures, acquisition costs, expansion, construction or exploration costs
and borrowing costs.
Tax Risk
The Fund's ability to meet its investment objective depends on the level of
taxable income and distributions it receives from the MLP, MLP-related entities
and energy company securities in which the Fund invests, a factor over which the
Fund has no control. The benefit the Fund derives from its investment in MLPs is
largely dependent on their being treated as partnerships for federal income tax
purposes. As a partnership, an MLP has no income tax liability at the entity
level. If, as a result of a change in an MLP's business, an MLP were treated as
a corporation for federal income tax purposes, such MLP would be obligated to
pay federal income tax on its income at the applicable corporate tax rate. If an
MLP was classified as a corporation for federal income tax purposes, the amount
of cash available for distribution with respect to the units would be reduced
and any such distributions received by the Fund would be taxed entirely as
dividend income if paid out of the earnings of the MLP. Therefore, treatment of
an MLP as a corporation for federal income tax purposes would result in a
material reduction in the after-tax return to the Fund, likely causing a
substantial reduction in the value of the common shares.
-40-
Tax Law Change Risk
Changes in tax laws or regulations, or interpretations thereof in the
future, could adversely affect the Fund or the MLPs in which it invests. Any
such changes could negatively impact the Fund and its common shareholders. For
example, if, by reason of a change in law or otherwise, an MLP in which the Fund
invests is treated as a corporation rather than a partnership, the MLP would be
subject to entity level corporate taxation and any distributions received by the
Fund would be treated as dividend income. This would negatively impact the
amount and tax characterization of distributions received by common
shareholders.
Deferred Tax Risk
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 tax
deductions. The Fund will incur a current tax liability on that portion of an
MLP's income that is not offset by tax deductions, with the remaining portion of
the distribution being treated as a tax-deferred return of capital. The
percentage of an MLP's income which is offset by tax deductions will fluctuate
over time for various reasons. A significant slowdown in acquisition or
investment activity by MLPs held in the Fund's portfolio 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 gains as a
result of the sale of portfolio securities will reduce that portion of the
Fund's distribution treated as a tax-deferred return of capital and increase
that portion treated as dividend income, resulting in reduced Fund distributions
and lower after-tax distributions to the Fund's common shareholders. For
purposes of computing net asset value, the Fund will accrue deferred income
taxes for its future tax liability associated with that portion of MLP
distributions considered to be tax-deferred return of capital as well as capital
appreciation of its investments. The Fund will rely to some extent on
information provided by 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. From time to time the Fund will modify its estimates
and/or assumptions regarding its deferred tax liability as new information
becomes available.
Delay in Investing the Proceeds of this Offering
Although the Fund currently intends to invest the proceeds of any sales of
Common Shares as soon as practicable following the completion of the offering,
such investments may be delayed if suitable investments are unavailable at the
time or if the Fund is unable to secure firm commitments for direct placements.
The trading market and volumes for MLP, MLP-related entity and energy company
shares may at times be less liquid than the market for other securities. As a
result, it is not anticipated that the Fund will be fully invested immediately
after the completion of the offering and it may take a period of time before the
Fund is able to accumulate positions in certain securities. Prior to the time
the proceeds of this offering are fully invested, such proceeds may be invested
in cash, cash equivalents or other securities, pending investment in MLP,
MLP-related entity or energy company securities. Income received by the Fund
from these securities would subject the Fund to corporate tax before any
distributions to Common Shareholders. As a result, the return and yield on the
Common Shares in the period following any offering pursuant to this prospectus
and applicable prospectus supplement 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 common 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
energy 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 MLP units and other equity
securities may be particularly sensitive to rising interest rates given their
yield-based nature.
Certain of the MLPs, MLP-related entity and other energy companies in which
the Fund may invest may have comparatively smaller capitalizations than other
companies. Investing in securities of smaller MLPs, MLP-related entities and
-41-
energy companies presents some unique investment risks. These MLPs, MLP-related
entities and energy 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 energy
companies and may be more vulnerable to adverse general market or economic
developments. Stocks of smaller MLPs, MLP-related entities and energy companies
may be less liquid than those of larger MLPs, MLP-related entities and energy
companies and may experience greater price fluctuations than larger energy
companies. In addition, small-cap securities may not be widely followed by the
investment community, which may result in reduced demand.
A few of the Midstream MLPs are dependent on their parents or sponsors for a
majority of their revenues. Any failure by the parents or sponsors to satisfy
their payments or obligations would impact the MLPs' revenues and cash flows and
ability to make distributions.
MLP subordinated units in which the Fund will invest generally convert to
common units at a one-to-one ratio. The purchase or sale price of subordinated
units 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.
The Fund invests, and may in the future invest, in I-Shares which represent
an indirect investment in MLP i-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.
Leverage Risk
The Fund may borrow an amount up to 33(1)/3% (or such other percentage to
the extent permitted by the 1940 Act) of its Managed Assets (including the
amount borrowed) less all liabilities other than borrowings. The Fund may also
issue Preferred Shares in an amount up to 50% of the Fund's Managed Assets
(including the proceeds of the Preferred Shares and any borrowings). As of March
3, 2010, the principal amount of Borrowings under the Commitment Facility
represented approximately 26% of the Fund's Managed Assets. As of March 3, 2010,
the Fund had $10.7 million of unutilized funds available for Borrowing under the
Commitment Facility. Such Borrowings and the issuance of Preferred Shares are
referred to in this prospectus collectively as "leverage." The successful use of
leverage depends on the Sub-Advisor's ability to predict or hedge correctly
interest rate and market movements. Although the use of leverage by the Fund may
create an opportunity for increased returns for the common shares, it also
results in additional risks and 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 or gains from the securities and investments purchased with such proceeds
does not cover the cost of leverage, the return to the common shares will be
less than if leverage had not been used. There is no assurance that a leveraging
strategy will continue to be used or will be successful. Leverage involves risks
and special considerations for common shareholders including:
o the likelihood of greater volatility of net asset value 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 net asset value 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 financial leverage, the investment advisory fee
payable to the Advisor, and the sub-advisory fee payable by the
Advisor to the Sub-Advisor, will be higher than if the Fund did not
use leverage.
The issuance of Leverage Instruments by the Fund, in addition to Borrowings
under the Commitment Facility, would involve offering expenses and other costs,
including interest or dividend payments, which would be borne indirectly by the
-42-
common shareholders. Increased operating costs, including the financing cost
associated with any leverage, may reduce the Fund's total return.
The Board of Trustees, in its judgment, nevertheless may determine to
continue to use leverage if it expects that the benefits to the Fund's common
shareholders of maintaining the leveraged position will outweigh the current
reduced return.
The funds borrowed pursuant to a borrowing program (such as a credit line or
commercial paper program), 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. 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 certain asset coverage 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 MLP units and other assets of the Fund)
and, if any such default is not cured, the lenders may be able to control the
liquidation as well. Certain types of leverage may result in the Fund being
subject to covenants relating to asset coverage and the Fund's 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 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 net asset value 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.
In addition, recent turmoil in the credit markets have adversely impacted
borrowing availability and costs. These market developments have increased, and
may continue to increase, the financing costs of the Fund. Because common
shareholders indirectly 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.
Certain types of Borrowings may result in the Fund being subject to
covenants in credit agreements relating to asset coverage and portfolio
composition requirements. The Fund may be subject to certain restrictions on
investments imposed by guidelines of one or more rating agencies, which may
issue ratings for the short-term corporate 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. In addition, the loan documents under the Commitment Facility include
customary provisions including a restriction on the Fund's ability to pledge its
assets and contains customary events of default including failure of the Fund to
meet the asset coverage test of the 1940 Act described below. There is no
assurance that the Fund will not violate financial covenants relating to the
Commitment Facility or other 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
-43-
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.
It is possible that the Fund will be unable to obtain additional Financial
Leverage. The capital and credit markets have recently experienced extreme
volatility and disruption. The availability of Financial Leverage will depend on
a variety of factors, such as market conditions, the general availability of
credit, the volume of trading activities, the overall availability of credit to
the closed-end management investment companies, the Fund's credit ratings and
credit capacity, the Fund's asset class, as well as the possibility that lenders
could develop a negative perception of the Fund's long- or short-term financial
prospects if the Fund incurs large investment losses due to a market downturn.
Similarly, the Fund's access to Financial Leverage may be impaired if regulatory
authorities or rating agencies take negative actions against the Fund. The Fund
may not be able to successfully obtain additional Financial Leverage on
favorable terms, or at all. In the current economic environment, it has become
more difficult for borrowers, including the Fund, to find third parties willing
to extend credit or purchase securities that would constitute Financial
Leverage. If the Fund is unable to increase Financial Leverage after the
issuance of additional Common Shares pursuant to this prospectus and applicable
prospectus supplement, there could be an adverse impact on the return to common
shareholders.
With respect to a borrowing program instituted by the Fund, the credit
agreements governing such a program, including the Commitment Facility, includes
usual and customary covenants for this type of transaction, including, but not
limited to, limits on the Fund's ability to: (i) issue Preferred Shares; (ii)
incur liens or pledge portfolio securities or investments; (iii) change its
investment objective or fundamental investment restrictions without the approval
of lenders; (iv) make changes in any of its business objectives, purposes or
operations that could result in a material adverse effect; (v) make any changes
in its capital structure; (vi) amend the Fund documents in a manner which could
adversely affect the rights, interests or obligations of any of the lenders;
(vii) engage in any business other than the business currently engaged in;
(viii) create, incur, assume or permit to exist certain debt except for certain
specific types of debt; and (ix) permit any of its Employee Retirement Income
Security Act ("ERISA") affiliates to cause or permit to occur an event that
could result in the imposition of a lien under the Internal Revenue Code or
ERISA. In addition, the Commitment Facility does not permit the Fund's asset
coverage ratio (as defined in the Commitment Facility) to fall below 300% at any
time.
Under the requirements of the 1940 Act, the Fund must have asset coverage of
at least 300% immediately after any borrowing, including borrowing under any
borrowing program the Fund implements. For this purpose, asset coverage means
the ratio which the value of the total assets of the Fund, less liabilities and
indebtedness not represented by senior securities, bears to the aggregate amount
of borrowings represented by senior securities issued by the Fund. The
Commitment Facility limits the Fund's ability to pay dividends or make other
distributions on the Fund's common shares unless the Fund complies with the 300%
asset coverage test. In addition, the Commitment Facility does not permit the
Fund to declare dividends or other distributions or purchase or redeem common
shares or Preferred Shares: (i) at any time that any event of default under the
Commitment Facility has occurred and is continuing; or (ii) if, after giving
effect to such declaration, the Fund would not meet the Commitment Facility's
300% asset coverage test set forth in the credit agreements governing the
Commitment Facility. To the extent necessary, the Fund intends to repay
indebtedness to maintain the required asset coverage. Doing so may require the
Fund to liquidate portfolio securities at a time when it would not otherwise be
desirable to do so.
Derivatives Risk
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 transaction 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.
-44-
There are several risks associated with transactions in options on
securities. For example, there are significant differences between the
securities and options markets that could result in an imperfect correlation
between these markets, causing a given transaction not to achieve its
objectives. A decision as to whether, when and how to use options involves the
exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events. As
the writer of a covered call option, the Fund forgoes, during the option's life,
the opportunity to profit from increases in the market value of the security
covering the call option above the sum of the premium and the strike price of
the call but has retained the risk of loss should the price of the underlying
security decline. The writer of an option has no control over the time when it
may be required to fulfill its obligation as a writer of the option. Once an
option writer has received an exercise notice, it cannot effect a closing
purchase transaction in order to terminate its obligation under the option and
must deliver the underlying security at the exercise price.
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 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 or commodity 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 Financial Leverage, the Fund may be required to redeem or
prepay some or all of the Financial 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 intends to maintain, 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.
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 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
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. 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.
-45-
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
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.
The use of interest rate and commodity swaps and caps 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 or caps could enhance
or harm the overall performance of the common shares. For example, the Fund may
utilize interest rate swaps and caps in connection with the Fund's use of
Financial Leverage. To the extent there is a decline in interest rates, the
value of the interest rate swap or cap could decline, and could result in a
decline in the net asset value 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. Buying
interest rate caps could enhance the performance of the common shares by
providing a maximum leverage expense. Buying interest rate caps could also
decrease the net earnings of the common shares in the event that the premium
paid by the Fund to the counterparty exceeds the additional amount the Fund
would have been required to pay had it not entered into the cap agreement. The
Fund has no current intention of selling an interest rate swap but is expected
to enter into an interest rate cap.
Interest rate and commodity swaps and caps do not involve the delivery of
securities or other underlying assets or principal. Accordingly, the risk of
loss with respect to interest rate and commodity 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 or cap to offset any declines in the value of the Fund's
portfolio assets being hedged or the increase in the Fund's cost of Financial
Leverage. Depending on whether the Fund would be entitled to receive net
payments from the counterparty on the swap or cap, which in turn would depend on
the general state of the market rates at that point in time, such a default
could negatively impact the performance of the common shares.
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 30% under normal circumstances, but may be
higher or lower in certain periods. For the fiscal year ended November 30, 2009,
portfolio turnover was approximately 43%. 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 to the Fund. A high portfolio turnover may
-46-
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."
Restricted Securities
The Fund invests, and may in the future invest, in unregistered or otherwise
restricted securities. The term "restricted securities" refers to securities
that have not been registered under the 1933 Act or are 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 acquiror 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
stocks of certain energy companies trade on the NYSE, NYSE Amex and The NASDAQ
Stock Market, certain securities may trade less frequently, particularly those
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, derivatives transactions or
leverage restrictions, the Fund may have difficulty selling these investments in
a timely manner, be forced to sell them for less than the Fund 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 lowest 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.
Valuation Risk
Market prices may not be readily available for subordinated units, direct
ownership of general partner interests, restricted securities or unregistered
securities of certain MLPs, MLP-related entities or private companies, 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 will rely 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 and to estimate
associated deferred tax liability for purposes of financial statement reporting
and determining the Fund's net asset value. From time to time the Fund will
modify its estimates and/or assumptions 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. See
"Net Asset Value."
-47-
Interest Rate Risk
Interest rate risk is the risk that equity and debt securities will decline
in value because of changes in market interest rates. The Fund's investment in
such securities means that the net asset value and market price of the common
shares will tend to decline if market interest rates rise. Interest rates are at
or near historic lows, and as a result, they are likely to rise over time.
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 their debt instruments with lower yielding debt
instruments if the credit standing of the issuer improves. To the extent the
Fund's debt securities are called or redeemed, the Fund may be forced to
reinvest in lower yielding securities.
Below Investment Grade Securities Risk
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. As of February 28, 2010, the
Fund did not invest in any below investment grade securities. Below investment
grade securities, also sometimes referred to as "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 energy 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.
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
-48-
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.
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.
Non-Diversification
The Fund is a non-diversified, closed-end management investment company
under the 1940 Act and will not be treated as a regulated investment company
under the Internal Revenue Code. Accordingly, there are no regulatory
requirements under the 1940 Act or the Internal Revenue Code on the minimum
number or size of securities held by the Fund. As of February 28, 2010, there
were approximately sixty-seven (67) publicly traded MLPs, approximately 80% of
which operate energy assets. The Fund intends to select its MLP investments from
this small pool of issuers. The Fund may invest in securities of MLP-related
entities and non-MLP securities issued by energy companies, consistent with its
investment objective and policies. As of February 28, 2010, the Fund held
investments in thirty-four (34) MLP issuers.
Market Disruption Risk
The terrorist attacks in the United States on September 11, 2001 had a
disruptive effect on the securities markets. U.S. military and related action
in Iraq is ongoing and events in the Middle East could have significant adverse
effects on the U.S. economy and the stock market. The Fund cannot predict the
effects of similar events in the future on the U.S. economy.
Anti-Takeover Provisions
The Fund's Declaration 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."
Competition Risk
There exist other alternatives to the Fund as a vehicle for investment in a
portfolio of MLPs, including other publicly traded investment companies and
private funds. In addition, recent tax law changes or future tax law changes may
increase the ability of regulated investment companies or other institutions to
invest in MLPs. Because of the limited number of MLP issuers, these competitive
conditions may adversely impact the Fund's ability to make investments in the
MLP market and could adversely impact the Fund's distributions to common
shareholders.
Potential Tax Changes
In addition to the specific tax risks and matters discussed elsewhere in
this prospectus, the President of the United States has indicated a desire to
make significant changes to the Internal Revenue Code. The Fund has no way of
knowing whether such changes of the Internal Revenue Code might occur or, if
enacted, what effect such changes might have on the Fund's common shareholders
or the MLPs and MLP-related entities in which the Fund invests.
Market Discount From Net Asset Value
The Fund's common shares have been publicly traded since June 24, 2004 and
have traded both at a premium and at a discount relative to net asset value.
There is no assurance that any premium of the public offering price for the
Common Shares in any offering made hereby will continue after such offering or
that the common shares will not again trade at a discount. Shares of closed-end
investment companies frequently trade at a discount from their net asset value.
This characteristic is a risk separate and distinct from the risk that the
Fund's net asset value could decrease as a result of its investment activities
and may be greater for investors expecting to sell their Common Shares in a
-49-
relatively short period following completion of this offering. 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 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 will be affected by factors such as net asset value,
dividend or distribution levels (which are dependent, in part, on expenses),
supply of and demand for the common shares, stability of dividends or
distributions, trading volume of the common shares, general market and economic
conditions, and other factors beyond the control of the Fund, the Fund cannot
predict whether the Common Shares will trade at, below or above net asset value
or at, below or above the price at which shares may be offered in any offering
pursuant to this prospectus.
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.
Certain Affiliations
Certain broker-dealers may be considered to be affiliated persons of the
Fund, First Trust Advisors or Energy Income Partners. Absent an exemption from
the SEC or other regulatory relief, the Fund is generally precluded from
effecting certain principal transactions with affiliated brokers, and its
ability to utilize affiliated brokers for agency transactions, is subject to
restrictions. This could limit the Fund's ability to engage in securities
transactions and take advantage of market opportunities. In addition, until the
underwriting syndicate is broken in connection with any public offering of the
Common Shares offered by this prospectus, the Fund will be precluded from
effecting principal transactions with brokers who are members of the syndicate.
MANAGEMENT OF THE FUND
Trustees and Officers
The Board of Trustees is responsible for the general supervision of the
duties performed by the Advisor and the Sub-Advisor. 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, 120 East Liberty Drive, Suite 400, Wheaton, Illinois
60187, is the investment advisor to the Fund and is responsible for supervising
the Sub-Advisor. First Trust Advisors serves as investment advisor or portfolio
supervisor to investment portfolios with approximately $28 billion in assets
which it managed or supervised as of February 28, 2010.
First Trust Advisors is also responsible for the ongoing monitoring of the
Fund's investment portfolio, managing the Fund's business affairs and providing
certain clerical, bookkeeping and other administrative services.
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, as amended. First Trust Advisors 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 interests. The
Charger Corporation is an Illinois corporation controlled by the Robert Donald
Van Kampen family. First Trust Advisors is controlled by Grace Partners and The
Charger Corporation.
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For additional information concerning First Trust Advisors, including a
description of the services provided, see the SAI under "Investment Advisor."
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 49 Riverside Avenue, Westport,
Connecticut 06880, is a registered investment advisor and serves as investment
advisor to investment portfolios with approximately $408 million of assets as of
February 28, 2010.
