|DAILY DATA as of 6/26/17|
|Closing Market Price||21.86|
|Current Distribution Rate||7.03%|
|Monthly Dividend Per Share||0.128|
|52 Week High/Low Market Price||22.22 / 18.55|
|52 Week High/Low NAV||20.44 / 18.47|
|Intraday Trading Information||NYSE|
|WEEKLY DATA as of 6/23/17|
|Closing Market Price||21.70|
|Common Shares Outstanding||44,107,215|
|52-Week Average Premium/Discount||5.94%|
|ANNUAL DATA as of 11/30/16|
|Portfolio Manager||Flaherty & Crumrine|
|Shareholder Servicing Agent||Destra Capital Investments
|Portfolio Turnover Rate||13%|
1 As a percentage of total assets. This figure is calculated on a weekly basis.
2 Annualized, excluding interest expense associated with the Fund’s financial leverage strategy for the fiscal year ended November 30, 2016.
|Inception Date||January 28, 2003|
|The Wall Street Journal Listing||FlrtyClayPfdSec|
|Inception Market Price||$25.00|
|FINANCIAL LEVERAGE as of 6/23/17|
|1940 Act Asset Coverage Ratio||307.6%|
as of 5/31/17
|Since Inception (1/28/03)||8.98%||8.44%|
Performance data quoted represents past performance, which is no guarantee of future results, and current performance may be lower or higher than the figures shown. Since Inception returns assume a purchase of common shares at the initial offering price of $25.00 per share for market price returns or initial net asset value (NAV) of $23.88 per share for NAV returns. Returns for periods of less than one year are not annualized. All distributions are assumed to be reinvested either in accordance with the Dividend Reinvestment Plan (DRIP) for market price returns or NAV for NAV returns. Until the DRIP price is available from the Plan Agent, the market price returns reflect the reinvestment at the closing market price on the last business day of the month. Once the DRIP is available around mid-month, the market price returns are updated to reflect reinvestment at the DRIP price.
The Fund’s investment objective is high current income for holders of its common stock consistent with preservation of capital. Under normal market conditions, the Fund invests at least 80% of its “Managed Assets” in a portfolio of preferred securities issued by U.S. and non-U.S. companies, including traditional preferred stock, trust preferred securities, and hybrid securities that have characteristics of both equity and debt securities.
The Fund seeks to enhance the level of its distributions and total return the use of leverage. The Fund may utilize economic leverage through borrowing, including loans from certain financial institutions and/or the issuance of debt securities, preferred shares and reverse repurchase agreements in an amount, determined at the time of issuance of such leverage, up to 33 1/3% of its managed assets. The Fund currently borrows money under a credit facility and the dollar balance and percentage amounts of financial leverage of the Fund outstanding as of any particular date are detailed above under “Financial Leverage.”
The use of leverage can create special risks and there can be no assurance a leveraging strategy will be successful during any period in which it is employed. “See Leverage Risk.”
The preferred securities market is a complex one for the individual investor or average investment advisor to effectively navigate. Flaherty & Crumrine was formed in 1983 with the express intention of managing portfolios of preferred securities for institutional investors. The firm has experience dating back to 1991 in managing leveraged and hedged preferred securities funds. Through its experience in the preferred securities markets, Flaherty & Crumrine has developed the expertise necessary to implement the portfolio and interest rate management strategies necessary in seeking to obtain the highest sustainable income.
Focus...The preferred market is a relatively small and often overlooked segment of the capital markets. It has been the focus of Flaherty & Crumrine's principals for over 30 years, enabling them to find and exploit numerous opportunities in this wonderfully inefficient market.
Philosophy...Flaherty & Crumrine feels that the best way to achieve consistently superior investment results is a combination of intensive credit research and quantitative analysis, along with some very pragmatic trading strategies. We have been described as "a curious blend of mad scientist and horse trader.” However, we do not believe in strategies which require heroic bets on individual credits or on the direction of interest rates.
Independence...Flaherty & Crumrine is an independent firm, not affiliated with any brokerage or other securities firm. This independence allows them the flexibility to serve their clients, and keeps their focus on managing preferred portfolios. Their clients' assets are held by an independent custodian of their choosing, typically a bank or trust company.
As a matter of philosophy, Flaherty & Crumrine operates with a very compact staff of highly qualified professionals, all of whom share in the profits of the firm. This approach is designed to encourage the focus on their specialized investment niche and to avoid having the attention of their key people diverted.
