As filed with the Securities and Exchange Commission on March 18, 2005
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1933 Act File No. 333-
1940 Act File No. 811-21549
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-2
(Check appropriate box or boxes)
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[ ] Pre-Effective Amendment No.
[ ] Post-Effective Amendment No.
and
[ ] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[X] Amendment No. 8
ENERGY INCOME AND GROWTH FUND
Exact Name of Registrant as Specified in Declaration of Trust
1001 Warrenville Road, Suite 300, Lisle, Illinois 60532
Address of Principal Executive Offices (Number, Street, City, State, Zip Code)
(630) 241-4141
Registrant's Telephone Number, including Area Code
W. Scott Jardine, Esq.
First Trust Portfolios L.P.
1001 Warrenville Road, Suite 300
Lisle, Illinois 60532
Name and Address (Number, Street, City, State, Zip Code) of Agent for Service
Copies of Communications to:
Eric F. Fess, Esq.
Chapman and Cutler LLP
111 West Monroe Street
Chicago, Illinois 60603
Approximate Date of Proposed Public Offering: As soon as practicable after the
effective date of this Registration Statement
Page 1
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If any of the securities being registered on this form are offered on a delayed
or continuous basis in reliance on Rule 415 under the Securities Act of 1933,
other than securities offered in connection with a dividend reinvestment plan,
check the following box. [ ]
It is proposed that this filing will become effective (check appropriate box)
[ ] when declared effective pursuant to section 8(c)
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CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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---------------- ------------ ---------------- ----------------- --------------
Title of Proposed Proposed
Securities Amount Maximum Maximum Amount of
Being Being Offering Price Aggregate Registration
Registered Registered Per Unit Offering Price(1) Fee
---------------- ------------ ---------------- ----------------- --------------
Common Shares, 1,000 $20.00 $20,000 $2.35
$0.01 par value
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(1) Estimated solely for the purpose of calculating the registration fee.
The Registrant hereby amends this Registration Statement on such date or dates
as may be necessary to delay its effective date until the Registrant shall file
a further amendment which specifically states this Registration Statement shall
thereafter become effective in accordance with Section 8(a) of the Securities
Act of 1933 or until the Registration Statement shall become effective on such
dates as the Commission, acting pursuant to said Section 8(a), may determine.
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Page 2
Subject to Completion, March 18, 2005
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIEIS AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
PROSPECTUS
____________ COMMON SHARES
Energy Income and Growth Fund
COMMON SHARES
$_____ PER SHARE
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-adviser 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 significant portion of its income will 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.
Investment Strategy. 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 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 has in the past
written (or sold), and may in the future write (or sell), 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 this offering of common shares in securities that meet the Fund's investment
objective and policies within one month after the completion of this 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, listed on the American Stock Exchange
("AMEX") under the trading or "ticker" symbol "FEN." The net asset value of the
Fund's common shares at the close of business on February 28, 2005 was $22.81
per common share, and the last sale price of the common shares on the AMEX on
such date was $23.65.
(continued on following page)
INVESTING IN COMMON SHARES INVOLVES CERTAIN RISKS. SEE "RISKS" BEGINNING
ON PAGE __.
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.
PER SHARE TOTAL(1)
--------- --------
Public Offering Price $ $
Underwriting Discount $ $
Proceeds, before expenses, to the Fund(2) $ $
(notes on following page)
Page 1
(1) The Fund has granted the underwriters an option to purchase up to _____
additional common shares at the public offering price, less the underwriting
discount, within 45 days of the date of the Prospectus solely to cover
overallotments, if any. If such option is exercised in full, the total price to
the public, underwriting discount and proceeds, before expenses, to the Fund
will be $_____, $_____ and $_____, respectively. See "Underwriting."
(2) Total expenses of the offering of the common shares of the Fund paid by
the Fund (other than the underwriting discount) are estimated to be $_______,
which represents ______% (or $_______ per common share) of the Fund's offering
price. The Fund's investment adviser, First Trust Advisors L.P., has agreed to
pay all offering costs of the Fund (other than the underwriting discount) that
exceed _____% (or $_______ per common share) of the Fund's offering price. The
Fund's sub-adviser, Fiduciary Asset Management, LLC, has agreed to reimburse the
Fund's investment adviser for one-half of such offering costs of the Fund that
exceed _____% (or $_____ per common share) of the Fund's offering price.
Prospectus dated ________, 2005
Page 2
Due to the nature of MLP distributions, 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 Adviser and Sub-Adviser. First Trust Advisors L.P. ("First Trust
Advisors" or the "Adviser") is the Fund's investment adviser, responsible for
supervising the Fund's sub-adviser, monitoring the Fund's investment portfolio,
managing the Fund's business affairs and providing certain clerical and
bookkeeping and other administrative services. The Adviser, in consultation with
the Sub-Adviser (as defined below), is also responsible for determining the
Fund's overall investment strategy and overseeing its implementation. Fiduciary
Asset Management, LLC ("Fiduciary Asset Management" or the "Sub-Adviser") is the
Fund's sub-adviser and is primarily responsible for the day-to-day supervision
and investment strategy of the Fund.
First Trust Advisors serves as investment adviser or portfolio supervisor
to investment portfolios with approximately $17.1 billion in assets which it
managed or supervised as of February 28, 2005. Fiduciary Asset Management serves
as investment adviser or portfolio supervisor to investment portfolios with
approximately $15.5 billion in assets which it managed or supervised as of
February 28, 2005. See the Statement of Additional Information ("SAI") under
"Investment Adviser."
Use of Financial Leverage. The Fund may seek to enhance the level of its
current distributions through the use of financial leverage. The Fund may
leverage through the issuance of preferred shares ("Preferred Shares") and/or
through the issuance of commercial paper or notes (in addition to the Notes, as
defined below) and/or other borrowings ("Borrowings") by the Fund. The aggregate
financial leverage through the issuance of Preferred Shares and/or Borrowings
(collectively, "Financial Leverage") is expected to be up to approximately 20%
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, including the
Notes), 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").
In this regard, on January 28, 2005, the Fund issued $34,000,000 principal
amount of auction rate senior notes due March 2, 2045 ("Notes") which were are
rated "Aaa" and "AAA" by Moody's Investors Service, Inc. ("Moody's") and Fitch
Ratings Services, Inc. ("Fitch"), respectively. As of February 28, 2005, the
principal amount of the Notes represented 18.81% of the Fund's Managed Assets.
The Fund may, in the future, issue additional series of Notes or other senior
securities to the extent permitted by the Investment Company Act of 1940, as
amended (the "1940 Act"). The Fund's common shares are junior in liquidation and
distribution rights to the Notes. The issuance of debt and preferred stock,
including the Notes, 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 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 Adviser's and Sub-Adviser's fees
are based on Managed Assets (including assets obtained through leverage), both
the Adviser's and Sub-Adviser's fees are higher when the Fund is leveraged.
There can be no assurance that a leveraged strategy will be successful during
any period in which it is used.
There is no assurance that the Fund will utilize Financial Leverage in
addition to the Notes or, if additional Financial Leverage is utilized, that it
will be successful in enhancing the level of the Fund's current distributions.
The net asset value of the common shares will be reduced by the fees and
issuance costs of any Financial Leverage. See "Use of Financial Leverage -
Effects of Leverage," "Risks - Leverage Risk" and "Description of Shares."
You should read this Prospectus, which contains important information about
the Fund, before deciding whether to invest in the common shares, and retain it
for future reference. This Prospectus sets forth concisely the information about
Page 3
the Fund that a prospective investor ought to know before investing. The SAI,
dated ____________, 2005, 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 __ 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). 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).
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.
Page 4
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, including the documents incorporated by reference into it,
particularly the section entitled "Risks" beginning on page __.
THE FUND......................... Energy Income and Growth Fund (the "Fund")
is a non-diversified, closed-end management
investment company which commenced
operations in June 2004. 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. The Fund raised an
additional $34 million through the issuance
of the Notes in January 2005. The Fund paid
distributions to holders of common shares on
October 29, 2004 and January 31, 2005 in the
amounts of $0.325, and $0.330 per share,
respectively. The Fund expects that a
significant portion of these distributions
will be treated as a return of capital to
common shareholders for tax purposes. As of
February 28, 2005, the Fund had 6,434,334
common shares outstanding and net assets
applicable to common shares of $146,767,159.
THE OFFERING..................... The Fund is offering __________ common
shares of beneficial interest through a
group of underwriters (the "Underwriters")
led by _______________________________. The
common shares of beneficial interest offered
by this Prospectus are called "Common
Shares" and the holders of Common Shares are
called "Common Shareholders" in this
Prospectus. As used in this Prospectus,
unless the context requires otherwise,
"common shares" refers to the Fund's common
shares of beneficial interest currently
outstanding as well as those Common Shares
offered by this Prospectus and the holders
of common shares are called "common
shareholders." The minimum purchase in this
offering is 100 Common Shares ($_____). The
Fund has given the Underwriters an option to
purchase up to __________ additional Common
Shares to cover over-allotments. The Adviser
has agreed to pay all offering costs of the
Fund (other than the underwriting discount)
that exceed % (or $_______ per Common Share)
of the Fund's offering price. The
Sub-Adviser has agreed to reimburse the
Adviser for one-half of such offering costs
of the Fund that exceed % (or $_______ per
Common Share) of the Fund's offering price.
See "Underwriting."
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 publicly traded master limited
partnerships ("MLPs") and related public
entities in the energy sector which the
Fund's Sub-Adviser 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
Page 5
under current law of cash distributions made
by MLPs to their investors (such as the
Fund), the Fund believes that a significant
portion of its income will be tax deferred,
thereby maximizing 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, 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% 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-Adviser.
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 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 (collectively, "Financial
Leverage")) or market risks
associated with the Fund's portfolio.
To generate additional income, the Fund has
in the past written (or sold), and may in
the future write (or sell), 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 this offering of Common Shares in
securities that meet the Fund's investment
objective and policies within one month
after the completion of this offering.
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. 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
Page 6
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 (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, and
may in the future purchase, 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 has in the past written (or
sold), and may in the future write (or
sell), covered call options on the common
stock of energy companies held in the Fund's
portfolio.
Page 7
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. The Fund has in the past
written (or sold), and may in the future
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-Adviser (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, 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 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. On
January 28, 2005, the Fund issued
$34,000,000 principal amount of auction rate
senior notes due March 2, 2045 ("Notes")
which were rated "Aaa" and "AAA" by Moody's
and Fitch Ratings Services, Inc. ("Fitch"),
respectively. As of February 28, 2005, the
principal amount of the Notes represented
18.81% of the Fund's Managed Assets. The
Fund may make further use of Financial
Leverage through the issuance of additional
notes or other senior securities to the
extent permitted by the Investment Company
Act of 1940, as amended (the "1940 Act").
The Fund's common shares are junior in
liquidation and distribution rights to the
Notes. The issuance of Preferred Shares
and/or Borrowings, including the Notes,
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
Page 8
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 Adviser's and Sub-Adviser's
fees are based on Managed Assets (including
assets obtained through leverage), both the
Adviser's and Sub-Adviser's fees are higher
when the Fund is leveraged. There can be no
assurance that a leveraged strategy will be
successful during any period in which it is
used. The Fund intends to continue to use
leverage through the issuance of Preferred
Shares and/or other Borrowings, in addition
to the Notes (each a "Leverage Instrument"
and collectively, the "Leverage
Instruments") in an aggregate amount up to
approximately 20% of the Fund's Managed
Assets after such issuance and/or borrowing.
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. Leverage Instruments will have
seniority over the common shares. The use of
Leverage Instruments will leverage your
investment in the Common Shares. If the Fund
uses additional Leverage Instruments,
associated costs will be borne immediately
by common shareholders and result in a
reduction of the net asset value of the
common shares.
Preferred Shares will pay dividends based on
short-term rates, which will 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
holders of common shares. When leverage is
employed, the net asset value and market
prices of the common shares and the yield to
holders of common shares will be more
volatile.
There is no assurance that the Fund will
utilize Financial Leverage in addition to
the Notes or, if additional Financial
Leverage is utilized, that it will be
successful in enhancing the level of the
Fund's current distributions. 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 U.S. Internal Revenue Code of
1986, as amended (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, the distributions from which
generally are not qualifying income for a
regulated investment company. 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 significant portion of
the distributions it receives from MLPs will
be treated as a tax-deferred return of
capital, thus reducing the Fund's current
tax liability. The taxation of Fund
distributions is discussed further under
"Tax Matters."
Page 9
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 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 a distribution not offset
by tax deductions with the remaining
portion of the 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 likely increase the Fund's taxable
gain 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
activity by MLPs held by the Fund could
result in a reduction of accelerated
depreciation or other deductions
generated by new acquisitions, which may
result in increased current tax liability
to the Fund. A reduction in the
percentage of a distribution 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 dividend income, resulting 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 it is 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 will invest.
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. Dividend income
generally will qualify for treatment as
"qualified dividend income" for federal
income tax purposes if holding period and
other requirements are satisfied.
Qualified dividend income received by
individual shareholders is taxed at
long-term capital gains rates, which
reach a maximum of 15%. The special tax
Page 10
treatment afforded to qualified dividend
income is set to end as of December 31,
2008 (assuming such special tax treatment
is not repealed by Congress before then).
Higher tax rates will apply in 2009
unless further legislative action is
taken by Congress. 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 upon the sale
of the common shares. Additionally,
excess distributions that exceed a common
shareholder's tax basis in its common
shares will 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.
o Sale of Shares. Common shareholders
generally will recognize a gain or loss
upon the sale of their common shares.
Such gain or loss is equal to the
difference between the common
shareholder's federal income tax basis in
its common shares sold (as adjusted to
reflect return of capital) and the sale
proceeds received by the common
shareholder upon the disposition of
common shares. As a general rule, the
sale of a capital asset, like common
shares, held for more than a year will
result in a long-term capital gain or
loss. See "Tax Matters."
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. The Fund,
however, would be subject to the
passive activity income and loss
rules if in the future it elects to
be treated as a regulated investment
company for federal income tax
purposes; and
o Income received by tax-exempt
investors, including employee benefit
plans and IRA accounts, from MLPs is
treated as unrelated business taxable
income ("UBTI"), whereas
distributions these investors receive
from an entity treated for federal
Page 11
income tax purposes as a corporation
(such as the Fund) will generally not
be treated as UBTI, unless the stock
is debt-financed.
INVESTMENT ADVISER
AND SUB-ADVISER.................. First Trust Advisors L.P. ("First Trust
Advisors" or the "Adviser") is the Fund's
investment adviser, responsible for
supervising the Fund's sub-adviser,
monitoring the Fund's investment portfolio,
managing the Fund's business affairs and
providing certain clerical and bookkeeping
and other administrative services. The
Adviser, in consultation with the
Sub-Adviser (as defined below), is also
responsible for determining the Fund's
overall investment strategy and overseeing
its implementation. Fiduciary Asset
Management, LLC ("Fiduciary Asset
Management" or the "Sub-Adviser") is the
Fund's sub-adviser and is primarily
responsible for the day-to-day supervision
and investment strategy of the Fund.
First Trust Advisors, a registered
investment adviser, is an Illinois limited
partnership formed in 1991. First Trust
Advisors serves as investment adviser or
portfolio supervisor to investment
portfolios with approximately $17.1 billion
in assets which it managed or supervised as
of February 28, 2005.
Fiduciary Asset Management, LLC is a
Missouri limited liability company and a
registered investment adviser, which manages
a broad range of equity and fixed income
securities for institutional and private
wealth clients. Founded in 1994, Fiduciary
Asset Management serves as investment
adviser or portfolio supervisor to
investment portfolios with approximately
$15.5 billion of assets, which it managed or
supervised as of February 28, 2005.
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. The Fund paid
distributions to holders of common shares on
October 29, 2004 and January 31, 2005 in the
amounts of $0.325, and $0.330 per share,
respectively. In the case of the October,
2004 distribution, 100% of such distribution
represented a return of capital for tax
purposes. Due to the tax treatment under
current law of cash distributions made by
MLPs in which the Fund invests, a
significant portion of distributions the
Fund makes to common shareholders consists
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 "Shareholder
Tax Features" 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."
LISTING.......................... The Fund's currently outstanding common
shares are, and the Common Shares offered in
this Prospectus will be, listed on the
American Stock Exchange ("AMEX") under the
trading or "ticker" symbol "FEN." The net
asset value of the Fund's common shares at
the close of business on February 28, 2005
was $22.81 per common share, and the last
sale price of the common shares on the AMEX
on such date was $23.65.
Page 12
CORPORATE FINANCE SERVICES
AND CONSULTING AGENT............. A.G. Edwards & Sons, Inc. serves as
corporate finance services and consulting
agent. See "Corporate Finance Services and
Consulting Fee."
CUSTODIAN, ADMINISTRATOR
AND TRANSFER AGENT............... PFPC Trust Company serves as custodian, and
PFPC Inc. serves as administrator, fund
accountant and transfer agent, for the Fund.
See "Custodian, Administrator and Transfer
Agent."
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 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 in the best
interests of the shareholders. 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 the Board of Trustees 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."
Page 13
SPECIAL RISK
CONSIDERATIONS................... Limited Operating History. The Fund is a
non-diversified, closed-end management
investment company registered under the 1940
Act, which commenced operations in June
2004.
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.
Management Risk. The Fund is subject to
management risk because it is an actively
managed portfolio. The Adviser and
Sub-Adviser 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 who 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 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, natural gas
liquids ("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
Page 14
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.
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 the 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 Risk. The ability of MLPs to
grow and to increase distributions to
unitholders is dependent principally on
their ability to make acquisitions that
result in an increase in adjusted
operating surplus per unit. In the event
that MLPs are unable to make such
accretive acquisitions either because
they are unable to identify attractive
acquisition candidates or negotiate
acceptable purchase contracts or because
Page 15
they are unable to raise financing for
such acquisitions on economically
acceptable terms or because they are
outbid by competitors, their future
growth and ability to raise distributions
will be limited. Furthermore, even if
MLPs do consummate acquisitions 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 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
the transporting, processing, storing,
distributing or marketing of natural gas,
NGLs, crude oil, refined petroleum
products or other hydrocarbons, or in the
exploring, managing or producing of 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.
o Terrorism/Market Disruption Risk. The
terrorist attacks in the United States on
September 11, 2001 had a disruptive
effect on the securities markets. United
States 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
Page 16
energy assets, specifically the United
States' 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.
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,
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 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.
Page 17
Tax Risk of MLPs. 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 at the entity level.
If, as a result of a change in current law
or 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 it
its income at the corporate tax rate. If an
MLP was classified as a corporation for
federal income tax purposes, the amount of
cash available for distribution would be
reduced and distributions received by the
Fund would be taxed entirely as dividend
income. Therefore, treatment of an MLP as a
corporation for federal 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.