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
MLPs 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 three unregistered investment companies and one private
registered investment company for high net worth individuals and institutions.
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.
James J. Murchie is the Founder, Chief Executive Officer, co-portfolio
manager and a Principal of Energy Income Partners. 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 is co-portfolio manager
for all its funds. She has been with EIP since inception in 2003. From 2005 to
mid-2006, Ms. Pao joined Pequot Capital Management during EIP'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.
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 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.
Investment Management Agreement
Pursuant to an investment management agreement (the "Investment Management
Agreement") between First Trust Advisors and the Fund, 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.
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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 and the liquidation preference of
any outstanding Preferred Shares).
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)
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 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. In this
regard, if the Fund uses leverage in the amount equal to 26% 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."
NET ASSET VALUE
The Fund determines the net asset value of its common shares daily as of the
close of regular session trading on the NYSE (normally 4:00 p.m. eastern time).
Net asset value 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 will rely 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 and to
estimate the associated deferred tax liability. From time to time the Fund will
modify its estimates and/or assumptions 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.
For purposes of determining the net asset value of the Fund, readily
marketable portfolio securities listed on any exchange other than The Nasdaq
Stock Market 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 The Nasdaq
Stock Market 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 The Nasdaq Stock Market, 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. 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.
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 net asset value. 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.
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DISTRIBUTIONS
The Fund intends to make quarterly distributions to common shareholders.
Fund distributions will generally consist of (i) cash or paid-in-kind
distributions from MLPs or their affiliates, interest payments received on debt
securities owned by the Fund and dividend or other payments on equity securities
owned by the Fund, less (ii) current or accrued operating expenses of the Fund,
including taxes on Fund taxable income and leverage costs. The Fund anticipates
that, due to the tax treatment under current law of cash distributions made by
MLPs in which the Fund will invest, a portion of distributions the Fund makes to
common shareholders may consist of a tax-deferred return of capital.
Distributions to Common Shareholders are 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.
Distributions made from current and accumulated earnings and profits of the
Fund will be 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 tax-deferred 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. All realized capital gains, if any, net of applicable taxes,
will be retained by the Fund. Unless you elect to receive cash distributions,
your distributions of net investment income will automatically be reinvested
into additional common shares pursuant to the Fund's Dividend Reinvestment Plan.
Distributions by the Fund, whether paid in cash or in additional common
shares, will be taken into account in measuring the performance of the Fund with
respect to its investment objective.
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, unless you elect to receive cash distributions, all
dividends and distributions on your common shares will be automatically
reinvested by the Plan Agent, PNC Global Investment Servicing (U.S.) Inc., in
additional common shares under the Dividend Reinvestment Plan (the "Plan"). If
you elect to receive cash distributions, you will receive all distributions in
cash paid by check mailed directly to you by PNC Global Investment Servicing
(U.S.) 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 net asset value at the time
of valuation, the Fund will issue new shares at a price equal to the greater of
(i) net asset value per common share on that date or (ii) 95% of the market
price on that date.
(2) If common shares are trading below net asset value 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 Amex 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
certificate for each whole share in your account under the Plan and you will
receive a cash payment for any fraction of a share in your account. If you wish,
the Plan Agent will sell your shares and send you the proceeds, minus brokerage
commissions.
The Plan Agent maintains all 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
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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 advisor for more information.
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 PNC Global Investment
Servicing (U.S.) Inc., 301 Bellevue Parkway, Wilmington, Delaware 19809.
PLAN OF DISTRIBUTION
The Fund may sell the Common Shares being offered under this prospectus in
any one or more of the following ways:
o directly to purchasers;
o through agents;
o to or through underwriters; or
o through dealers.
The Fund may distribute the Common Shares from time to time in one or more
transactions at:
o a fixed price or prices, which may be changed;
o market prices prevailing at the time of sale;
o prices related to prevailing market prices; or
o negotiated prices.
The Fund may directly solicit offers to purchase Common Shares, or the Fund
may designate agents to solicit such offers. The Fund will, in a prospectus
supplement relating to such offering, name any agent that could be viewed as an
underwriter under the Securities Act of 1933 and describe any commissions the
Fund must pay. Any such agent will be acting on a best efforts basis for the
period of its appointment or, if indicated in the applicable prospectus
supplement or other offering materials, on a firm commitment basis. Agents,
dealers and underwriters may be customers of, engage in transactions with, or
perform services for the Fund in the ordinary course of business.
If any underwriters or agents are utilized in the sale of Common Shares in
respect of which this prospectus is delivered, the Fund will enter into an
underwriting agreement or other agreement with them at the time of sale to them,
and the Fund will set forth in the prospectus supplement relating to such
offering their names and the terms of the Fund's agreement with them.
If a dealer is utilized in the sale of Common Shares in respect of which
this prospectus is delivered, the Fund will sell such Common Shares to the
dealer, as principal. The dealer may then resell such Common Shares to the
public at varying prices to be determined by such dealer at the time of resale.
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 an underwriter or
underwriters acting as principal or agent for the Fund.
Agents, underwriters and dealers may be entitled under agreements which they
may enter into with the Fund to indemnification by the Fund against certain
civil liabilities, including liabilities under the Securities Act, and may be
customers of, engage in transactions with or perform services for the Fund in
the ordinary course of business.
-54-
In order to facilitate the offering of the Common Shares, any underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
price of the Common Shares or any other Common Shares the prices of which may be
used to determine payments on the Common Shares. Specifically, any underwriters
may over-allot in connection with the offering, creating a short position for
their own accounts. In addition, to cover over-allotments or to stabilize the
price of the Common Shares or of any such other Common Shares, the underwriters
may bid for, and purchase, the Common Shares or any such other Common Shares in
the open market. Finally, in any offering of the Common Shares through a
syndicate of underwriters, the underwriting syndicate may reclaim selling
concessions allowed to an underwriter or a dealer for distributing the Common
Shares in the offering if the syndicate repurchases previously distributed
Common Shares in transactions to cover syndicate short positions, in
stabilization transactions or otherwise. Any of these activities may stabilize
or maintain the market price of the Common Shares above independent market
levels. Any such underwriters are not required to engage in these activities and
may end any of these activities at any time.
The Fund may enter into derivative transactions with third parties, or sell
Common Shares not covered by this prospectus to third parties in privately
negotiated transactions. If the applicable prospectus supplement indicates, in
connection with those derivatives, the third parties may sell Common Shares
covered by this prospectus and the applicable prospectus supplement or other
offering materials, including in short sale transactions. If so, the third
parties may use Common Shares pledged by the Fund or borrowed from the Fund or
others to settle those sales or to close out any related open borrowings of
stock, and may use Common Shares received from the Fund in settlement of those
derivatives to close out any related open borrowings of stock. The third parties
in such sale transactions will be underwriters and, if not identified in this
prospectus, will be identified in the applicable prospectus supplement or other
offering materials (or a post-effective amendment).
The Fund or one of the Fund's affiliates may loan or pledge Common Shares to
a financial institution or other third party that in turn may sell the Common
Shares using this prospectus. Such financial institution or third party may
transfer its short position to investors in our Common Shares or in connection
with a simultaneous offering of other Common Shares offered by this prospectus
or otherwise.
The maximum commission or discount to be received by any member of the
Financial Industry Regulatory Authority will not be greater than eight percent
of the initial gross proceeds from the sale of any security being sold.
Any underwriter, agent or dealer utilized in the initial offering of Common
Shares will not confirm sales to accounts over which it exercises discretionary
authority without the prior specific written approval of its customer.
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 this offering have a par
value of $0.01 per share and, subject to the rights of holders of Preferred
Shares, if any, have equal rights to the payment of dividends and the
distribution of assets upon liquidation. As of March 3, 2010, the Fund had
7,609,755 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 Trustees in their 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 Amex (formerly the American Stock Exchange) under the trading or
"ticker" symbol "FEN."
Section 23(b) of the 1940 Act, in relevant part, provides that a
registered closed-end fund may not sell any of its common stock at a price below
the current net asset value of such stock, exclusive of any distribution
commission or discount, except with the consent of a majority of its common
stockholders, or under certain other circumstances. At a special meeting of
shareholders of the Fund held on January 8, 2008, the Fund obtained authority
from its shareholders to issue and sell common shares at a net price less than
its then-current net asset value per share, subject to the following conditions:
o The per share offering price, before the deduction of underwriting
fees, commissions and offering expenses, will not be less than the
-55-
net asset value per share of the Fund's common shares, as
determined at any time within two business days prior to the
pricing of the common shares to be sold in the offering.
o Immediately following each offering of such common shares, after
deducting underwriting fees, commissions and offering expenses, the
net asset value per share of the Fund's common shares, as
determined at any time within two business days prior to the
pricing of the common shares to be sold, would not have been
diluted by greater than a total of 1% of the net asset value per
share of all of the Fund's outstanding common shares. The Fund will
not be subject to a maximum number of common shares that can be
sold or a defined minimum sales price per share in any offering so
long as for each offering the number of common shares offered and
the price at which such common shares are sold together would not
result in dilution of the net asset value per share of the Fund's
common shares in excess of the 1% limitation described above.
o A majority of the Independent Trustees makes a determination, based
on information and a recommendation from the Advisor, that they
reasonably expect that the investments to be made with the net
proceeds of such issuance will lead to a long-term increase in the
Fund's net asset value or a long-term increase in the level of the
Fund's distributions to shareholders.
In connection with any sale of Common Shares below net asset value as
described above, the Advisor and Sub-Advisor have committed to waive a portion
of their investment advisory fees and sub-advisory fees following any such
offering of Common Shares in the following manner:
o the Advisor and Sub-Advisor will waive all investment advisory fees
and sub-advisory fees with respect to the Fund's assets
attributable to such newly issued Common Shares (including any
assets attributable to associated financial leverage) for the first
three-month period following any offering of Common Shares; and
o the Advisor and Sub-Advisor will waive 50% of investment advisory
fees and sub-advisory fees with respect to the Fund's assets
attributable to such newly issued Common Shares (including such
assets attributable to associated financial leverage) for the
second three-month period following such offering of Common Shares.
See "Management of the Fund - Investment Management Agreement" for a
description of the investment advisory and sub-advisory fees payable to the
Advisor and the Sub-Advisor.
The Fund will not issue and sell Common Shares at a price less than its
then-current net asset value per share in accordance with the above conditions
unless set forth in a prospectus supplement to this prospectus.
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 net asset value. Shares of closed-end
investment companies like the Fund have during some periods traded at prices
higher than net asset value and during other periods have traded at prices lower
than net asset value. 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, net asset value,
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 the common shares will trade at a price equal to or
higher than net asset value 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. See "Structure of the Fund;
Common Share Repurchases and Change in Fund Structure."
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 holders
of the common shareholders. Holders of common shares have no preemptive right to
purchase any Preferred Shares that might be issued.
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The Fund may elect to issue Preferred Shares as part of its leverage
strategy. The Board of Trustees also reserves the right to issue Preferred
Shares to the extent permitted by the 1940 Act, which currently limits the
aggregate liquidation preference of all outstanding Preferred Shares to 50% of
the value of the Fund's Managed Assets less liabilities and indebtedness of the
Fund. The Fund cannot assure you, however, that any Preferred Shares will be
issued. Although the terms of any Preferred Shares, including dividend rate,
liquidation preference and redemption provisions, will be determined by the
Board of Trustees, subject to applicable law and the Declaration of Trust, it is
likely that the Preferred Shares will be structured to carry a relatively
short-term dividend rate reflecting interest rates on short-term bonds, by
providing for the periodic redetermination of the dividend rate at relatively
short intervals through an auction, remarketing or other procedure. The Fund
also believes that it is likely that the liquidation preference, voting rights
and redemption provisions of the Preferred Shares will be similar to those
stated below.
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of 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 holders of common shares. After payment of the full amount
of the liquidating distribution to which they are entitled, the holders of
Preferred Shares will not be entitled to any further participation in any
distribution of assets by 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 two years'
dividends on any Preferred Shares are unpaid. The 1940 Act also requires that,
in addition to any approval by shareholders that might otherwise be required,
the approval of the holders of a majority of any outstanding Preferred Shares,
voting separately as a class, would be required to (1) adopt any plan of
reorganization that would adversely affect the Preferred Shares, and (2) 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, holders of
Preferred Shares will have equal voting rights with holders of common shares
(one vote per share, unless otherwise required by the 1940 Act) and will vote
together with holders of common shares as a single class.
The affirmative vote of the holders of a majority of the outstanding
Preferred Shares, voting as a separate class, will be required to amend, alter
or repeal any of the preferences, rights or powers of holders of Preferred
Shares so as to affect materially and adversely such preferences, rights or
powers, or to increase or decrease the authorized number of Preferred Shares.
The class vote of holders of Preferred Shares described above will in each case
be in addition to any other vote required to authorize the action in question.
Redemption, Purchase and Sale of Preferred Shares by the Fund. The terms of
any Preferred Shares issued are expected to provide that (1) they are redeemable
by the Fund in whole or in part at the original purchase price per share plus
accrued dividends per share, (2) the Fund may tender for or purchase Preferred
Shares and (3) the Fund may subsequently resell any shares so tendered for or
purchased. Any redemption or purchase of Preferred Shares by the Fund will
reduce the 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 holders of common
shares, may authorize an offering of Preferred Shares or may determine not to
authorize such an offering, and may fix the terms of the Preferred Shares to be
offered.
Description of Borrowings
The Fund's 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
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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% (33(1)/3% of
Managed Assets after borrowings). With respect to such borrowing, asset coverage
means the ratio which the value of the Managed 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 represented by
senior securities issued by the Fund.
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. 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. In
the event that the Fund elects to be treated as a regulated investment company,
and that such provisions would impair the Fund's status as a regulated
investment company under the Internal Revenue Code, the Fund, subject to its
ability to liquidate its relatively illiquid portfolio, intends to repay the
borrowings. Any borrowing will likely be ranked 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 relating to asset coverage and portfolio
composition requirements. The Fund may be subject to certain restrictions on
investments imposed by guidelines of one or more rating agencies, which may
issue ratings for the short-term corporate 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
Sub-Advisor from managing the Fund's portfolio in accordance with the Fund's
investment objective and policies.
The Commitment Facility can be used by the Fund for general corporate
purposes, including for financing a portion of the Fund's investments. The
Commitment Facility is secured by a first priority perfected security interest
in the assets of the Fund. In addition, the loan documents under the Commitment
Facility restrict the Fund's ability to change its investment advisor,
sub-advisor or custodian, amend its fundamental investment policies or
investment objective, or take on additional indebtedness without prior consent
from the provider of the Commitment Facility.
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 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. 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 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 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. 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; (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 (subject to
a limited exception if the acquiring fund is not an operating entity immediately
prior to the transaction); (3) a sale, lease or exchange of all or substantially
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all of the Fund's assets (other than in the regular course of the Fund's
investment activities, in connection with the termination of the Fund, and other
limited circumstances set forth in the Declaration of Trust); (4) in certain
circumstances, a termination of the Fund; (5) a removal of trustees by common
shareholders; or (6) certain transactions 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) 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 (or, in the
case of removing a trustee, when the trustee has been elected by only one
class), 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. Approval of Fund shareholders is
not required, however, for any transaction, whether deemed a merger,
consolidation, reorganization, exchange of shares or otherwise whereby the Fund
issues shares in connection with the acquisition of assets (including those
subject to liabilities) from any other investment company or similar entity.
None of the foregoing provisions may be amended except by the vote of at least
two-thirds of the common shares and Preferred Shares, if any, outstanding and
entitled to vote. See the SAI under "Certain Provisions in the Declaration of
Trust and By-Laws."
The provisions of the Declaration of Trust and By-Laws 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 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.
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 net asset value 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 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 net asset value, 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
net asset value. 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 net asset value and the
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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 net asset value 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 net asset value per common share.
In addition, as noted above, the Board of Trustees determined in connection with
the initial offering of common shares of the Fund that the closed-end structure
is desirable, 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 convert the Fund to an open-end investment company.
Repurchase of Common Shares and Tender Offers
In recognition of the possibility that the common shares might trade at a
discount to net asset value and that any such discount may not be in the
interest of shareholders, the Fund's Board of Trustees, in consultation with the
Advisor, Sub-Advisor and the corporate finance services and consulting agent
that the Advisor has retained, from time to time will review possible actions to
reduce any such discount. The Board of Trustees of the Fund will consider from
time to time open market repurchases of and/or tender offers for common shares
to seek to reduce any market discount from net asset value that may develop. In
connection with its consideration from time to time of open-end repurchases of
and/or tender offers for common shares, the Board of Trustees of the Fund will
consider whether to commence a tender offer or share-repurchase program at the
first quarterly board meeting following a calendar year in which the Fund's
common shares have traded at an average weekly discount from net asset value of
more than 10% in the last 12 weeks of that calendar year. After any
consideration of potential actions to seek to reduce any significant market
discount, the Board may, subject to its 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 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 tender offers for any of its common
shares. The Fund may, subject to its investment limitation with respect to
borrowings and limitations on seniority within the Fund's capital structure if
the Fund has other borrowings outstanding at such time, 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 net asset value. 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 net asset value 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 net asset value for a
portion of their common shares in conjunction with an announced repurchase
program or tender offer for the common shares.
Although the Board of Trustees believes that repurchases or tender offers
generally would 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 Preferred
Shares outstanding. Because of the nature of the Fund's investment objective,
policies and portfolio, the Advisor and the Sub-Advisor do 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 common shares outstanding
and entitled to vote; provided, however, that such vote shall be by Majority
Shareholder Vote 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 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 Amex or other national securities exchange or market
system. Any Preferred Shares would need to be redeemed and any Borrowings may
need to be repaid upon conversion to an open-end investment company.
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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 this prospectus to the extent discussed herein.
Such limitations could adversely affect distributions to Fund common
shareholders in the event of conversion to an open-end fund. The Board of
Trustees believes, however, that the closed-end structure is desirable, given
the Fund's investment objective and policies. Investors should assume,
therefore, that it is unlikely that the Board of Trustees would vote to convert
the Fund 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 net asset value, less such redemption 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 intends 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 likely
that new common shares would be sold at net asset value 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 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
Internal Revenue 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 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, (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 Internal Revenue 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 35%. In addition, the United
States also imposes a 20% alternative minimum tax on the recalculated
alternative minimum taxable income of an entity treated as a corporation. Any
such U.S. corporate income tax or alternative minimum 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, either because the
states follow the federal election or because the states separately impose a tax
on the Fund.
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The MLPs in which the Fund intends to invest 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 intends to invest 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 intends to hold 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 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, decreased for any distributions of cash received
by the Fund in excess of the Fund's allocable share of taxable income and
decreased by the Fund's allocable share of net losses. Thus, although cash 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 35%.
In calculating the Fund's alternative minimum taxable income, certain
percentage depletion deductions and intangible drilling costs may be treated as
items of tax preference. Items of tax preference increase alternative minimum
taxable income and increase the likelihood that the Fund may be subject to the
alternative minimum tax.
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. 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.
As discussed in greater detail below, prior to 2011, dividends that qualify
as "qualified dividend income" are generally taxed to individuals at a maximum
15% rate if certain holding period and other requirements are met by the common
shareholder receiving such dividend. After 2010, individuals will be taxed at
ordinary rates on dividend income. The current maximum rate for individuals on
ordinary income is 35%. This rate is scheduled to increase to 39.6% after 2010.