|R. Eric Chadwick, CFA | Portfolio Manager and President|
|1/99 - Present||Flaherty & Crumrine Incorporated|
|1/97 - 12/98||Koch Industries, Inc.|
|Portfolio Manager/Financial Associate|
|5/96 - 8/96||J.C. Penney|
|Supervisor – Internship|
|University of Kansas – B.S. Business, 1996 (Honor Roll)|
|Anderson School of Business University of California, Los Angeles – M.B.A., 2003|
|Chad Conwell | Executive Vice President, Chief Legal Officer and Chief Compliance Officer|
|7/05 - Present||Flaherty & Crumrine Incorporated|
|9/98 - 6/05||Paul, Hastings, Janofsky & Walker, LLP|
|University of California at Berkeley - B.A. Political Science, 1993 (With distinction)|
|Georgetown University Law Center, Washington, D.C. - J.D., 1998 (Cum laude)|
|Bradford S. Stone | Portfolio Manager, Executive Vice President and Chief Financial Officer|
|5/03 - Present||Flaherty & Crumrine Incorporated|
|6/01 - 5/03||Barclays Capital|
|Director, US Market Strategy|
|2/87 - 6/01||Goldman, Sachs & Company|
|Vice President, Interest Rate Strategy|
|Executive Director, Global Hedge Fund Sales|
|8/83 - 2/87||Salomon Brothers Inc.|
|Vice President, Government & Derivatives Sales|
|Associate, Options Trading Hedge Fund Sales|
|Dartmouth College – A.B. Economics, 1981|
|The Wharton School, University of Pennsylvania - M.B.A., 1983 (With Distinction, Director’s Honor List)|
|Rick J. Seto, CFA | Managing Director|
|10/03 - Present||Flaherty & Crumrine Incorporated|
|10/99 - 10/03||UBS Investment Bank|
|Associate Analyst (Equity Research)|
|Natural Gas & Electric Utilities, MLPs|
|10/96 - 10/99||Moody's Investors Service|
|Associate Analyst, Investment Grade - Consumer Products and Retail Companies|
|12/91 - 10/96||Fleet Bank, N.A. (formerly NatWest Bank, N.A.)|
|Assistant Vice President, Commercial Lending Officer|
|Assistant Treasurer, Diversified Industries and Corporate Finance Group|
|Financial Analyst, Asset-Based Lending|
|New York University, B.S. Statistics and Econometrics, 1989|
|NatWest Bank, N.A., Formal Credit Training Program, 1994-95|
|Lisa C. Tucci, CFA | Managing Director|
|3/05 - Present||Flaherty & Crumrine Incorporated|
|11/00 - 3/05||UBS Investment Bank|
|Associate Director (Equity Research) - Natural Gas & Electric Utilities|
|State University at Albany, New York, B.S., 2000 (With Honors)|
|Gordon Russo | Senior Credit Analyst|
|12/12 - Present||Flaherty & Crumrine Incorporated|
|12/00 - 5/05||Dwight Asset Management|
|Senior Vice President|
|Insurance and Healthcare|
|8/92 - 5/00||Sandler O'Neill and Partners, L.P.|
|11/89 - 8/92||U.S. Department of the Treasury|
|Office of Thrift Supervision|
|Bank Examiner / Supervisory Analyst|
|2/85 - 5/89||Bank of New England|
|Corporation Corporate Accountant|
|Bently College Graduate School, Masters of Science in Finance (MSF), 1989|
|Rutgers College, B.A. Economics with Accounting Concentration, 1985|
|Roger W. Ko | Trader|
|9/13 - Present||Flaherty & Crumrine Incorporated|
|8/04 - 7/13||Deutsche Bank Securities, Inc (Trader)|
|University of Michigan Law School - J.D., 2003|
|Haverford College - B.S. Chemistry, 1996 (Honors)|
A preferred security is a creature of both equity and debt. It ranks in between a bond and common stock in a company’s capital structure, typically is either perpetual or has a very long maturity and, yet, it pays dividend or interest amounts which may be fixed or floating according to the terms of the issue and it does not directly participate in the growth or profitability of the company.
Because of these equity features and its longer duration, a preferred security will yield higher than a bond of the same issuer. In fact, because of the generally higher credit quality of preferred securities issuers, preferred securities are generally the highest-yielding securities of investment-grade companies.
Preferred securities pay dividends or interest at either a fixed-rate or a variable rate determined either by formula or through a Dutch auction process. Because of the ranking of preferred securities, an issuer may not pay income to its common shareholders without first paying all its current obligations to holders of its preferred securities. In some circumstances, the issuer may, however, pay its debt holders without paying anything to its preferred holders.
Dividends and interest payments can be either cumulative or non-cumulative. If cumulative, all dividends or interest payments that have not been paid will accumulate and must be paid before holders of common stock receive any dividends. If non-cumulative, the company may elect not to pay a particular periodic dividend to preferred holders without any further obligation to repay that dividend.
In certain instances, failure to pay preferred dividends may entitle preferred shareholders to representation on the company’s board of directors.
In the event of liquidation, preferred shareholders must be paid all dividends and principal before distributions may be made to common shareholders. Many preferred securities are listed on major stock exchanges, and specialized trading departments of several investment brokerage firms further enhance liquidity.
Some preferred securities may be convertible into the common stock of the issuing corporation.
Returns from investment grade preferred securities correlate much more closely with investment grade bonds and U.S. Treasury securities than with common stocks or "junk" bonds.