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 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 activity
by MLPs held in the Fund's portfolio could
result in a reduction of accelerated
depreciation or other deductions generated
by new acquisitions, which may result in
increased current tax liability to the Fund.
A reduction in the percentage of a
distribution 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 dividend income, resulting in
reduced Fund distributions and lower
after-tax distributions to the Fund's Common
Shareholders. See "Risks - Deferred Tax
Risk."
Delay in Investing the Proceeds of this
Offering. Although the Fund currently
intends to invest the proceeds of the sale
of the Common Shares offered hereby as soon
as practicable following the completion of
this 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 fully invest the proceeds from this
offering 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
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 this offering 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
Page 18
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, 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.
Page 19
Leverage Risk. The Fund currently utilizes
leverage in the form of the Notes 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
Page 20
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. In certain types of borrowings,
the Fund may also be 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 financial leverage,
the investment advisory fee payable to
the Adviser and Sub-Adviser will be
higher than if the Fund did not use
leverage.
The issuance of Leverage Instruments by the
Fund, in addition to the Notes, would
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.
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.
Derivatives. 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-Adviser'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
Page 21
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."
Portfolio Turnover Risk. The Fund's annual
portfolio turnover rate may vary greatly
from year to year. From the commencement of
operations through November 30, 2004, the
Fund's actual portfolio turnover was
approximately 35%. 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.
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
Securities Act of 1933, as amended (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
Page 22
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 stock of energy companies trade on
the New York Stock Exchange ("NYSE"), AMEX,
and the NASDAQ National 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. 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-Adviser
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 not
necessarily 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 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.
Page 23
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.
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. There currently are approximately
forty-nine (49) publicly traded MLPs,
approximately 70% 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, 2005, the Fund
held investments in 25 issuers.
Market Disruption Risk. The terrorist
attacks in the United States on September
11, 2001 had a disruptive effect on the
securities markets. United States 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 (the "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 "Risks -
Anti-Takeover Provisions."
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
Page 24
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 overhaul the Internal Revenue Code and
has convened a panel of experts to receive
testimony toward that end. We have no way of
knowing whether such an overhaul of the
Internal Revenue Code might occur or, if
enacted, what effect such an overhaul 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 a limited trading
history and have traded both at a premium
and at a discount relative to net asset
value. The public offering price for the
Common Shares represents a ____% premium
over the per share net asset value on
_________, 2005; however there is no
assurance that this premium will continue
after this offering or that the 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 shares in a relatively short period
following completion of this offering. The
net asset value of the common shares will be
reduced immediately following this offering
as a result of the payment of certain
offering costs. Although the value of the
Fund's net assets is generally considered by
market participants in determining whether
to purchase or sell 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 initial
public offering price.
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
Fiduciary Asset Management. Absent an
exemption from the Securities and Exchange
Commission or other regulatory relief, the
Page 25
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 the initial
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.
Page 26
SUMMARY OF FUND EXPENSES
The following table contains information about the costs and expenses that
Common Shareholders will bear directly or indirectly, after giving effect to the
issuance of Common Shares pursuant to this Prospectus. Both the table and
footnote (5) assume that existing leverage (Notes in an aggregate principal
amount of $34 million) remain outstanding. The table also assumes that the Fund
issues additional Notes following this offering in an aggregate principal amount
of approximately $______ million, which would increase outstanding leverage to
approximately ____% of the Fund's Managed Assets (including the proceeds of
leverage). Footnote (5) assumes that no additional leverage is used. In this
case, existing leverage would represent _____% of the Fund's Managed Assets.
SHAREHOLDER TRANSACTION EXPENSES:
Underwriting Discount (as a percentage of offering price) ..................................... _____%
Offering Expenses Borne by the Fund (as a percentage of offering price)(1)..................... %
=====
Offering Expenses of additional Notes expected to be borne by the Fund
(as a percentage of offering price)* .......................................................... _____%
Dividend Reinvestment Plan Fees................................................................ None(2)
PERCENTAGE OF NET ASSETS
ATTRIBUTABLE TO COMMON SHARES,
AFTER GIVING EFFECT TO THE SALE
OF COMMON SHARES OFFERED
IN THIS PROSPECTUS
(ASSUMES __% LEVERAGE IS OUTSTANDING)
ANNUAL EXPENSES:
Management Fees(3) ............................................................................ _____%
Leverage Costs(4)(5)........................................................................... _____%
Other Expenses (exclusive of deferred income tax expense)(6)................................... _____%(5)
Deferred income tax expense(6)................................................................. _____%
Total Annual Expenses.......................................................................... %
Fee and Expense Reimbursement (Years 1 and 2)(7)............................................... ( )%
Total Net Annual Expenses................................................................. _____%
--------------
* Assuming the Fund expenses the entire amount of the offering expenses upon
the issuance of additional Notes. Offering expenses of additional Notes
are estimated to be $______.
(1) The Adviser has agreed to pay all offering costs of the Fund (other than
the underwriting discount) that exceed $____ per Common Share. The
Sub-Adviser has agreed to reimburse the Adviser for one-half of such
offering costs of the Fund that exceed $____ per Common Share.
(2) You will pay brokerage charges if you direct PFPC Inc., as agent for the
Common Shareholders (the "Plan Agent"), to sell your Common Shares held in
a dividend reinvestment account.
(3) Represents the aggregate fee payable to the Adviser (and by the Adviser to
the Sub-Adviser).
(4) Leverage costs in the table reflect the weighted average cost to the Fund
of the Notes, expressed as a percentage of the Fund's net assets, based on
interest rates in effect as of _________, 2005. The table assumes
outstanding Notes of $____ million, which reflects leverage in an amount
representing ____% of net assets.
(5) The table presented below in this footnote estimates what the Fund's annual
expenses would be, stated as percentages of the Fund's net assets
attributable to Common Shares, assuming no additional leverage is utilized.
Unlike the table above, this table assumes that no debt and no leverage in
addition to the currently outstanding Notes in the principal amount of
$34.0 million is used. In accordance with these assumptions, the Fund's
expenses would be estimated to be as follows:
Page 27
PERCENTAGE OF NET ASSETS
ATTRIBUTABLE TO COMMON SHARES,
AFTER GIVING EFFECT TO THE SALE
OF COMMON SHARES OFFERED
IN THIS PROSPECTUS
(ASSUMES NO ADDITIONAL DEBT IS USED)
ANNUAL EXPENSES:
Management Fees(3).............................................. %
Leverage Costs(a)............................................... ____%
Other Expenses (exclusive of deferred income tax expense)(b).... %
Deferred income tax expense(b).................................. %
Total Annual Expenses........................................... %
====
Fee and Expense Reimbursement (Years 1 and 2)(7)................ ____%
Total Net Annual Expenses.................................. %
====
(a) Leverage Costs in the table reflect the weighted average cost
to the Fund of the Notes, expressed as a percentage of the Fund's net
assets, based on interest rates in effect as of _______, 2005. The table
assumes outstanding Notes of $34 million, which reflects existing
leverage.
(b) The Fund does not expect to recognize net investment income
for its initial fiscal year. Accordingly, other expenses do not include
current or deferred income tax expense (benefit) related to items of net
investment income (loss). Also, other expenses do not include income tax
expense (benefit) related or unrealized investment gains or losses.
(6) The Fund does not expect to recognize net investment income for its initial
fiscal year. Accordingly, other expenses do not include current or deferred
income tax expense (benefit) related to items of net investment income
(loss). Also, other expenses do not include income tax expense (benefit)
related to realized or unrealized investment gains or losses.
(7) For each of the first two years following the commencement of the Fund's
operations through June 24, 2006, the Adviser has 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
Sub-Adviser has 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. Management fees and waivers are expressed as a
percentage of Managed Assets in the table. Because holders of the Notes do
not bear management fees and other expenses, the cost to common
shareholders increases as leverage increases.
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 first year of operations unless otherwise indicated and assume that the
Fund has issued Common Shares in an aggregate amount of $_____ million in this
offering. If the Fund issues fewer Common Shares, all other things being equal,
these expenses would increase on a per common share basis. See "Management of
the Fund" and "Dividend Reinvestment Plan."
Page 28
The following example illustrates the expenses (including the underwriting
discount of $______, and estimated offering expenses of this offering of $_____)
that you would pay on a $1,000 investment in Common Shares, assuming: (i) total
annual expenses of _____% of net assets attributable to Common Shares in years 1
and 2, increasing to _____% in years 3 through 10 and; (ii) a 5% annual
return(1):
1 YEAR 3 YEARS(2) 5 YEARS 10 YEARS
------- ---------- --------- --------
$ $ $ $
(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 _____% of total assets, assuming a ____% cost of leverage. The cost of
leverage is expressed as an interest rate and represents the weighted
average of interest payable on the Notes. 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.
(2) Assumes reimbursement of fees and expenses of 0.25% of the average daily
Managed Assets of the Fund in years 1 and 2. The Adviser has not agreed to
reimburse the Fund for any portion of its fees and expenses beyond June 24,
2006. See footnote 7 above and "Management of the Fund - Investment
Management Agreement."
Page 29
FINANCIAL HIGHLIGHTS
Information contained in the table below shows the audited operating
performance of the Fund from the commencement of the Fund's investment
operations on June 17, 2004 until November 30, 2004, the last day of the Fund's
most recent fiscal year. As of November 30, 2004, the Fund had invested
approximately 100% of its assets.
Since the Fund commenced operations on June 17, 2004, the table covers
approximately five months of operations, during which a portion of the Fund's
assets was held in cash pending investment in MLPs, dividend-paying common
stocks and other securities that meet the Fund's investment objective and
policies. Accordingly, the information presented may not provide a meaningful
picture of the Fund's operating performance.
JUNE 17, 2004-
NOVEMBER 30, 2004
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period............................................................. $ 19.10
-------
INCOME FROM INVESTMENT OPERATIONS:
Net investment loss.............................................................................. (0.13)
Net realized and unrealized gain on investments.................................................. 2.74
-------
Total from investment operations................................................................. 2.61
-------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Return of capital................................................................................ (0.33)
-------
Total from distributions......................................................................... (0.33)
-------
Common shares offering costs charged to paid-in captial.......................................... (0.04)
-------
Net asset value, end of period................................................................... $ 21.34
-------
Market value, end of period...................................................................... $ 22.12
=======
Total return based on net asset value(A)+........................................................ 13.53%
=======
Total return based on market value(B)+........................................................... 12.38%
=======
Net assets, end of period (in thousands)......................................................... $136,993
RATIO OF EXPENSES TO AVERAGE NET ASSETS*:
Including tax expense, reimbursements, and interest expense...................................... 18.09%
Excluding tax expense and reimbursements and including interest expense.......................... 2.20%
Excluding tax expense and including interest expense and reimbursements.......................... 1.91%
Excluding interest expense and tax expenses and including reimbursements......................... 1.36%
RATIO OF NET INVESTMENT LOSS TO AVERAGE NET ASSETS*:
Excluding tax expense and including interest expense and reimbursements.......................... (1.49)%
Including tax expense, reimbursements, and interest expense...................................... (17.67)%
Portfolio turnover rate.......................................................................... 34.86%
SENIOR INDEBTEDNESS:
Total loan outstanding (in thousands)............................................................ $ 30,000
Asset coverage per $1,000 senior indebtedness(C)................................................. $ 5,566
---------------
*Annualized
(A) Total return on net asset value is the combination of reinvested dividend
income and reinvested capital gains distributions, at prices obtained by
the Dividend Reinvestment Plan, if any, and changes in net asset value per
common share.
(B) Total return on market value is the combination of reinvested dividend
income and reinvested capital gains distributions, at prices obtained by
the Dividend Reinvestment Plan, if any, and changes in stock price per
common share, all based on market price per common share.
(C) Calculated by subtracting the Fund's total liabilities (not including loan
outstanding) from the Fund's total assets and dividing this by the amount
of senior indebtedness.
+ Total return is not annualized for periods less than one year and does not
reflect sales load.
Page 30
MARKET AND NET ASSET VALUE INFORMATION
The Fund's currently outstanding common shares are, and the Common Shares
offered by this Prospectus, subject to notice of issuance, will be, listed on
the American Stock Exchange. The Fund's common shares commenced trading on the
AMEX on June 25, 2004.
The Fund's common shares have a limited trading history and 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 following table sets forth for each of the periods indictated the high
and low closing market prices for shares of the Fund on the AMEX, the net asset
value per share and the premium or discount to net asset value per share at
which the Fund's shares were trading. Net asset value is generally determined as
of the close of regular session trading on the NYSE (normally 4:00 p.m. eastern
time) no less frequently than weekly on Friday of each week. See "Net Asst
Value" for information as to the determination of the Fund's net asset value.
NET ASSET PREMIUM/(DISCOUNT)
MARKET PRICE(3) VALUE(1) TO NET ASSET VALUE(2)
Month Ended High Low High Low
July 31, 2004.......... $20.01 $19.76 $19.10 4.76% 3.46%
August 31, 2004........ $20.65 $19.60 $19.35 6.72% 1.29%
September 30, 2004..... $22.20 $20.65 $19.63 13.09% 5.20%
October 31, 2004....... $22.35 $20.60 $20.44 9.34% 0.78%
November 30, 2004...... $22.98 $20.95 $20.18 13.88% 3.82%
December 31, 2004...... $22.39 $21.50 $21.30 5.12% 0.94%
January 31, 2005....... $22.83 $21.50 $21.82 4.63% (1.47%)
February 28, 2005...... $23.97 $22.70 $22.48 6.63% 0.98%
March 31, 2005......... $22.81
The last reported sale price, net asset value per share and percentage
premium to net asset value per share of the common shares on ______________,
2005 were $____________, $____________ and ____________, respectively. As of
February 28, 2005, the Fund had 6,434,334 common shares outstanding and
net assets of the Fund were $146,767,159.
-----------------
(1) Based on the net asset value calculated on the close of business on the
last business day of each prior calendar month
(2) Calculated based on the information presented.
(3) Based on high and low closing market price for the respective month.
Page 31
CAPITALIZATION
The following table sets forth the capitalization of the Fund as of
November 30, 2004, and as adjusted to give effect to the issuance of (i) the
Common Shares offered hereby, and (ii) the issuance of $34.0 million principal
amount of Notes on January 28, 2005, the net proceeds of which were used to
repay short-term indebtedness in the amount of $30.0 million. As indicated
below, common shareholders will bear the offering costs associated with this
offering.
ACTUAL AS ADJUSTED
--------- -----------
Long-Term Debt:
Notes..................................................................... $ $
Common Shareholders' Equity:
Common shares, $.01 par value per share; unlimited shares authorized,
6,420,643 shares outstanding, actual and _______ shares outstanding, as
adjusted(1)................................................................. $ 64,206 $
Paid-in surplus............................................................. 120,248,810
Accumulated net investment loss............................................. (507,085)
Net unrealized appreciation of investments.................................. 17,187,341
------------
Net assets applicable to common shares...................................... $136,993,272 $
============
-----------------
(1) None of these outstanding securities are held by or for the account of the
Fund.
THE FUND
The Fund is a recently organized, 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. As a recently
organized entity, the Fund has a limited operating history. On June 29, 2004,
the Fund issued an aggregate of 6,400,000 common shares in its initial public
offering. The Fund's currently outstanding common shares are, and the Common
Shares offered in this Prospectus will be, listed on the AMEX under the symbol
"FEN." The Fund's principal office is located at 1001 Warrenville Road, Suite
300, Lisle, Illinois 60532, and its telephone number is (630) 241-4141.
The following table provides information about the Fund's outstanding
securities as of February 28, 2005:
AMOUNT HELD BY THE
AMOUNT FUND OR FOR ITS AMOUNT
TITLE OF CLASS AUTHORIZED ACCOUNT OUTSTANDING
------------------ --------------- ------------------ --------------
Common shares....................... Unlimited 0 6,434,334
Energy Notes Series A............... $34,000,000 0 $34,000,000
Page 32
The Fund paid distributions to common shareholders on October 29, 2004 and
January 31, 2005 in the amounts of $0.325 and $0.330 per share, respectively.
The Fund expects that a significant portion of these distributions will be
treated as a return of capital to common shareholders for tax purposes.
USE OF PROCEEDS
The net proceeds of the offering of Common Shares will be approximately
$___________ ($___________ if the Underwriters exercise the over-allotment
option in full) after deducting the estimated offering costs. The Fund will
invest the net proceeds of the offering in accordance with the Fund's investment
objective and policies as stated below. The Fund expects it will be able to
invest substantially all of the net proceeds in securities that meet the Fund's
investment objective and policies within one month after the completion of the
offering. Pending such investment, 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-Adviser 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 significant portion of its income will be tax deferred
thereby maximizing 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.
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-Adviser believes offer attractive distribution rates and capital
appreciation potential. The Fund also may invest in other securities set forth
below if the Sub-Adviser 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
Page 33
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 ("junk
bonds"). 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-Adviser.
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.
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, MLPs and MLP-related entities.
The Sub-Adviser seeks securities that offer a combination of quality, growth and
yield intended to result in superior total returns over the long run. The
Sub-Adviser's securities selection process includes a comparison of
quantitative, qualitative, and relative value factors. While the Sub-Adviser
maintains an active dialogue with several research analysts in the energy
sector, the Sub-Adviser's primary emphasis is placed on proprietary analysis and
valuation models conducted and maintained by their in-house investment analysts.
To determine whether a company meets its criteria, the Sub-Adviser 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 are contained in the Fund's SA1.
Energy Companies. The Fund's investments consist of equity and/or debt
securities issued by energy companies, 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. To generate
additional income, the Fund intends, on a consistent and ongoing basis, to write
(or sell) covered call options on the common stock of energy companies held in
the Fund's portfolio.
Page 34
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 will invest 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).
Page 35
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 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 MLP's, I-Shares of MLP-related
entities and common stock of MLP-related entities, such as general partners or
other affiliates of the MLP's
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.
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 New York Stock Exchange.
Page 36
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. To generate
additional income, the Fund intends, on a consistent and ongoing basis, to 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 or B3 by Moody's or a
comparable rating by another NRSRO or, if unrated, determined to be of
comparable quality by the Sub-Adviser. 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-Adviser 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-Adviser, 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 this offering of Common Shares
are being invested, or during periods in which the Sub-Adviser 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-Adviser'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 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-Adviser (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
Page 37
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."
Hedging and Interest Rate 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. The Fund has in the
past written (or sold), and may in the future 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 mutual funds and other
institutional investors. Although the Sub-Adviser 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 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 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-Adviser'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" in the Prospectus and "Investment Policies and
Techniques" in the Fund's Statement of Additional Information 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. From the commencement of operations through November
30, 2004, the Fund's actual portfolio turnover rate was approximately 35%.