Corporations are generally subject to tax on dividends at a maximum 35% rate,
but corporations may be eligible to exclude 70% of the dividends if certain
holding period requirements are met. Common shareholders that are not U.S.
persons are generally subject to a 30% withholding tax, unless (i) the common
shareholder's interest in the Fund is effectively connected to a U.S. trade or
business and the common shareholder provides the Fund with a Form W8ECI signed
under penalties of perjury (in which case, the common shareholder will be
subject to the normal U.S. graduated rates) or (ii) the common shareholder is
eligible for the benefits of a U.S. income tax treaty and provides the Fund with
a Form W-8BEN signed under penalties of perjury (in which case, the common
shareholder will be subject to the rate of withholding provided for in the
relevant treaty).
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 of the excess distribution. 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 15% on long-term
capital gains. This rate is currently scheduled to increase to 20% for tax years
beginning after December 31, 2010. Corporations are taxed on capital gains at
their ordinary graduated rates.
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Because unsevered natural resources are viewed as interests in real property
for some purposes of the Internal Revenue Code, depending upon the nature and
location of the MLPs' assets, the Fund could from time to time be classified as
a U.S. real property holding corporation. If the Fund is classified as a U.S.
real property holding corporation, dispositions of interests in the Fund by a
non-U.S. common shareholder and distributions in excess of a non-U.S. common
shareholder's basis may be subject to 10% withholding.
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.
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.
The maximum federal income tax rate for individuals on qualified dividend
income is currently generally 15% for tax years ending on or before December 31,
2010, unless such favorable treatment is repealed sooner by new legislation. 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. This rate of
tax on dividends is currently scheduled to increase back to ordinary income
rates after December 31, 2010, with the maximum marginal federal income tax rate
being 39.6% at such time.
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 federal income
tax status of Fund distributions to them.
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 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.
Information Reporting and Withholding. The Fund will be required to report
annually to 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) will be required to provide
the Fund, under penalties of perjury, an IRS Form W-9, Form W-8BEN, Form W-8ECI
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 for domestic persons is 28%, but such
rate is scheduled to increase to 31% after December 31, 2010. As mentioned
above, non-U.S. persons may be subject to withholding tax at a rate of 30%, if
appropriate documentation demonstrating eligibility for a lower rate is not
provided. 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 furnished to the IRS.
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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.
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
currently invests in energy MLPs, so the income of the MLPs should qualify as
qualifying income.
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 and allocations of deductions (such as percentage depletion) and
losses, and increased for capital contributions and allocations 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. 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) rather
than based upon the income, gain, loss or deductions of the MLPs in which the
Fund invests.
Other Investments. The Fund has in the past, and may in the future, 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.
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.
-64-
CORPORATE FINANCE SERVICES AND CONSULTING FEE
First Trust Advisors (and not the Fund) has entered into a Corporate Finance
Services and Consulting Agreement with Wells Fargo Advisors, LLC, as successor
to A.G. Edwards (the "Consultant"), and has agreed to pay from its own assets a
fee to the Consultant. This fee was payable quarterly at the annual rate of
0.10% of the Fund's Managed Assets through June 29, 2006 and is payable
quarterly at the annual rate of 0.15% of the Fund's Managed Assets after June
29, 2006 and will be payable only so long as the Investment Management Agreement
remains in effect between the Fund and First Trust Advisors or any successor in
interest or affiliate of First Trust Advisors, as and to the extent that such
Investment Management Agreement is renewed or continued periodically in
accordance with the 1940 Act. Pursuant to the Corporate Finance Services and
Consulting Agreement, the Consultant will: (i) provide relevant information,
studies or reports regarding closed-end investment companies with similar
investment objectives and/or strategies as the Fund as well as general trends in
the closed-end investment company and asset management industries, and consult
with representatives of First Trust Advisors in connection therewith; (ii) at
the request of First Trust Advisors, provide certain economic research and
statistical information and reports on behalf of First Trust Advisors or the
Fund and consult with representatives of First Trust Advisors or the Fund,
and/or Trustees of the Fund in connection therewith, which information and
reports shall include: (a) statistical and financial market information with
respect to the Fund's market performance; and (b) comparative information
regarding the Fund and other closed-end management investment companies with
respect to (x) the net asset value of their respective shares (as made publicly
available by the Fund and such investment companies), (y) the respective market
performance of the Fund and such other companies, and (z) other relevant
performance indicators; and (iii) provide First Trust Advisors with such other
services in connection with the Common Shares relating to the trading price and
market price thereof upon which First Trust Advisors and the Consultant shall,
from time to time, agree, including after-market services designed to maintain
the visibility of the Fund in the market. The incremental additional amounts
paid as service fees applicable to daily assets of the Fund attributable to the
common shares initially offered by the Fund will not exceed 4.461% of the
offering price of such common shares.
CUSTODIAN, ADMINISTRATOR AND TRANSFER AGENT
The custodian of the assets of the Fund is PFPC Trust Company (which will be
renamed PNC Trust Company effective June 7, 2010) ("Custodian"), 301 Bellevue
Parkway, Wilmington, Delaware 19809. The Fund's transfer, shareholder services
and dividend paying agent is PNC Global Investment Servicing (U.S.) Inc., 301
Bellevue Parkway, Wilmington, Delaware 19809. Pursuant to an Administration and
Accounting Services Agreement, PNC Global Investment Servicing (U.S.) Inc. 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 providing such independent
registered public accounting firm with various audit-related information with
respect to the Fund; and providing other continuous accounting and
administrative services. As compensation for accounting and administrative
services, the Fund has agreed to pay PNC Global Investment Servicing (U.S.) Inc.
an annual fee, calculated daily and payable on a monthly basis, of 0.095% of the
Fund's first $200 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
Bingham McCutchen 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.
-65-
TABLE OF CONTENTS FOR THE
STATEMENT OF ADDITIONAL INFORMATION
Page
Use of Proceeds .......................................................................... 1
Investment Objective ..................................................................... 1
Investment Restrictions .................................................................. 2
Investment Policies and Techniques ....................................................... 4
Additional Information About the Fund's Investments and Investment Risks.................. 6
Other Investment Policies and Techniques ................................................. 25
Management of the Fund ................................................................... 34
Investment Advisor ....................................................................... 41
Sub-Advisor .............................................................................. 43
Portfolio Transactions and Brokerage ..................................................... 47
Certain Provisions in the Declaration of Trust and By-Laws................................ 48
Repurchase of Fund Shares; Conversion to Open-End Fund ................................... 51
Net Asset Value .......................................................................... 53
Tax Matters .............................................................................. 56
Performance Related and Comparative Information .......................................... 61
Experts .................................................................................. 63
Custodian, Administrator and Transfer Agent .............................................. 64
Additional Information ................................................................... 64
Financial Statements and Report of Independent Registered Public Accounting Firm.......... F-1
Appendix A -- Ratings of Investments ......................................................A-1
Appendix B --Energy Income Partners, LLC Proxy Voting Policy ..............................B-1
-66-
This page is intentionally left blank.
-67-
You should rely only on the information contained or incorporated by
reference in this prospectus. The Fund has not authorized anyone to provide you
with different information. The Fund is not making an offer of these securities
in any state where the offer is not permitted.
---------------------------------------------------------------------------------------------
TABLE OF CONTENTS
Page
Prospectus Summary...........................................................................1
Summary of Fund Expenses....................................................................22
Financial Highlights........................................................................24
Senior Securities...........................................................................26
Market and Net Asset Value Information......................................................27
The Fund....................................................................................28
Use of Proceeds.............................................................................28
The Fund's Investments......................................................................28
Use of Financial Leverage...................................................................33
Risks.......................................................................................37
Management of the Fund......................................................................50
Net Asset Value.............................................................................52
Distributions...............................................................................53
Dividend Reinvestment Plan..................................................................53
Plan of Distribution........................................................................54
Description of Shares.......................................................................55
Certain Provisions in the Declaration of Trust and By-Laws..................................58
Structure of the Fund; Common Share Repurchases and Change in Fund Structure................59
Tax Matters.................................................................................61
Corporate Finance Services and Consulting Fee...............................................65
Custodian, Administrator and Transfer Agent.................................................65
Legal Opinions..............................................................................66
----------------------------------------------------------------------------------------------
-68-
Energy Income and Growth Fund
1,700,000 Common Shares
-------------------------------------------------------------------------------
PROSPECTUS SUPPLEMENT
-------------------------------------------------------------------------------
April 30, 2010
ENERGY INCOME AND GROWTH FUND
STATEMENT OF ADDITIONAL INFORMATION
The Energy Income and Growth Fund (the "Fund") is a non-diversified
closed-end management investment company which commenced operations in June
2004.
This Statement of Additional Information relates to the offering, on an
immediate, continuous or delayed basis, of up to 3,348,960 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 April 9, 2010
(the "Prospectus") 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 NYSE Amex under the symbol "FEN."
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 Fund's Prospectus and any
prospectus supplement prior to purchasing such shares. A copy of the Fund's
Prospectus and any prospectus supplement may be obtained without charge by
calling (800) 988-5891 or on the Securities and Exchange Commission's web site
(http://www.sec.gov). 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 April 9, 2010.
Table of Contents
Page
Use of Proceeds..............................................................................1
Investment Objective.........................................................................1
Investment Restrictions......................................................................2
Investment Policies and Techniques...........................................................4
Additional Information About the Fund's Investments and Investment Risks.....................6
Other Investment Policies and Techniques....................................................25
Management of the Fund......................................................................34
Investment Advisor..........................................................................41
Sub-Advisor.................................................................................43
Portfolio Transactions and Brokerage........................................................47
Certain Provisions in the Declaration of Trust and By-Laws..................................48
Repurchase of Fund Shares; Conversion to Open-End Fund......................................51
Net Asset Value.............................................................................53
Tax Matters.................................................................................56
Performance Related and Comparative Information.............................................61
Experts.....................................................................................63
Custodian, Administrator and Transfer Agent.................................................64
Additional Information......................................................................64
Financial Statements and Report of Independent Registered Public Accounting Firm............F-1
Appendix A -- Ratings of Investments.................................................A-1
Appendix B -- Energy Income Partners, LLC Proxy Voting Policy........................B-1
-ii-
Use of Proceeds
The Fund will 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,
to repay indebtedness or for other general corporate purposes.
Pending investment in securities that meet the Fund's investment
objective and policies, the net proceeds of this offering will be invested in
cash or cash equivalents.
Investment Objective
The Fund's investment objective is to seek a high level of after-tax
total return with an emphasis on current distributions paid to 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 an efficient vehicle to invest in
a portfolio of cash generating securities of energy companies. The Fund focuses
on investing in publicly traded master limited partnerships ("MLPs") and related
public entities in the energy sector which the Fund's sub-advisor, Energy Income
Partners, LLC ("Energy Income Partners" or the "Sub-Advisor"), believes offer
opportunities for income and growth. As used in this Statement of Additional
Information, unless the context requires otherwise, MLPs are MLPs in the energy
sector. Due to the tax treatment under current law of cash distributions made by
MLPs to their investors (such as the Fund), the Fund believes that a portion of
its income may be tax deferred, thereby increasing cash available for
distribution by the Fund to its shareholders. There can be no assurance that the
Fund's investment objective will be achieved.
The Fund's investment objective is considered fundamental and may not be
changed without shareholder approval. 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 without shareholder approval, provided
that shareholders receive at least 60 days prior written notice of any change.
The Fund seeks to achieve its investment objective by investing
primarily in securities of MLPs and MLP-related entities in the energy sector
that the Sub-Advisor believes offer attractive distribution rates and capital
appreciation potential. The Fund also may invest in other securities set forth
below if the Sub-Advisor expects to achieve the Fund's objective with such
investments.
-1-
Investment Restrictions
The Fund has adopted the following non-fundamental policies:
o Under normal market conditions, the Fund invests at least 85% of
its Managed Assets (including assets obtained through leverage)
in securities of energy companies, energy sector MLPs and
MLP-related entities.
o Under normal market conditions, the Fund invests at least 65% and
up to 100% of its Managed Assets in equity securities of MLPs and
MLP-related entities. MLP and MLP-related entity equity
securities currently consist of common units, subordinated units
and I-Shares. The Fund also may invest in equity securities of
MLP-related entities, such as general partners or other
affiliates of MLPs.
o The Fund may invest up to 35% of its Managed Assets in
unregistered or otherwise restricted securities (including up to
10% of its Managed Assets in securities issued by private
companies). 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 companies.
o The Fund may invest up to 25% of its Managed Assets in debt
securities of energy companies, MLPs and MLP-related entities,
including below investment grade securities, which are commonly
referred to as "junk bonds." Below investment grade debt
securities will be rated at least B3 by Moody's and at least B-
by Standard & Poor's Ratings Group ("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.
o The Fund will not invest more than 10% 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 Financial
Leverage or market risks associated with the Fund's portfolio.
o The Fund may invest up to 15% of its Managed Assets in non-U.S.
securities as well as hedge the currency risk of the non-U.S.
securities using derivative instruments.
To generate additional income, the Fund writes (or sells) covered call
options on the common stock of energy companies held in the Fund's portfolio.
-2-
Except as described below, the Fund, as a fundamental policy, may not,
without the approval of the holders of a majority of its outstanding common
shares and Preferred Shares, if any, voting together as a single class, and of
the holders of the outstanding Preferred Shares voting as a single class:
(1) Issue senior securities, as defined in the 1940 Act, 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 1940 Act;
For a further discussion of the limitations imposed on borrowing by the
1940 Act, please see the section entitled "Use of Financial Leverage" in
the Fund's Prospectus;
(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 ("Securities Act"), 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); or
(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.
The foregoing fundamental investment policies, together with the
investment objective of the Fund, cannot 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 of the holders of the outstanding Preferred
Shares voting as a single class. Under the 1940 Act a "majority of the
outstanding voting securities" means the vote of: (1) 67% or more of the Fund's
shares present at a meeting, if the holders of more than 50% of the Fund's
shares are present or represented by proxy; or (2) more than 50% of the Fund's
shares, whichever is less.
-3-
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 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 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 United
States; (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 (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.
-4-
(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 reflects an
agreed-upon market rate. 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 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 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 will
be limited to commercial paper rated in the highest categories by a
nationally recognized statistical rating organization ("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
-5-
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.
Additional Information About the Fund's Investments and Investment Risks
Energy Companies
For purposes of the Fund's policy of investing 85% of its Managed Assets
(including assets obtained through leverage) in securities of energy companies,
energy sector MLPs and MLP-related entities, an energy company is one that
derives its revenues from transporting, processing, storing, distributing or
marketing natural gas, natural gas liquids ("NGLs"), crude oil, refined
petroleum products, coal or electricity, or exploring, developing, managing or
producing such commodities or products, or in supplying energy-related products
and services.
Energy sector MLPs are limited partnerships 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 services and coal MLPs may be directly affected by energy
commodity prices. Propane MLPs 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 exposure to commodity prices. The MLP sector 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, energy 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. Most Midstream MLPs
with 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
-6-
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 3% of the household energy needs in the
United States, largely for homes beyond the geographic reach of natural gas
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 supply of alternative
fuels to generators are the primary drivers of coal demand.
MLPs and MLP-related entities typically achieve distribution growth by
internal and external means. MLPs and MLP-related entities achieve growth
internally by experiencing higher commodity volume driven by the economy and
population, 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.
MLPs and MLP-related entities 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: 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 and MLP-related entities 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 and MLP-related entities operating interstate pipelines and storage
facilities are subject to substantial regulation by the 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 storage facilities; and
certain other matters. FERC also regulates the interstate transportation of
crude oil, including: regulation of rates and practices of oil pipeline
companies; establishing equal service conditions to provide shippers with equal
access to pipeline transportation; and establishment of reasonable rates for
transporting petroleum and petroleum products by pipeline.
-7-
Energy sector MLPs and MLP-related entities 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 energy sector MLPs and
MLP-related entities.
Energy sector MLPs and MLP-related entities 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 and MLP-related entities
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 and MLP-related entities to
successfully integrate recent or future acquisitions; and the general level of
the economy.
The energy industry and particular energy companies may be adversely
affected by possible terrorist attacks, such as the attacks that occurred on
September 11, 2001. It is possible that facilities of energy companies, due to
the critical nature of their energy 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, changes in the insurance markets after
September 11, 2001 may make 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 companies to raise needed capital.
Master Limited Partnerships
Under normal circumstances the Fund will invest at least 65% of its
Managed Assets in equity securities of energy sector MLPs and MLP-related
entities. An MLP is a limited partnership, the interests in which (known as
units) are traded on securities exchanges or over-the-counter. Organization as a
partnership eliminates tax on MLP qualifying income at the entity level.
An MLP has 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 company management or
another publicly traded sponsoring corporation. When an investor buys units in a
MLP, he or she becomes a limited partner.
-8-
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, other energy companies, and
utilities 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 than other types of
companies and the Fund intends to use 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 tax on MLP qualifying 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
distributions are treated differently for tax purposes. The MLP distribution is
treated as a tax-deferred return of capital to the extent of the investor's
basis in his 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. The basis is adjusted downwards with each distribution
and allocation of deductions (such as depreciation) and losses, and upwards with
each allocation of taxable income.
-9-
For a further discussion and a description of MLP tax matters, see the
section entitled "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. Consistent with its
investment objective, the Fund may invest up to 100% of its Managed Assets in
equity securities issued by energy sector MLPs. Equity securities currently
consist of common units, subordinated units and I-Shares (each discussed below).
The Fund also may invest in equity securities of MLP-related entities, such as
general partners or other affiliates of the MLPs. The Fund also may invest up to
15% of Managed Assets in equity or debt securities of non-MLPs or energy
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 net asset value per share, which
will 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 energy 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 energy companies may
involve greater risk than is associated with investing in more established MLPs,
MLP-related entities and energy companies. Smaller capitalization MLPs,
MLP-related entities and energy 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 energy companies.
MLP Common Units. MLP common units represent a limited partnership
interest in the MLP. Common units are listed and traded on U.S. securities
exchanges or over-the-counter with their value fluctuating predominantly based
on the success of the MLP. The Fund intends to purchase 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 have limited voting rights and 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
a quarterly distribution. 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
units, but not debt holders or preferred unit holders, to the remaining assets
of the MLP.
-10-
MLP Subordinated Units. MLP subordinated units typically are issued by
MLPs to their original sponsors, such as their founders, corporate general
partners of MLPs, entities that sell assets to the MLP, and institutional
investors. The Fund may purchase subordinated units directly from these
persons. Subordinated units have similar voting rights as common units and are
generally not 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 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.
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 receives additional I-Units in an amount equal to the
cash distributions received by 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. 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 traded on the New York
Stock Exchange.
Equity Securities of Energy Companies. The Fund does not intend to
invest more than 35% of its Managed Assets in equity securities issued by energy
companies which are not MLPs. The Fund intends to purchase 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 companies
held in the Fund's portfolio.
Debt Securities. The Fund may invest up to 25% of its Managed Assets in
debt securities of energy companies, MLPs and MLP-related entities, 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
-11-
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.