It is all basically a matter of taxes. In other respects, the two are really very similar. Traditional preferreds are treated for tax purposes just like any other equity security such as common stock. The issuer receives no deduction for tax purposes for dividend payments made to holders of preferred shares. On the other hand, those dividends are 70% tax free to corporate investors due to the Dividend Received Deduction ("DRD"). The purpose of the DRD is to eliminate in part the double taxation of these dollars at the corporate level that would otherwise occur. Additionally, these securities generally classify as qualified dividend income (QDI) to individual investors. QDI is currently taxed at 15% for most individual investors and a rate of 20% for very high income investors.
Hybrid preferreds were created in the mid-1990s for the purpose of allowing issuers to get a deduction for dividend payments on preferreds, just like they deduct interest payments on debt securities. Since no tax is paid by the issuer, there is no double tax to avoid and no DRD available to a corporate holder of hybrids. Initially, hybrids were primarily purchased by individual investors, but the market has now broadened to include institutions as well. The distributions from hybrid securities are classified as interest, and as such, they are taxed as ordinary income to the individual investor. Please contact your tax advisor for further discussion on this matter as neither Flaherty & Crumrine nor Destra Capital provides tax advice
The advantages to having access to both the institutional and retail preferred markets are evident in the current environment, particularly when comparing the preferred securities exchange-traded fund (“ETFs”) vs the Flaherty & Crumrine preferred securities closed-end funds. Generally, ETFs are limited to only listed preferred securities (typically on the NYSE), which constitute only about 50% of the total preferred securities market. The balance of the preferred market trades over-the-counter, a market that is generally unavailable to retail investors. The issues in this institutional market generally have better call protection and trade at higher yields.
The Fund uses leverage to enhance returns to common shareholders. Most of the time, the Fund is able to borrow money at rates well below rates it can earn on the investment portfolio. Of course, the benefit of leverage is greatest when the "spread" between income generated by the portfolio and cost of leverage is wide. However, the converse is also true; leverage doesn't provide as much income when the spread is narrow and may increase volatility of the common shares
The hedging strategy that may be employed by the Fund is designed to:
The mechanism is pretty straightforward - if long-terms rates rise significantly, the hedging instruments used by the Fund should under normal market conditions increase in value. This increase offsets some of the decline in the value of the Fund's investment portfolio (protecting the Fund's NAV) and produces gains which can be used by the Fund to purchase additional income-producing securities. Please note that on a temporary or extended basis, the Adviser may determine that hedging Fund holdings is not likely to produce these results. If it does, the Adviser may not utilize any hedging strategy for the Fund or may limit hedging to a large extent, and the above results would not occur. Consequently, the Fund could have less protection of NAV and could generate less income than if the hedging strategies had been used.
There is an expense associated with hedging, however. The Fund has to pay for its hedging instruments, and it only collects on the hedging strategy if long-term U.S. Treasury rates rise significantly. If rates do not rise significantly, then the Fund will lose the amount it paid for the hedging instrument without receiving any benefit. That being said, generally it is better to have the hedge in place and not need it than to need it and not have it. However, the Fund may not hedge the interest rate exposure of the portfolio if the Adviser believes that the cost of hedging outweighs the likely benefits of it. Similarly, when viewed historically, if it turns out that the cost of hedging did outweigh the benefits (either because long-term U.S. Treasury rates did not rise significantly or because the hedging instruments the Fund employed did not perform as expected), the Fund will have paid for a hedging strategy it ultimately did not need.
In addition, the cost of these hedging instruments are a function of many things, but a key factor is the differential between short- and long-term interest rates. As a general rule, when this differential is large, the cost of hedging is high.
Income, leverage cost and hedging cost create a three-legged distribution stool, and each leg can move up or down for different or similar reasons. Trying to forecast changes in one leg is difficult enough, let alone three. Consequently, projecting a distribution amount is a mixture of art and science, and becomes more difficult the further out in time we look.
Having said that, we can make some general observations about how the legs of the stool relate to one another. We already noted that falling long-term interest rates and rising short-term interest rates tend to lower income. At the same time, a flatter yield curve (i.e. a smaller difference between long and short rates) lowers the cost of hedging, potentially improving returns going forward. Conversely, rising long-term and short-term interest rates tend to increase income and, at the same time, increase the cost of the Fund's leverage. Whether the cost of hedging changes depends on how long-term and short-term interest rates move relative to each other. Although far from perfect, over the longer term there is some degree of balance among the three legs of the stool.
Nonetheless, over the shorter term, interest rate changes can adversely or positively impact the income a Fund receives and the cost of its leverage and hedging, and shareholders should consider these changes and their impact on the net income generated by that Fund and consequently the size of the distribution it is able to pay.
The Fund invests in a portfolio of income producing securities consistent with its objectives and guidelines. The Fund's strategy is pretty straightforward - maximize income over the long term, while not exposing the Fund's net asset value to unnecessary risk. Over the long run, income generated by a Fund's securities portfolio will be influenced primarily by two things - the level of long-term interest rates (typically measured by the yield on 30 year U.S. Treasury bonds) and the relationship of yields on the preferred securities held by the Fund to those long-term interest rates.