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. 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
Page 38
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 may seek to enhance the level of its current distributions through
the use of Financial Leverage. 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
as permitted by law) 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). However, the Fund intends, under
normal circumstances, to utilize leverage in an amount up to approximately 20%
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."
In this regard, on January 28, 2005, the Fund issued $34,000,000 principal
amount of auction rate senior notes due March 2, 2045 which were rated "Aaa" and
"AAA" by Moody's and Fitch, respectively. As of February 28, 2005, the principal
amount of the Notes represented 18.81% of the Fund's Managed Assets. The Fund
may, in the future, 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 the Notes.
The issuance of debt and Preferred Shares, including the Notes, 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 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 Adviser's and Sub-Adviser's fees are based on Managed Assets (including
assets obtained through leverage), both the Adviser's and Sub-Adviser's fees are
higher when the Fund is leveraged. There can be no assurance that a leveraged
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 Leverage
Instruments would have complete priority upon distribution of assets over common
shares. The issuance of Leverage Instruments would leverage the common shares.
Although based on recommendations by the Adviser and the Sub-Adviser, the
determination of whether to utilize Financial Leverage in addition to the Notes,
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
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
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 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-Adviser in its best judgment nevertheless
Page 39
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 Adviser and Sub-Adviser 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
Adviser and Sub-Adviser 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. Any borrowing will likely be ranked senior or equal to all other
existing and future borrowings of the Fund.
Certain types of borrowings may result in the Fund being subject to
covenants in credit agreements 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-Adviser from managing the Fund's portfolio in accordance with the Fund's
investment objective and policies.
If Preferred Shares are issued they would pay adjustable rate dividends
based on shorter-term interest rates, which would be redetermined periodically
by an auction process. 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.
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
Page 40
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 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
On January 28, 2005, the Fund issued Notes in an aggregate principal amount
of $34,000,000. The aggregate principal amount of Notes represented 18.81% of
Managed Assets as of February 28, 2005. Asset coverage with respect to the Notes
was 532% as of that date. The interest rate payable by the Fund on the Notes
varies based on auctions normally held every twenty-eight (28) days. As of
February 28, 2005, the current interest rate payable on the Notes was 2.94%.
Assuming that the Fund's leverage costs remain as described above (an
average annual cost of 2.94%), the annual return that the Fund's portfolio must
experience (net of expenses) in order to cover its leverage costs would be
.63%.
The following table is furnished in response to requirements of the
Securities and Exchange Commission. 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 reflects the issuance of Leverage Instruments
representing 20% of the Fund's Managed Assets, net of expenses, and the Fund's
currently projected annual leverage interest rate of 2.94%.
Assumed Portfolio Total Return (Net of Expenses) ...... (10)% (5)% 0% 5% 10%
Common Share Total Return ............................. (13.27)% (7.01)% (0.74)% 5.52% 11.78%
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 Securities and Exchange Commission 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
Adviser and the Sub-Adviser 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 Adviser and the Sub-Adviser have a financial
incentive to leverage the Fund, which may create a conflict of interest between
Page 41
the Adviser and Sub-Adviser on the one hand and the common shareholders on the
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.
Page 42
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.
LIMITED OPERATING HISTORY
The Fund is a recently organized, non-diversified, closed-end management
investment company which commenced operations in June 2004.
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.
MANAGEMENT RISK
The Fund is subject to management risk because it is an actively
managed portfolio. The Adviser and Sub-Adviser 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 who 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.
Page 43
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.
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 the 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 Risk. The ability of MLPs to grow and to increase
distributions to unitholders is dependent principally on their
ability to make acquisitions that result in an increase in adjusted
operating surplus per unit. In the event that MLPs are unable to
make such accretive acquisitions either because they are unable to
identify attractive acquisition candidates or negotiate acceptable
purchase contracts or because they are unable to raise financing
for such acquisitions on economically acceptable terms or because
they are outbid by competitors, their future growth and ability to
raise distributions will be limited. Furthermore, even if MLPs do
consummate acquisitions that they believe will be accretive, the
acquisitions may in fact turn out to result in a decrease in
Page 44
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 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 the
transporting, processing, storing, distributing or marketing of
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. United States 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 United States' 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.
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
Page 45
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, 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 corporate tax rate. If an MLP was
classified as a corporation for federal income tax purposes, the amount of cash
available for distribution would be reduced and distributions received by the
Fund would be taxed entirely as dividend income. 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
Page 46
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
activity by MLPs held in the Fund's portfolio could result in a reduction of
accelerated depreciation or other deductions generated by new acquisitions,
which may result in increased current tax liability to the Fund. A reduction in
the percentage of a distribution 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
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 not necessarily 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 year following this offering 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, 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.
Page 47
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
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 as
permitted by law) 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). The Fund currently has outstanding Notes
with a principal amount of $34 million. As of February 28, 2005, the principal
amount of the Notes represented 18.81% of the Fund's Managed Assets. However,
the Fund intends, under normal circumstances, to utilize leverage in an amount
up to approximately 20% of the Fund's Managed Assets. 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-Adviser'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 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
Page 48
o when the Fund uses financial leverage, the investment advisory fee
payable to the Adviser and the Sub-Adviser's fee will be higher
than if the Fund did not use leverage.
The issuance of Leverage Instruments by the Fund, in addition to the Notes,
would 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.
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 leverage 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 leverage
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 leverage 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 leverage 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-Adviser 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.
Restrictive Covenants and 1940 Act Restrictions. With respect to a
borrowing program instituted by the Fund, the credit agreements governing such a
program (the "Credit Agreements") will likely include 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
Page 49
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 Credit Agreements would not permit the Fund's asset coverage ratio (as
defined in the Credit Agreements) 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 Credit
Agreements would limit the Fund's ability to pay dividends or make other
distributions on the Fund's Common Shares unless the Fund complies with the
Credit Agreements' 300% asset coverage test. In addition, the Credit Agreements
will 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 Credit Agreements has occurred and is continuing; or (ii) if,
after giving effect to such declaration, the Fund would not meet the Credit
Agreements' 300% asset coverage test set forth in the Credit Agreements. 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
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-Adviser'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.
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
Page 50
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-Adviser'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 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 any use by the Fund 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 or 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.
Page 51
PORTFOLIO TURNOVER RISK
The Fund's annual portfolio turnover rate may vary greatly from year to
year. From the commencement of operations through November 30, 2004, the Fund's
actual portfolio turnover was approximately 35%. 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. 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 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 energy companies trade on the NYSE, AMEX and the NASDAQ National
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.
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-Adviser 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 not necessarily 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."
Page 52
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-Adviser. 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
Page 53
securities or instruments by the Fund, although the Sub-Adviser will consider
these events in determining whether the Fund should continue to hold the
securities.
The market for below investment grade and comparable unrated securities has
experienced periods of significantly adverse price and liquidity several times,
particularly at or around times of economic recession. Past market recessions
have adversely affected the value of such securities as well as the ability of
certain issuers of such securities to repay principal and pay interest thereon
or to refinance such securities. The market for these securities may react in a
similar fashion in the future.
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. There currently are approximately
forty-nine (49) publicly traded MLPs, approximately 70% 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, 2005, the Fund held investments in 25 issuers.
MARKET DISRUPTION RISK
The terrorist attacks in the United States on September 11, 2001 had a
disruptive effect on the securities markets. United States 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."
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
overhaul the Internal Revenue Code and has convened a panel of experts to
receive testimony toward that end. We have no way of knowing whether such an
overhaul of the Internal Revenue Code might occur or, if enacted, what effect
Page 54
such an overhaul 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 a limited trading history and have traded
both at a premium and at a discount relative to net asset value. The public
offering price for the Common Shares represents a ____% premium over the per
share net asset value on _________, 2005; however, there is no assurance that
this premium will continue after this offering or that the 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 shares in a relatively short period following completion of this
offering. The net asset value of the common shares will be reduced immediately
following this offering as a result of the payment of certain offering costs.
Although the value of the Fund's net assets is generally considered by market
participants in determining whether to purchase or sell 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 initial public offering price.
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 Fiduciary Asset Management. Absent an exemption
from the Securities and Exchange Commission 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 the
initial 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 Adviser and the Sub-Adviser. 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.
Page 55
INVESTMENT ADVISER
First Trust Advisors, 1001 Warrenville Road, Suite 300, Lisle, Illinois
60532, is the investment adviser to the Fund and is responsible for supervising
the Sub-Adviser. First Trust Advisors serves as investment adviser or portfolio
supervisor to investment portfolios with approximately $17.1 billion in assets
which it managed or supervised as of February 28, 2005.
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 adviser registered with the Securities and Exchange Commission
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.
For additional information concerning First Trust Advisors, including a
description of the services provided, see the SAI.
SUB-ADVISER
The Sub-Adviser, Fiduciary Asset Management located at 8112 Maryland
Avenue, Suite 400, St. Louis, Missouri 63105, is a registered investment adviser
and serves as investment adviser or portfolio supervisor to investment
portfolios with approximately $15.5 billion of assets as of February 28, 2005.
Fiduciary Asset Management invests in a broad range of equity, hedged
equity, master limited partnership, and fixed income securities for
institutional and high net worth clients. Fiduciary Asset Management's clients
include Fortune 500 companies, public pensions and large endowments and
foundations. Fiduciary Asset Management has managed master limited partnership
portfolios for clients since 1995.
Fiduciary Asset Management was founded as an independent investment firm in
1994 by Charles D. Walbrandt. From 1974 through 1994, Mr. Walbrandt served in
various capacities with General Dynamics Corporation, including Corporate Vice
President, Trust Investment and Treasurer. While at General Dynamics, Mr.
Walbrandt created the internal investment department in 1983, designed the
investment management process and managed both equity and fixed income
portfolios. Mr. Walbrandt holds a B.S. degree in economics from the University
of Wisconsin, a M.B.A. in finance from St. Louis University and is a Chartered
Financial Analyst. Fiduciary Asset Management is controlled by Mr. Walbrandt.
Fiduciary Asset Management's investment committee includes Charles D.
Walbrandt, Wiley D. Angell, Mohammad Riad, James J. Cunnane Jr. and Joseph E.
Gallagher. Mr. Cunnane serves as the primary portfolio manager for the Fund.
Mr. Cunnane has over ten years experience managing portfolios and is a
member of the equity portfolio management team and performs securities research.
Prior to joining Fiduciary Asset Management in 1996, he was a research analyst
with A.G. Edwards from 1994 to 1996. He also worked as an analyst for Maguire
Investment Advisors, where he gained extensive experiences in the development of
master limited partnership and mid- and small-cap stock portfolios. He holds a
B.S. degree in finance from Indiana University. Mr. Cunnane is a Chartered
Financial Analyst, and serves on the investment committee of the Archdiocese of
St. Louis and the board of the St. Louis internship program. The SAI provides
Page 56
additional information about the portfolio manager's compensation, other
accounts managed by the portfolio manager and the portfolio manager's ownership
of common shares of the Fund.
William N. Adams performs securities research on equity and fixed income
securities and focuses on the energy sector. Prior to joining Fiduciary Asset
Management in 2004, Mr. Adams was a research analyst with Banc of America
Capital Management and previous entities from 1981 to 2004, specializing in
integrated oils, oil field services, oil and natural gas exploration, and
refining and marketing. Mr. Adams received his BSBA/MBA degrees from Washington
University in St. Louis and is a Chartered Financial Analyst.
For additional information concerning Fiduciary Asset Management, including
a description of the services provided, see "Sub-Adviser" 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.
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 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-Adviser receives a portfolio management fee equal to 0.50% of the
Fund's Managed Assets. The Sub-Adviser's fee is paid by the Adviser out of the
Adviser's management fee.
For each of the first two years following the commencement of the Fund's
operations through June 24, 2006, the Adviser has 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 Sub-Adviser has
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 Adviser has agreed to pay all offering costs of the Fund (other than
the underwriting discount) that exceed % (or $ per Common Share) of the Fund's
offering price. The Sub-Adviser has agreed to reimburse the Adviser for one-half
of such offering costs of the Fund that exceed % (or $ per Common Share) of
the Fund's offering price.
Because the fee paid to the Adviser and Sub-Adviser will be calculated on
the basis of the Fund's Managed Assets, which include the proceeds of leverage,
the dollar amount of the Adviser's and Sub-Adviser's fees from the Fund will be
higher (and the Adviser and Sub-Adviser will be benefited to that extent) when
leverage is utilized. In this regard, if the Fund uses leverage in the amount
equal to 20% of the Fund's Managed Assets (after their issuance), the Fund's
management fee would be ____% of net assets attributable to Common Shares. See
"Summary of Fund Expenses."
Page 57
NET ASSET VALUE
The Fund determines the net asset value of its common shares as of the
close of regular session trading on the NYSE (normally 4:00 p.m. eastern time)
no less frequently than weekly on Friday of each week. 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 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 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.
DISTRIBUTIONS
The Fund intends to make quarterly distributions to common shareholders.
The Fund anticipates that a portion of the first distribution after this
offering may be made from sources other than cash distributions from its
portfolio of MLP and MLP-related entity investments, and may consist of a return
of investors' capital. 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 significant
portion of distributions the Fund makes to common shareholders will consist of a
tax-deferred return of capital. The Fund paid distributions to holders of common
shares on October 29, 2004 and January 31, 2005 in the amounts of $0.325, and
Page 58
$0.330 per share, respectively. In the case of the October, 2004 distribution,
100% of such distribution represented a return of capital for tax purposes. It
is expected that the Fund will declare and pay a distribution to common
shareholders at the end of each fiscal quarter beginning, with respect to the
Common Shares offered in this Prospectus, with the quarter ending July 31, 2005.
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, PFPC 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 PFPC Inc., as dividend paying agent.
If you decide to participate in the Plan, the number of common shares you
will receive will be determined as follows:
(1) If 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 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
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.
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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 PFPC Inc., 301
Bellevue Parkway, Wilmington, Delaware 19809.
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 , 2005, the Fund had 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," 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, listed on the AMEX under the trading or
"ticker" symbol "FEN."
Net asset value will be reduced immediately following the offering by the
amount of the underwriting discount and offering expenses paid by the Fund. The
Adviser has agreed to pay all offering costs of the Fund (other than the
underwriting discount) that exceed % (or $______ per Common Share) of the Fund's
offering price. The Sub-Adviser has agreed to reimburse the Adviser for one-half
of such offering costs of the Fund that exceed % (or $______ per Common Share)
of the Fund's offering price.
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 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."
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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 shares. Holders of common shares have no preemptive right to
purchase any Preferred Shares that might be issued.
The Fund may elect to issue Preferred Shares as part of its leverage
strategy. The 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. We 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." 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.
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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 NOTES AND 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
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 senior or equal to all other
existing and future borrowings of the Fund.
Certain types of borrowings may result in the Fund being subject to
covenants in credit agreements 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-Adviser from managing the Fund's portfolio in accordance with the Fund's
investment objective and policies.
On January 28, 2005, the Fund issued $34,000,000 principal amount of
auction rate senior notes due March 2, 2045 which were rated "Aaa" and "AAA" by
Moody's and Fitch, respectively. The Notes pay interest at rates that vary based
on auctions normally held every twenty-eight (28) days. The Notes rank senior to
the Fund's common shares. Under the 1940 Act, the Fund may only issue one class
of senior securities representing indebtedness. So long as the Notes are
outstanding, additional senior debt securities must rank on a parity with the
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Notes. The Notes may be redeemed prior to their maturity at the option of the
Fund, in whole or in part, under certain circumstances and are subject to
mandatory redemption upon failure of the Fund to maintain asset coverage
requirements with respect to the Notes.
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST
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 includes 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. 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 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 Statement of Additional Information under "Certain
Provisions in the Declaration of Trust."
The provisions of the Declaration of Trust described above could have the
effect of depriving the Common Shareholders of opportunities to sell their
common shares at a premium over the then current market price of the Common
Shares by discouraging a third party from seeking to obtain control of the Fund
in a tender offer or similar transaction. The overall effect of these provisions
is to render more difficult the accomplishment of a merger or the assumption of
control by a third party. They provide, however, the advantage of potentially
Page 63
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
Securities and Exchange Commission 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
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
mutual 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 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
Adviser, Sub-Adviser and any corporate finance services and consulting agent
that the Adviser may retain, 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
Page 64
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, 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 Adviser and the Sub-Adviser 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 AMEX or other national securities exchange or market system.
Any Preferred Shares or Borrowings would need to be redeemed or repaid upon
conversion to an open-end investment company. The Board of Trustees believes,
however, that the closed-end structure is 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
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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 United States 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 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 will be 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.
Page 66
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 partnership 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 will not be 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 is intending to invest in MLPs that invest in energy ventures,
it is not expected that the Fund will 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, dividends that qualify as "qualified
dividend income" are generally taxed to individuals at a maximum 15% rate if
certain holding period requirements are met. 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
Page 67
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, 2008. 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 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 company. If the Fund is classified as
a U.S. real property holding company, 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,
2008, 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, 2008, with the maximum marginal federal income tax rate
being 35% at such time with another increase to 39.6% currently scheduled to be
effective after December 31, 2010.
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
Page 68
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 W9, Form W8BEN, Form W8ECI 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.
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 ("PTPs") are
generally treated as corporations for federal income tax purposes. However, if a
PTP satisfies certain income character requirements, the PTP will generally
continue to be treated as partnership for federal income tax purposes. Under
these requirements, a PTP must receive at least 90% of its gross income from
certain "qualifying income" sources.
Qualifying income for most PTPs 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 anticipates investing in
energy PTPs, so the income of the PTPs should qualify as qualifying income.
The federal tax rules relating to PTPs provide that the "qualifying income"
exception to corporate tax treatment does not apply, in general, to any
partnership that would be treated as a regulated investment company for federal
income tax purposes if the partnership were a corporation. For this reason, PTPs
are generally structured to not be registered under the 1940 Act.
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
Page 69
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.
Nature of Fund's Investments. The Fund expects 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) and (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.
Page 70
UNDERWRITING
The underwriters named below (the "Underwriters"), acting through
______________________________, as lead manager ("____________") and
___________________________________, as their representatives (including
____________, the "Representatives"), have severally agreed, subject to the
terms and conditions of the Underwriting Agreement with the Fund, First Trust
Advisors and Fiduciary Asset Management (the "Underwriting Agreement"), to
purchase from the Fund the number of Common Shares set forth below opposite
their respective names.
UNDERWRITERS SHARES
------------- ------
______________________ ......................................... ________
Total ....................................................... ========
The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions, including the absence of any
materially adverse change in the Fund's business and the receipt of certain
certificates, opinions and letters from the Fund and the Fund's attorneys and
independent accountants. The nature of the Underwriters' obligation is such that
they are committed to purchase all Common Shares offered hereby if they purchase
any of the Common Shares.