Below Investment Grade Debt Securities. The Fund may invest up to 25% of
its Managed Assets 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 "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:
-- increased price sensitivity to changing interest rates and to a
deteriorating economic environment;
-- greater risk of loss due to default or declining credit quality;
-- adverse company specific events are more likely to render the
issuer unable to make interest and/or principal payments; and
-- 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 industries, such as the energy industry, could adversely affect the
ability of below investment grade debt issuers in that 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
-12-
quality securities may have an adverse effect on the Fund's net asset value 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.
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 and S&P's ratings.
Restricted Securities. The Fund may invest in unregistered or otherwise
restricted securities. The term "restricted securities" refers to securities
that are unregistered or are 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
-13-
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.
Restricted securities generally can be sold in privately negotiated
transactions, pursuant to an exemption from registration under the Securities
Act, or in a registered public offering. The Sub-Advisor has the ability to deem
restricted securities as liquid. To enable the Fund to sell its holdings of a
restricted security not registered for public sale, the Fund may have to cause
those securities to be registered. In situations in which the Fund must arrange
registration because the Fund wishes to sell the security, 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. The Fund would
bear the risks of any downward price fluctuation during that period.
In recent years, a large institutional market has developed for certain
securities that are not registered under the Securities Act, including private
placements, repurchase agreements, commercial paper, foreign securities and
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 Securities Act establishes a "safe harbor" from the
registration requirements of the Securities 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 companies
trade on the New York Stock Exchange, The Nasdaq National Market 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
-14-
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.
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 Managed Assets 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
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 will write call
options only if they are "covered." In the case of a call option on a common
stock or other security, the option is "covered" if the Fund owns the security
underlying the call or has an absolute and immediate right to acquire that
security without additional cash consideration (or, if additional cash
consideration is required, cash or other assets determined to be liquid by the
Sub-Advisor (in accordance with procedures approved by the Board of Trustees) in
such amount are segregated by the Fund's custodian) upon conversion or exchange
of other securities held by the Fund.
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.
See "Tax Matters."
-15-
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 Financial Leverage by the Fund, to facilitate portfolio management and
mitigate risks, including interest rate, currency and credit risks. The Fund
writes (or sells), covered call options on the common stock of energy companies
held in the Fund's portfolio. 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 Financial Leverage issued by the Fund, or establish
positions in the derivatives markets as a temporary substitute for purchasing or
selling particular securities. Market conditions will determine whether and in
what circumstances the Fund would employ any of the hedging and strategic
techniques described below. The Fund will incur brokerage and other costs in
connection with its hedging transactions.
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 writes (or sells), covered call
options on the common stock of energy 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.
-16-
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. A written call
option or put option may be covered by (1) maintaining cash or liquid securities
in a segregated account with a value at least equal to the Fund's obligation
under the option, (2) entering into an offsetting forward commitment and/or (3)
purchasing an offsetting option or any other option which, by virtue of its
exercise price or otherwise, reduces the Fund's net exposure on its written
option position. A written call option on securities is typically covered by
maintaining the securities that are subject to the option in a segregated
account. The Fund may cover call options on a securities index by owning
securities whose price changes are expected to be similar to those of the
underlying index.
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."
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
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
-17-
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.
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. 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 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. 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.
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
-18-
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
underlying securities or currency whenever it appears economically advantageous
to do so. A clearing corporation 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.
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
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
-19-
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 intends to
purchase. 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 intends to purchase. 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 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.
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
-20-
establish a segregated account consisting of cash or liquid securities in an
amount equal to the underlying value of such contracts and options.
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.
Some futures contracts or options on futures may become illiquid under
adverse market conditions. In addition, 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. 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.
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 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. 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.
-21-
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
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 or Commodity 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 or commodity 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 on any debt securities, including the Notes, or preferred
shares issued by the Fund for leverage purposes. The Fund intends to use these
transactions primarily as a hedge. However, the Fund also may invest in equity
and interest rate or commodity 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
-22-
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.
The Fund usually will enter into equity and interest rate or commodity
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 will be accrued on a daily
basis, and an amount of cash or liquid instruments having an aggregate net asset
value at least equal to the accrued excess will be 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 will be
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 interest rate or commodity caps or floors that it does not
own. 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 will enter into equity and
interest rate or commodity transactions will be broker-dealers and other
financial institutions. The Fund will not enter into any equity swap, interest
rate or commodity swap, cap or floor transaction unless the unsecured senior
debt or the claims-paying ability of the other party thereto is rated investment
grade quality 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. Certain federal income tax requirements may limit the Fund's
ability to engage in interest rate swaps.
-23-
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
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 quality 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.
If the Fund enters into a credit default swap, the Fund may be required
to report the swap as a "reportable transaction" for tax shelter reporting
purposes on the Fund's federal income tax return. If the Internal Revenue
Service (the "IRS") were to determine that the credit default swap is a tax
shelter, the Fund could be subject to penalties under the Internal Revenue Code
of 1986, as amended (the "Code").
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.
-24-
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.
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 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 intends to acquire. 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 Securities and Exchange Commission (the
"Commission"), the several options and futures exchanges upon which they are
traded, the CFTC and various state regulatory authorities. In addition, the
Fund's ability to use hedging instruments may be limited by tax considerations.
General Limitations on Futures and Options Transactions. The Fund has
filed a notice of eligibility for exclusion from the definition of the term
"commodity pool operator" with the CFTC and the National Futures Association,
which regulate trading in the futures markets. Pursuant to Section 4.5 of the
regulations under the Commodity Exchange Act (the "CEA"), the Fund is not
subject to regulation as a commodity pool under the CEA.
Various exchanges and regulatory authorities have undertaken reviews of
options and futures trading in light of market volatility. Among the possible
actions that have been presented are proposals to adopt new or more stringent
daily price fluctuation limits for Futures and options transactions and
-25-
proposals to increase the margin requirements for various types of futures
transactions.
Asset Coverage for Futures and Options Positions. The Fund will comply
with the regulatory requirements of the Commission and the CFTC with respect to
coverage of options and futures positions by registered investment companies
and, if the guidelines so require, will set aside cash, U.S. government
securities, high grade liquid debt securities and/or other liquid assets
permitted by the Commission 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.
Options. As an anticipatory hedge, the Fund may purchase put and call
options on stock or other securities. A put option embodies the right of its
purchaser to compel the writer of the option to purchase from the option holder
an underlying security or its equivalent at a specified price at any time during
the option period. In contrast, a call option gives the purchaser the right to
buy the underlying security covered by the option or its equivalent from the
writer of the option at the stated exercise price.
As a holder of a put option, the Fund will have the right to sell the
securities underlying the option and as the holder of a call option, the Fund
will have the right to purchase the securities underlying the option, in each
case at their exercise price at any time prior to the option's expiration date.
The Fund may seek to terminate its option positions prior to their expiration by
entering into closing transactions. The ability of the Fund to enter into a
closing sale transaction depends on the existence of a liquid secondary market.
There can be no assurance that a closing purchase or sale transaction can be
effected when the Fund so desires.
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.
Some, but not all, of the derivative instruments may be traded and
listed on an exchange. There is no assurance that a liquid secondary market on
an options exchange will exist for any particular 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 sale transaction with respect
to options on securities that it has purchased, it would have to exercise the
-26-
option in order to realize any profit and would incur transaction costs upon the
purchase and sale of the underlying securities.
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
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.
-27-
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.
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.
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 respective 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.
-28-
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.
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
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.
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.
-29-
Risks and Special Considerations Concerning Derivatives. In addition to
the foregoing, the use of derivative instruments involves certain general risks
and considerations as 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. Market risk is the
primary risk associated with derivative transactions. 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 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 hedging purposes
might result in a poorer overall performance for the Fund, whether or
not adjusted for risk, than if the Fund had not hedged its portfolio
holdings.
(2) Credit 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 less than for privately-negotiated or
over-the-counter derivatives, since generally a clearing agency, which
is the issuer or counterparty to each exchange-traded instrument,
provides a guarantee of performance. For privately-negotiated
instruments, there is no similar clearing agency guarantee. 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. 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.
(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
-30-
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 liquid
because the exchange clearinghouse is the counterparty of every
contract. OTC transactions are less liquid than exchange-traded
derivatives since they often can only be closed out with the other party
to the transaction. 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 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) 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
For hedging purposes, 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
-31-
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 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 Commission. 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
-32-
securities on a when-issued or delayed delivery basis, the Fund is required
under rules of the Commission 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 repurchase contract. Income generated from transactions in
repurchase agreements will be taxable. 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 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.
-33-
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 shareholder 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 losses, including
(a) 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, (b) possible subnormal levels of income and lack of access to income
during this period, and (c) expenses of enforcing its rights.
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. For the
fiscal year ended November 30, 2009, the Fund's portfolio turnover rate was
approximately 43%. A higher portfolio turnover rate 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 be taxable as ordinary income to the Fund. A 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 a
dividend to the Fund's common shareholders. See "Tax Matters" in the Fund's
Prospectus and in this Statement of Additional Information.
Management of the Fund
Trustees and Officers
The following is a list of the Trustees and 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. 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 has been 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. The officers of the Fund
serve indefinite terms. Each Trustee, except for James A. Bowen, is an
Independent Trustee. Mr. Bowen is deemed an "interested person" (as that term is
defined in the 1940 Act) ("Interested Trustee") of the Funds due to his position
as President of First Trust Advisors L.P., investment advisor to the Funds.
-34-
Number of
Term of Office Portfolios in Other
and Year First Fund Complex Directorships
Name, Address and Position and Offices Elected or Principal Occupations Overseen by Held by
Date of Birth with Fund Appointed(2) During Past 5 Years Trustee Trustee
_______________________ _____________________ _______________ _____________________ ______________ ______________
Trustee who is an Interested
Person of the Fund
____________________________
James A. Bowen(1) President, Chairman o Class III President, First Trust 63 Portfolios Trustee of
120 East Liberty Drive of the Board, Chief o 2004 Advisors L.P. and First Wheaton College
Suite 400 Executive Officer Trust Portfolios L.P.;
Wheaton, IL 60187 and Trustee Chairman of the Board of
D.O.B.: 09/55 Directors, BondWave LLC
(Software Development
Company/Investment Advisor)
and Stonebridge Advisors LLC
(Investment Advisor)
Trustees who are not
Interested Persons of the Fund
_______________________________
Richard E. Erickson Trustee o Class II Physician; President, 63 Portfolios None
c/o First Trust Advisors L.P. o 2004 Wheaton Orthopedics; Co-
120 East Liberty Drive owner and Co-Director
Suite 400 (January 1996 to May 2007),
Wheaton, IL 60187 Sports Med Center for
D.O.B.: 04/51 Fitness; Limited Partner,
Gundersen Real Estate
Limited Partnership; Member,
Sportsmed LLC
Thomas R. Kadlec Trustee o Class II President (March 2010 to 63 Portfolios Director of
c/o First Trust Advisors L.P. o 2004 present), Senior Vice ADM Investor
120 East Liberty Drive President and Chief Services, Inc.
Suite 400 Financial Officer (May and ADM
Wheaton, IL 60187 2007 to March 2010), Investor
D.O.B.: 11/57 Vice President and Chief Services
Financial Officer (1990 International
to May 2007), ADM Investor
Services, Inc. (Futures
Commission Merchant)
Robert F. Keith Trustee o Class I President (2003 to Present), 63 Portfolios None
c/o First Trust Advisors L.P. o 2006 Hibs Enterprises (Financial
120 East Liberty Drive and Management Consulting)
Suite 400
Wheaton, IL 60187
D.O.B.: 11/56
Niel B. Nielson Trustee o Class III President (2002 63 Portfolios Director of
c/o First Trust Advisors L.P. o 2004 to Present), Covenant Covenant
120 East Liberty Drive College Transport Inc
Suite 400
Wheaton, IL 60187
D.O.B.: 03/54
Officers of the Fund
____________________
Mark R. Bradley Treasurer, o Indefinite term Chief Financial Officer, N/A N/A
120 East Liberty Drive Controller, Chief o 2004 First Trust Advisors L.P.
Suite 400 Financial Officer and First Trust Portfolios
Wheaton, IL 60187 and Chief Accounting L.P.; Chief Financial
D.O.B.: 11/57 Officer Officer, BondWave LLC
(Software Development
Company/Broker-
Dealer/Investment Advisor)
and Stonebridge Advisors LLC
(Investment Advisor)
-35-
Erin E. Chapman Assistant Secretary o Indefinite term Assistant General Counsel N/A N/A
120 East Liberty Drive, o 2009 (October 2007 to Present),
Suite 400 Associate Counsel (March
Wheaton, IL 60187 2006 to October 2007), First
D.O.B.: 08/76 Trust Portfolios L.P. and
First Trust Advisors L.P.;
Associate Attorney (November
2003 to March 2006) Doyle &
Bolotin, Ltd.
James M. Dykas Assistant Treasurer o Indefinite term Senior Vice President (April N/A N/A
120 East Liberty Drive o 2005 2007 to Present), Vice
Suite 400 President (January 2005 to
Wheaton, IL 60187 April 2007), First Trust
D.O.B.: 01/66 Advisors L.P. and First
Trust Portfolios L.P.
Christopher R. Fallow Assistant Vice o Indefinite term Assistant Vice President N/A N/A
120 East Liberty Drive President o 2006 (August 2006 to Present),
Suite 400 Associate (January 2005 to
Wheaton, IL 60187 August 2006), First Trust
D.O.B.: 04/79 Advisors L.P. and First
Trust Portfolios L.P.
W. Scott Jardine Secretary and Chief o Indefinite term General Counsel, First Trust N/A N/A
120 East Liberty Drive Compliance Officer o 2004 Portfolios L.P., First Trust
Suite 400 Advisors L.P. and BondWave
Wheaton, IL 60187 LLC (Software Development
D.O.B.: 05/60 Company/Investment Advisor)
Secretary, Stonebridge
Advisors LLC (Investment
Advisor)
Daniel J. Lindquist Vice President o Indefinite term Senior Vice President N/A N/A
120 East Liberty Drive o 2005 (September 2005 to Present),
Suite 400 Vice President (April 2004
Wheaton, IL 60187 to September 2005), First
D.O.B: 02/70 Trust Advisors L.P. and
First Trust Portfolios L.P.
Coleen D. Lynch Assistant Vice o Indefinite term Assistant Vice President N/A N/A
120 East Liberty Drive President o 2008 (January 2008 to Present),
Suite 400 First Trust Advisors L.P.
Wheaton, IL 60187 and First Trust Portfolios
DOB: 07/58 L.P.; Vice President (May
1998 to January 2008), Van
Kampen Asset Management and
Morgan Stanley Investment
Management
-36-
Kristi A. Maher Assistant Secretary o Indefinite term Deputy General Counsel (May N/A N/A
120 East Liberty Drive and Deputy Chief o 2004 2007 to Present), Assistant
Suite 400 Compliance Officer General Counsel (March 2004
Wheaton, IL 60187 to May 2007), First Trust
D.O.B.: 12/66 Advisors L.P. and First
Trust Portfolios L.P.
____________________
(1) Mr. Bowen is deemed an "interested person" of the Fund due to his position
of President of First Trust Advisors, investment Advisor of the Fund.
(2) Currently, Robert F. Keith, as a Class I Trustee, is serving as a trustee
until the Fund's 2011 annual meeting of shareholders. Richard E. Erickson
and Thomas R. Kadlec, as Class II Trustees, are each serving as trustees
until the Fund's 2009 annual meeting of shareholders. James A. Bowen and
Niel B. Nielson, as Class III Trustees, are each serving as trustees until
the Fund's 2010 annual meeting. Officers of the Fund have an indefinite
term.
The Board of Trustees of the Fund has four standing committees: the
Executive Committee (also known as 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 shall also serve as a special committee
of the Board known as the Pricing and Dividend Committee which is authorized to
exercise all of the powers and authority of the Board 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 shares are to be sold and approval of the
final terms of the underwriting agreement, including approval of the members of
the underwriting syndicate. Such committee is also responsible for the
declaration and setting of dividends. Messrs. Erickson and Bowen are members of
the Executive Committee. The Executive Committee serving as the Pricing and
Dividend Committee met four times during the Fund's last fiscal year.
The Nominating and Governance Committee is responsible for appointing
and nominating non-interested persons to the Fund's Board of Trustees. Messrs.
Erickson, Nielson, Kadlec and Keith are members of the Nominating and Governance
Committee. If there is no vacancy on the Board of Trustees, the Board will not
actively seek recommendations from other parties, including shareholders. The
Fund has a retirement policy of age 72 for Trustees. 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 the Fund. To
submit a recommendation for nomination as a candidate for a position on the
Board of Trustees, shareholders of the Fund shall mail such recommendation to W.
Scott Jardine at the Fund's address, 120 East Liberty Drive, Suite 400, Wheaton,
Illinois 60187. Such recommendation shall include the following information: (a)
evidence of Fund ownership of the person or entity recommending the candidate
(if a Fund Shareholder), (b) a full description of the proposed candidate's
background, including their education, experience, current employment, and date
-37-
of birth, (c) names and addresses of at least three professional references for
the candidate, (d) 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 (e) 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 the outside 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.
The Nominating and Governance Committee met four times during the Fund's last
fiscal year.
The Valuation Committee is responsible for the oversight of the pricing
procedures of the Fund. Messrs. Erickson, Kadlec, Nielson and Keith are members
of the Valuation Committee. The Valuation Committee met four times during the
Fund's last fiscal year.
The Audit Committee is responsible for overseeing the Fund's accounting
and financial reporting process, the system of internal controls, audit process
and evaluating and appointing independent auditors (subject also to Board
approval). Messrs. Erickson, Nielson, Kadlec and Keith serve on the Audit
Committee. The Audit Committee met eight times during the Fund's last fiscal
year.
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 serves as a trustee of First Defined
Portfolio Fund, LLC, an open-end fund with 8 portfolios advised by First Trust
Advisors, as well as First Trust/Four Corners Senior Floating Rate Income Fund,
First Trust/Four Corners Senior Floating Rate Income Fund II, Macquarie/First
Trust Global Infrastructure/Utilities Dividend & Income Fund, Energy Income and
Growth Fund, First Trust Enhanced Equity Income Fund, First Trust/Aberdeen
Global Opportunity Income Fund, First Trust/FIDAC Mortgage Income Fund, First
Trust Strategic High Income Fund, First Trust Strategic High Income Fund II,
First Trust Strategic High Income Fund III, First Trust/Aberdeen Emerging
Opportunity Fund and First Trust Specialty Finance and Financial Opportunities
Fund, closed-end funds advised by First Trust Advisors, and First Trust
Exchange-Traded Fund, First Trust Exchange-Traded Fund II and First Trust
Exchange-Traded AlphaDEX(R) Fund, exchange-traded funds with 42 portfolios,
respectively, advised by First Trust Advisors (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. In addition, Mr. Bowen and the other
officers of the Fund (other than Christopher R. Fallow) hold the same positions
with the other funds in the First Trust Fund Complex as they hold with the Fund.
Mr. Fallow, Assistant Vice President of the Fund, serves in the same position
for all of the funds in the First Trust Fund Complex with the exception of First
Defined Portfolio Fund, LLC, First Trust Exchange-Traded Fund, First Trust
Exchange-Traded Fund II, First Trust Exchange-Traded Fund III and First Trust
Exchange-Traded AlphaDEX(R) Fund.