The Fund will calculate the breakdown between Qualified Dividend Income (QDI) and interest and report it to shareholders on Form 1099. We will also publish the breakdown on the Fund's website and in the Annual Report to Shareholders.
The answer to both questions is yes. The Fund's Dividend Reinvestment Plan (the "DRIP") provides a means of acquiring additional shares of the Fund without paying the full market premium, if any. When the market price is above NAV, new shares will be issued to participants in the Plan at the higher of NAV or 95% of the then current market price. Participating shareholders can therefore receive a discount on their reinvested shares of up to 5% of the market price. If the market price of the shares is below the NAV, the Plan purchases shares in the open market. The brokerage commission charged for acquiring these shares is competitive with most "discount" brokers. Shareholders should be aware that not all broker-dealers participate in the Fund's Dividend Reinvestment Plan. If your shares are held in a brokerage account, ask your broker if his/her firm is set up to participate. If you hold your shares in certificate form, or if you would just like more information, call BNY Mellon Investment Servicing (US) Inc., at 1-866-351-7446.
Every month the Funds pay distributions, and the value of the distribution is subtracted from the Funds' NAVs on the Ex-Dividend date each month. So when the NAVs are reported with an "Ex-Div" behind them, it means that the amount of the distribution has been taken out of the Net Asset Value.
As a result of the credit crunch that began in July 2007, there has been a lower correlation between changes in the value of preferred securities and the put options on Treasury bond futures that the Fund would normally use to hedge its preferred securities. Preferred securities have tended to trade more based on credit quality than on changes in interest rates as expressed in Treasury bond rates. At the same time, the cost of hedging has increased as short-term interest rates have dropped substantially below long-term rates and interest-rate volatility has increased. As a result, the Fund does not currently use any instruments to hedge against significant increases in long-term interest rates. The Fund continues to evaluate the potential benefits and costs of hedging . At any particular time, all, none or some portion of the Fund’s holdings may be hedged.
Although their name sounds rather strange, interest rate swaps are one of the most widely used forms of derivative contracts. A swaption is simply an option to enter into an interest rate swap on pre-determined terms if that turns out to be attractive to do before the option expires. Similar to the put options on Treasury bond futures contracts that the Fund may purchase as hedges, the entire price paid for the swaption is at risk. However, that is the most that a purchaser of a swaption can lose on the contract. For this reason, swaptions are probably more interesting to the Fund than swaps.
At the risk of oversimplification, this is the essence of an interest rate swap between two parties. Party A makes a "loan" to Party B at an interest rate that is fixed for the life of the swap. Party B makes a "loan" to Party A for the identical amount and life at an interest rate that will be variable based on a market indicator of short-term interest rates, which is often LIBOR (the London Interbank Offer Rate). Since the amounts of the "loans" offset each other, the only cash that actually changes hands is the difference between the fixed and variable interest rates, which will fluctuate over the life of the swap as the variable interest rate changes.
The structure of interest rate swaps, although it may seem somewhat contorted, makes them very useful in a wide range of hedging situations. The market value of existing interest rate swaps will reflect swings in general interest rates in a reasonably systematic way, which will, depending on how things turn out, be good for one of the parties to a swap and bad for the other. In this respect, swaps resemble options-based hedges, but they also differ since they are not tied specifically to interest rates on Treasury bonds. At any point in time, they may or may not track preferred stocks closely given the often-observed idiosyncrasies of the preferred market.
There are various other risks of derivatives involved in interest rate swaps and swaptions. Even though major financial and broker/dealer organizations are the usual counterparties, anyone entering into such an agreement must carefully consider the other party's credit worthiness and its ability to perform its obligations. Market liquidity may also be a risk at certain times. Furthermore, legal and operational risks may be a reason to avoid more exotic derivative contracts. As is the case with option-based hedges, interest rate swaps and swaptions can involve significant economic leverage that could cause relatively small changes in interest rates to produce disproportionally large swings in the market value of the swaps or swaptions and a significant risk of loss.
The Fund’s shares trade on the New York Stock Exchange (NYSE) under the symbol “FFC”. As with any other companies listed on the NYSE, investors can purchase or sell shares of Common Stock of the Fund during normal business hours of the NYSE through a registered broker-dealer.
Managing preferred portfolios has been the specialty of Flaherty & Crumrine since its inception in 1983 (and the experience of the portfolio managers goes back well beyond that at their prior employer). Flaherty & Crumrine has been managing similarly structured hedged and leveraged closed-end preferred funds since 1991.
FFC is a closed-end investment company. Closed-end funds have inherent advantages over traditional mutual funds (or “open-end funds”). For example, a closed-end fund like FFC can use leverage and as a fixed pool, it can fully allocate its assets to higher yielding securities without regard to volatile inflows and outflows associated with shareholder purchases and redemptions that may occur in open-end funds. Both these advantages can work to increase the distributions paid to FFC’s common shareholders.