The Fund has granted to the Underwriters an option, exercisable for 45 days
from the date of this Prospectus, to purchase up to an aggregate of ________
additional Common Shares to cover over-allotments, if any, at the initial
offering price. The Underwriters may exercise such option solely for the purpose
of covering over-allotments incurred in the sale of the Common Shares offered
hereby. To the extent that the Underwriters exercise this option, each of the
Underwriters will have a firm commitment, subject to certain conditions, to
purchase an additional number of Common Shares proportionate to such
Underwriter's initial commitment.
The Representatives have advised the Fund that the Underwriters propose to
offer some of the Common Shares directly to investors at the offering price of
$_____ per Common Share, and may offer some of the Common Shares to certain
dealers at the offering price less a concession not in excess of $_____ per
Common Share, and such dealers may reallow a concession not in excess of $_____
per Common Share on sales to certain other dealers. The Common Shares are
offered by the Underwriters, subject to prior sale, when, as and if delivered to
and accepted by the Underwriters, and subject to their right to reject orders in
whole or in part.
The Fund will pay its Common Share offering costs (other than sales load).
The Adviser has agreed to pay all of the Common Share offering costs (other than
the underwriting discount) that exceed % (or $ per Common Share) of the Fund's
offering price. The Sub-Adviser has agreed to reimburse the Adviser for one-half
of such offering costs of the Fund that exceed ___% (or $____ per Common Share)
of the Fund's offering price. To the extent that aggregate offering expenses are
less than $_____ per Common Share, up to 0.10% of the public offering price of
the securities sold in this offering, up to such expense limit, will be paid to
First Trust Portfolios, L.P. ("First Trust Portfolios") as reimbursement for the
distribution services they provide to the Fund (the "Contingent Reimbursement
Amount"). First Trust Portfolios is an affiliate of the Adviser.
The Fund's common shares currently outstanding are, and the Common Shares
offered by this Prospectus will be, listed on the AMEX. The trading or "ticker"
symbol of the Common Shares is "FEN."
The Fund, First Trust Advisors and Fiduciary Asset Management have each
agreed to indemnify the several Underwriters for or to contribute to the losses
arising out of certain liabilities, including liabilities under the Securities
Act of 1933, as amended.
Page 71
The Fund has agreed not to offer or sell any additional Common Shares of
the Fund, other than as contemplated by this Prospectus, for a period of 60 days
after the date of the Underwriting Agreement without the prior written consent
of the Representatives.
The Fund anticipates that the Representatives and certain other
Underwriters may from time to time act as brokers or dealers in connection with
the execution of its portfolio transactions after they have ceased to be
Underwriters and, subject to certain restrictions, may so act while they are
Underwriters.
Until the distribution of Common Shares is completed, rules of the
Securities and Exchange Commission may limit the ability of the Underwriters and
certain selling group members to bid for and purchase the Common Shares. As an
exception to these rules, the Underwriters are permitted to engage in certain
transactions that stabilize the price of the Common Shares. Such transactions
may consist of short sales, stabilizing transactions and purchases to cover
positions created by short sales. Short sales involve the sale by the
Underwriters of a greater number of Common Shares than they are required to
purchase in the offering. Stabilizing transactions consist of certain bids or
purchases made for the purpose of preventing or retarding a decline in the
market price of the Common Shares while the offering is in progress.
The Underwriters also may impose a penalty bid. This occurs when a
particular Underwriter repays to the other Underwriters all or a portion of the
underwriting discount received by it because the Representatives have
repurchased shares sold by or for the account of such Underwriter in stabilizing
or short covering transactions. The same penalty bid may be imposed by an
Underwriter who distributes Common Shares to another broker-dealer, who is not
an Underwriter, if said broker-dealer sells shares which are repurchased by the
Underwriters in stabilizing or short covering transactions.
These activities by the Underwriters may stabilize, maintain or otherwise
affect the market price of the Common Shares. As a result, the price of the
Common Shares may be higher than the price that otherwise might exist in the
open market. If these activities are commenced, they may be discontinued by the
Underwriters without notice at any time. These transactions may be effected on
the American Stock Exchange or otherwise.
As described below under "Corporate Finance Services and Consulting Fee,"
A.G. Edwards & Sons, Inc. ("A.G. Edwards") provides the corporate finance and
consulting services described below (the "Services") pursuant to an agreement
with First Trust Advisors (the "Services Agreement") and is entitled to receive
the fees (the "Service Fees") described below.
As described above, First Trust Portfolios, L.P., an affiliate of the
Adviser, will provide distribution assistance in connection with the sale of the
Common Shares of the Fund, and may receive from the Fund an amount as
reimbursement for related expenses up to the Contingent Reimbursement Amount,
which will not exceed 0.10% of the total price to the public of the Common
Shares sold in this offering. First Trust Portfolios is a registered
broker-dealer and a member of the National Association of Securities Dealers
("NASD"). However, because the offering expenses are expected to exceed $____
per Common Share, the Fund will not pay First Trust Portfolios any amount of the
Contingent Reimbursement Amount.
The total amount of the partial reimbursement of the expenses of the
Underwriters, the amount paid to First Trust Portfolios, and, under current
interpretations of the NASD staff in effect on the date of this Prospectus
(which may be subject to change), the Service Fees will not exceed 4.5% of the
total price to the public of the Common Shares sold in this offering. The sum
total of all compensation to Underwriters in connection with the public offering
of Common Shares, including sales load and all forms of additional compensation
to Underwriters, will be limited to 9.0% of the total price to the public of the
Common Shares.
Page 72
The address of the lead managing underwriter is __________________________
_______________________________________________________.
CORPORATE FINANCE SERVICES AND CONSULTING FEE
The Fund has agreed to pay the Contingent Reimbursement Amount to First
Trust Portfolios.
First Trust Advisors (and not the Fund) has also entered into a Corporate
Finance Services and Consulting Agreement with A.G. Edwards and has agreed to
pay from its own assets a fee to A.G. Edwards. This fee will be payable
quarterly at the annual rate of 0.15% of the Fund's average daily net assets 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,
A.G. Edwards 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 A.G. Edwards shall,
from time to time, agree, including after-market services designed to maintain
the visibility of the Fund in the market. The amounts paid as Service Fees will
not exceed _____% of the offering price of the Common Shares. NASD
interpretations regarding Service Fees are subject to change.
CUSTODIAN, ADMINISTRATOR AND TRANSFER AGENT
The custodian of the assets of the Fund is PFPC Trust Company
("Custodian"), 301 Bellevue Parkway, Wilmington, Delaware 19809. The Fund's
transfer, shareholder services and dividend paying agent is PFPC Inc., 301
Bellevue Parkway, Wilmington, Delaware 19809. Pursuant to an Administration and
Accounting Services Agreement, PFPC 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 public accountant
providing such accountant with various audit-related information with respect to
the Fund; and providing other continuous accounting and administrative services.
As compensation for these services, the Fund has agreed to pay PFPC Inc. an
annual fee, calculated daily and payable on a monthly basis, of 0.06% of the
Fund's first $250 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, and for the
Underwriters by _____________________________________, ___________,
____________. Chapman and Cutler LLP may rely as to certain matters of
Massachusetts law on the opinion of Bingham McCutchen LLP.
Page 73
TABLE OF CONTENTS FOR THE
STATEMENT OF ADDITIONAL INFORMATION
PAGE
----
Use of Proceeds ........................................................... 1
Investment Objective ...................................................... 1
Investment Restrictions.................................................... 2
Investment Policies and Techniques ........................................ 3
Additional Information About the Fund's Investments and
Investment Risks...................................................... 6
Other Investment Policies and Techniques .................................. 24
Management of the Fund .................................................... 33
Investment Adviser ........................................................ 38
Sub-Adviser................................................................ 42
Portfolio Transactions and Brokerage ...................................... 46
Certain Provisions in the Declaration of Trust ............................ 47
Repurchase of Fund Shares; Conversion to Open-End Fund .................... 50
Net Asset Value............................................................ 52
Tax Matters ............................................................... 55
Performance Related and Comparative Information ........................... 60
Experts ................................................................... 62
Custodian, Administrator and Transfer Agent ............................... 62
Additional Information .................................................... 63
Report of Independent Registered Public Accounting Firm ................... 64
Financial Statements ......................................................F-1
Appendix A -- Ratings of Investments.......................................A-1
Appendix B -- Fiduciary Asset Management, LLC Proxy Voting Policy..........B-1
Page 74
--------------------------------------------------------------------------------
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 ................................................... 5
Summary of Fund Expenses ............................................. 25
Financial Highlights.................................................. 27
Market and Net Asset Value Information................................ 28
Capitalization........................................................ 29
The Fund ............................................................. 29
Use of Proceeds ...................................................... 30
The Fund's Investments ............................................... 30
Use of Financial Leverage ............................................ 35
Risks ................................................................ 39
Management of the Fund ............................................... 51
Net Asset Value ...................................................... 53
Distributions ........................................................ 53
Dividend Reinvestment Plan ........................................... 54
Description of Shares ................................................ 55
Certain Provisions in the Declaration of Trust ....................... 57
Structure of the Fund; Common Share
Repurchases and Change in Fund Structure........................... 58
Tax Matters........................................................... 60
Underwriting ......................................................... 65
Corporate Finance Services and
Consulting Fee..................................................... 66
Custodian, Administrator and
Transfer Agent .................................................... 67
Legal Opinions ....................................................... 67
Table of Contents for the Statement of
Additional Information ............................................ 68
Until _________, 2005 (25 days after the date of this Prospectus), all
dealers that buy, sell or trade the Common Shares, whether or not participating
in this offering, may be required to deliver a prospectus. This is in addition
to the dealers' obligation to deliver a prospectus when acting as Underwriters
and with respect to their unsold allotments or subscriptions.
____________ SHARES
ENERGY INCOME AND
GROWTH FUND
COMMON SHARES
PROSPECTUS
___________, 2005
Back Cover
SUBJECT TO COMPLETION, DATED MARCH 18, 2005
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 common shares of
beneficial interest of the Fund offered by the Fund's Prospectus relating
thereto dated __________, 2005 (the "Prospectus"). This Statement of Additional
Information is not a prospectus, but should be read in conjunction with the
Prospectus. As used in this Statement of Additional Information, 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 the Prospectus and the holders of the common shares are called
"common shareholders."
On June 29, 2004, the Fund issued an aggregate of 6,400,000 common
shares in its initial public offering. The Fund's currently outstanding common
shares are, and the Common Shares offered by the Prospectus will be, listed on
the American Stock Exchange under the symbol "FEN." On January 28, 2005, the
Fund issued $34,000,000 principal amount of auction rate senior notes due March
2, 2045 (the "Notes") which were rated "Aaa" and "AAA" by Moody's Investor
Service ("Moody's") and Fitch Rating Services, Inc. ("Fitch"), respectively. As
of February 28, 2005, the principal amount of the Notes represented 18.81% of
the Fund's Managed Assets. The Fund may, in the future, issue additional series
of the Notes or other senior securities to the extent permitted by the
Investment Company Act of 1940, as amended (the "1940 Act"). The Fund's common
shares are junior in liquidation and distribution rights to the Notes. The
issuance of debt and preferred shares, including the Notes, represent the
leveraging of the Fund's common shares. The issuance of additional Common Shares
in this offering will enable the Fund to increase the aggregate amount of its
leverage.
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 prior to
purchasing such shares. A copy of the Fund's Prospectus 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.
This Statement of Additional Information is dated __________, 2005.
THE INFORMATION IN THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT
COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE
REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS
EFFECTIVE. THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT AN OFFER TO SELL
THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN
ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
Front Page
TABLE OF CONTENTS
PAGE
USE OF PROCEEDS...............................................................1
INVESTMENT OBJECTIVE..........................................................1
INVESTMENT RESTRICTIONS.......................................................2
INVESTMENT OBJECTIVE POLICIES AND TECHNIQUES..................................3
ADDITIONAL INFORMATION ABOUT THE FUND'S INVESTMENTS
AND INVESTMENT RISKS......................................................6
OTHER INVESTMENT POLICIES AND TECHNIQUES.....................................24
MANAGEMENT OF THE FUND.......................................................33
INVESTMENT ADVISER...........................................................38
SUB-ADVISER..................................................................42
PORTFOLIO TRANSACTIONS AND BROKERAGE.........................................46
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST...............................47
REPURCHASE OF FUND SHARES; CONVERSION TO OPEN-END FUND.......................50
NET ASSET VALUE..............................................................52
TAX MATTERS..................................................................55
PERFORMANCE RELATED AND COMPARATIVE INFORMATION..............................60
EXPERTS......................................................................62
CUSTODIAN, ADMINISTRATOR AND TRANSFER AGENT..................................62
ADDITIONAL INFORMATION.......................................................63
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM......................64
FINANCIAL STATEMENTS........................................................F-1
APPENDIX A -- Ratings of Investments........................................A-1
APPENDIX B -- Fiduciary Asset Management, LLC Proxy Voting Policy...........B-1
Page ii
USE OF PROCEEDS
As of November 30, 2004, the Fund had invested 100% of its total
assets. The net proceeds of this offering of Common Shares of the Fund will be
approximately $_____________ ($_____________if the Underwriters exercise the
overallotment option in full) after deducting the estimated offering costs. The
Fund expects it will be able to invest substantially all of the net proceeds of
this offering of Common Shares in securities and other instruments that meet the
investment objective and policies within one month after completion of this
offering.
For the Fund, First Trust Advisors L.P. ("First Trust Advisors" or
"Adviser") has agreed to pay all offering costs of the Fund (other than the
underwriting discount) that exceed __% (or $____ per Common Share) of the Fund's
offering price. Fiduciary Asset Management, LLC ("Fiduciary Asset Management" or
"Sub-Adviser") has agreed to reimburse the Adviser for one-half of such offering
costs of the Fund that exceed __% (or $____ per Common Share) of the Fund's
offering price.
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-Adviser 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 significant
portion of its income will 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.
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-Adviser believes offer attractive distribution rates and capital
appreciation potential. The Fund also may invest in other securities set forth
below if the Sub-Adviser 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% 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-Adviser.
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.
To generate additional income, the Fund has in the past written (or
sold), and may in the future write (or sell), covered call options on the common
stock of energy companies held in the Fund's portfolio.
The foregoing non-fundamental policies 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.
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:
-2-
(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.
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.
-3-
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-Adviser 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-Adviser'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, whose
securities are supported by the discretionary authority of the U.S.
government to purchase certain obligations of the agency or
instrumentality; 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 FDIC regulations, the
maximum insurance payable as to any one certificate of deposit is
$100,000, therefore, certificates of deposit purchased by the Fund may
not be fully insured.
(3) Repurchase agreements, which involve purchases of debt
securities. At the time the Fund purchases securities pursuant to a
repurchase agreement, it simultaneously agrees to resell and redeliver
such securities to the seller, who also simultaneously agrees to buy
back the securities at a fixed price and time. This assures a
predetermined yield for the Fund during its holding period, since the
resale price is always greater than the purchase price and reflects an
agreed-upon market rate. Such actions afford an opportunity for the
-4-
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-Adviser 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-Adviser 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-Adviser 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 NRSRO and which mature within one year of the date of
purchase or carry a variable or floating rate of interest.
(5) The Fund may invest in bankers' acceptances which are
short-term credit instruments used to finance commercial transactions.
Generally, an acceptance is a time draft drawn on a bank by an exporter
or an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by a bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on
its maturity date. The acceptance may then be held by the accepting
bank as an asset or it may be sold in the secondary market at the going
rate of interest for a specific maturity.
(6) The Fund may invest in bank time deposits, which are
monies kept on deposit with banks or savings and loan associations for
a stated period of time at a fixed rate of interest. There may be
penalties for the early withdrawal of such time deposits, in which case
the yields of these investments will be reduced.
(7) The Fund may invest in shares of money market funds in
accordance with the provisions of the 1940 Act.
-5-
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-Adviser 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 MLP's 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 natural gas liquids (primarily
propane, ethane, butane and natural gasoline). Midstream MLP crude oil services
include gathering, transportation, storage and terminalling of crude oil.
Midstream MLP refined petroleum product services include the transportation
(usually via pipelines, barges, rail cars and trucks), storage and terminalling
of refined petroleum products (primarily gasoline, diesel fuel and jet fuel) and
other hydrocarbon by-products. Midstream MLPs also may operate ancillary
businesses, including the marketing of the products and logistical services.
Propane MLP services include the distribution of propane to homeowners
for space and water heating and to commercial, industrial and agriculture
customers. Propane serves approximately 3% of the household energy needs in the
-6-
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.
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.
-7-
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 potential 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 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 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.
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.
-8-
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, 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.
When the units are sold, the difference between the sales price and the
investor's adjusted basis represents taxable gain. The limited partner will not
be taxed on distributions until (1) he sells his MLP units and pays tax on his
gain, which gain is increased due to the basis decrease resulting from prior
distributions; or (2) his basis reaches zero.
For a further discussion and a description of MLP tax matters, see the
section entitled "Tax Matters."
-9-
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 prices, 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.
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
-10-
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
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 affiliates
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. 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 has in the past
written (or sold), and may in the future 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-Adviser to be of comparable quality. If a security satisfies the
Fund's minimum rating criteria at the time of purchase and is subsequently
downgraded below such rating, the Fund will not be required to dispose of such
security. If a downgrade occurs, the Sub-Adviser 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-Adviser, in evaluating the creditworthiness of an issue, whether rated or
-11-
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-Adviser 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
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
-12-
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-Adviser 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 energy companies trade on
the New York Stock Exchange, the American Stock Exchange, The Nasdaq Stock
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-Adviser'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-Adviser 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 substantially
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-Adviser (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-
HEDGING AND INTEREST RATE 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 any
use of Financial Leverage by the Fund, to facilitate portfolio management and
mitigate risks. The Fund has in the past written (or sold), and may in the
future write (or sell), 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 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 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 of 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 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 has in the past written (or sold),
and may in the future write (or sell), 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. Writing covered call options may deprive the Fund of the
opportunity to profit from an increase in the market price of the securities in
-16-
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
-17-
the options are written or purchased on the same or different exchanges, boards
of trade or other trading facilities or are held or written in one or more
accounts or through one or more brokers. Thus, the number of options which the
Fund may write or purchase may be affected by options written or purchased by
other investment advisory clients of the Sub-Adviser. 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-Adviser 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-Adviser'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-Adviser, 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-Adviser 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.
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 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
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
-21-
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-Adviser 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.
-22-
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-Adviser 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 shares
at a discount from recent prices, or sell the shares in small lots over an
extended period of time.
-23-
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. 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
-24-
daily price fluctuation limits for Futures and options transactions and
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
-25-
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 security
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.
-26-
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.
-27-
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.