-38-
The management of the Fund, including general supervision of the duties
performed for the Fund under the investment management agreement between the
Fund and the Advisor, is the responsibility of the Board of Trustees. The
Trustees of the Fund set broad policies for the Fund, choose the Fund's
officers, and hire the Fund's investment advisor, sub-advisor and other service
providers. The officers of a Fund manage the day-to-day operations and are
responsible to the Fund's Board. The Fund's Board is composed of four
Independent Trustees and one Interested Trustee. The Interested Trustee, James
A. Bowen, serves as both the Chief Executive Officer for each Fund and the
Chairman of each Board.
Each trust in the First Trust Fund Complex pays each Trustee who is not
an officer or employee of First Trust Advisors, any sub-advisor or any of their
affiliates ("Independent Trustees") an annual retainer of $10,000 per trust for
the first 14 trusts in the First Trust Fund Complex and an annual retainer of
$7,500 per trust for each subsequent trust added to the First Trust Fund
Complex. The annual retainer is allocated equally among each of the trusts.
For the period January 1, 2008 through December 31, 2009, Dr. Erickson
was paid annual compensation of $10,000 to serve as the Lead Trustee, Mr. Keith
was paid annual compensation of $5,000 to serve as the chairman of the Audit
Committee, Mr. Kadlec was paid annual compensation of $2,500 to serve as the
chairman of the Valuation Committee and Mr. Nielson was paid annual compensation
of $2,500 to serve as the chairman of the Nominating and Governance Committee.
Each chairman served two years before rotating to serve as a chairman of another
committee or as Lead Trustee. The annual compensation was allocated equally
among each of the trusts in the First Trust Fund Complex. Trustees were also
reimbursed by the investment companies in the First Trust Fund Complex for
travel and out-of-pocket expenses incurred in connection with all meetings.
Effective January 1, 2010, Mr. Nielson is paid annual compensation of
$10,000 to serve as the Lead Trustee, Mr. Kadlec is paid annual compensation of
$5,000 to serve as the chairman of the Audit Committee, Dr. Erickson is paid
annual compensation of $2,500 to serve as the chairman of the Valuation
Committee and Mr. Keith is paid annual compensation of $2,500 to serve as the
chairman of the Nominating and Governance Committee. The Chairmen and the Lead
Trustee will serve for a two-year period, ending December 31, 2011, before
rotating to serve as a Chairman of another committee or as Lead Trustee. The
additional compensation is allocated equally among each of the trusts in the
First Trust Fund Complex.
The following table sets forth compensation paid by the Fund during the
Fund's last fiscal year to each of the Trustees and total compensation paid to
each of the Trustees by the First Trust Fund Complex for a full calendar year.
The Fund has no retirement or pension plans. The officers and the Trustee who
are "interested persons" as designated above serve without any compensation from
the Fund.
-39-
Total Compensation
Aggregate from Fund and
Name of Trustee Compensation from Fund (1) Fund Complex(2)
_______________ __________________________ ________________
James A. Bowen $0 $0
Richard E. Erickson $10,064 $176,733
Thomas R. Kadlec $9,614 $168,750
Robert F. Keith $9,755 $171,250
Niel B. Nielson $9,749 $171,591
--------------------
(1) The compensation paid by the Fund to the Trustees for the last fiscal
year for services to the Fund.
(2) The total compensation paid to Messrs. Erickson, Kadlec, Keith and
Nielson, Independent Trustees, from the Fund and the First Trust Fund
Complex for a full calendar year is based on estimated compensation to be
paid to these Trustees for a full calendar year for services as Trustees
to the Fund and the First Defined Portfolio Fund, LLC, an open-end fund
(with eight portfolios), the First Trust Exchange-Traded Fund, First Trust
Exchange-Traded Fund II and the First Trust Exchange-Traded AlphaDEX(R)
Fund, exchange-traded funds, plus estimated compensation to be paid to
these Trustees by the First Trust/Four Corners Senior Floating Rate Income
Fund, the First Trust/Four Corners Senior Floating Rate Income Fund II,
the Macquarie/First Trust Global Infrastructure/Utilities Dividend &
Income Fund, the First Trust Enhanced Equity Income Fund, the First
Trust/Aberdeen Global Opportunity Income Fund, the First Trust/FIDAC
Mortgage Income Fund, the First Trust Strategic High Income Fund, the
First Trust Strategic High Income Fund II, First Trust Strategic High
Income Fund III, the First Trust Tax-Advantaged Preferred Income Fund, the
First Trust/Aberdeen Emerging Opportunity Fund, the First Trust Specialty
Finance and Financial Opportunities Fund and the First Trust Active
Dividend Income Fund.
The Fund has no employees. Its officers are compensated by First Trust
Advisors. Shareholders of the Fund will elect certain Trustees 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, 2009:
Aggregate Dollar Range of
Equity Securities in
Dollar Range of All Registered Investment Companies
Equity Securities Overseen by Trustee in
Trustee in the Fund First Trust Fund Complex
James A. Bowen None $50,000 - $100,000
Richard E. Erickson $1 - $10,000 $50,001 - $100,000
Thomas R. Kadlec $10,000 - $50,000 Over $100,000
Robert F. Keith None Over $100,000
Niel B. Nielson $1 - $10,000 Over $100,000
As of December 31, 2009, the Trustees of the Fund who are not
"interested persons" 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.
-40-
Control Persons
As of December 31, 2009, no person owned of record or beneficially more
than 5% of the Fund's common shares.
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 $28 billion in assets which it managed or supervised as of
February 28, 2010. As investment Advisor, First Trust Advisors provides the Fund
with professional investment supervision and management 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 Commission under the Investment
Advisers Act of 1940 (the "Advisers Act"). First Trust Advisors 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 the Robert Donald Van Kampen family. First Trust Advisors is
controlled by Grace Partners and The Charger Corporation.
First Trust Advisors is also Advisor or sub-advisor to 20 mutual funds,
42 exchange-traded funds and 13 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 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 to date, more
than $115 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 so long as its continuation is approved at
least annually by the Trustees including a majority of the Trustees who are not
parties to such agreement or interested persons of any such party except in
their capacity as Trustees of the Fund, 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 action of the Board or by a majority vote of the outstanding voting
securities of the Fund (accompanied by appropriate notice), and will terminate
automatically upon assignment. The Investment Management Agreement may also be
-41-
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 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 such
recommendation shall have been 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.
Pursuant to the Investment Management Agreement between the Advisor and
the Fund, 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.
-42-
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, including 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.
On September 14, 2007, the Fund entered into an interim sub-advisory
agreement with the Advisor and the Sub-Advisor. Subsequently, on January 8,
2008, the Fund entered into a sub-advisory agreement with the Advisor and the
Sub-Advisor (the "Sub-Advisory Agreement"). The interim sub-advisory agreement
replaced a previous sub-advisory agreement (the "Predecessor Sub-Advisory
Agreement") between the Fund, the Advisor and Fiduciary Asset Management, LLC
(the "Predecessor Sub-Advisor"). For each of the first two years following the
commencement of the Fund's operations through June 24, 2006, the Advisor agreed
to reduce its annual management fee to 0.75% of the Fund's Managed Assets in
order to reimburse the Fund for certain fees and expenses incurred by the Fund.
The Predecessor Sub-Advisor agreed to bear a portion of this reduction by
reducing the amount of its full sub-advisory fee during such period to 0.382% of
the Fund's Managed Assets.
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 26% 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" 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 Commission's
Public Reference Room in Washington, D.C. Information on the operation of the
Public Reference Room may be obtained by calling the Commission at (202)
551-8090. The codes of ethics are available on the EDGAR Database on the
Commission'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 Commission Public
Reference Section, Washington, D.C. 20549-0102.
Proxy Voting 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 economic 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 Energy Income Partners. Energy Income Partners' Proxy Voting Policy is set
forth in Appendix B to the Statement of Additional Information.
Information regarding how the Fund voted proxies relating to portfolio
securities is available: (i) without charge, upon request, by calling (800)
621-1675; (ii) on the Fund's website at http://www.ftportfolios.com; and (iii)
by accessing the Commission's website at http://www.sec.gov.
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.
-43-
Energy Income Partners, located at 49 Riverside Avenue, Westport,
Connecticut 06880, is a registered investment Advisor and serves as investment
Advisor or portfolio supervisor to investment portfolios with approximately $408
million of assets as of February 28, 2010.
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 three unregistered investment
companies and one private registered investment company for high net worth
individuals and institutions. 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 seven persons.
James J. Murchie is the Founder, Chief Executive Officer, co-portfolio
manager and a Principal of Energy Income Partners. 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. 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 is co-portfolio
manager for all its funds. 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.
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 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.
-44-
-------------------------------------------------------------------------------
Number of Other Accounts Managed and Assets by Account Type
As of December 31, 2009
-------------------------------------------------------------------------------
Registered Investment
Companies Other Pooled
(other than the Fund) Investment Vehicles Other Accounts
---------------------- ------------------- --------------
Number: 1 Number: 3 Number: 12
Assets: $97 million Assets: $113 Assets: $7.6
million million
-------------------------------------------------------------------------------
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
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.
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.
-45-
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 Commission 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 the Sub-Advisory Agreement among the Advisor, the
Sub-Advisor and the Fund, the Advisor has agreed to pay for the services and
facilities provided by the Sub-Advisor through sub-advisory fees. 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.
From the commencement of the Fund's operations through September 13,
2007, the Fund paid the Advisor, $5,594,220 of which $2,822,136 was paid by the
Advisor to the Predecessor Sub-Advisor. From September 14, 2007 through
February 28, 2010, the Fund paid the Advisor $4,624,840 of which $2,312,420
was paid by the Advisor to the Sub-Advisor. See "Summary of Fund Expenses" and
"Management of the Fund -- Investment Management Agreement" in the Fund's
Prospectus.
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.
-46-
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.
Portfolio Transactions and Brokerage
Subject to the supervision of the Board of Trustees, the Sub-Advisor is
responsible for decisions to buy and sell securities for the Fund and for the
placement of the Fund's securities business, the negotiation of the commissions
to be paid on brokered transactions, the prices for principal trades in
securities, and the allocation of portfolio brokerage and principal business. It
is the policy of the Sub-Advisor to seek the best execution at the best security
price available with respect to each transaction, and with respect to brokered
transactions in light of the overall quality of brokerage and research services
provided to the Sub-Advisor and its advisees. The best price to the Fund means
the best net price without regard to the mix between purchase or sale price and
commission, if any. Purchases may be made from underwriters, dealers, and, on
occasion, the issuers. Commissions will be paid on the Fund's futures and
options transactions, if any. The purchase price of portfolio securities
purchased from an underwriter or dealer may include underwriting commissions and
dealer spreads. The Fund may pay mark-ups on principal transactions. In
selecting broker/dealers and in negotiating commissions, the Sub-Advisor
considers, among other things, the firm's reliability, the quality of its
execution services on a continuing basis and its financial condition. The
selection of a broker-dealer may take into account the sale of products
sponsored or advised by the Sub-Advisor and/or its affiliates. If approved by
the Fund's Board of Trustees, the Sub-Advisor may select an affiliated
broker-dealer to effect transactions in the Fund, so long as such transactions
are consistent with Rule 17e-1 under the 1940 Act. The Fund paid brokerage
commissions in the amounts of $316,694, $402,583 and $228,792 in 2009, 2008
and 2007, respectively. The Fund did not pay any brokerage commissions to any
affiliated persons of the Fund.
Section 28(e) of the Securities Exchange Act of 1934, as amended
("Section 28(e)"), permits an investment Advisor, under certain circumstances,
to cause an account to pay a broker or dealer who supplies brokerage and
research services a commission for effecting a transaction in excess of the
amount of commission another broker or dealer would have charged for effecting
the transaction. Brokerage and research services include (a) furnishing advice
as to the value of securities, the advisability of investing, purchasing or
selling securities, and the availability of securities or purchasers or sellers
of securities; (b) furnishing analyses and reports concerning issuers,
industries, securities, economic factors and trends, portfolio strategy, and the
performance of accounts; and (c) effecting securities transactions and
performing functions incidental thereto (such as clearance, settlement, and
custody).
In light of the above, in selecting brokers, the Sub-Advisor may
consider investment and market information and other research, such as economic,
securities and performance measurement research, provided by such brokers, and
the quality and reliability of brokerage services, including execution
capability, performance, and financial responsibility. Accordingly, the
commissions charged by any such broker may be greater than the amount another
firm might charge if the Sub-Advisor determines in good faith that the amount of
-47-
such commissions is reasonable in relation to the value of the research
information and brokerage services provided by such broker to the Sub-Advisor or
the Fund. The Sub-Advisor believes that the research information received in
this manner provides the Fund with benefits by supplementing the research
otherwise available to the Fund. The investment advisory fees paid by the Fund
to the Advisor under the Investment Management Agreement is not reduced as a
result of receipt by the Advisor or the Sub-Advisor of research services.
The Advisor and Sub-Advisor may place portfolio transactions for other
advisory accounts advised by them, and research services furnished by firms
through which the Fund effects its securities transactions may be used by the
Sub-Advisor in servicing all of its accounts; not all of such services may be
used by the Sub-Advisor in connection with the Fund. The Sub-Advisor believes it
is not possible to measure separately the benefits from research services to
each of the accounts (including the Fund) they advise. Because the volume and
nature of the trading activities of the accounts are not uniform, the amount of
commissions in excess of those charged by another broker paid by each account
for brokerage and research services will vary. However, the Sub-Advisor believes
such costs to the Fund will not be disproportionate to the benefits received by
the Fund on a continuing basis. The Sub-Advisor seeks to allocate portfolio
transactions equitably whenever concurrent decisions are made to purchase or
sell securities by the Fund and another advisory account. In some cases, this
procedure could have an adverse effect on the price or the amount of securities
available to the Fund. In making such allocations between the Fund and other
advisory accounts, the main factors considered by the Sub-Advisor are the
investment objective, the relative size of portfolio holding of the same or
comparable securities, the availability of cash for investment and the size of
investment commitments generally held, and the opinions of the persons
responsible for recommending investments to the Fund and such other accounts and
funds.
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
-48-
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.
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 (other than a merger,
consolidation, reorganization or sale of assets with an acquiring fund that is
not an operating entity immediately prior to the transaction), (3) a sale, lease
or exchange of all or substantially all of the Fund's assets (other than in the
regular course of business of the Fund, sales of assets in connection with the
termination of the Fund as provided in the Declaration of Trust, or sale of
assets with an acquiring fund that is not an operating entity immediately prior
to the transaction), (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.
Approval of shareholders is not required, however, for any transaction,
whether deemed a merger, consolidation, reorganization or otherwise whereby the
Fund issues shares in connection with the acquisition of assets (including those
subject to liabilities) from any other investment company or similar entity.
None of the foregoing provisions may be amended except by the vote of at least
two-thirds of the Shares outstanding and entitled to vote.
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
-49-
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 the Trustees shall by resolution
have approved a memorandum of understanding with such Principal 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. 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 Commission
for the full text of these provisions.
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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 is be a function
of several factors, including dividend levels (which are in turn affected by
expenses), NAV, call protection, 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 has retained 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, 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 Commission 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
-51-
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 Amex, 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 Amex, (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
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 Amex. 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 net asset value, 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.
-52-
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.
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 New York Stock Exchange
(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 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 (as defined below) 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 The Nasdaq Stock
Market 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
-53-
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.
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 projected cash flows for the issuer or borrower;
o the fundamental business data relating to the issuer or borrower;
o an evaluation of the forces which influence the market in which
these securities are purchased and sold;
o the type, size and cost of holding;
o the financial statements of the issuer or borrower;
o the credit quality and cash flow of issuer, based on the Sub-
Advisor's or external analysis;
o the information as to any transactions in or offers for the holding;
o the price extent of public trading in similar securities
(or equity securities) of the issuer/borrower, or comparable
companies;
o the coupon payments;
-54-
o the quality, value and saleability of collateral securing the
security or loan;
o the business prospects of the issuer/borrower, including any ability
to obtain money or resources from a parent or affiliate and an
assessment of the issuer's or borrower's management;
o the prospects for the issuer's or borrower's industry, and multiples
(of earnings and/or cash flow) being paid for similar businesses in
that industry;
o any decline in value over time due to the nature of the assets - for
example, an entity that has a finite-life concession agreement with a
government agency to provide a service (e.g., toll roads and
airports); and
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) ordinarily
will be valued 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 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 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 recognized for federal income tax
purposes. It is anticipated that cash distributions, for MLPs in which the Fund
invests, will not equal the amount of taxable income allocable to the Fund
primarily due to depreciation and amortization recorded by MLPs which generally
results in a portion of the cash distribution received to not be recognizable as
income for tax purposes. The relative portion of such distributions not
recognized for tax purposes 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 portion of each distribution recognized as taxable income
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 Code Section 312.
-55-
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.
persons, as defined herein. The discussion that follows is based on the
provisions of the Code, 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 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, (iii)
persons whose functional currency is not the United States 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 United
States 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 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 35%. In addition, the United
States also imposes a 20% alternative minimum tax on the recalculated
-56-
alternative minimum taxable income of an entity treated as a corporation. Any
such U.S. corporate income tax or alternative minimum 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, either because the
states follow the federal election or because the states separately impose a tax
on the Fund.
The MLPs in which the Fund intends to invest 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.
The Fund intends to invest 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.
In general, for certain periods in the investment life cycle, energy
ventures historically have generated taxable income in amounts less than the
amount of cash distributions that they have produced. The Fund anticipates that
it will not incur U.S. federal income tax on a significant portion of its cash
flow received, particularly after taking into account the Fund's current
operating expenses. However, the Fund's particular investments may not perform
consistently with historical patterns in the industry, and additional tax may be
incurred by the Fund.
Although the Fund intends to hold 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, decreased for any distributions
of cash received by the Fund in excess of the Fund's allocable share of taxable
income and decreased by the Fund's allocable share of net losses. Thus, although
cash 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 35%.
In calculating the Fund's alternative minimum taxable income, certain
percentage depletion deductions and intangible drilling costs may be treated as
items of tax preference. Items of tax preference increase alternative minimum
taxable income and increase the likelihood that the Fund may be subject to the
alternative minimum tax.
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
-57-
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.
As discussed in greater detail below, prior to 2011, dividends that
qualify as "qualified dividend income" are generally taxed to individuals at a
maximum 15% rate if certain holding period and other requirements are met. After
2010, individuals will be taxed at ordinary rates on dividend income. The
current maximum rate for individuals on ordinary income is 35%. This rate is
scheduled to increase to 39.6% after 2010. Corporations are generally subject to
tax on dividends at a maximum 35% rate, but corporations may be eligible to
exclude 70% of the dividends if certain holding period requirements are met by
the common shareholder receiving such dividend. Common shareholders that are not
U.S. persons are generally subject to a 30% withholding tax, unless (i) the
common shareholder's interest in the Fund is effectively connected to a U.S.
trade or business and the common shareholder provides the Fund with a Form
W-8ECI signed under penalties of perjury (in which case, the common shareholder
will be subject to the normal U.S. graduated rates) or (ii) the common
shareholder is eligible for the benefits of a U.S. income tax treaty and
provides the Fund with a Form W-8BEN signed under penalties of perjury (in which
case, the common shareholder will be subject to the rate of withholding provided
for in the relevant treaty).