These benefits are accompanied by investment risks that do not exist with open-end funds. Open-end funds issue and redeem shares directly with their shareholders at a price equal to the underlying value of all fund assets (Net Asset Value or NAV). Closed-end fund shareholders do not have the right to redeem their shares. Instead, closed-end fund shareholders buy and sell their shares on markets like the New York Stock Exchange. A closed-end fund’s shares should trade relative to the NAV of the fund – the market, however, further exposes the price of the shares to the laws of supply and demand and the price can and does vary widely from NAV.
Supply and demand for a fund is dictated by each investor’s perception of the underlying value of the shares relative to other available investment options.
The starting point for any investor considering selling or purchasing shares of a fund is the NAV calculated by the fund. With income funds, like FFC, investors also consider distribution levels. These two performance components of NAV and income are reflected in the fund’s total investment return on NAV. In fact, the best measure of the performance of an investment adviser is the fund’s total return based on NAV.
Like all investors, investors in closed-end funds make their own decisions about the fundamental quality of a fund’s NAV and the likelihood that it will continue to produce similar total returns on NAV. An investor may value a fund’s shares at a premium to NAV if the investor believes that the fund is likely to perform better than it has in the past, because of projected distribution levels, net asset value, net asset value volatility, call protection, quality of fund management and portfolio credit quality. Alternatively, an investor may similarly value a fund’s shares at a discount to NAV based on negative interpretations of the same factors.
Investor decisions are never made in isolation, however, and supply and demand cannot be fully understood without reference to the market conditions for a fund’s shares and the investor’s objectives and alternative investment opportunities. In other words, an investor may decide to purchase or sell shares of a fund based on reasons unrelated to his or her assessment of the fund’s total return on NAV. Commentators speculate that some investors apply an automatic discount to NAV because of the nature of the closed-end fund structure itself – yet some funds consistently trade at premiums. Once an investor has decided to purchase shares of a closed-end fund (perhaps because of some of their inherent advantages), comparative performance matters as well. Stated another way, a fixed-income investor will typically gravitate to that fund in a group of funds with similar investment objectives which offers the best yield for the amount of risk involved.
Finally, investment decisions may be motivated for reasons beyond the performance of the fund, the closed-end structure, or comparative performance. Investors always have personal economic situations that impact their decisions. One example of this may be year-end tax selling. If an investor has losses in a closed-end fund, and gains in some other investment, that investor may make a rational decision to sell his or her shares of the fund at year-end in order to offset any tax gains. In a market environment, tax selling is especially detrimental because it can provide increased supply which may drive down the market price which can in turn lead to more tax selling.
Of course, no single reason can explain the price determined by a market. There are as many reasons, or combination of reasons, as there are shareholders for why each investor sells or buys shares. And, in the end, the collective effect of all these investor decisions may result in market prices at a premium or discount to NAV.
FFC is no different than any other closed-end fund, and its market price will be controlled by the laws of supply and demand.
Closed-end funds such as FFC differ from open-end funds in some very important ways.
First, let's identify the similarities. In general terms, both types are built around professionally managed portfolios intended to meet a specific investment objective. At any point in time, the value of the portfolio can be determined, and, adjusting for any liabilities incurred by the fund, used to calculate the net asset value ("NAV"). The NAV per share is the intrinsic value of one share of the fund.
The key difference between a closed-end fund and an open-end fund is the manner in which the shares change hands. Closed-end funds issue a fixed number of shares at the inception of the fund (hence the term "closed"). The shares are usually listed on a major stock exchange (FFC is listed on the NYSE) and the price of the shares will fluctuate based on what a willing buyer would pay for the shares of a willing seller(just like buying or selling shares of Microsoft or any other listed company). The price may or may not bear a close relationship to the NAV. If the market price is above the NAV, the Fund is said to be trading at a "premium". If the market price is below the NAV, the Fund is said to be trading at a "discount".
Open-end funds issue new shares and redeem old shares daily (hence the term "open"). During business hours, investors may indicate to the fund their desire to purchase or sell shares in the fund. The fund will compute the NAV as of the close of business and either issue new shares or redeem outstanding shares at that NAV.
There are other important differences (for example, it is more common for closed-end funds to employ leverage), but the key difference is the mechanism for trading the shares of each.
The Fund is a non-diversified, closed-end management investment company designed primarily as a long-term investment and not as a trading vehicle. The Fund is not intended to be a complete investment program and, due to the uncertainty inherent in all investments, there can be no assurance that the Fund will achieve its investment objective.
Investment Risk. An investment in the Fund is subject to investment risk, including the possible loss of the entire principal amount that you invest. The Fund’s Common Shares may be affected by such factors as liquidity and market supply and demand. In addition, the common shares of closed-end management investment companies frequently trade at a discount from their NAV. The Fund cannot assure you that its Common Shares will trade at a price higher than or equal to NAV.