-28-
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-Adviser'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-Adviser'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-Adviser 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-Adviser's ability to
correctly predict changes in relationships of such hedge instruments to
the Fund's portfolio holdings, and there can be no assurance that the
-29-
Sub-Adviser'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
individually negotiated and structured to include exposure to a variety of
-30-
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
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,
-31-
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-Adviser, 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-Adviser 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.
-32-
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-Adviser'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-Adviser. There are no limits on the rate of portfolio turnover. From the
commencement of operations through November 30, 2004, the Fund's actual
portfolio turnover rate was 35%. 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 general supervision of the duties performed for the Fund under the
Management Agreement and Sub-Advisory Agreement is the responsibility of the
Board of Trustees. The Trustees set broad policies for the Fund and choose the
Fund's 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, with the Trustee who is an "interested person" (as such
term is defined in the 1940 Act) of the Fund identified as such.
NUMBER OF
PORTFOLIOS
TERM OF IN FUND
OFFICE AND COMPLEX OTHER
POSITION AND YEAR FIRST PRINCIPAL OVERSEEN TRUSTEESHIPS
OFFICES WITH ELECTED OR OCCUPATIONS DURING BY TRUSTEE HELD BY
NAME, ADDRESS AND AGE FUND APPOINTED PAST 5 YEARS OR OFFICER TRUSTEE
--------------------- ------------ ---------- ------------- ---------- ------------
Trustee who is an
Interested Person of
the Fund
--------------------
James A. Bowen(1)* President, o One Year(2) President, First Trust 21 Portfolios None
1001 Warrenville Road, Chairman of Portfolios and First
Suite 300 the Board, Chief o 2004 Trust Advisors; Chairman
Lisle, IL 60532 Executive Officer of the Board of Directors
D.O.B.: 09/55 and Trustee Bond Wave, LL and
Stonebridge Advisors LLC
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NUMBER OF
PORTFOLIOS
TERM OF IN FUND
OFFICE AND COMPLEX OTHER
POSITION AND YEAR FIRST PRINCIPAL OVERSEEN TRUSTEESHIPS
OFFICES WITH ELECTED OR OCCUPATIONS DURING BY TRUSTEE HELD BY
NAME, ADDRESS AND AGE FUND APPOINTED PAST 5 YEARS OR OFFICER TRUSTEE
--------------------- ------------ ---------- ------------- ---------- ------------
Trustees who are not
Interested Persons of
the Fund
--------------------
Richard E. Erickson Trustee o One Year(2) Physician, 21 Portfolios None
c/o First Trust Sportsmed/Wheaton
Advisors L.P. o 2004 Orthopedics
1001 Warrenville Road,
Suite 300
Lisle, IL 60532
D.O.B.: 04/51
Niel B. Nielson Trustee o One Year(2) President (2002 to 21 Portfolios Director of Good
c/o First Trust to Present), Covenant News Publishers -
Advisors L.P. o 2004 College; Pastor (1997 to Crossway Books;
1001 Warrenville Road, 2002), College Church Covenant Transport
Suite 300 in Wheaton Inc.
Lisle, IL 60532
D.O.B.: 03/54
Thomas R. Kadlec Trustee o One Year(2) Vice President, Chief 21 Portfolios None
c/o First Trust Financial Officer (1990
Advisors L.P. o 2004 to Present), ADM Investor
1001 Warrenville Road, Services, Inc. (Futures
Suite 300 Commission Merchant);
Lisle, IL 60532 Registered Representative
D.O.B.: 11/57 (2000 to Present), Segerdahl
& Company, Inc., an NASD
member (Broker-Dealer)
David M. Oster Trustee o One Year(2) Trader (Self-Employed) 10 Portfolios None
c/o First Trust (1987 to Present)
Advisors L.P. o 2004 (Options Trading and
1001 Warrenville Road, Market Making)
Suite 300
Lisle, IL 60532
D.O.B.: 03/64
Officers of the Fund
--------------------
Mark R. Bradley Treasurer, o Indefinite term Chief Financial 21 Portfolios N/A
1001 Warrenville Road, Controller, Officer, Managing
Suite 300 Chief Financial o 2004 Director, First Trust
Lisle, IL 60532 Officer and Portfolios and First
D.O.B.: 11/57 Chief Accounting Trust Advisors; Chief
Officer Financial Officer, Bond
Wave LLC and Stonebridge
Advisors LLC
Susan M. Brix Assistant o Indefinite term Representative, 21 Portfolios N/A
1001 Warrenville Road, Vice President First Trust Portfolios;
Suite 300 o 2004 Assistant Portfolio
Lisle, IL 60532 Manager, First
D.O.B.: 01/60 Trust Advisors
Robert F. Carey Vice President o Indefinite term Senior Vice President, 21 Portfolios N/A
1001 Warrenville Road, First Trust Portfolios
Suite 300 o 2004 and First Trust
Lisle, IL 60532 Advisors
D.O.B.: 07/63
-34-
NUMBER OF
PORTFOLIOS
TERM OF IN FUND
OFFICE AND COMPLEX OTHER
POSITION AND YEAR FIRST PRINCIPAL OVERSEEN TRUSTEESHIPS
OFFICES WITH ELECTED OR OCCUPATIONS DURING BY TRUSTEE HELD BY
NAME, ADDRESS AND AGE FUND APPOINTED PAST 5 YEARS OR OFFICER TRUSTEE
--------------------- ------------ ---------- ------------- ---------- ------------
W. Scott Jardine Secretary and o Indefinite term General Counsel, First 21 Portfolios N/A
1001 Warrenville Road, Chief Compliance Trust Portfolios and
Suite 300 Officer o 2004 First Trust Advisors;
Lisle, IL 60532 Secretary, Bond Wave, LLC
D.O.B.: 05/60 and Stonebridge Advisors
LLC
Kristi A. Maher Assistant o Indefinite term Assistant General 21 Portfolios N/A
1001 Warrenville Road, Secretary Counsel (March 2004 to
Suite 300 o 2004 Present), First Trust
Lisle, IL 60532 Portfolios and First Trust
D.O.B.: 12/66 Advisors; Associate
(1995 to March 2004),
Chapman and Cutler LLP
Roger Testin Vice President o Indefinite term Vice President 21 Portfolios N/A
1001 Warrenville Road, (August 2001 to Present),
Suite 300 o 2004 First Trust Advisors;
Lisle, IL 60532 Analyst (1998 to 2001),
D.O.B.: 06/66 Dolan Capital Management
--------------------
(1) Mr. Bowen is deemed an "interested person" of the Fund due to his position
of President of First Trust Advisors, investment adviser of the Fund.
(2) Trustees are elected each year by shareholders and serve a one year term
until their successors are elected. Mr. Bowen's officer positions with the
Fund have an indefinite term.
The Board of Trustees of the Fund has four standing committees, the
Executive Committee (and Pricing and Dividend Committee), the Nominating and
Governance Committee, the Valuation Committee, and the Audit Committee. The
Executive Committee, which meets between Board meetings, is authorized to
exercise all powers of and to act in the place of the Board of Trustees to the
extent permitted by the Fund's Declaration of Trust and By-laws. The members of
the Executive Committee 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. Kadlec and Bowen are members of the Executive Committee. The
Executive Committee serving as the Pricing and Dividend Committee met three
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 Oster 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. When a
vacancy on the Board 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, shareholders of the Fund shall mail such recommendation to W. Scott
Jardine at the Fund's address, 1001 Warrenville Road, Suite 300, Lisle, Illinois
60532. Such recommendation shall include the following information: (a) evidence
-35-
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 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 such Fund, as such term is defined in the 1940 Act, as amended,
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 once 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 and Oster are members of the
Valuation Committee. The Valuation Committee did not meet 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 Oster serve on the
Audit Committee. The Audit Committee met four times during the Fund's last
fiscal year.
Messrs. Erickson, Nielson, Kadlec and Bowen are also Trustees of First
Defined Portfolio Fund, LLC, an open-end fund advised by First Trust Advisors
with 12 portfolios. Messrs. Bowen, Erickson, Nielson, Kadlec and Oster are also
Trustees of the First Trust Value Line(R) 100 Fund, First Trust Value Line(R)
Dividend Fund, 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, First Trust/Value
Line(R) & Ibbotson Equity Allocation Fund, First Trust/Fiduciary Asset
Management Covered Call Fund, First Trust/Aberdeen Global Opportunity Income
Fund and First Trust/FIDAC Mortgage Income Fund, closed-end funds advised by
First Trust Advisors. 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 or their affiliates. In addition, Mr. Bowen and the other officers of
the Fund hold the same positions with the First Defined Portfolio Fund, LLC,
First Trust Value Line(R) 100 Fund, First Trust Value Line(R) Dividend Fund,
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, First Trust/Value Line(R) &
Ibbotson Equity Allocation Fund, First Trust/Fiduciary Asset Management Covered
Call Fund, First Trust/Aberdeen Global Opportunity Income Fund and First
Trust/FIDAC Mortgage Income Fund (collectively, the "First Trust Fund Complex")
as they hold with the Fund.
-36-
Each fund in the First Trust Fund Complex pays each Trustee who is not
an officer or employee of First Trust Advisors, any sub-adviser or any of their
affiliates ("Independent Trustees") an annual retainer of $10,000 which includes
compensation for all regular quarterly board meetings and regular committee
meetings. No additional meeting fees are paid in connection with regular
quarterly board meetings or regular committee meetings. Additional fees of
$1,000 and $500 are paid to Independent Trustees for special board meetings and
non-regular committee meetings, respectively. These additional fees are shared
by the funds in the First Trust Fund Complex that participate in the particular
meeting and are not per fund fees. Trustees are also reimbursed for travel and
out-of-pocket expenses in connection with all meetings.
The following table sets forth estimated compensation to be paid by the
Fund projected during the Fund's first full fiscal year to each of the Trustees
and estimated total compensation to be 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.
ESTIMATED ESTIMATED TOTAL
AGGREGATE COMPENSATION
COMPENSATION FROM FUND AND
NAME OF TRUSTEE FROM FUND(1) FUND COMPLEX(2)
--------------- ------------ ---------------
James A. Bowen $0 $0
Richard E. Erickson $10,000 $110,000
Thomas R. Kadlec $10,000 $110,000
Niel B. Nielson $10,000 $110,000
David M. Oster $10,000 $100,000
--------------------
(1) The compensation estimated to be paid by the Fund to the Trustees for the
first full fiscal year for services to the Fund.
(2) The total estimated compensation to be paid to Messrs. Erickson, Kadlec and
Nielson, Independent Trustees, from the Fund and 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 First
Defined Portfolio Fund, LLC, an open-end fund (with 12 portfolios) advised
by First Trust Advisors plus estimated compensation to be paid to these
trustees by the First Value Line(R) 100 Fund, the First Trust Value Line(R)
Dividend Fund, 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/Value Line(R) & Ibbotson Equity Allocation Fund, the
First Trust/Fiduciary Asset Management Covered Call Fund, the First
Trust/Aberdeen Global Opportunity Income Fund, the First Trust/FIDAC
Mortgage Income Fund and the Fund for a full calendar year. Mr. Oster is
currently not a trustee of the First Defined Portfolio Fund, LLC.
Accordingly, his estimated total compensation is based on the estimated
compensation to be paid by the First Trust Value Line(R) 100 Fund, the First
Trust/Four Corners Senior Floating Rate Income Fund II, the First Trust
Value Line(R) Dividend Fund, the First Trust/Four Corners Senior Floating
Rate Income Fund, the Macquarie/First Trust Global Infrastructure/Utilities
Dividend & Income Fund, the First Trust/Value Line(R) & Ibbotson Equity
Allocation Fund, the First Trust/Fiduciary Asset Management Covered Call
Fund, the First Trust/Aberdeen Global Opportunity Income Fund, the First
Trust/FIDAC Mortgage Income Fund and the Fund for a full calendar year.
The Fund has no employees. Its officers are compensated by First Trust
Advisors. Shareholders of the Fund will elect Trustees at the next annual
meeting of shareholders.
-37-
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, 2004:
AGGREGATE DOLLAR RANGE OF EQUITY
SECURITIES IN ALL REGISTERED
DOLLAR RANGE OF INVESTMENT COMPANIES
EQUITY SECURITIES OVERSEEN BY TRUSTEE IN
TRUSTEE IN THE FUND FIRST TRUST FUND COMPLEX
------- ----------------- --------------------------------
Mr. Bowen None Over $100,000
Mr. Erickson None $ 10,001-$50,000
Mr. Kadlec None $ 50,001-$100,000
Mr. Nielson None $10,001-$50,000
Mr. Oster None Over $100,000
As of December 31, 2004, 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 adviser or
principal underwriter of the Fund or any person directly or indirectly
controlling, controlled by, or under common control with an investment adviser
or principal underwriter of the Fund. As of March 10, 2005, the officers and
Trustees of the Fund, as a group, owned less than one percent of the common
shares of the Fund.
CONTROL PERSONS
[As of ___________, 2005, _______ owned of record or beneficially more
than 5% of the Fund's common shares.]
INVESTMENT ADVISER
First Trust Advisors, 1001 Warrenville Road, Suite 300, Lisle, Illinois
60532, is the investment adviser to the Fund. First Trust Advisors serves as
investment adviser or portfolio supervisor to investment portfolios with
approximately $17.1 billion in assets which it managed or supervised as of
February 28, 2005. As investment adviser, 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-Adviser 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 adviser registered with the Commission under the Investment
Advisers Act of 1940. 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
-38-
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 adviser or sub-adviser to eight mutual
funds and ten closed-end funds (including the Fund) and is the portfolio
supervisor of certain unit investment trusts sponsored by First Trust
Portfolios. First Trust Portfolios specializes in the underwriting, trading and
distribution of unit investment trusts and other securities. First Trust
Portfolios, an Illinois limited partnership formed in 1991, 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.
First Trust Portfolios introduced the first insured unit investment trust in
1974 and to date, more than $56 billion in gross assets have been deposited in
First Trust Portfolios unit investment trusts.
First Trust Advisors acts as investment adviser to the Fund pursuant to
an Investment Management Agreement. The Investment Management Agreement
continues in effect for the Fund from year to year after its initial two-year
term so long as its continuation is approved at least annually by the Trustees
including a majority of the 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 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 Adviser, or any officer or
director of the Adviser, has taken any action which results in a breach of the
covenants of the Adviser 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 Adviser 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 Adviser and
the Fund, the Fund has agreed to pay for the services and facilities provided by
the Adviser an annual management fee, payable on a monthly basis, equal to 1.00%
of the Fund's Managed Assets.
For purposes of calculation of the management fee, the Fund's "Managed
Assets" means the average daily gross asset value of the Fund (which includes
assets attributable to the Fund's Preferred Shares, if any, and the principal
amount of borrowings), minus the sum of the Fund's accrued and unpaid dividends
on any outstanding Preferred Shares and accrued liabilities (other than the
principal amount of any borrowings incurred, commercial paper or notes or other
-39-
forms of indebtedness issued by the Fund and the liquidation preference of any
outstanding Preferred Shares).
In addition to the fee of the Adviser, the Fund pays all other costs
and expenses of its operations, including compensation of its Trustees (other
than those affiliated with the Adviser), 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. All fees and expenses are accrued daily and deducted before payment of
dividends to investors.
The Sub-Adviser receives a portfolio management fee equal to 0.50% of
the Fund's Managed Assets. The Sub-Adviser's fee is paid by the Adviser out of
the Adviser's management fee.
For each of the first two years following the commencement of the
Fund's operations through June 24, 2006, the Adviser has 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
Sub-Adviser has 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 Adviser has agreed to pay all offering costs of the Fund (other
than the underwriting discount) that exceed __% (or $____ per Common Share) of
the Fund's offering price. The Sub-Adviser has agreed to reimburse the Adviser
for one-half of such offering costs of the Fund that exceed __% (or $____ per
Common Share) of the Fund's offering price.
Because the fee paid to the Adviser and Sub-Adviser will be calculated
on the basis of the Fund's Managed Assets, which include the proceeds of
leverage, the dollar amount of the Adviser's and Sub-Adviser's fees from the
Fund will be higher (and the Adviser and Sub-Adviser will be benefited to that
extent) when leverage is utilized. In this regard, if the Fund uses leverage in
the amount equal to 20% of the Fund's Managed Assets (after their issuance), the
Fund's management fee would be ____% of net assets attributable to common
shares. See "Summary of Fund Expenses" in the Fund's Prospectus.
From the commencement of the Fund's operations through November 30,
2004, the Fund paid the Adviser $664,100 of which $254,263 was paid by the
Adviser to the Sub-Adviser. Of the remaining $409,837, the Adviser waived
$87,661. See "Summary of Fund Expenses" and "Management of the Fund --
Investment Management Agreement" in the Fund's Prospectus.
On April 18, 2004, the Trustees of the Fund met with representatives of
the Adviser and the Sub-Adviser to consider, among other things, the possible
approval of the Investment Management Agreement between the Fund and First Trust
Advisors and the Sub-Advisory Agreement between the Adviser, the Sub-Adviser and
the Fund. Prior to the meeting, the Independent Trustees received a memorandum
describing their legal obligations and duties relating to the approval of an
investment advisory contract, including the duties of the Trustees under the
1940 Act and the general principles of state law; the requirements of the 1940
-40-
Act in such matters; the fiduciary duty of the Adviser; the standards used in
determining whether boards of trustees have fulfilled their duties; and various
factors to be considered by the Trustees in voting on whether to approve
advisory agreements. In evaluating the Investment Management Agreement and the
Sub-Advisory Agreement, the Independent Trustees met with their legal counsel
privately to discuss their responsibilities and obligations with respect to the
Investment Management Agreement and Sub-Advisory Agreement and the terms of the
proposed agreements.
In evaluating the Investment Management Agreement and the Sub-Advisory
Agreement, the Trustees considered narrative information concerning, among other
things, the nature of the services to be provided by the respective adviser or
sub-adviser, the fees to be paid to the respective adviser and sub-adviser and
the experience, resources and staffing of the respective adviser and
sub-adviser. As First Trust Advisors already serves as investment adviser on the
various funds in the First Trust complex, the Trustees noted that they are well
informed as to its personnel, staffing, experience, investment philosophy and
fees paid by other clients. In evaluating the Investment Management Agreement,
the Trustees considered the supervisory services to be provided by First Trust
Advisors, as the investment adviser, the resources available to fulfill such
function and the advisory fees to be paid to First Trust Advisors.
In evaluating the Sub-Advisory Agreement with Fiduciary Asset
Management, the Trustees met with the relevant investment personnel from
Fiduciary Asset Management and considered information relating to the education,
experience and number of investment professionals and other personnel who would
provide services under the applicable agreement, its investment philosophy and
process. The Trustees received and reviewed written materials regarding
Fiduciary Asset Management's organizational structure, Fiduciary Asset
Management's and its affiliates experience with the MLP asset class, and
resources available to Fiduciary Asset Management. The Trustees considered the
nature of the services provided by Fiduciary Asset Management as well as the fee
to be paid.