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 of the excess distribution. 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 15% on
long-term capital gains. This rate is currently scheduled to increase to 20% for
tax years beginning after December 31, 2010. Corporations are taxed on capital
gains at their ordinary graduated rates.
Because unsevered natural resources are viewed as interests in real
property for some purposes of the Code, depending upon the nature and location
of the MLPs' assets, the Fund could from time to time be classified as a U.S.
real property holding corporation. If the Fund is classified as a U.S. real
property holding corporation, dispositions of interests in the Fund by a
non-U.S. common shareholder and distributions in excess of a non-U.S. common
shareholder's basis may be subject to 10% withholding.
A corporation's earnings and profits are generally calculated by making
certain adjustments to the corporation's reported taxable income. Based upon the
-58-
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.
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.
The maximum federal income tax rate for individuals on qualified
dividend income is currently generally 15% for tax years ending on or before
December 31, 2010, unless such favorable treatment is repealed sooner by new
legislation. 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. This rate of tax on dividends is currently scheduled to increase
back to ordinary income rates after December 31, 2010, with the maximum marginal
federal income tax rate being 39.6%.
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 federal
income tax status of Fund distributions to them.
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 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.
Information Reporting and Withholding. The Fund will be required to
report annually to 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) will be required to
provide the Fund, under penalties of perjury, an IRS Form W-9, Form W-8BEN, Form
W-8ECI or an equivalent form containing the common shareholder's name, address,
-59-
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 for domestic persons is 28%, but such
rate is scheduled to increase to 31% after December 31, 2010. As mentioned
above, non-U.S. persons may be subject to withholding tax at a rate of 30%, if
appropriate documentation demonstrating eligibility for a lower rate is not
provided. 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 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.
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
currently invests in energy MLPs, so the income of the MLPs should qualify as
qualifying income.
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 and allocations of deductions (such as percentage depletion) and
losses, and increased for capital contributions and allocations of net income
and gains.
-60-
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. 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) 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.
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.
Performance Related and Comparative Information
The Fund may quote certain performance-related information and may
compare certain aspects of its portfolio and structure to other substantially
similar closed-end funds. In reports or other communications to shareholders of
the Fund or in advertising materials, the Fund may compare its performance with
that of (1) other investment companies listed in the rankings prepared by
Lipper, Inc. ("Lipper"), Morningstar Inc. or other independent services;
publications such as Barrons, Business Week, Forbes, Fortune, Institutional
Investor, Kiplinger's Personal Finance, Money, Morningstar Mutual Fund Values,
The New York Times, The Wall Street Journal and USA Today; or other industry or
financial publications or (2) the Standard & Poor's Index of 500 Stocks, the Dow
Jones Industrial Average, NASDAQ Composite Index and other relevant indices and
industry publications. Comparison of the Fund to an alternative investment
should be made with consideration of differences in features and expected
performance. The Fund may obtain data from sources or reporting services, such
as Bloomberg Financial and Lipper Inc., that the Fund believes to be generally
accurate.
-61-
From time to time, the Fund may quote the Fund's total return, aggregate
total return or yield in advertisements or in reports and other communications
to shareholders. The Fund's performance will vary depending upon market
conditions, the composition of its portfolio and its operating expenses.
Consequently any given performance quotation should not be considered
representative of the Fund's performance in the future. In addition, because
performance will fluctuate, it may not provide a basis for comparing an
investment in the Fund with certain bank deposits or other investments that pay
a fixed yield for a stated period of time. Investors comparing the Fund's
performance with that of other investment companies should give consideration to
the quality and type of the respective investment companies' portfolio
securities.
The Fund's "average annual total return" is computed according to a
formula prescribed by the Commission. The formula can be expressed as follows:
Average Annual Total Return will be computed as follows:
ERV = P(1+T)/n/
Where P = a hypothetical initial payment of $1,000
T = average annual total return n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1-, 5-, or 10-year periods at
the end of the 1-, 5-, or 10-year periods (or fractional
portion).
The Fund may also quote after-tax total returns to show the impact of
assumed federal income taxes on an investment in the Fund. The Fund's total
return "after taxes on distributions" shows the effect of taxable distributions,
but not any taxable gain or loss, on an investment in shares of the Fund for a
specified period of time. The Fund's total return "after taxes on distributions
and sale of Fund shares" shows the effect of both taxable distributions and any
taxable gain or loss realized by the shareholder upon the sale of Fund shares at
the end of a specified period. To determine these figures, all income,
short-term capital gain distributions, and long-term capital gains distributions
are assumed to have been taxed at the highest marginal individualized federal
tax rate then in effect. Those maximum tax rates are applied to distributions
prior to reinvestment and the after-tax portion is assumed to have been
reinvested in the Fund. State and local taxes are ignored.
Actual after-tax returns depend on a shareholder's tax situation and may
differ from those shown. After-tax returns reflect past tax effects and are not
predictive of future tax effects.
-62-
Average Annual Total Return (After Taxes on Distributions) will be
computed as follows:
ATV/D/ = P(1+T)/n/
Where: P = a hypothetical initial investment of $1,000
T = average annual total return (after taxes on distributions)
n = number of years
ATV/D/ = ending value of a hypothetical $1,000 investment made at
the beginning of the period, at the end of the period (or
fractional portion thereof), after taxes on fund
distributions but not after taxes on redemptions.
Average Annual Total Return (After Taxes on Distributions and Sale of
Fund Shares) will be computed as follows:
ATV/DR/ = P(1+T)/n/
Where: P = a hypothetical initial investment of $1,000
T = average annual total return (after taxes on distributions
and redemption)
n = number of years
ATV/DR/ = ending value of a hypothetical $1,000 investment made at
the beginning periods, at the end of the periods (or
fractional portion thereof), after taxes on fund
distributions and redemptions.
Quotations of yield for the Fund will be based on all investment income
per share earned during a particular 30-day period (including dividends and
interest), less expenses accrued during the period ("net investment income") and
are computed by dividing net investment income by the maximum offering price per
share on the last day of the period, according to the following formula:
Yield = 2 [( a-b/cd +1)/6/ - 1]
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends
d = the maximum offering price per share on the last day of
the period
Past performance is not indicative of future results. At the time
shareholders sell their shares, they may be worth more or less than their
original investment.
Experts
The Financial Statements of the Fund as of November 30, 2009,
incorporated by reference in this Statement of Additional Information, have been
audited by Deloitte & Touche LLP, an independent registered public accounting
-63-
firm, as set forth in their report thereon incorporated by reference in this
Statement of Additional Information, and is incorporated in reliance upon the
report of such firm given upon their authority as experts in accounting and
auditing services. 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
PFPC Trust Company, 301 Bellevue Parkway, Wilmington, Delaware 19809,
serves as custodian for the Fund. As such, PFPC Trust Company (which will be
renamed PNC Trust Company effective June 7, 2010) 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. PNC Global Investment Servicing (U.S.) Inc., 301 Bellevue Parkway,
Wilmington, Delaware 19809, is the transfer, 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.
PNC Global Investment Servicing (U.S.) Inc. 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 Commission. The Fund's Prospectus, any Prospectus Supplement and this
Statement of Additional Information do not contain all of the information set
forth in the Registration Statement, 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 Prospectus Supplement 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 Commission's principal office in Washington, D.C., and copies of
all or any part thereof may be obtained from the Commission upon the payment of
certain fees prescribed by the Commission.
-64-
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 Annual Report for the year
ended November 30, 2009 contained in the Fund's Form N-CSR filed with the
Commission on January 27, 2010 are hereby incorporated by reference into, and
are made part of, this Statement of Additional Information. A copy of such
Annual Report must accompany the delivery of this Statement of Additional
Information.
F-1
Appendix A
Standard & Poor's Ratings Group -- A brief description of the applicable
Standard & Poor's Ratings Group, 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 current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations, or a specific financial program. It
takes into consideration the creditworthiness of guarantors, insurers, or other
forms of credit enhancement on the obligation. The issue credit rating is not a
recommendation to purchase, sell, or hold a financial obligation, inasmuch as it
does not comment as to market price or suitability for a particular investor.
Issue credit ratings are based on current information furnished by the
obligors or obtained by Standard & Poor's from other sources it considers
reliable. Standard & Poor's does not perform an audit in connection with any
credit rating and may, on occasion, rely on unaudited financial information.
Credit ratings may be changed, suspended, or withdrawn as a result of changes
in, or unavailability of, such information, or based on other circumstances.
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. The result is a dual
rating, in which the short-term rating addresses the put feature, in addition to
the usual long-term rating. Medium-term notes are assigned long-term ratings.
Long-term Issue Credit Ratings
Issue credit ratings are based in varying degrees, on 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
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.
The issue ratings definitions are expressed in terms of default risk. As
such, they pertain to senior obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to reflect the lower priority in
bankruptcy, as noted above.
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
in 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.
C
The `C' rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments on this
obligation are being continued.
D
An obligation rated `D' is in payment default. The `D' rating category
is used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poor's believes that
such payments will be made during such grace period. The `D' rating also will be
used upon the filing of a bankruptcy petition or the taking of a similar action
if payments on an obligation are jeopardized.
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.
c
The `c' subscript is 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 is below an investment-grade level and/or
the issuer's bonds are deemed taxable.
p
The letter `p' indicates 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 is largely
or entirely dependent upon the successful, timely completion of the project.
This rating, however, while addressing credit quality subsequent to completion
of the project, makes no comment on the likelihood of or the risk of default
upon failure of such completion. The investor should exercise his own judgment
with respect to such likelihood and risk.
A-3
*
Continuance of the ratings is contingent upon Standard & Poor's receipt
of an executed copy of the escrow agreement or closing documentation confirming
investments and cash flows.
r
The `r' highlights derivative, hybrid, and certain other obligations
that Standard & Poor's believes may experience high volatility or high
variability in expected returns as a result of noncredit risks. Examples of such
obligations are securities with principal or interest return indexed to
equities, commodities, or currencies; certain swaps and options; and
interest-only and principal-only mortgage securities. The absence of an `r'
symbol should not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
N.R.
Not rated.
Debt obligations of issuers outside the United States and its
territories are rated on the same basis as domestic corporate and municipal
issues. The ratings measure the creditworthiness of the obligor but do not take
into account currency exchange and related uncertainties.
Bond Investment Quality Standards
Under present commercial bank regulations issued by the Comptroller of
the Currency, bonds rated in the top four categories (`AAA,' `AA,' `A,' `BBB,'
commonly known as investment-grade ratings) generally are regarded as eligible
for bank investment. Also, the laws of various states governing legal
investments impose certain rating or other standards for obligations eligible
for investment by savings banks, trust companies, insurance companies, and
fiduciaries in general.
Short-Term Issue Credit Ratings
Notes. A Standard & Poor's note rating reflects the liquidity factors
and market access risks unique to notes. Notes due in three years or less will
likely receive a note rating. Notes maturing beyond three years will most likely
receive a long-term debt rating. The following criteria will be used in making
that assessment:
o Chapter 1 Amortization schedule -- the larger the final maturity
relative to other maturities, the more likely it will be treated
as a note; and
o Chapter 2 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-4
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.
Commercial Paper
An S&P commercial paper rating is a current assessment of the likelihood
of timely payment of debt having an original maturity of no more than 365 days.
Ratings are graded into several categories, ranging from `A-1' for the highest
quality obligations to `D' for the lowest. These categories are as follows:
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.
A-5
B
A short-term obligation rated `B' is regarded as having significant
speculative characteristics. 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 commitment on the obligation.
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 payment default. The `D' rating
category is used when payments on an obligation are not made on the date due
even if the applicable grace period has not expired, unless Standard & Poor's
believes that such payments will be made during such grace period. The `D'
rating also will be used upon the filing of a bankruptcy petition or the taking
of a similar action if payments on an obligation are jeopardized.
Moody's Investors Service, Inc. -- A brief description of the applicable
Moody's Investors Service, Inc. ("Moody's") rating symbols and their meanings
(as published by Moody's) follows:
Long-Term Debt Ratings
Aaa
Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa
Bonds rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risk appear somewhat larger than the Aaa securities.
A-6
A
Bonds rated A possess many favorable investment attributes and are to be
considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
Baa
Bonds rated Baa are considered as medium-grade obligations (i.e., they
are neither highly protected nor poorly secured). Interest payments and
principal security appear adequate for the present, but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba
Bonds rated Ba are judged to have speculative elements; their future
cannot be considered as well-assured. Often the protection of interest and
principal payments may be very moderate, and thereby not well safeguarded during
both good and bad times over the future. Uncertainty of position characterizes
bonds in this class.
B
Bonds rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa
Bonds rated Caa are of poor standing. Such issues may be in default or
there may be present elements of danger with respect to principal or interest.
Ca
Bonds rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked shortcomings.
C
Bonds rated C are the lowest rated class of bonds, and issues so rated
can be regarded as having extremely poor prospects of ever attaining any real
investment standing.
Note: Moody's applies numerical modifiers 1, 2, and 3 in each generic rating
classification from Aa through Caa. The modifier 1 indicates that the obligation
A-7
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.
Short-Term Debt 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.
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.
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.
A-8
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.
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.
Commercial Paper
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.
A-9
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.
Note: Canadian issuers rated P-1 or P-2 have their short-term ratings enhanced
by the senior-most long-term rating of the issuer, its guarantor or support-
provider.
Fitch Rating Services, Inc.-- A brief description of the applicable
Fitch Rating Services, Inc. ("Fitch") ratings symbols and meanings (as
published by Fitch) follows:
Long-Term Credit Ratings
International Long-Term Credit Ratings are more commonly referred to as
simply "Long-Term Ratings." The following scale applies to foreign currency and
local currency ratings.
International credit ratings assess the capacity to meet foreign or
local currency commitments. Both foreign and local currency ratings are
internationally comparable assessments. The local currency rating measures the
probability of payment only within the sovereign state's currency and
jurisdiction.
AAA
Highest credit quality. `AAA' ratings denote the lowest expectation of
credit risk. They are assigned only in case of exceptionally strong capacity for
timely payment of financial commitments. This capacity is highly unlikely to be
adversely affected by foreseeable events.
AA
Very high credit quality. `AA' ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
A
High credit quality. `A' ratings denote a low expectation of credit
risk. The capacity for timely payment of financial commitments is considered
strong. This capacity may, nevertheless, be more vulnerable to changes in
circumstances or in economic conditions than is the case for higher ratings.
A-10
BBB
Good credit quality. `BBB' ratings indicate that there is currently a
low expectation of credit risk. The capacity for timely payment of financial
commitments is considered adequate, but adverse changes in circumstances and in
economic conditions are more likely to impair this capacity. This is the lowest
investment-grade category.
BB
Speculative. `BB' ratings indicate that there is a possibility of credit
risk developing, particularly as the result of adverse economic change over
time; however, business or financial alternatives may be available to allow
financial commitments to be met. Securities rated in this category are not
investment grade.
B
Highly speculative. `B' ratings indicate that significant credit risk is
present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is contingent upon
a sustained, favorable business and economic environment.
CCC, CC, C
High default risk. Default is a real possibility. Capacity for meeting
financial commitments is solely reliant upon sustained, favorable business or
economic developments. A `CC' rating indicates that default of some kind appears
probable. `C' ratings signal imminent default.
DDD, DD, D
Default. The ratings of obligations in this category are based on their
prospects for achieving partial or full recovery in a reorganization or
liquidation of the obligor. While expected recovery values are highly
speculative and cannot be estimated with any precision, the following serve as
general guidelines. `DDD' obligations have the highest potential for recovery,
around 90%-100% of outstanding amounts and accrued interest. `DD' indicates
potential recoveries in the range of 50%-90% and `D' the lowest recovery
potential, i.e., below 50%.
Entities rated in this category have defaulted on some or all of their
obligations. Entities rated `DDD' have the highest prospect for resumption of
performance or continued operation with or without a formal reorganization
process. Entities rated `DD' and `D' are generally undergoing a formal
reorganization or liquidation process; those rated `DD' are likely to satisfy a
higher portion of their outstanding obligations, while entities rated `D' have a
poor prospect of repaying all obligations.
A-11
Short-Term Credit Ratings
International Short-Term Credit Ratings are more commonly referred to as
simply "Short-Term Ratings." The following scale applies to foreign currency and
local currency ratings.
A short-term rating has a time horizon of less than 12 months for most
obligations, or up to three years for U.S. public finance securities, and thus
places greater emphasis on the liquidity necessary to meet financial commitments
in a timely manner.
International credit ratings assess the capacity to meet foreign or
local currency commitments. Both foreign and local currency ratings are
internationally comparable assessments. The local currency rating measures the
probability of payment only within the sovereign state's currency and
jurisdiction.
F1
Highest credit quality. Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
F2
Good credit quality. A satisfactory capacity for timely payment of
financial commitments, but the margin of safety is not as great as in the case
of the higher ratings.
F3
Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.
B
Speculative. Minimal capacity for timely payment of financial
commitments, plus vulnerability to near-term adverse changes in financial and
economic conditions.
C
High default risk. Default is a real possibility. Capacity for meeting
financial commitments is solely reliant upon a sustained, favorable business and
economic environment.
D
Default. Denotes actual or imminent payment default.
A-12
Notes to Long-term and Short-term ratings:
"+" or "-" may be appended to a rating to denote relative status within
major rating categories. Such suffixes are not added to the `AAA' Long-term
rating category, to categories below `CCC,' or to Short-term ratings other than
`F1'.
`NR' indicates that Fitch does not rate the issuer or issue in question.
`Withdrawn': A rating is withdrawn when Fitch deems the amount of
information available to be inadequate for rating purposes, or when an
obligation matures, is called, or refinanced.
Rating Watch: Ratings are placed on Rating Watch to notify investors
that there is a reasonable probability of a rating change and the likely
direction of such change. These are designated as "Positive," indicating a
potential upgrade, "Negative," for a potential downgrade, or "Evolving," if
ratings may be raised, lowered or maintained. Rating Watch is typically resolved
over a relatively short period.
A Rating Outlook indicates the direction a rating is likely to move over
a one to two year period. Outlooks may be positive, stable, or negative. A
positive or negative Rating Outlook does not imply a rating change is
inevitable. Similarly, ratings for which outlooks are `stable' could be
downgraded before an outlook moves to positive or negative if circumstances
warrant such an action. Occasionally, Fitch may be unable to identify the
fundamental trend. In these cases, the Rating Outlook may be described as
evolving.
A-13
Appendix B
Energy Income Partners, LLC
Proxy Voting Policies and Procedures
If an Advisor exercises voting authority with respect to client securities,
Advisers Act Rule 206(4)-6 requires the Advisor 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 Advisor's fiduciary duty includes handling
the voting of proxies on securities held in client accounts over which the
Advisor 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;
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 RiskMetrics Group
With the aim of ensuring that proxies are voted in the best interest of EIP
clients, EIP has engaged RiskMetrics Group ("RiskMetrics"), formerly known as
Institutional Shareholder Services, 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 RiskMetrics 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 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.
B-1
EIP addresses these conflicts or appearances of conflicts by ensuring that
proxies are voted in accordance with the recommendations made by RiskMetrics, an
independent third party proxy voting service. As previously noted, in most
cases, proxies will be voted in accordance with RiskMetrics'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 RiskMetrics 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.
*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
B-2
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 RiskMetrics 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
RiskMetrics 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.