Market Risk. The market values of securities owned by the Fund may decline, at times sharply and unpredictably. Under normal conditions, markets generally move in cycles over time, with periods of rising prices followed by periods of declining prices. These fluctuations could be a sustained trend or a drastic movement and the value of your investment may reflect these fluctuations. The Fund may utilize leverage, which magnifies this risk. Your Common Shares at any point in time may be worth less than what you invested, even after taking into account the reinvestment of Fund dividends and distributions. See “Use of Leverage—Leverage Risk.”
Preferred and Subordinated Securities Risk. Preferred and other subordinated securities rank lower than bonds and other debt instruments in a company’s capital structure and therefore will be subject to greater credit risk than those debt instruments. Distributions on some types of these securities may also be skipped or deferred by issuers without causing a default. Finally, some of these securities typically have special redemption rights that allow the issuer to redeem the security at par earlier than scheduled. If this occurs, the Fund may be forced to reinvest in lower yielding securities. There are various risks associated with investing in preferred securities, including:
The Dodd-Frank Act contains provisions which will make certain hybrid-preferred securities less attractive for issuing banks, which the Adviser believes is likely to result in a significant reduction in the availability of these types of securities and potentially in many outstanding issues being redeemed. These changes may negatively impact the prices of some securities, particularly those trading above their par values as the new legislation may make near-term redemptions at par possible. However, other securities may be positively affected, particularly those trading at discounts to par value. Such securities may experience an increase in market value from issuers’ redemption activity. A longer-term consequence of the relevant provisions of the Dodd-Frank Act, which are to be phased in over a period of a few years, is the potential for some types of preferred securities in which the Fund intends to invest to become more scarce and potentially less liquid. In addition, proposals of the Basel Committee on Banking Supervision to update capital requirements for banks globally, if finalized and adopted in the United States, would further limit the attractiveness to issuing banks of a broader range of preferred security types and possibly have more significant consequences, including a smaller market of issues and less liquidity. It is not possible to predict the impact of the Dodd-Frank Act and these proposals on the Fund’s ability to pursue its investment strategy. Although it is expected that over time new types of preferred securities in which the Fund may invest will be issued, the availability of such investments cannot be determined.
Credit Risk. Credit risk is the risk that an issuer of a security will be unable or unwilling to make dividend, interest and principal payments when due and the related risk that the value of a security may decline because of concerns about the issuer’s ability to make such payments. Credit risk may be heightened for the Fund because the Fund may invest in “high yield” or “high risk” securities; such securities, while generally offering higher yields than investment grade securities with similar maturities, involve greater risks, including the possibility of default or bankruptcy, and are regarded as predominantly speculative with respect to the issuer’s capacity to pay dividends and interest and repay principal.
Interest Rate Risk. Interest rate risk is the risk that preferred and other income-producing securities will decline in value because of rising market interest rates. When market interest rates rise, the market value of such securities generally will fall. Preferred securities with longer periods before maturity (if any) or longer durations may be more sensitive to interest rate changes.
Duration Risk. Duration is the sensitivity, expressed in years, of the price of a fixed-income security to changes in the general level of interest rates (or yields). Securities with longer durations tend to be more sensitive to interest rate (or yield) changes than securities with shorter durations. For example, a three-year duration means a bond is expected to decrease in value by 3% if interest rates rise 1% and increase in value by 3% if interest rates fall 1%. Because the Fund initially expects to have a long duration, it will be more sensitive to interest rate or yield changes. Although the Fund can buy securities of any maturity, it initially expects to have an effective duration between 9 and 14 years. Because of events affecting the bond markets and interest rate changes, the duration of the portfolio might not meet its target duration at all times. Duration differs from maturity in that it considers potential changes to interest rates, and a security’s coupon payments, yield, price and par value and call features, in addition to the amount of time until the security matures. Various techniques may be used to shorten or lengthen the Fund’s duration, including investments in floating-rate and fixed-to-floating-rate securities and interest rate and other hedging transactions such as pay-fixed interest rate swaps, interest rate cap transactions or Eurodollar strips, designed to reduce the interest rate risk. The duration of a security will be expected to change over time with changes in market factors and time to maturity.
Floating-Rate and Fixed-to-Floating-Rate Securities Risk. The market value of floating-rate securities is a reflection of discounted expected cash flows based on expectations for future interest rate resets. The market value of such securities may fall in a declining interest rate environment and may also fall in a rising interest rate environment if there is a lag between the rise in interest rates and the reset. This risk may also be present with respect to fixed-to-floating-rate securities in which the Fund may invest. A secondary risk associated with declining interest rates is the risk that income earned by the Fund on floating-rate and fixed-to-floating-rate securities will decline due to lower coupon payments on floating-rate securities.
Liquidity Risk. The Fund may invest, without limit, in illiquid securities. From time to time, certain securities held by the Fund may have limited marketability and may be difficult to sell at favorable times or prices. It is possible that certain securities held by the Fund will not be able to be sold in sufficient amounts or in a sufficiently timely manner to raise the cash necessary to meet any potentially large redemption requests by Fund shareholders.