In considering the overall advisory arrangement, the Trustees also
received and reviewed written information regarding advisory fees paid by other
analogous closed-end funds and their respective expense ratios. The Board of
Trustees, including all of the Independent Trustees of the Fund, and the sole
shareholder of the Fund, each approved the Investment Management Agreement and
the Sub-Advisory Agreement. The Independent Trustees determined that the terms
of the Fund's Investment Management Agreement and the Sub-Advisory Agreement,
including the fees, are fair and reasonable, and that they will enable the Fund
to obtain high quality investment management services.
CODE OF ETHICS
The Fund, the Adviser and the Sub-Adviser 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)
942-8090. The codes of ethics are available on the EDGAR Database on the
-41-
Commission's website (http://www.sec.gov), and copies of these code 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 Fiduciary Asset Management. Fiduciary Asset Management's Proxy Voting Policy
is set forth in Appendix B to the Statement of Additional Information.
When required by applicable regulations, information regarding how the
Fund voted proxies relating to portfolio securities will be available without
charge by calling (800) 988-5891 or by accessing the Commission's website at
http://www.sec.gov.
SUB-ADVISER
Fiduciary Asset Management serves as the Fund's Sub-Adviser. In this
capacity, Fiduciary Asset Management is responsible for the selection and
on-going monitoring of the securities in the Fund's investment portfolio.
Fiduciary Asset Management, located at 8112 Maryland Avenue, Suite 400,
St. Louis, Missouri 63105, is a registered investment adviser and serves as
investment adviser or portfolio supervisor to investment portfolios with
approximately $15.5 billion of assets as of February 28, 2005.
Fiduciary Asset Management invests in a broad range of equity, hedged
equity, master limited partnership, and fixed income strategies for
institutional and high net worth clients. Fiduciary Asset Management's clients
include closed-end investment companies, Fortune 500 companies, public pensions
and large endowments and foundations. Fiduciary Asset Management was established
as an independent investment firm in 1994. It serves as sub-adviser, with
responsibilities for day-to-day management, for two closed-end investment
companies, including the Fund, that invest primarily in master limited
partnerships and has managed Master Limited Partnership portfolios for clients
since 1995.
Fiduciary Asset Management was founded in 1994 by Charles D. Walbrandt.
From 1974 through 1994 Mr. Walbrandt served in various capacities with General
Dynamics Corporation, including Corporate Vice President, Trust Investment and
Treasurer. While at General Dynamics, Mr. Walbrandt created the internal
investment department in 1983, designed the investment management process and
managed both equity and fixed income portfolios. Mr. Walbrandt holds a B.S.
-42-
degree in economics from the University of Wisconsin, an M.B.A. in finance from
St. Louis University and is a Chartered Financial Analyst. Fiduciary Asset
Management is controlled by Mr. Walbrandt.
Fiduciary Asset Management's investment committee includes Charles D.
Walbrandt, Wiley D. Angell, Mohammad Riad, James J. Cunnane Jr., and Joseph E.
Gallagher. Mr. Cunnane serves as the primary portfolio manager for the Fund.
Mr. Cunnane has over ten years experience managing portfolios and is a
member of the equity portfolio management team and performs securities research.
Prior to joining Fiduciary Asset Management in 1996, he was a research analyst
with A.G. Edwards from 1994 to 1996. He also worked as an analyst for Maguire
Investment Advisors, where he gained extensive experiences in the development of
master limited partnership and mid- and small-cap stock portfolios. He holds a
B.S. degree in finance from Indiana University. Mr. Cunnane is a Chartered
Financial Analyst, and serves on the investment committee of the Archdiocese of
St. Louis and the board of the St. Louis internship program.
William N. Adams performs securities research on equity and fixed
income securities and focuses on the energy sector. Prior to joining Fiduciary
Asset Management in 2004, Mr. Adams was a research analyst with Banc of America
Capital Management from 1981 to 2004, specializing in integrated oils, oil field
services, oil and natural gas exploration, and refining and marketing. Mr. Adams
received his B.S.B.A. and M.B.A degrees from Washington University in St. Louis
and is a Chartered Financial Analyst.
Mr. Cunnane also has responsibility for the day-to-day management of
accounts other than the Fund. The advisory fees received by the Sub-Adviser in
connection with the management of the Fund and other accounts are not based on
the performance of the Fund or other accounts. Information regarding those other
accounts is set forth below.
-------------------- ----------------------------------------------------------
NUMBER OF OTHER ACCOUNTS MANAGED AND ASSETS BY
ACCOUNT TYPE AS OF MARCH 16, 2005
-------------------- ---------------------- -------------- --------------------
PORTFOLIO MANAGER REGISTERED INVESTMENT OTHER POOLED OTHER ACCOUNTS
COMPANIES (OTHER INVESTMENT
THAN THE FUND) VEHICLES
-------------------- ---------------------- -------------- --------------------
James J. Cunnane Jr. Number: 1 Number: 0 Number: 104
Assets: $360,754,806 Assets: N/A Assets: $2.3 billion
-------------------- ---------------------- -------------- --------------------
-43-
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 following
potential conflicts:
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-Adviser 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-Adviser has adopted procedures for allocating
portfolio transactions across multiple accounts.
With respect to securities transactions for the Fund, the Sub-Adviser
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-Adviser acts as
sub-advisor, other pooled investment vehicles that are not registered mutual
funds, and other accounts managed for organizations and individuals), the
Sub-Adviser 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 the fund or other account(s) involved.
The Sub-Adviser, the Adviser 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.
As of March 16, 2005, Mr. Cunnane received all of his compensation from
the Sub-Adviser. Mr. Cunnane's compensation consists of the following elements:
1. Base Salary. Mr. Cunnane is paid a base salary which is
set at a level determined to be appropriate based upon his experience
and responsibilities through the use of independent compensation
surveys of the investment management industry.
2. Annual Bonus. Mr. Cunnane is paid a pre-tax annual bonus
calculated as 25% of the profitability of the product line for which he
is responsible. The product line profitability is defined as the
revenue generated by all accounts within his investment discipline less
the fixed and variable costs associated with supporting that revenue.
Such costs include employee costs, technology, office administration,
etc.
Mr. Cunnane also participates in benefit plans and programs generally
available to all employees.
-44-
As of March 16, 2005, Mr. Cunnane beneficially owned $50,001-$100,000
of equity securities in the Fund.
The Sub-Adviser, subject to the Trustees' and the Adviser's
supervision, provides the Fund with discretionary investment services.
Specifically, the Sub-Adviser 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-Adviser in writing. The Sub-Adviser 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-Adviser 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-Adviser is responsible for
effecting all security transactions for the Fund's assets. The Sub-Advisory
Agreement provides that the Sub-Adviser shall not be liable for any loss
suffered by the Fund or the Adviser (including, without limitation, by reason of
the purchase, sale or retention of any security) in connection with the
performance of the Sub-Adviser'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-Adviser 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 Adviser, the
Sub-Adviser and the Fund, the Adviser has agreed to pay for the services and
facilities provided by the Sub-Adviser through sub-advisory fees. The
Sub-Adviser receives a portfolio management fee equal to 0.50% of the Fund's
Managed Assets. The Sub-Adviser's fee is paid by the Adviser out of the
Adviser's management fee.
As indicated above, for each of the first two years following the
commencement of the Fund's operations through June 24, 2006, the Adviser has
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 Sub-Adviser has 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 Adviser has agreed to pay all offering costs of the Fund (other
than the underwriting discount) that exceed __% (or $____ per Common Share) of
the Fund's offering price. The Sub-Adviser has agreed to reimburse the Adviser
for one-half of such offering costs of the Fund that exceed __% (or $____ per
Common Share) of the Fund's offering price.
From the commencement of the Fund's operations through November 30,
2004, the Adviser paid the Sub-Adviser $254,263, and $78,364 was waived by the
Sub-Adviser.
-45-
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-Adviser. Pursuant to a separate agreement
between the Sub-Adviser and First Trust Advisors, First Trust Advisors has
agreed that if First Trust Advisors or the Fund terminates or fails to renew the
Sub-Advisory Agreement with the Sub-Adviser other than for cause, First Trust
Advisors will resign and will not agree to be reinstated as investment adviser
to the Fund, which resignation shall be effective no later than 60 days
following the effective date of the Sub-Adviser's termination.
All fees and expenses are accrued daily and deducted before payment of
dividends to investors. The Sub-Advisory Agreement has been approved by a
majority of the Independent Trustees of the Fund and the sole shareholder of the
Fund.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the supervision of the Board of Trustees, the Sub-Adviser 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-Adviser 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-Adviser 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-Adviser
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-Adviser and/or its affiliates. If approved by
the Fund's Board of Trustees, the Sub-Adviser 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. From the commencement of the
Fund's operations through November 30, 2004, the Fund paid brokerage commissions
in an aggregate amount of $147,000. 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 adviser, 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
-46-
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-Adviser 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-Adviser determines in good faith that the amount of
such commissions is reasonable in relation to the value of the research
information and brokerage services provided by such broker to the Sub-Adviser or
the Fund. The Sub-Adviser 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 Adviser under the Investment Management Agreement is not reduced as a
result of receipt by the Adviser or the Sub-Adviser of research services.
The Adviser and Sub-Adviser 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-Adviser in servicing all of its accounts; not all of such services may be
used by the Sub-Adviser in connection with the Fund. The Sub-Adviser 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-Adviser believes
such costs to the Fund will not be disproportionate to the benefits received by
the Fund on a continuing basis. The Sub-Adviser 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-Adviser 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
Under Massachusetts law, shareholders could, in certain circumstances,
be held personally liable for the obligations of the Fund. However, 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
-47-
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 includes 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. Specifically, 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
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
-48-
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.
Reference should be made to the Declaration on file with the Commission
for the full text of these provisions.
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.
-49-
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 will trade in the open market at a price that
will be a function of several factors, including dividend levels (which are in
turn affected by expenses), NAV, 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 Adviser, Sub-Adviser and any corporate finance
services and consulting agent that the Adviser may retain from time to time, may
review possible actions to reduce any such discount. Actions may include the
repurchase of such shares in the open market or in private transactions, the
making of a tender offer for such shares, 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
-50-
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 American Stock Exchange, 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's 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 American Stock Exchange, (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 American Stock Exchange. Any Preferred Shares or other
Borrowings would need to be redeemed or repaid upon conversion to an open-end
investment company. 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.
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.
-51-
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
as of the close of regular session trading on the New York Stock Exchange
(normally 4:00 p.m. eastern time) no less frequently than weekly on Friday of
each week. 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, 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-Adviser 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
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.
-52-
U.S. 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.
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-Adviser'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;
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;
-53-
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 for
approval 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 Internal Revenue Code Section 312.
TAX MATTERS
The following discussion of federal income tax matters is based on the
advice of Chapman and Cutler LLP, counsel to the Fund.
-54-
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 will be 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
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.
-55-
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 partnership 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 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
income and assets of the company must meet certain minimum threshold tests.
Because the Fund invests in MLPs that invest in energy ventures, it is not
expected that the Fund will 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, 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. Corporations are
-56-
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 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, 2008. 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 company. If the Fund is classified as a U.S. real property
holding company, 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, 2008, 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
-57-
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, 2008, with the maximum marginal
federal income tax rate being 35% at such time with another increase to 39.6%
currently scheduled to be effective after December 31, 2010.
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 W9, 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.
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
-58-
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 ("PTPs")
are generally treated as corporations for federal income tax purposes. However,
if a PTP satisfies certain income character requirements, the PTP will generally
continue to be treated as partnership for federal income tax purposes. Under
these requirements, a PTP must receive at least 90% of its gross income from
certain "qualifying income" sources.
Qualifying income for most PTPs 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 anticipates investing in
energy PTPs, so the income of the PTPs should qualify as qualifying income.
The federal tax rules relating to PTPs provide that the "qualifying
income" exception to corporate tax treatment does not apply, in general, to any
partnership that would be treated as a regulated investment company for federal
income tax purposes if the partnership were a corporation. For this reason, PTPs
are generally structured to not be registered under the 1940 Act.
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.
-59-
Nature of Fund's Investments. The Fund expects 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) and (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 ("Bloomberg") and Lipper, that the Fund believes to be
generally accurate.
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.
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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.
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.
-61-
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, 2004, appearing
in this Statement of Additional Information have been audited by Deloitte &
Touche LLP, an independent registered public accounting firm, as set forth in
their report thereon appearing elsewhere herein, and is included in reliance
upon such report given upon the authority of such firm as experts in accounting
and auditing. Deloitte & Touche LLP provides auditing and tax preparation
services to the Fund. The principal business address of Deloitte & Touche LLP is
180 North Stetson Avenue, Chicago, Illinois 60601.
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 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. PFPC Inc., 301 Bellevue Parkway, Wilmington, Delaware 19809 is the
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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. PFPC 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 public accountant and
providing the accountant 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, Washington, D.C. The Fund's Prospectus 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 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.
-63-
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, 2004 and the related statements of operations, changes
in net assets, and cash flows and the financial highlights for the period June
17, 2004 (inception) through November 30, 2004. 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 audit.
We conducted our audit in accordance with standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements and financial highlights are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. Our procedures included
confirmation of securities owned as of November 30, 2004, by correspondence with
the Fund's custodian, brokers and agent banks. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audit provides 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 at November 30, 2004, the results of
its operations, the changes in its net assets, cash flows and the financial
highlights for the period June 17, 2004 (inception) through November 30, 2004,
in conformity with accounting principles generally accepted in the United States
of America.
/s/DELOITTE & TOUCHE LLP
Chicago, Illinois
January 19, 2005
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ENERGY INCOME AND GROWTH FUND
FINANCIAL STATEMENTS
Energy Income and Growth Fund
Statement of Assets and Liabilities
November 30, 2004
ASSETS:
Investments, at value
(See portfolio of investments) (a):......................... $174,158,003
Cash.......................................................... 3,603,067
Receivable for investment securities sold..................... 906,212
Dividends receivable.......................................... 44,555
Interest receivable........................................... 1,601
------------
Total Assets............................................... 178,713,438
------------
LIABILITIES:
Outstanding Loan Payable (Note 6)............................. 30,000,000
Deferred federal income tax liability......................... 8,922,778
Payable for investment securities purchased................... 2,048,358
Options written, at value (Premiums received $214,192)........ 397,435
Investment advisory fee payable............................... 101,065
Interest due on loan payable to bank (Note 6)................. 75,019
Audit and legal fees payable.................................. 63,354
Deferred state income tax liability........................... 54,634
Printing fees payable......................................... 26,121
Payable to administrator...................................... 13,475
Custodian fee payable......................................... 7,412
Trustees' fees payable........................................ 6,667
Accrued expenses and other payables........................... 3,848
------------
Total Liabilities........................................... 41,720,166
------------
NET ASSETS.................................................... $136,993,272
============
(a) Investments, at cost...................................... $147,810,007
============
NET ASSETS CONSIST OF:
Accumulated net investment loss............................... $ (507,085)
Net unrealized appreciation of investments.................... 17,187,341
Par value..................................................... 64,206
Paid-in capital............................................... 120,248,810
------------
Total Net Assets............................................ $136,993,272
============
NET ASSET VALUE, per Common Share
(par value $0.01 per Common Share).......................... $21.34
============
Number of Common Shares outstanding........................... 6,420,643
============
See Notes to Financial Statements.
F-1
Energy Income and Growth Fund
Statement of Operations
For the Period Ended November 30, 2004*
INVESTMENT INCOME:
Dividends..................................................... $ 196,884
Interest...................................................... 35,992
-----------
Total investment income..................................... 232,876
-----------
EXPENSES:
Investment advisory fee....................................... 664,100
Interest on outstanding loan payable (Note 6)................. 303,666
Legal and audit fees.......................................... 94,040
Administration fee............................................ 66,410
Printing fees................................................. 26,673
Trustees' fees and expenses................................... 17,142
Custodian fees................................................ 10,360
Other......................................................... 40,560
-----------
Total expenses................................................ 1,222,951
Expenses reimbursed by investment advisor..................... (166,025)
-----------
Net expenses................................................ 1,056,926
-----------
NET INVESTMENT LOSS BEFORE TAXES.............................. (824,050)
-----------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain/(loss) on:
Securities transactions..................................... 885,284
Written option transactions (568,319)
-----------
Net realized gain on investments during the period............ 316,965
-----------
Net change in unrealized appreciation/(depreciation) of:
Securities transactions..................................... 26,347,996
Written option transactions................................. (183,243)
-----------
Net change in unrealized appreciation/(depreciation) of
investments during the period.............................. 26,164,753
-----------
Net realized and unrealized gain on investments............... 26,481,718
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS
BEFORE TAXES................................................ 25,657,668
-----------
Deferred federal income tax expense........................... 8,922,778
Deferred state income tax expense............................. 54,634
Total deferred income tax expense............................. 8,977,412
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS
AFTER INCOME TAX EXPENSE.................................... $16,680,256
===========
See Notes to Financial Statements.
----------------------------
* The Fund commenced operations on June 17, 2004.
F-2
Energy Income and Growth Fund
Statement of Changes in Net Assets
for the Period Ended November 30, 2004*
PERIOD
ENDED
11/30/2004*
Net investment loss............................................ $ (824,050)
Net realized gain on investments............................... 316,965
Net change in unrealized appreciation/(depreciation)
of investments during the period............................. 26,164,753
Deferred income tax expense.................................... (8,977,412)
------------
Net increase in net assets resulting from operations........... 16,680,256
DISTRIBUTIONS TO SHAREHOLDERS:
Return of capital.............................................. (2,081,702)
------------
Total distributions to shareholders............................ (2,081,702)
CAPITAL TRANSACTIONS:
Net proceeds from sale of 6,405,236 shares of Common Shares.... 122,083,798
Value of 15,407 shares reinvested.............................. 310,920
------------
Total capital transactions..................................... 122,394,718
------------
Net increase in net assets..................................... 136,993,272
NET ASSETS:
Beginning of period............................................ --
------------
End of period.................................................. $136,993,272
============
Accumulated net investment loss at end of period............... $ (507,085)
============
See Notes to Financial Statements.
----------------------------
* The Fund commenced operations on June 17, 2004.