Appendix A
Proxy Voting Guidelines
ISS Proxy Voting Guidelines Summary
The following is a concise summary of ISS's 2010 proxy voting policy guidelines.
Routine/Miscellaneous:
Auditor Ratification
Vote FOR proposals to ratify auditors, unless any of the following apply:
o An auditor has a financial interest in or association with the
company, and is therefore not independent;
o There is reason to believe that the independent auditor has rendered
an opinion which is neither accurate nor indicative of the company's
financial position;
o Poor accounting practices are identified that rise to a serious level
of concern, such as: fraud; misapplication of GAAP; and material
weaknesses identified in Section 404 disclosures; or
B-3
o Fees for non-audit services ("Other" fees) are excessive.
Non-audit fees are excessive if:
o Non-audit ("other") fees exceed audit fees + audit-related fees + tax
compliance/preparation fees
Board of Directors:
Votes on director nominees should be determined on a CASE-BY-CASE basis.
Four fundamental principles apply when determining votes on director nominees:
o Board Accountability
o Board Responsiveness
o Director Independence
o Director Competence
Board Accountability
Problematic Takeover Defenses
VOTE WITHHOLD/AGAINST(1) the entire board of directors (except new nominees(2),
who should be considered on a CASE-by-CASE basis), if:
o The board is classified, and a continuing director responsible for a
problematic governance issue at the board/committee level that would
warrant a withhold/against vote recommendation is not up for election
-- any or all appropriate nominees (except new) may be held
accountable;
___________________
(1) In general, companies with a plurality vote standard use "Withhold" as the
valid contrary vote option in director elections; companies with a majority vote
standard use "Against". However, it will vary by company and the proxy must be
checked to determine the valid contrary vote option for the particular company.
(2) A "new nominee" is any current nominee who has not already been elected by
shareholders and who joined the board after the problematic action in question
transpired. If RMG cannot determine whether the nominee joined the board before
or after the problematic action transpired, the nominee will be considered a
"new nominee" if he or she joined the board within the 12 months prior to the
upcoming shareholder meeting.
o The company's poison pill has a "dead-hand" or "modified dead-hand"
feature. Vote withhold/against every year until this feature is
removed;
o The board adopts a poison pill with a term of more than 12 months
("long-term pill"), or renews any existing pill, including any
"short-term" pill (12 months or less), without shareholder approval. A
commitment or policy that puts a newly-adopted pill to a binding
shareholder vote may potentially offset an adverse vote
recommendation. Review such companies with classified boards every
year, and such companies with annually-elected boards at least once
every three years, and vote AGAINST or WITHHOLD votes from all
nominees if the company still maintains a non-shareholder-approved
poison pill. This policy applies to all companies adopting or renewing
pills after the announcement of this policy (Nov 19, 2009);
B-4
o The board makes a material adverse change to an existing poison pill
without shareholder approval.
Vote CASE-By-CASE on all nominees if the board adopts a poison pill with a term
of 12 months or less ("short-term pill") without shareholder approval, taking
into account the following factors:
o The date of the pill's adoption relative to the date of the next
meeting of shareholders- i.e. whether the company had time to put the
pill on ballot for shareholder ratification given the circumstances;
o The issuer's rationale;
o The issuer's governance structure and practices; and
o The issuer's track record of accountability to shareholders.
Problematic Audit-Related Practices
Generally, vote AGAINST or WITHHOLD from the members of the Audit Committee if:
o The non-audit fees paid to the auditor are excessive (see discussion
under "Auditor Ratification");
o The company receives an adverse opinion on the company's financial
statements from its auditor; or
o There is persuasive evidence that the audit committee entered into an
inappropriate indemnification agreement with its auditor that limits
the ability of the company, or its shareholders, to pursue legitimate
legal recourse against the audit firm.
Vote CASE-by-CASE on members of the Audit Committee and/or the full board if:
o Poor accounting practices are identified that rise to a level of
serious concern, such as: fraud; misapplication of GAAP; and material
weaknesses identified in Section 404 disclosures. Examine the
severity, breadth, chronological sequence and duration, as well as the
company's efforts at remediation or corrective actions, in determining
whether WITHHOLD/AGAINST votes are warranted.
Problematic Compensation Practices
VOTE WITHHOLD/AGAINST the members of the Compensation Committee and potentially
the full board if:
o There is a negative correlation between chief executive pay and
company performance (see Pay for Performance Policy);
o The company reprices underwater options for stock, cash, or other
consideration without prior shareholder approval, even if allowed in
the firm's equity plan;
o The company fails to submit one-time transfers of stock options to a
shareholder vote;
o The company fails to fulfill the terms of a burn rate commitment made
to shareholders;
o The company has problematic pay practices. Problematic pay practices
may warrant withholding votes from the CEO and potentially the entire
board as well.
B-5
Other Problematic Governance Practices
VOTE WITHHOLD/AGAINST the entire board of directors (except new nominees, who
should be considered on a CASE-by-CASE basis), if:
o The company's proxy indicates that not all directors attended 75
percent of the aggregate board and committee meetings, but fails to
provide the required disclosure of the names of the director(s)
involved. If this information cannot be obtained, withhold from all
incumbent directors;
o The board lacks accountability and oversight, coupled with sustained
poor performance relative to peers. Sustained poor performance is
measured by one- and three-year total shareholder returns in the
bottom half of a company's four-digit GICS industry group (Russell
3000 companies only). Take into consideration the company's five-year
total shareholder return and five-year operational metrics.
Problematic provisions include but are not limited to:
- A classified board structure;
- A supermajority vote requirement;
- Majority vote standard for director elections with no carve out
for contested elections;
- The inability for shareholders to call special meetings;
- The inability for shareholders to act by written consent;
- A dual-class structure; and/or
- A non-shareholder approved poison pill.
Under extraordinary circumstances, vote AGAINST or WITHHOLD from directors
individually, committee members, or the entire board, due to:
o Material failures of governance, stewardship, or fiduciary
responsibilities at the company;
o Failure to replace management as appropriate; or
o Egregious actions related to the director(s)' service on other boards
that raise substantial doubt about his or her ability to effectively
oversee management and serve the best interests of shareholders at any
company.
Board Responsiveness
Vote WITHHOLD/AGAINST the entire board of directors (except new nominees, who
should be considered on a CASE-by-CASE basis), if:
o The board failed to act on a shareholder proposal that received
approval by a majority of the shares outstanding the previous year (a
management proposal with other than a FOR recommendation by management
will not be considered as sufficient action taken);
o The board failed to act on a shareholder proposal that received
approval of the majority of shares cast for the previous two
consecutive years (a management proposal with other than a FOR
recommendation by management will not be considered as sufficient
action taken);
B-7
o The board failed to act on takeover offers where the majority of the
shareholders tendered their shares; or
o At the previous board election, any director received more than 50
percent withhold/against votes of the shares cast and the company has
failed to address the issue(s) that caused the high withhold/against
vote.
Director Independence
Vote WITHHOLD/AGAINST Inside Directors and Affiliated Outside Directors (per the
Categorization of Directors in the Summary Guidelines) when:
o The inside or affiliated outside director serves on any of the three
key committees: audit, compensation, or nominating;
o The company lacks an audit, compensation, or nominating committee so
that the full board functions as that committee;
o The company lacks a formal nominating committee, even if the board
attests that the independent directors fulfill the functions of such a
committee; or
o The full board is less than majority independent.
Director Competence
Vote AGAINST or WITHHOLD from individual directors who:
o Attend less than 75 percent of the board and committee meetings
without a valid excuse, such as illness, service to the nation, work
on behalf of the company, or funeral obligations. If the company
provides meaningful public or private disclosure explaining the
director's absences, evaluate the information on a CASE-BY-CASE basis
taking into account the following factors:
- Degree to which absences were due to an unavoidable conflict;
- Pattern of absenteeism; and
- Other extraordinary circumstances underlying the director's
absence;
o Sit on more than six public company boards;
o Are CEOs of public companies who sit on the boards of more than two
public companies besides their own-- withhold only at their outside
boards.
Voting for Director Nominees in Contested Elections
Vote CASE-BY-CASE on the election of directors in contested elections,
considering the following factors:
o Long-term financial performance of the target company relative to its
industry;
o Management's track record;
o Background to the proxy contest;
B-8
o Qualifications of director nominees (both slates);
o Strategic plan of dissident slate and quality of critique against
management;
o Likelihood that the proposed goals and objectives can be achieved
(both slates);
o Stock ownership positions.
Independent Chair (Separate Chair/CEO)
Generally vote FOR shareholder proposals requiring that the chairman's position
be filled by an independent director, unless the company satisfies all of the
following criteria:
The company maintains the following counterbalancing features:
o Designated lead director, elected by and from the independent board
members with clearly delineated and comprehensive duties. (The role
may alternatively reside with a presiding director, vice chairman, or
rotating lead director; however the director must serve a minimum of
one year in order to qualify as a lead director.) The duties should
include, but are not limited to, the following:
- presides at all meetings of the board at which the chairman is
not present, including executive sessions of the independent
directors;
- serves as liaison between the chairman and the independent
directors;
- approves information sent to the board;
- approves meeting agendas for the board;
- approves meeting schedules to assure that there is sufficient
time for discussion of all agenda items;
- has the authority to call meetings of the independent directors;
- if requested by major shareholders, ensures that he is available
for consultation and direct communication;
o Two-thirds independent board;
o All independent key committees;
o Established governance guidelines;
o A company in the Russell 3000 universe must not have exhibited
sustained poor total shareholder return (TSR) performance, defined as
one- and three-year TSR in the bottom half of the company's four-digit
GICS industry group within the Russell 3000 only), unless there has
been a change in the Chairman/CEO position within that time;
o The company does not have any problematic governance or management
issues, examples of which include, but are not limited to:
B-9
- Egregious compensation practices;
- Multiple related-party transactions or other issues putting
director independence at risk;
- Corporate and/or management scandals;
- Excessive problematic corporate governance provisions; or
- Flagrant board or management actions with potential or realized
negative impact on shareholders.
Shareholder Rights & Defenses:
Net Operating Loss (NOL) Protective Amendments
For management proposals to adopt a protective amendment for the stated purpose
of protecting a company's net operating losses ("NOLs"), the following factors
should be considered on a CASE-BY-CASE basis:
o The ownership threshold (NOL protective amendments generally prohibit
stock ownership transfers that would result in a new 5-percent holder
or increase the stock ownership percentage of an existing five-percent
holder);
o The value of the NOLs;
o Shareholder protection mechanisms (sunset provision or commitment to
cause expiration of the protective amendment upon exhaustion or
expiration of the NOL);
o The company's existing governance structure including: board
independence, existing takeover defenses, track record of
responsiveness to shareholders, and any other problematic governance
concerns; and
o Any other factors that may be applicable.
Poison Pills- Shareholder Proposals to put Pill to a Vote and/or Adopt a Pill
Policy
Vote FOR shareholder proposals requesting that the company submit its
poison pill to a shareholder vote or redeem it UNLESS the company has: (1) A
shareholder approved poison pill in place; or (2) The company has adopted a
policy concerning the adoption of a pill in the future specifying that the board
will only adopt a shareholder rights plan if either:
o Shareholders have approved the adoption of the plan; or
o The board, in its exercise of its fiduciary responsibilities,
determines that it is in the best interest of shareholders under the
circumstances to adopt a pill without the delay in adoption that would
result from seeking stockholder approval (i.e., the "fiduciary out"
provision). A poison pill adopted under this fiduciary out will be put
to a shareholder ratification vote within 12 months of adoption or
expire. If the pill is not approved by a majority of the votes cast on
this issue, the plan will immediately terminate.
B-10
If the shareholder proposal calls for a time period of less than 12 months for
shareholder ratification after adoption, vote FOR the proposal, but add the
caveat that a vote within 12 months would be considered sufficient
implementation.
Poison Pills- Management Proposals to Ratify Poison Pill
Vote CASE-by-CASE on management proposals on poison pill ratification, focusing
on the features of the shareholder rights plan. Rights plans should contain the
following attributes:
o No lower than a 20% trigger, flip-in or flip-over;
o A term of no more than three years;
o No dead-hand, slow-hand, no-hand or similar feature that limits the
ability of a future board to redeem the pill;
o Shareholder redemption feature (qualifying offer clause); if the board
refuses to redeem the pill 90 days after a qualifying offer is
announced, 10 percent of the shares may call a special meeting or seek
a written consent to vote on rescinding the pill.
In addition, the rationale for adopting the pill should be thoroughly explained
by the company. In examining the request for the pill, take into consideration
the company's existing governance structure, including: board independence,
existing takeover defenses, and any problematic governance concerns.
Poison Pills- Management Proposals to ratify a Pill to preserve Net Operating
Losses (NOLs)
Vote CASE-BY-CASE on management proposals for poison pill ratification.
For management proposals to adopt a poison pill for the stated purpose of
preserving a company's net operating losses ("NOLs"), the following factors are
considered on a CASE-BY-CASE basis:
o The ownership threshold to transfer (NOL pills generally have a
trigger slightly below 5%);
o The value of the NOLs;
o The term;
o Shareholder protection mechanisms (sunset provision, or commitment to
cause expiration of the pill upon exhaustion or expiration of NOLs);
o The company's existing governance structure including: board
independence, existing takeover defenses, track record of
responsiveness to shareholders, and any other problematic governance
concerns; and
o Any other factors that may be applicable.
Shareholder Ability to Call Special Meetings
Vote AGAINST management or shareholder proposals to restrict or prohibit
shareholders' ability to call special meetings.
Generally vote FOR management or shareholder proposals that provide
shareholders with the ability to call special meetings taking into account
the following factors:
B-11
o Shareholders' current right to call special meetings;
o Minimum ownership threshold necessary to call special meetings (10%
preferred);
o The inclusion of exclusionary or prohibitive language;
o Investor ownership structure; and
o Shareholder support of and management's response to previous
shareholder proposals.
Supermajority Vote Requirements
Vote AGAINST proposals to require a supermajority shareholder vote.
Vote FOR management or shareholder proposals to reduce supermajority vote
requirements. However, for companies with shareholder(s) who have significant
ownership levels, vote CASE-BY-CASE, taking into account:
o Ownership structure;
o Quorum requirements; and
o Supermajority vote requirements.
Capital/Restructuring:
Common Stock Authorization
Vote CASE-BY-CASE on proposals to increase the number of shares of common stock
authorized for issuance. Take into account company-specific factors which
include, at a minimum, the following:
o Past Board Performance:
o The company's use of authorized shares during the last three
years;
o One- and three-year total shareholder return; and
o The board's governance structure and practices;
o The Current Request:
o Disclosure in the proxy statement of the specific reasons for the
proposed increase;
o The dilutive impact of the request as determined through an
allowable cap generated by RiskMetrics' quantitative model, which
examines the company's need for shares and its three-year total
shareholder return; and
o Risks to shareholders of not approving the request.
Vote AGAINST proposals at companies with more than one class of common stock to
increase the number of authorized shares of the class that has superior voting
rights.
Preferred Stock
Vote CASE-BY-CASE on proposals to increase the number of shares of preferred
stock authorized for issuance. Take into account company-specific factors
that include, at a minimum, the following:
B-12
o Past Board Performance:
o The company's use of authorized preferred shares during the last
three years;
o One- and three-year total shareholder return; and
o The board's governance structure and practices;
o The Current Request:
o Disclosure in the proxy statement of specific reasons for the
proposed increase;
o In cases where the company has existing authorized preferred
stock, the dilutive impact of the request as determined through
an allowable cap generated by RiskMetrics' quantitative model,
which examines the company's need for shares and three-year total
shareholder return; and
o Whether the shares requested are blank check preferred shares,
and whether they are declawed.
Vote AGAINST proposals at companies with more than one class or series of
preferred stock to increase the number of authorized shares of the class or
series that has superior voting rights.
Mergers and Acquisitions
Vote CASE - BY - CASE on mergers and acquisitions. Review and evaluate the
merits and drawbacks of the proposed transaction, balancing various and
sometimes countervailing factors including:
o Valuation - Is the value to be received by the target shareholders (or
paid by the acquirer) reasonable? While the fairness opinion may
provide an initial starting point for assessing valuation
reasonableness, emphasis is placed on the offer premium, market
reaction and strategic rationale.
o Market reaction - How has the market responded to the proposed deal? A
negative market reaction should cause closer scrutiny of a deal.
o Strategic rationale - Does the deal make sense strategically? From
where is the value derived? Cost and revenue synergies should not be
overly aggressive or optimistic, but reasonably achievable. Management
should also have a favorable track record of successful integration of
historical acquisitions.
o Negotiations and process - Were the terms of the transaction
negotiated at arm's-length? Was the process fair and equitable? A fair
process helps to ensure the best price for shareholders. Significant
negotiation "wins" can also signify the deal makers' competency. The
comprehensiveness of the sales process (e.g., full auction, partial
auction, no auction) can also affect shareholder value.
o Conflicts of interest - Are insiders benefiting from the transaction
disproportionately and inappropriately as compared to non-insider
shareholders? As the result of potential conflicts, the directors and
officers of the company may be more likely to vote to approve a merger
than if they did not hold these interests. Consider whether these
interests may have influenced these directors and officers to support
B-13
or recommend the merger. The change-in-control figure presented in the
"RMG Transaction Summary" section of this report is an aggregate
figure that can in certain cases be a misleading indicator of the true
value transfer from shareholders to insiders. Where such figure
appears to be excessive, analyze the underlying assumptions to
determine whether a potential conflict exists.
o Governance - Will the combined company have a better or worse
governance profile than the current governance profiles of the
respective parties to the transaction? If the governance profile is to
change for the worse, the burden is on the company to prove that other
issues (such as valuation) outweigh any deterioration in governance.
Compensation:
Executive Pay Evaluation
Underlying all evaluations are five global principles that most investors expect
corporations to adhere to in designing and administering executive and director
compensation programs:
1. Maintain appropriate pay-for-performance alignment, with emphasis on
long-term shareholder value: This principle encompasses overall
executive pay practices, which must be designed to attract, retain,
and appropriately motivate the key employees who drive shareholder
value creation over the long term. It will take into consideration,
among other factors, the link between pay and performance; the mix
between fixed and variable pay; performance goals; and equity-based
plan costs;
2. Avoid arrangements that risk "pay for failure": This principle
addresses the appropriateness of long or indefinite contracts,
excessive severance packages, and guaranteed compensation;
3. Maintain an independent and effective compensation committee: This
principle promotes oversight of executive pay programs by directors
with appropriate skills, knowledge, experience, and a sound process
for compensation decision-making (e.g., including access to
independent expertise and advice when needed);
4. Provide shareholders with clear, comprehensive compensation
disclosures: This principle underscores the importance of informative
and timely disclosures that enable shareholders to evaluate executive
pay practices fully and fairly;
5. Avoid inappropriate pay to non-executive directors: This principle
recognizes the interests of shareholders in ensuring that compensation
to outside directors does not compromise their independence and
ability to make appropriate judgments in overseeing managers' pay and
performance. At the market level, it may incorporate a variety of
generally accepted best practices.