Concentration Risk. The Fund intends to invest 25% or more of its total assets in the financials sector. This policy makes the Fund more susceptible to adverse economic or regulatory occurrences affecting the financials sector.
Financials Sector Risk. Because the Fund invests 25% or more of its total assets in the financials sector, it will be more susceptible to adverse economic or regulatory occurrences affecting this sector, such as changes in interest rates, loan concentration and competition. In many countries, companies in the financials sector are regulated by governmental entities, which can increase costs for new services or products and make it difficult to pass increased costs on to consumers. In certain areas, deregulation of financial companies has resulted in increased competition and reduced profitability for certain companies. The profitability of many types of financial companies may be adversely affected in certain market cycles, including periods of rising interest rates, which may restrict the availability and increase the cost of capital, and declining economic conditions, which may cause credit losses due to financial difficulties of borrowers. Because many types of financial companies are vulnerable to these economic cycles, the Fund’s investments in these companies may lose significant value during such periods.
The financial services industries also are subject to relatively rapid changes as a result of industry consolidation trends which may result in distinctions between different financial service segments (for example, banking, insurance and brokerage businesses) becoming less clear. In the recent past, the financial services industries have experienced considerable financial distress, which has led to the implementation of government programs designed to ease that distress.
REITs Risk. Investments in REITs expose the Fund to risks similar to investing directly in real estate. The value of these underlying investments may be affected by changes in the value of the underlying real estate, the quality of the property management, the creditworthiness of the issuer of the investments, and changes in property taxes, interest rates and the real estate regulatory environment. Investments in REITs are also affected by general economic conditions.
Foreign Investment Risk. Investments in foreign securities involve certain risks not involved in domestic investments. Securities markets in certain foreign countries are not as developed, efficient or liquid as securities markets in the United States. Therefore, the prices of foreign securities can be volatile. Certain foreign countries may impose restrictions on the ability of issuers of foreign securities to make payments of principal and interest to investors located outside the country, due to blockage of foreign currency exchanges or otherwise. In addition, the Fund will be subject to risks associated with adverse political and economic developments in foreign countries, which could cause the Fund to lose money on its investments in foreign securities. Furthermore, certain investments in foreign securities also may be subject to foreign withholding taxes, and dividend income the Fund receives from foreign securities may not be eligible for reduced rates of taxation that may be applicable to QDI.
Investing in these foreign securities involves certain risks not involved in domestic investments, including, but not limited to:
In addition, individual foreign economies may differ favorably or unfavorably from the U.S. economy in such respects as:
To the extent the Fund has investments in a geographic region or country, the Fund will be subject to the risks of adverse changes in that region or country. In addition, income from the Fund’s investments in certain foreign securities may also be subject to foreign withholding taxes, which would reduce the Fund’s return on those securities.
As a result of these potential risks, the Adviser may determine that, notwithstanding otherwise favorable investment criteria, it may not be practicable or appropriate to invest in a particular country. The Fund may invest in countries in which foreign investors, including the Adviser, have had no or limited prior experience.
Currency Risk. Although the Fund will report its net asset value and pay dividends in U.S. dollars, foreign securities often are purchased with, and make dividend or interest payments in, foreign currencies. Therefore, when the Fund invests in foreign securities, it will be subject to foreign currency risk, which means that the Fund’s net asset value could decline as a result of changes in the exchange rates between foreign currencies and the U.S. dollar. Certain foreign countries may impose restrictions on the ability of issuers of foreign securities to make payments of principal, interest or dividends to investors located outside the country, due to blockage of foreign currency exchanges or other factors. The Fund’s transactions in foreign currencies may increase or accelerate the Fund’s recognition of ordinary income and may affect the timing or character of the Fund’s distributions.
Convertible Securities Risk. Although to a lesser extent than with non-convertible fixed-income securities, the market value of convertible securities tends to decline as interest rates increase and, conversely, tends to increase as interest rates decline. In addition, because of the conversion feature, the market value of convertible securities tends to vary with fluctuations in the market value of the underlying common stock. A unique feature of convertible securities is that as the market price of the underlying common stock declines, convertible securities tend to trade increasingly on a yield basis, and so may not experience market value declines to the same extent as the underlying common stock. When the market price of the underlying common stock increases, the prices of the convertible securities tend to rise as a reflection of the value of the underlying common stock.
High Yield Securities Risk. The Fund may invest in securities that are rated below investment grade. Securities rated below investment grade are regarded as having predominantly speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal, and these bonds are commonly referred to as “junk bonds.” These securities are subject to a greater risk of default. The prices of these lower grade securities are more sensitive to negative developments, such as a decline in the issuer’s revenues or a general economic downturn, than are the prices of higher grade securities. Lower grade securities tend to be less liquid than investment grade securities. The market values of lower grade securities tend to be more volatile than investment grade securities.