F-3
Energy Income and Growth Fund
Statement of Cash Flows
for the Period Ended November 30, 2004*
Cash flows from operating activities:
Investment income received........................................... $ 34,391
Dividend income received............................................. 152,329
Payment of operating expenses........................................ (531,318)
Interest expense..................................................... (228,647)
Proceeds from sales of long-term securities.......................... 40,230,784
Proceeds from written option transactions............................ 1,780,721
Purchases of closing options transactions............................ (2,134,848)
Returns of capital received.......................................... 4,404,600
Purchases of long-term securities.................................... (190,417,961)
--------------
CASH USED BY OPERATING ACTIVITIES....................................... $(146,709,949)
Cash flows from financing activities:
Net proceeds from shares sold........................................ 122,394,718
Return of capital paid............................................... (2,081,702)
Issuance of loan..................................................... 30,000,000
--------------
CASH PROVIDED BY FINANCING ACTIVITIES................................... 150,313,016
-------------
Increase in cash..................................................... 3,603,067
Cash at beginning of period.......................................... --
-------------
Cash at end of period................................................ $ 3,603,067
=============
RECONCILIATION OF NET INCREASE IN NET ASSETS FROM OPERATIONS TO CASH
USED BY OPERATING ACTIVITIES:
Net increase in net assets resulting from operations.................... $ 16,680,256
Increase in investments**............................................ $(174,158,003)
Increase in interest and dividends receivable........................ (46,156)
Increase in receivables for investments sold......................... (906,212)
Increase in written options.......................................... 397,435
Increase in payable for investments purchased........................ 2,048,358
Increase in interest expense payable................................. 75,019
Increase in accrued expenses......................................... 221,942
Increase in deferred federal income tax expense...................... 8,922,778
Increase in deferred state income tax expense........................ 54,634
--------------
(163,390,205)
-------------
CASH USED BY OPERATING ACTIVITIES $(146,709,949)
=============
See Notes to Financial Statements.
----------------------------
* The Fund commenced operations on June 17, 2004.
** Includes change in unrealized appreciation of $26,347,996.
F-4
Energy Income and Growth Fund
Financial Highlights
For a Common Share outstanding throughout the period.
PERIOD
ENDED
11/30/2004*
Net asset value, beginning of period........................................... $ 19.10
--------
INCOME FROM INVESTMENT OPERATIONS:
Net investment loss............................................................ (0.13)
Net realized and unrealized gain on investments................................ 2.74
--------
Total from investment operations............................................... 2.61
--------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Return of capital.............................................................. (0.33)
--------
Total from Distributions....................................................... (0.33)
--------
Common shares offering costs charged to paid-in capital........................ (0.04)
--------
Net asset value, end of period................................................. $21.34
--------
Market value, end of period.................................................... $22.12
========
TOTAL RETURN BASED ON NET ASSET VALUE (A)+..................................... 13.53%
========
TOTAL RETURN BASED ON MARKET VALUE (B)+........................................ 12.38%
========
Net assets, end of period (in 000's)........................................... $136,993
RATIO OF EXPENSES TO AVERAGE NET ASSETS**:
Excluding interest expense and tax expense and including reimbursements........ 1.36%
Excluding tax expense and reimbursements and including interest expense........ 2.20%
Excluding tax expense and including interest expense and reimbursements........ 1.91%
Including tax expense, reimbursements, and interest expense.................... 18.09%
RATIO OF NET INVESTMENT LOSS TO AVERAGE NET ASSETS**:
Excluding tax expense and including interest expense and reimbursements........ (1.49)%
Including tax expense, reimbursements, and interest expense.................... (17.67)%
Portfolio turnover rate........................................................ 34.86%
SENIOR INDEBTEDNESS:
Total loan outstanding (in 000's).............................................. $30,000
Asset coverage per $1,000 senior indebtedness (c).............................. $ 5,566
See Notes to Financial Statements.
-------------------------------
* The Fund commenced operations on June 17, 2004.
** Annualized.
(a) Total Return on net asset value is the combination of reinvested
dividend income and reinvested capital gains distributions, at prices
obtained by the Dividend Reinvestment Plan, if any, and changes in net
asset value per share.
(b) Total Return on market value is the combination of reinvested dividend
income and reinvested capital gains distributions, at prices obtained
by the Dividend Reinvestment Plan, if any, and changes in stock price
per share, all based on market price per share.
(c) Calculated by subtracting the Fund's total liabilities (not including
loan outstanding) from the Fund's total assets and dividing this by the
amount of senior indebtedness.
+ Total return is not annualized for periods less than one year and does not
reflect sales load.
F-5
Energy Income and Growth Fund
Portfolio of Investments
November 30, 2004
MARKET
SHARES VALUE
MASTER LIMITED PARTNERSHIPS - 122.1%
OIL & GAS - 96.4%
131,300 Atlas Pipeline Partners, L.P. +++.......... $ 5,513,287
73,576 Buckeye Partners, L.P. +++................. 3,021,766
375,272 Crosstex Energy, L.P. +++.................. 11,644,690
114,057 Enbridge Energy Partners, L.P.............. 5,665,211
644,998 Enterprise Product Partners, L.P. +++...... 15,796,001
250,000 Holly Energy Partners, L.P. +++............ 8,322,500
103,212 Kaneb Pipeline Partners, L.P. +++.......... 6,187,560
201,371 Kinder Morgan Energy Partners, L.P. +++.... 9,150,298
68,165 Magellan Midstream Partners, L.P........... 3,968,566
85,250 MarkWest Energy Partners, L.P. +++......... 4,052,785
144,928 MarkWest Energy Partners, L.P. +........... 6,304,238
174,974 Northern Border Partners, L.P. +++......... 8,314,765
209,843 Pacific Energy Partners, L.P. +++.......... 5,894,490
344,956 Plains All American Pipeline, L.P. +++..... 12,739,225
78,134 Sunoco Logistics Partners, L.P. +++........ 3,153,488
241,932 TEPPCO Partners, L.P. +++.................. 9,495,831
215,895 Valero, L.P. +++........................... 12,897,567
-------------
132,122,268
-------------
UTILITIES - 12.1%
98,500 Energy Transfer Partners, L.P.............. 5,317,030
385,275 Inergy, L.P. +++........................... 11,296,263
-------------
16,613,293
-------------
COAL - 11.8%
154,045 Alliance Resource Partners, L.P+++......... 10,821,661
100,169 Natural Resource Partners, L.P............. 5,288,923
-------------
16,110,584
-------------
TRANSPORTATION - 1.3%
70,000 U.S. Shipping Partners, L.P.*.............. 1,746,500
-------------
CHEMICALS - 0.5%
25,477 Martin Midstream Partners, L.P. +++........ 733,738
-------------
TOTAL MASTER LIMITED PARTNERSHIPS.......... 167,326,383
(Cost $142,011,932) -------------
F-6
COMMON STOCKS - 5.0%
ENERGY - 3.8%
37,500 ChevronTexaco Corp. ++..................... 2,047,500
22,000 Exxon Mobil Corp. ++....................... 1,127,500
29,400 Kinder Morgan, Inc. ++..................... 2,037,420
------------
5,212,420
------------
UTILITIES - 1.2%
40,000 Copano Energy, LLC*........................ $ 987,200
25,000 Duke Energy Corp. ++....................... 632,000
------------
1,619,200
------------
TOTAL COMMON STOCKS........................ 6,831,620
(Cost $5,798,075) ------------
TOTAL INVESTMENTS - 127.1%................. 174,158,003
(Cost $147,810,007)**
CALL OPTIONS WRITTEN - (0.3)%.............. (397,435)
(Premiums received $214,192)
NET OTHER ASSETS & LIABILITIES - (4.9)%.... (6,767,296)
LOAN OUTSTANDING - (21.9)% (30,000,000)
-------------
NET ASSETS - 100.0%........................ $136,993,272
============
-------------------------
* Non-income producing security.
** Aggregate cost for federal tax purposes.
+ Securities are restricted securities and market value is determined in
accordance with procedures established by the Board of Trustees (Note 2).
++ Securities or partial securities on which call options were written.
+++ Security segregated as collateral for the loan outstanding.
See Notes to Financial Statements.
F-7
NUMBER OF CONTRACTS MARKET
VALUE
CALL OPTIONS WRITTEN - (0.3%)
ChevronTexaco Corp. Calls
180 @ 55 due Mar 05........................... $ (36,900)
195 @ 55 due Jan 06........................... (77,025)
-----------
(113,925)
-----------
250 Duke Energy Call
@ 25 due Jan 06........................... (51,250)
-----------
220 Exxon Mobil Corp. Call
@ 50 due Jan 06........................... (86,900)
-----------
Kinder Morgan, Inc. Calls
65 @ 65 due Feb 05........................... (33,150)
229 @ 70 due Jan 06........................... (112,210)
-----------
(145,360)
-----------
Total Call Options Written $(397,435)
===========
(Premiums received $214,192)
See Notes to Financial Statements.
F-8
Energy Income and Growth Fund
November 30, 2004
Notes to Financial Statements
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'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 will focus
on investing in publicly traded master limited partnerships ("MLPs") and related
public entities in the energy sector, which the Fund's sub-adviser believes
offer opportunities for income and growth. Due to the tax treatment of cash
distributions made by MLPs to their investors, the Fund believes that a
significant portion of the distributions received will 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.
Portfolio Valuation:
The Fund will determine the net asset value of its Common Shares as of
the close of regular session trading on the New York Stock Exchange (normally
4:00 p.m. Eastern time) no less frequently than weekly on Friday of each week.
Net asset value is computed by dividing the value of all assets of the Fund
(including 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) by the
total number of shares outstanding. 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 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.
The Fund's investments are valued at market value or, in the absence of
market value with respect to any portfolio securities, at fair value as
determined by or under the direction of the Fund's Board of Trustees. Portfolio
securities listed on any exchange other than the NASDAQ National Market
("NASDAQ") are valued at the last sale price on the business day 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
F-9
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.
When price quotes are not available, fair market value is based on prices of
comparable securities. Short-term investments that mature in 60 days or less are
valued at amortized cost.
Exchange traded options and futures contracts are valued at the closing
price in the market where such contracts are principally traded.
Option Contracts:
The Fund may enter into various hedging and strategic transactions to
seek to reduce interest rate risks arising from any use of financial leverage by
the Fund, to facilitate portfolio management and mitigate risks.
Call options are contracts representing the right to purchase a common
stock at a specified price (the "strike price") through 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
Fiduciary Asset Management, LLC (the "Sub-Adviser") (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.
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.
Cash Flow Information:
The Fund issues its shares and distributes dividends from return of
capital (which are either paid in cash or reinvested at the discretion of
shareholders). These activities are reported in the Statement of Changes in Net
Assets. Information on cash receipts and disbursements is presented in the
Statement of Cash Flows. Accounting practices that do not affect reporting
activities on a cash basis include unrealized gain or loss on investment
securities.
F-10
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.
Distributions received from the Fund's investments in MLPs generally
are comprised of return of capital from the MLP. The Fund records investment
income and return of capital based on estimates made at the time such
distributions are received. Such estimates are based on historical information
available from each MLP and other industry sources. These estimates may
subsequently be revised based on information received from MLPs after their tax
reporting periods are concluded.
Securities purchased or sold on a when-issued or delayed-delivery basis
may be settled a month or more after the trade date; interest income is not
accrued until settlement date. The Fund instructs the custodian to segregate
assets of the Fund with a current value at least equal to the amount of its
when-issued purchase commitments.
Restricted Securities:
The Fund may invest up to 35% of its managed assets in restricted
securities. The Fund currently holds the restricted shares shown in the
following table of MarkWest Energy Partners, L.P. ("MarkWest"), which were
purchased in a private placement transaction. Restricted securities are valued
at fair value in accordance with procedures adopted by the Fund's Board of
Trustees. Pursuant to a Registration Rights Agreement, MarkWest has agreed to
provide certain demand and piggyback registration rights to the Fund and the
other purchasers in the private placement with respect to these restricted
securities. On November 24, 2004, MarkWest filed a registration statement with
the Securities and Exchange Commission ("SEC") on Form S-3. As of November 30,
2004, the SEC had not yet declared this registration statement effective.
Carrying
Value Per Cost Per Carrying Value
Share Share Per Share 11/30/04
Acquisition 11/30/04 7/30/04 7/30/04 Value % of Net
Security Date Shares (Restricted) (Restricted) (Unrestricted) (Restricted) Assets
MarkWest Energy 7/30/04 144,928 $43.50 $34.50 $43.92 $6,304,238 4.61%
Partners, L.P. ======= ====== ====== ====== ========== =====
-----------------------------
* This is the carrying value of unrestricted shares of MarkWest at 7/30/04,
which is the date of purchase and date an enforceable right to acquire the
restricted MarkWest securities was obtained by the Fund.
Distributions to Shareholders
The Fund intends to make quarterly distributions to Common
Shareholders. 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
F-11
the Fund less operating expenses, including taxes. 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 its Common Shares, and such
distributions would correspondingly reduce the shareholder's basis in its Common
Shares. A reduction in the shareholder's basis would increase the realized gain
or reduce the amount of realized loss 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 its Common Shares will be taxed
as a capital gain.
Distributions paid during the period ended November 30, 2004, of
$2,081,702 have been characterized as return of capital for tax purposes.
Distributions will automatically be reinvested into additional Common Shares
pursuant to the Fund's Dividend Reinvestment Plan unless cash distributions are
elected by the shareholder. Permanent differences incurred during the period
ended November 30, 2004, resulting from differences in book and tax accounting
and have been reclassified at year end to reflect an increase in net investment
loss by $316,965 and a decrease to net realized gain on investments by $316,965.
Net assets were not affected by this reclassification.
INCOME TAXES:
The Fund has elected to be 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 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. This differs from most investment companies, which elect to be
treated as "regulated investment companies" under the United States Internal
Revenue Code of 1986, as amended.
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.
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 period ended November 30, 2004, distributions of $4,404,600
received from MLPs have been classified as return of capital.
The Fund's provision for income taxes is calculated in accordance with
SFAS No. 109 Accounting for Income Taxes and consists of the following:
Current Federal and State Income Taxes............. $ --
Deferred Federal Income Taxes...................... 8,922,778
Deferred State Income Taxes........................ 54,634
----------
Total income tax expense........................... $8,977,412
==========
F-12
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. Components of the
Fund's deferred tax assets and liabilities as of November 30, 2004 are as
follows:
DEFERRED TAX ASSETS:
Organization costs........................................ $ --
Net operating loss carryforwards.......................... 215,764
State income taxes........................................ 19,122
----------
$ 234,886
DEFERRED TAX LIABILITIES:
Unrealized gains on investment securities................. $9,212,298
----------
$9,212,298
Total net deferred tax liability.......................... $8,977,412
==========
The components of income tax expense include $8,922,778 and $54,634 for
deferred federal and state income taxes, respectively. For the period ended
November 30, 2004, the Fund had a net operating loss for federal income tax
purposes of approximately $616,469. This net loss may be carried forward for 20
years, and accordingly would expire after the year ended November 30, 2024.
Total income taxes differ from the amount computed by applying the
federal statutory income tax rate of 35% to net investment income and realized
and unrealized gains on investments.
Application of statutory income tax rate............... $8,980,184
Dividends received deduction........................... (38,284)
State income taxes, net................................ 35,512
----------
Total.................................................. $8,977,412
==========
Expenses:
The Fund pays all expenses directly related to its operations.
Organizational and Offering Costs:
Organization costs consist of costs incurred to establish the Fund and
enable it to legally do business. These costs include filing fees, legal
services pertaining to the organization of the business and audit fees relating
to the initial registration and auditing the initial statement of assets and
liabilities, among other fees. Offering costs consist of legal fees pertaining
to the Fund's shares offered for sale, registration fees, underwriting fees, and
printing of the initial prospectus, among other fees. First Trust Advisors, L.P.
("First Trust") has paid all organizational expenses and will pay all offering
costs of the Fund (other than sales load) that exceed $0.04 per Common Share.
F-13
The Fund's share of Common Share offering costs, $256,209, were recorded as a
reduction of the proceeds from the sale of Common Shares at November 30, 2004.
3. Investment Advisory Fee and Other Affiliated Transactions
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 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 average daily gross asset value of
the Fund minus accrued liabilities.
Fiduciary Asset Management, LLC (the "Sub-Adviser") serves as the
Fund's sub-adviser and manages the Fund's portfolio subject to First Trust's
supervision. The Sub-Adviser receives a portfolio management fee of 0.50% of
Managed Assets that is paid monthly by First Trust out of the First Trust
management fee.
First Trust has agreed to reimburse the Fund for fees and expenses in
an amount equal to 0.25% of the average daily Managed Assets of the Fund for the
first two years of the Fund's operations through June 24, 2006. The Sub-Adviser
has agreed to bear a portion of this expense reimbursement obligation by
reducing the amount of its full sub-advisory fee to 0.382%. Reimbursements are
reported as "expenses reimbursed by investment advisor" in the statement of
operations.
PFPC Inc. ("PFPC"), an indirect, majority-owned subsidiary of The PNC
Financial Services Group Inc., serves as the Fund's Administrator and Transfer
Agent in accordance with certain fee arrangements. PFPC Trust Company, an
indirect, majority-owned subsidiary of The PNC Financial Services Group Inc.,
serves as the Fund's Custodian in accordance with certain fee arrangements.
The Fund pays each Trustee who is not an officer or employee of First
Trust or any of their affiliates an annual retainer of $10,000, which includes
compensation for all regular quarterly board meetings and regular committee
meetings. No additional meeting fees are paid in connection with regular
quarterly board meetings or regular committee meetings. Additional fees of
$1,000 and $500 are paid to non-interested Trustees for special board meetings
and non-regular committee meetings, respectively. These additional fees are
shared by the funds in the First Trust fund complex that participate in the
particular meeting and are not per fund fees. Trustees are also reimbursed for
travel and out-of-pocket expenses in connection with all meetings.
4. Purchases and Sales of Securities
Cost of purchases and proceeds from sales of investment securities, excluding
short-term investments, for the period ended November 30, 2004, aggregated
amounts were $192,466,319 and $41,136,996, respectively.
As of November 30, 2004, the aggregate gross unrealized appreciation
for all securities, in which there was an excess of value over tax cost, was
$26,389,868 and the aggregate gross unrealized depreciation for all securities,
in which there was an excess of tax cost over value, was $41,872.
F-14
WRITTEN OPTION ACTIVITY FOR THE FUND WAS AS FOLLOWS:
Number of
Written Options Contracts Premiums
Options outstanding at inception of Fund.......... -- $ --
Options written................................... 8,425 1,780,721
Options closed.................................... (7,286) (1,566,529)
------- ----------
Options outstanding at November 30, 2004.......... 1,139 $ 214,192
======= ===========
5. Common Stock
As of November 30, 2004, 6,420,643 of $0.01 par value Common Shares were issued
and outstanding. An unlimited number of Common Shares has been authorized under
the Fund's Dividend Reinvestment Plan.