Equity Compensation Plans
Vote CASE-BY-CASE on equity-based compensation plans. Vote AGAINST the equity
plan if any of the following factors apply:
o The total cost of the company's equity plans is unreasonable;
B-14
o The plan expressly permits the repricing of stock options/stock
appreciate rights (SARs) without prior shareholder approval;
o The CEO is a participant in the proposed equity-based compensation
plan and there is a disconnect between CEO pay and the company's
performance where over 50 percent of the year-over-year increase is
attributed to equity awards (see Pay-for-Performance);
o The company's three year burn rate exceeds the greater of 2% or the
mean plus one standard deviation of its industry group;
o Liberal Change of Control Definition: The plan provides for the
acceleration of vesting of equity awards even though an actual change
in control may not occur (e.g., upon shareholder approval of a
transaction or the announcement of a tender offer); or
o The plan is a vehicle for problematic pay practices.
Other Compensation Proposals and Policies
Advisory Votes on Executive Compensation- Management Proposals (Management
Say-on-Pay)
In general, the management say on pay (MSOP) ballot item is the
primary focus of voting on executive pay practices- dissatisfaction with
compensation practices can be expressed by voting against the MSOP rather than
withholding or voting against the compensation committee. However, if there is
no MSOP on which to express the dissatisfaction, then the secondary target will
be members of the compensation committee. In addition, in egregious cases, or if
the board fails to respond to concerns raised by a prior MSOP proposal; then
vote withhold or against compensation committee member (or, if the full board is
deemed accountable, to all directors). If the negative factors impact
equity-based plans, then vote AGAINST an equity-based plan proposal presented
for shareholder approval.
Evaluate executive pay and practices, as well as certain aspects of outside
director compensation, on a CASE-BY-CASE basis.
Vote AGAINST management say on pay (MSOP) proposals, AGAINST/WITHHOLD on
compensation committee members (or, in rare cases where the full board is deemed
responsible, all directors including the CEO), and/or AGAINST an equity-based
incentive plan proposal if:
o There is a misalignment between CEO pay and company performance (pay
for performance);
o The company maintains problematic pay practices;
o The board exhibits poor communication and responsiveness to
shareholders.
Additional CASE-BY-CASE considerations for the management say on pay (MSOP)
proposals:
o Evaluation of performance metrics in short-term and long-term plans,
as discussed and explained in the Compensation Discussion & Analysis
(CD&A). Consider the measures, goals, and target awards reported by
the company for executives' short- and long-term incentive awards:
disclosure, explanation of their alignment with the company's business
strategy, and whether goals appear to be sufficiently challenging in
relation to resulting payouts;
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o Evaluation of peer group benchmarking used to set target pay or award
opportunities. Consider the rationale stated by the company for
constituents in its pay benchmarking peer group, as well as the
benchmark targets it uses to set or validate executives' pay (e.g.,
median, 75th percentile, etc.,) to ascertain whether the benchmarking
process is sound or may result in pay "ratcheting" due to
inappropriate peer group constituents (e.g., much larger companies) or
targeting (e.g., above median); and
o Balance of performance-based versus non-performance-based pay.
Consider the ratio of performance-based (not including plain vanilla
stock options) vs. non-performance-based pay elements reported for the
CEO's latest reported fiscal year compensation, especially in
conjunction with concerns about other factors such as performance
metrics/goals, benchmarking practices, and pay-for-performance
disconnects.
Pay for Performance
Evaluate the alignment of the CEO's pay with performance over time, focusing
particularly on companies that have underperformed their peers over a sustained
period. From a shareholders' perspective, performance is predominantly gauged by
the company's stock performance over time. Even when financial or operational
measures are utilized in incentive awards, the achievement related to these
measures should ultimately translate into superior shareholder returns in the
long-term.
Focus on companies with sustained underperformance relative to peers,
considering the following key factors:
o Whether a company's one-year and three-year total shareholder returns
("TSR") are in the bottom half of its industry group (i.e., four-digit
GICS - Global Industry Classification Group); and
o Whether the total compensation of a CEO who has served at least two
consecutive fiscal years is aligned with the company's total
shareholder return over time, including both recent and long-term
periods.
If a company falls in the bottom half of its four-digit GICS, further analysis
of the CD&A is required to better understand the various pay elements and
whether they create or reinforce shareholder alignment. Also assess the CEO's
pay relative to the company's TSR over a time horizon of at least five years.
The most recent year-over-year increase or decrease in pay remains a key
consideration, but there will be additional emphasis on the long term trend of
CEO total compensation relative to shareholder return. Also consider the mix of
performance-based compensation relative to total compensation. In general,
standard stock options or time-vested restricted stock are not considered to be
performance-based. If a company provides performance-based incentives to its
executives, the company is highly encouraged to provide the complete disclosure
of the performance measure and goals (hurdle rate) so that shareholders can
assess the rigor of the performance program. The use of non-GAAP financial
metrics also makes it very challenging for shareholders to ascertain the rigor
of the program as shareholders often cannot tell the type of adjustments being
made and if the adjustments were made consistently. Complete and transparent
disclosure helps shareholders to better understand the company's pay for
performance linkage.
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Problematic Pay Practices The focus is on executive compensation practices
that contravene the global pay principles, including:
o Problematic practices related to non-performance-based compensation
elements;
o Incentives that may motivate excessive risk-taking; and
o Options Backdating.
Non-Performance based Compensation Elements
Companies adopt a variety of pay arrangements that may be acceptable in their
particular industries, or unique for a particular situation, and all companies
are reviewed on a case-by-case basis. However, there are certain adverse
practices that are particularly contrary to a performance-based pay philosophy,
including guaranteed pay and excessive or inappropriate non-performance-based
pay elements. While not exhaustive, this is the list of practices that carry
greatest weight in this consideration and may result in negative vote
recommendations on a stand-alone basis. For more details, please refer to RMG's
Compensation FAQ document:
http://www.riskmetrics.com/policy/2010_compensation_FAQ:
o Multi-year guarantees for salary increases, non-performance based
bonuses, and equity compensation;
o Including additional years of unworked service that result in
significant additional benefits, without sufficient justification, or
including long-term equity awards in the pension calculation;
o Perquisites for former and/or retired executives, and extraordinary
relocation benefits (including home buyouts) for current executives;
o Change-in-control payments exceeding 3 times base salary and target
bonus; change-in-control payments without job loss or substantial
diminution of duties ("Single Triggers"); new or materially amended
agreements that provide for "modified single triggers" (under which an
executive may voluntarily leave for any reason and still receive the
change-in-control severance package); new or materially amended
agreements that provide for an excise tax gross-up (including
"modified gross-ups");
o Tax Reimbursements related to executive perquisites or other payments
such as personal use of corporate aircraft, executive life insurance,
bonus, etc; (see also excise tax gross-ups above)
o Dividends or dividend equivalents paid on unvested performance shares
or units;
o Executives using company stock in hedging activities, such as
"cashless" collars, forward sales, equity swaps or other similar
arrangements; or
o Repricing or replacing of underwater stock options/stock appreciation
rights without prior shareholder approval (including cash buyouts and
voluntary surrender/subsequent regrant of underwater options).
Incentives that may Motivate Excessive Risk-Taking
Assess company policies and disclosure related to compensation that could
incentivize excessive risk-taking, for example:
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o Guaranteed bonuses;
o A single performance metric used for short- and long-term plans;
o Lucrative severance packages;
o High pay opportunities relative to industry peers;
o Disproportionate supplemental pensions; or
o Mega annual equity grants that provide unlimited upside with no
downside risk.
Factors that potentially mitigate the impact of risky incentives include
rigorous claw-back provisions and robust stock ownership/holding guidelines.
Options Backdating
Vote CASE-by-CASE on options backdating issues. Generally,
when a company has recently practiced options backdating, WITHHOLD from or vote
AGAINST the compensation committee, depending on the severity of the practices
and the subsequent corrective actions on the part of the board. When deciding on
votes on compensation committee members who oversaw questionable options grant
practices or current compensation committee members who fail to respond to the
issue proactively, consider several factors, including, but not limited to, the
following:
o Reason and motive for the options backdating issue, such as
inadvertent vs. deliberate grant date changes;
o Duration of options backdating;
o Size of restatement due to options backdating;
o Corrective actions taken by the board or compensation committee, such
as canceling or re-pricing backdated options, the recouping of option
gains on backdated grants; and
o Adoption of a grant policy that prohibits backdating, and creates a
fixed grant schedule or window period for equity grants in the future.
A CASE-by-CASE analysis approach allows distinctions to be made between
companies that had "sloppy" plan administration versus those that acted
deliberately and/or committed fraud, as well as those companies that
subsequently took corrective action. Cases where companies have committed fraud
are considered most egregious.
Board Communications and Responsiveness
Consider the following factors on a CASE-BY-CASE basis when evaluating ballot
items related to executive pay:
o Poor disclosure practices, including:
- Unclear explanation of how the CEO is involved in the pay setting
process;
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- Retrospective performance targets and methodology not discussed;
- Methodology for benchmarking practices and/or peer group not
disclosed and explained.
o Board's responsiveness to investor input and engagement on
compensation issues, for example:
- Failure to respond to majority-supported shareholder proposals on
executive pay topics; or
- Failure to respond to concerns raised in connection with
significant opposition to MSOP proposals.
Option Exchange Programs/Repricing Options
Vote CASE-by-CASE on management proposals seeking approval to exchange/reprice
options, taking into consideration:
o Historic trading patterns--the stock price should not be so volatile
that the options are likely to be back "in-the-money" over the near
term;
o Rationale for the re-pricing--was the stock price decline beyond
management's control?
o Is this a value-for-value exchange?
o Are surrendered stock options added back to the plan reserve?
o Option vesting--does the new option vest immediately or is there a
black-out period?
o Term of the option--the term should remain the same as that of the
replaced option;
o Exercise price--should be set at fair market or a premium to market;
o Participants--executive officers and directors should be excluded.
If the surrendered options are added back to the equity plans for re-issuance,
then also take into consideration the company's total cost of equity plans and
its three-year average burn rate.
In addition to the above considerations, evaluate the intent, rationale, and
timing of the repricing proposal. The proposal should clearly articulate why the
board is choosing to conduct an exchange program at this point in time.
Repricing underwater options after a recent precipitous drop in the company's
stock price demonstrates poor timing. Repricing after a recent decline in stock
price triggers additional scrutiny and a potential AGAINST vote on the proposal.
At a minimum, the decline should not have happened within the past year. Also,
consider the terms of the surrendered options, such as the grant date, exercise
price and vesting schedule. Grant dates of surrendered options should be far
enough back (two to three years) so as not to suggest that repricings are being
done to take advantage of short-term downward price movements. Similarly, the
exercise price of surrendered options should be above the 52-week high for the
stock price.
Vote FOR shareholder proposals to put option repricings to a shareholder vote.
Shareholder Proposals on Compensation Advisory Vote on Executive
Compensation (Say-on-Pay)
B-19
Generally, vote FOR shareholder proposals that call for non-binding shareholder
ratification of the compensation of the Named Executive Officers and the
accompanying narrative disclosure of material factors provided to understand
the Summary Compensation Table.
Golden Coffins/Executive Death Benefits
Generally vote FOR proposals calling companies to adopt a policy of obtaining
shareholder approval for any future agreements and corporate policies that could
oblige the company to make payments or awards following the death of a senior
executive in the form of unearned salary or bonuses, accelerated vesting or the
continuation in force of unvested equity grants, perquisites and other payments
or awards made in lieu of compensation. This would not apply to any benefit
programs or equity plan proposals that the broad-based employee population is
eligible.
Recoup Bonuses
Vote on a CASE-BY-CASE on proposals to recoup unearned incentive bonuses or
other incentive payments made to senior executives if it is later determined
that the figures upon which incentive compensation is earned later turn out to
have been in error. This is line with the clawback provision in the Trouble
Asset Relief Program. Many companies have adopted policies that permit
recoupment in cases where fraud, misconduct, or negligence significantly
contributed to a restatement of financial results that led to the awarding of
unearned incentive compensation. RMG will take into consideration:
o If the company has adopted a formal recoupment bonus policy;
o If the company has chronic restatement history or material financial
problems; or
o If the company's policy substantially addresses the concerns raised by
the proponent.
Stock Ownership or Holding Period Guidelines
Generally vote AGAINST shareholder proposals that mandate a minimum amount of
stock that directors must own in order to qualify as a director or to remain on
the board. While RMG favors stock ownership on the part of directors, the
company should determine the appropriate ownership requirement.
Vote on a CASE-BY-CASE on shareholder proposals asking companies to adopt
policies requiring Named Executive Officers to retain 75% of the shares
acquired through compensation plans while employed and/or for two years
following the termination of their employment, and to report to shareholders
regarding this policy. The following factors will be taken into account:
o Whether the company has any holding period, retention ratio, or
officer ownership requirements in place. These should consist of:
- Rigorous stock ownership guidelines, or
- A holding period requirement coupled with a significant long-term
ownership requirement, or
- A meaningful retention ratio,
o Actual officer stock ownership and the degree to which it meets or
exceeds the proponent's suggested holding period/retention ratio or
the company's own stock ownership or retention requirements.
B-20
o Problematic pay practices, current and past, which may promote a
short-term versus a long-term focus.
A rigorous stock ownership guideline should be at least 10x base salary for the
CEO, with the multiple declining for other executives. A meaningful retention
ratio should constitute at least 50 percent of the stock received
from equity awards (on a net proceeds basis) held on a long-term basis, such as
the executive's tenure with the company or even a few years past the
executive's termination with the company.
6. Social/Environmental Issues:
Overall Approach
o When evaluating social and environmental shareholder proposals, RMG
considers the following factors:
o Whether adoption of the proposal is likely to enhance or protect
shareholder value;
o Whether the information requested concerns business issues that relate
to a meaningful percentage of the company's business as measured by
sales, assets, and earnings;
o The degree to which the company's stated position on the issues raised
in the proposal could affect its reputation or sales, or leave it
vulnerable to a boycott or selective purchasing;
o Whether the issues presented are more appropriately/effectively dealt
with through governmental or company-specific action;
o Whether the company has already responded in some appropriate manner
to the request embodied in the proposal;
o Whether the company's analysis and voting recommendation to
shareholders are persuasive;
o What other companies have done in response to the issue addressed in
the proposal;
o Whether the proposal itself is well framed and the cost of preparing
the report is reasonable;
o Whether implementation of the proposal's request would achieve the
proposal's objectives;
o Whether the subject of the proposal is best left to the discretion of
the board;
o Whether the requested information is available to shareholders either
from the company or from a publicly available source; and
o Whether providing this information would reveal proprietary or
confidential information that would place the company at a competitive
disadvantage.
Board Diversity
Generally vote FOR requests for reports on the company's efforts to diversify
the board, unless:
B-21
o The gender and racial minority representation of the company's board
is reasonably inclusive in relation to companies of similar size and
business; and
o The board already reports on its nominating procedures and gender and
racial minority initiatives on the board and within the company.
Vote CASE-BY-CASE on proposals asking the company to increase the gender and
racial minority representation on its board, taking into account:
o The degree of existing gender and racial minority diversity on the
company's board and among its executive officers;
o The level of gender and racial minority representation that exists at
the company's industry peers;
o The company's established process for addressing gender and racial
minority board representation;
o Whether the proposal includes an overly prescriptive request to amend
nominating committee charter language;
o The independence of the company's nominating committee;
o The company uses an outside search firm to identify potential director
nominees; and
o Whether the company has had recent controversies, fines, or litigation
regarding equal employment practices.
Gender Identity, Sexual Orientation, and Domestic Partner Benefits
Generally vote FOR proposals seeking to amend a company's EEO statement or
diversity policies to prohibit discrimination based on sexual orientation and/or
gender identity, unless the change would result in excessive costs for the
company.
Generally vote AGAINST proposals to extend company benefits to, or eliminate
benefits from domestic partners. Decisions regarding benefits should be left to
the discretion of the company.
Greenhouse Gas (GHG) Emissions
Generally vote FOR proposals requesting a report on greenhouse gas (GHG)
emissions from company operations and/or products and operations, unless:
o The company already provides current, publicly-available information
on the impacts that GHG emissions may have on the company as well as
associated company policies and procedures to address related risks
and/or opportunities;
o The company's level of disclosure is comparable to that of industry
peers; and
o There are no significant, controversies, fines, penalties, or
litigation associated with the company's GHG emissions.
Vote CASE-BY-CASE on proposals that call for the adoption of GHG reduction goals
from products and operations, taking into account:
B-22
o Overly prescriptive requests for the reduction in GHG emissions by
specific amounts or within a specific time frame;
o Whether company disclosure lags behind industry peers;
o Whether the company has been the subject of recent, significant
violations, fines, litigation, or controversy related to GHG
emissions;
o The feasibility of reduction of GHGs given the company's product line
and current technology and;
o Whether the company already provides meaningful disclosure on GHG
emissions from its products and operations.
Political Contributions and Trade Association Spending
Generally vote AGAINST proposals asking the company to affirm political
nonpartisanship in the workplace so long as:
o There are no recent, significant controversies, fines or litigation
regarding the company's political contributions or trade association
spending; and
o The company has procedures in place to ensure that employee
contributions to company-sponsored political action committees (PACs)
are strictly voluntary and prohibits coercion.
Vote AGAINST proposals to publish in newspapers and public media the company's
political contributions. Such publications could present significant cost to the
company without providing commensurate value to shareholders.
Vote CASE-BY-CASE on proposals to improve the disclosure of a company's
political contributions and trade association spending, considering:
o Recent significant controversy or litigation related to the company's
political contributions or governmental affairs; and
o The public availability of a company policy on political contributions
and trade association spending including information on the types of
organizations supported, the business rationale for supporting these
organizations, and the oversight and compliance procedures related to
such expenditures of corporate assets.
Vote AGAINST proposals barring the company from making political contributions.
Businesses are affected by legislation at the federal, state, and local level
and barring political contributions can put the company at a competitive
disadvantage.
Vote AGAINST proposals asking for a list of company executives, directors,
consultants, legal counsels, lobbyists, or investment bankers that have prior
government service and whether such service had a bearing on the business of the
company. Such a list would be burdensome to prepare without providing any
meaningful information to shareholders.
Labor and Human Rights Standards
Generally vote FOR proposals requesting a report on company or company supplier
labor and/or human rights standards and policies unless such information is
already publicly disclosed. Vote CASE-BY-CASE on proposals to implement company
or company supplier labor and/or human rights standards and policies,
considering:
B-23
o The degree to which existing relevant policies and practices are
disclosed;
o Whether or not existing relevant policies are consistent with
internationally recognized standards;
o Whether company facilities and those of its suppliers are monitored
and how;
o Company participation in fair labor organizations or other
internationally recognized human rights initiatives;
o Scope and nature of business conducted in markets known to have higher
risk of workplace labor/human rights abuse;
o Recent, significant company controversies, fines, or litigation
regarding human rights at the company or its suppliers;
o The scope of the request; and
o Deviation from industry sector peer company standards and practices.
Sustainability Reporting
Generally vote FOR proposals requesting the company to report on its policies,
initiatives, and oversight mechanisms related to social, economic, and
environmental sustainability, unless:
The company already discloses similar information through existing reports or
policies such as an Environment, Health, and Safety (EHS) report; a
comprehensive Code of Corporate Conduct; and/or a Diversity Report; or
The company has formally committed to the implementation of a reporting program
based on Global Reporting Initiative (GRI) guidelines or a similar standard
within a specified time frame
B-24