Lower-rated securities, or equivalent unrated securities, may be considered speculative with respect to the issuer’s continuing ability to make principal and interest payments. Analysis of the creditworthiness of issuers of lower-rated securities may be more complex than for issuers of higher quality debt securities, and the Fund’s ability to achieve its investment objective may, to the extent it is invested in lower-rated securities, be more dependent upon such creditworthiness analysis than would be the case if it were investing in higher quality securities. An issuer of these securities has a currently identifiable vulnerability to default and the issuer may be in default or there may be present elements of danger with respect to principal or interest.
The secondary markets in which lower-rated securities are traded may be less liquid than the market for higher grade securities. Less liquidity in the secondary trading markets could adversely affect the price at which the Fund could sell a particular lower-rated security when necessary to meet liquidity needs or in response to a specific economic event, such as a deterioration in the creditworthiness of the issuer, and could adversely affect and cause large fluctuations in the net asset value of the Fund’s shares. Adverse publicity and investor perceptions may decrease the values and liquidity of high yield securities.
It is reasonable to expect that any adverse economic conditions could disrupt the market for lower-rated securities, have an adverse impact on the value of those securities and adversely affect the ability of the issuers of those securities to repay principal or interest on those securities. New laws and proposed new laws may adversely impact the market for lower-rated securities.
Rating agencies are private services that provide ratings of the credit quality of debt obligations, including convertible securities. Appendix B to the SAI describes the various ratings assigned to financial obligations by Moody’s Investors Service, Inc. (“Moody’s”), Standard and Poor’s Ratings Group, a subsidiary of The McGraw Hill Companies (“S&P”) and Fitch, Inc. (“Fitch”). Ratings assigned by a rating agency are not absolute standards of credit quality and do not evaluate market risks or the liquidity of securities. Rating agencies may fail to make timely changes in credit ratings and an issuer’s current financial condition may be better or worse than a rating indicates. Credit rating agencies may be paid by the companies whose securities they analyze and grade. To the extent that the issuer of a security pays a rating agency for the analysis of its security, an inherent conflict of interest may exist that could affect the reliability of the rating. The Fund will not necessarily sell a security when its rating is reduced below what its rating was at the time of purchase. The Adviser does not rely solely on credit ratings, and develops its own analysis of issuer credit quality. The ratings of a security may change over time. S&P, Moody’s and Fitch monitor and evaluate the ratings assigned to securities on an ongoing basis. As a result, securities held by the Fund could receive a higher rating (which would tend to increase their value) or a lower rating (which would tend to decrease their value) during the period in which they are held.
Because the Fund may invest in high yield securities, the Fund’s success in achieving its investment objective may depend more heavily on the Adviser’s analysis than if the Fund invested exclusively in higher-quality and rated securities. The Adviser will attempt to reduce the risks of investing in lower rated securities through active portfolio management, credit analysis and attention to current developments and trends in the economy and the financial markets.
Selection Risk. Selection risk is the risk that the securities selected by Fund management will underperform the markets, the relevant indices or the securities selected by other funds with similar investment objectives and investment strategies. This means you may lose money.
Management Risk. The Fund is an actively managed portfolio and its success depends upon the investment skills and analytical abilities of the Adviser to develop and effectively implement strategies that achieve the Fund’s investment objective. Subjective decisions made by the Adviser may cause the Fund to incur losses or to miss profit opportunities on which it may otherwise have capitalized.
Leverage Risk. Leverage is a speculative technique and there are special risks and costs associated with leveraging. If the Fund utilizes leverage, the fees paid to the Adviser for investment advisory and management services will be higher than if the Fund did not utilize leverage because the fees paid will be calculated based on the Fund’s Managed Assets, which include the principal amount of outstanding Borrowings and the liquidation preference of Preferred Shares, if any, and the proceeds of any Reverse Repurchase Agreements.
Risk of Market Price Discount from Net Asset Value. Shares of closed-end funds frequently trade at a discount from their net asset value. This characteristic is a risk separate and distinct from the risk that net asset value could decrease as a result of investment activities and may be greater for investors expecting to sell their shares in a relatively short period following completion of this offering. We cannot predict whether the Common Shares will trade at, above or below net asset value. Net asset value will be reduced immediately following the offering of the Common Shares by the amount of the sales load and the amount of organizational and offering expenses paid by the Fund, to the extent such expenses are not borne by the Adviser. Whether investors will realize gains or losses upon the sale of the shares will depend not upon the Fund’s net asset value but entirely upon whether the market price of the shares at the time of sale is above or below the investor’s purchase price for the shares. Because the market price of the shares will be determined by factors such as relative supply of and demand for shares in the market, general market and economic conditions, and other factors beyond the control of the Fund, we cannot predict whether the shares will trade at, above or below net asset value, or at below or above the initial public offering price.
See “Additional Risk Considerations” beginning on page 18 of the prospectus for additional risks relating to an investment in the Fund, including: Management Risk; Potential Conflicts of Interest Risk; Dependence on Key Personnel Risk; Portfolio Turnover Risk; Risk of Anti-Takeover Provisions; Derivatives Risk; Investment in Other Companies Risk; and Market Disruption Risk.