COMMON STOCK TRANSACTIONS WERE AS FOLLOWS:
Period Ended
November 30, 2004
Shares Amount
Proceeds from shares sold........................... 6,405,236 $122,340,007
Issued as reinvestment of dividends under the
Dividend Reinvestment Plan....................... 15,407 310,920
Offering Cost Common Shares......................... -- (256,209)
--------- ------------
6,420,643 $122,394,718
========= ============
6. Loan Outstanding
The Fund has a credit agreement with the Custodial Trust Company of Bear
Stearns, under which the Fund may borrow from the Custodial Trust Company an
aggregate amount of up to the lesser of $30,000,000 or the maximum amount the
Fund is permitted to borrow under the 1940 Act. For the period ended November
30, 2004, the average amount outstanding was $21,857,924 with a weighted average
interest rate of 2.50%. This loan has no maturity date and can be paid or called
at any time.
7. Concentration of Credit Risk
The Fund intends to invest 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 will be 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.
F-15
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.
8. Subsequent Events
On December 20, 2004, the Fund declared a dividend of $0.33 per share which
represents a return of capital to Common Shareholders of record January 12,
2005, payable January 31, 2005.
On December 13, 2004, the Fund's Board of Trustees approved plans to
issue auction rate senior notes. The Fund has filed a registration statement
related to such offering and expects that the notes will be issued during the
first quarter of 2005, subject to obtaining required regulatory approvals. The
Fund intends to issue Series A Notes in an amount up to approximately 20% of the
Fund's Managed Assets.
F-16
APPENDIX A
RATINGS OF INVESTMENTS
Standard & Poor's Corporation -- A brief description of the applicable
Standard & Poor's Corporation, 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.
A-1
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.
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
A-21
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.
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
A-3
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.
*
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 ratings 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 Amortization schedule -- the larger the final maturity relative to
other maturities, the more likely it will be treated as a note; and
A-4
o Source of payment -- the more dependent the issue is on the market
for its refinancing, the more likely it will be treated as a note.
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:
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.
A-6
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.
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.
A-7
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.
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.
A-8
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.
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
A-9
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.
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.
A-10
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.
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-11
APPENDIX B
FIDUCIARY ASSET MANAGEMENT, LLC
PROXY VOTING POLICY
A. STATEMENT OF POLICY
1. It is the policy of Fiduciary Asset Management, LLC ("FAM") to vote
all proxies over which it has voting authority in the best interest of FAM's
clients.
B. DEFINITIONS
2. By "best interest of FAM's clients," FAM means clients' best
economic interest over the long term -- that is, the common interest that all
clients share in seeing the value of a common investment increase over time.
Clients may have differing political or social interests, but their best
economic interest is generally uniform.
3. By "material conflict of interest," FAM means circumstances when
FAM itself knowingly does business with a particular proxy issuer or closely
affiliated entity, and may appear to have a significant conflict of interest
between its own interests and the interests of clients in how proxies of that
issuer are voted.
C. FAM INVESTS WITH MANAGEMENTS THAT SEEK SHAREHOLDERS' BEST INTERESTS
4. Under its investment philosophy, FAM generally invests client funds
in a company only if FAM believes that the company's management seeks to serve
shareholders' best interests. Because FAM has confidence in the managements of
the companies in which it invests, it believes that management decisions and
recommendations on issues such as proxy voting generally are likely to be in
shareholders' best interests.
5. FAM may periodically reassess its view of company managements. If
FAM concludes that a company's management no longer serves shareholders' best
interests, FAM generally sells its clients' shares of the company. FAM believes
that clients do not usually benefit from holding shares of a poorly managed
company or engaging in proxy contests with management.
D. FAM'S PROXY VOTING PROCEDURES
6. When companies in which FAM has invested client funds issue
proxies, FAM routinely votes the proxies as recommended by management, because
it believes that recommendations by these companies' managements generally are
in shareholders' best interests, and therefore in the best economic interest of
FAM's clients.
B-1
7. If FAM has decided to sell the shares of a company, whether because
of concerns about the company's management or for other reasons, FAM generally
abstains from voting proxies issued by the company after FAM has made the
decision to sell. FAM generally will not notify clients when this type of
routine abstention occurs.
8. FAM also may abstain from voting proxies in other circumstances.
FAM may determine, for example, that abstaining from voting is appropriate if
voting may be unduly burdensome or expensive, or otherwise not in the best
economic interest of clients, such as when foreign proxy issuers impose
unreasonable voting or holding requirements. FAM generally will not notify
clients when this type of routine abstention occurs.
9. The procedures in this policy apply to all proxy voting matters
over which FAM has voting authority, including changes in corporate governance
structures, the adoption or amendment of compensation plans (including stock
options), and matters involving social issues or corporate responsibility.
E. ALTERNATIVE PROCEDURES FOR POTENTIAL MATERIAL CONFLICTS OF INTEREST
10. In certain circumstances, such as when the proponent of a proxy
proposal is also a client of FAM, an appearance might arise of a potential
conflict between FAM's interests and the interests of affected clients in how
the proxies of that issuer are voted.
11. Because FAM does not exercise discretion in voting proxies, but
routinely votes proxies as recommended by management, no potential conflict of
interest could actually affect FAM's voting of the proxies.
12.a. Nevertheless, when FAM itself knowingly does business with a
particular proxy issuer and a material conflict of interest between FAM's
interests and clients' interests may appear to exist, FAM generally would, to
avoid any appearance concerns, follow an alternative procedure rather than vote
proxies as recommended by management. Such an alternative procedure generally
would involve causing the proxies to be voted in accordance with the
recommendations of an independent service provider that FAM may use to assist in
voting proxies. FAM generally will not notify clients if it uses this procedure
to resolve an apparent material conflict of interest. FAM will document the
identification of any material conflict of interest and its procedure for
resolving the particular conflict.
12.b. In unusual cases, FAM may use other alternative procedures to
address circumstances when a material conflict of interest may appear to exist,
such as, without limitation:
(i) Notifying affected clients of the conflict of interest
(if practical), and seeking a waiver of the conflict to permit FAM to
vote the proxies under its usual policy;
(ii) Abstaining from voting the proxies; or
B-2
(iii) Forwarding the proxies to clients so that clients may
vote the proxies themselves.
FAM generally will notify affected clients if it uses one of these
alternative procedures to resolve a material conflict of interest.
F. OTHER EXCEPTIONS
13. On an exceptions basis, FAM may for other reasons choose to depart
from its usual procedure of routinely voting proxies as recommended by
management.
G. VOTING BY CLIENT INSTEAD OF FAM
14. A FAM client may vote its own proxies instead of directing FAM to
do so. FAM recommends this approach if a client believes that proxies should be
voted based on political or social interests.
15. FAM generally will not accept proxy voting authority from a client
(and will encourage the client to vote its own proxies) if the client seeks to
impose client-specific voting guidelines that may be inconsistent with FAM's
guidelines or with the client's best economic interest in FAM's view.
16. FAM generally will abstain from voting on (or otherwise
participating in) the commencement of legal proceedings such as shareholder
class actions or bankruptcy proceedings.
H. PERSONS RESPONSIBLE FOR IMPLEMENTING FAM'S POLICY
17. FAM's client services staff has primary responsibility for
implementing FAM's proxy voting procedures, including ensuring that proxies are
timely submitted. FAM also may use a service provider to assist in voting
proxies, recordkeeping, and other matters.
18. FAM's security analysts routinely review proxy proposals as part of
their ongoing reassessment of companies and their managements.
I. RECORDKEEPING
19. FAM or a service provider maintains, in accordance with Rule 204-2
of the Investment Advisers Act:
(i) Copies of all proxy voting policies and procedures;
(ii) Copies of proxy statements received (unless maintained
elsewhere as described below);
B-3
(iii) Records of proxy votes cast on behalf of clients;
(iv) Documents prepared by FAM that are material to a decision
on how to vote or memorializing the basis for a decision; and
(v) Written client requests for proxy voting information, and
(vi) written responses by FAM to written or oral client requests.
20. FAM will obtain an undertaking from any service provider that the
service provider will provide copies of proxy voting records and other documents
promptly upon request if FAM relies on the service provider to maintain related
records.
21. FAM or its service provider may rely on the Commission's EDGAR
system to keep records of certain proxy statements if the proxy statements are
maintained by issuers on that system (as is generally true in the case of larger
U.S.-based issuers).
22. All proxy related records will be maintained in an easily
accessible place for five years (and an appropriate office of FAM or a service
provider for the first two years).
J. AVAILABILITY OF POLICY AND PROXY VOTING RECORDS TO CLIENTS
23. FAM will initially inform clients of this policy and how a client
may learn of FAM's voting record for the client's securities through summary
disclosure in Part II of FAM's Form ADV. Upon receipt of a client's request for
more information, FAM will provide to the client a copy of this proxy voting
policy and/or how FAM voted proxies for the client during the period since this
policy was adopted.
Adopted effective August 1, 2003 and as amended September 9, 2003
B-4
ENERGY INCOME AND GROWTH FUND
COMMON SHARES
___________, 2005
Back Cover
PART C - OTHER INFORMATION
Item 24: Financial Statements and Exhibits
1. Financial Statements:
The Registrant's audited financial statements dated November 30, 2004,
and notes to the financial statements are filed herein and appear in the
statement of additional information.
2. Exhibits:
a. Declaration of Trust dated March 25, 2004. (1)
b. By-Laws of Fund. (1)
c. None.
d. Form of Share Certificate. (2)
e. Terms and Conditions of the Dividend Reinvestment Plan. (2)
f. None.
g.1 Form of Investment Management Agreement between Registrant and
First Trust Advisors L.P. (2)
g.2 Form of Sub-Advisory Agreement between Registrant, First Trust
Advisors L.P. and Fiduciary Asset Management, LLC. (2)
h.1 Form of Underwriting Agreement. (2)
h.2 Form of Master Dealers Agreement (2)
h.2 Form of Master Agreement Among Underwriters (2)
i. None.
j. Form of Custodian Services Agreement between Registrant and PFPC
Trust Company. (2)
k.1 Form of Transfer Agency Services Agreement between Registrant and
PFPC Inc.(2)
k.2 Form of Administration and Accounting Services Agreement. (2)
k.3. Form of Corporate Finance Services and Consulting Agreement. (2)
l.1 Opinion and consent of Chapman and Cutler LLP.**
Page 1
l.2 Opinion and consent of Bingham McCutchen LLP. **
m. None.
n. Consent of Independent Registered Public Accounting Firm.*
o. None.
p. Subscription Agreement between Registrant and First Trust Advisors
L.P. (2)
q. None.
r.1 Code of Ethics of Registrant. (2)
r.2 Code of Ethics of First Trust Portfolios L.P. (2)
r.3 Code of Ethics of First Trust Advisors L.P. (2)
r.4 Code of Ethics of Fiduciary Asset Management, LLC. (2)
s. Powers of Attorney.*
-------------------
* Filed herewith
** To be filed by amendment.
(1) Incorporated by reference to Registrant's Registration Statement on Form
N-2, filed on April 1, 2004 (File Nos. 333-114131 and 811-21549)
(2) Incorporated by reference to Pre-Effective Amendment No. 3 to Registrant's
Registration Statement on Form N-2, filed on June 24, 2004 (File Nos.
333-114131 and 811-21549).
Item 25: Marketing Arrangements
Reference is made to the Form of Underwriting Agreement for the
Registrant's common shares, to be filed by amendment to the Registrant's
Registration Statement.
Page 2
Item 26: Other Expenses of Issuance and Distribution
------------------------------------------------------------ ------------------
Securities and Exchange Commission Fees $2.35
------------------------------------------------------------ ------------------
National Association of Securities Dealers, Inc. Fees $ *
------------------------------------------------------------ ------------------
Printing and Engraving Expenses $ *
------------------------------------------------------------ ------------------
Legal Fees $ *
------------------------------------------------------------ ------------------
Listing Fees $ *
------------------------------------------------------------ ------------------
Accounting Expenses $ *
------------------------------------------------------------ ------------------
Blue Sky Filing Fees and Expenses $ *
------------------------------------------------------------ ------------------
Miscellaneous Expenses $ *
------------------------------------------------------------ ------------------
Total $ *
------------------------------------------------------------ ------------------
---------
Item 27: Persons Controlled by or under Common Control with Registrant
Not applicable.
Item 28: Number of Holders of Securities
At March 1, 2005:
------------------------------------------------------------ ------------------
Number of
Title of Class Record Holders
------------------------------------------------------------ ------------------
Common Shares, $0.01 par value 16
------------------------------------------------------------ ------------------
Long-term Debt ($34,000,000 aggregate principal amount) 25
------------------------------------------------------------ ------------------
Page 3
Item 29: Indemnification
Section 5.3 of the Registrant's Declaration of Trust provides as follows:
(a) Subject to the exceptions and limitations contained in paragraph
(b) below:
(i) every person who is or has been a Trustee or officer of
the Trust (hereinafter referred to as a "Covered Person") shall be
indemnified by the Trust against all liability and against all expenses
reasonably incurred or paid by him or her in connection with any claim,
action, suit or proceeding in which that individual becomes involved as
a party or otherwise by virtue of being or having been a Trustee or
officer and against amounts paid or incurred by that individual in the
settlement thereof; and
(ii) the words "claim," "action," "suit" or "proceeding" shall
apply to all claims, actions, suits or proceedings (civil, criminal,
administrative or other, including appeals), actual or threatened; and
the words "liability" and "expenses" shall include, without limitation,
attorneys' fees, costs, judgments, amounts paid in settlement or
compromise, fines, penalties and other liabilities.
(b) No indemnification shall be provided hereunder to a Covered Person:
(i) against any liability to the Trust or the Shareholders by
reason of a final adjudication by the court or other body before which
the proceeding was brought that the Covered Person engaged in willful
misfeasance, bad faith, gross negligence or reckless disregard of the
duties involved in the conduct of that individual's office;
(ii) with respect to any matter as to which the Covered Person
shall have been finally adjudicated not to have acted in good faith in
the reasonable belief that that individual's action was in the best
interest of the Trust; or
(iii) in the event of a settlement involving a payment by a
Trustee, Trustee Emeritus or officer or other disposition not involving
a final adjudication as provided in paragraph (b)(i) or (b)(ii) above
resulting in a payment by a Covered Person, unless there has been
either a determination that such Covered Person did not engage in
willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of that individual's office by
the court or other body approving the settlement or other disposition
or by a reasonable determination, based upon a review of readily
available facts (as opposed to a full trial-type inquiry) that that
individual did not engage in such conduct:
(A) by vote of a majority of the Disinterested
Trustees (as defined below) acting on the matter (provided that a
majority of the Disinterested Trustees then in office act on the
matter); or
(B) by written opinion of (i) the then-current legal
counsel to the Trustees who are not Interested Persons of the Trust or
(ii) other legal counsel chosen by a majority of the Disinterested
Page 4
Trustees (or if there are no Disinterested Trustees with respect to the
matter in question, by a majority of the Trustees who are not
Interested Persons of the Trust) and determined by them in their
reasonable judgment to be independent.
(c) The rights of indemnification herein provided may be insured
against by policies maintained by the Trust, shall be severable, shall not
affect any other rights to which any Covered Person may now or hereafter be
entitled, shall continue as to a person who has ceased to be a Covered Person
and shall inure to the benefit of the heirs, executors and administrators of
such person. Nothing contained herein shall limit the Trust from entering into
other insurance arrangements or affect any rights to indemnification to which
Trust personnel, including Covered Persons, may be entitled by contract or
otherwise under law.
(d) Expenses of preparation and presentation of a defense to any claim,
action, suit, or proceeding of the character described in paragraph (a) of this
Section 5.3 shall be advanced by the Trust prior to final disposition thereof
upon receipt of an undertaking by or on behalf of the Covered Person to repay
such amount if it is ultimately determined that the Covered Person is not
entitled to indemnification under this Section 5.3, provided that either:
(i) such undertaking is secured by a surety bond or some
other appropriate security or the Trust shall be insured against losses
arising out of any such advances; or
(ii) a majority of the Disinterested Trustees acting on the
matter (provided that a majority of the Disinterested Trustees then in
office act on the matter) or legal counsel meeting the requirement in
Section 5.3(b)(iii)(B) above in a written opinion, shall determine,
based upon a review of readily available facts (as opposed to a full
trial-type inquiry), that there is reason to believe that the Covered
Person ultimately will be found entitled to indemnification.
As used in this Section 5.3, a "Disinterested Trustee" is one (i) who
is not an "Interested Person" of the Trust (including anyone who has
been exempted from being an "Interested Person" by any rule, regulation
or order of the Commission), and (ii) against whom none of such
actions, suits or other proceedings or another action, suit or other
proceeding on the same or similar grounds is then or had been pending.
(e) With respect to any such determination or opinion referred to in
clause (b)(iii) above or clause (d)(ii) above, a rebuttable presumption shall be
afforded that the Covered Person has not engaged in willful misfeasance, bad
faith, gross negligence or reckless disregard of the duties involved in the
conduct of such Covered Person's office in accordance with pronouncements of the
Commission.
Item 30: Business and Other Connections of Investment Advisers
a) First Trust Advisors L.P. ("First Trust Advisors") serves as investment
adviser to the fund and the First Defined Portfolio Fund, LLC and also serves as
advisor or subadviser to 29 mutual funds and is the portfolio supervisor of
Page 5
certain unit investment trusts. Its principal address is 1001 Warrenville Road,
Suite 300, Lisle, Illinois 60532.
The principal business of certain of First Trust Advisors' principal executive
officers involves various activities in connection with the family of unit
investment trusts sponsored by First Trust Portfolios L. P. ("First Trust
Portfolios"). The principal address of First Trust Portfolios is 1001
Warrenville Road, Suite 300, Lisle, Illinois 60532.
Page 6
Other Business, Profession, Vocation or Employment During Past Two Years
Name and Position with First Trust Advisors L.P. Employment During Past Two Years
------------------------------------------------------------ ---------------------------------------------------------
James A. Bowen, Managing Director/President Managing Director/President, First Trust Portfolios and
Chairman of the Board of Directors, Bond Wave LLC and
Stonebridge Advisors LLC
------------------------------------------------------------ ---------------------------------------------------------
Ronald Dean McAlister, Managing Director Managing Director, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Mark R. Bradley, Chief Financial Officer and Managing Chief Financial Officer and Managing Director, First
Director Trust Portfolios and Chief Financial Officer, Bond Wave
LLC and Stonebridge Advisors LLC
------------------------------------------------------------ ---------------------------------------------------------
Robert W. Bredemeier, Chief Operating Officer and Managing Chief Operations Officer and Managing Director, First
Director Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Robert Franklin Carey, Chief Investment Officer and Senior Senior Vice President, First Trust Portfolios
Vice President
------------------------------------------------------------ ---------------------------------------------------------
William Scott Jardine, General Counsel General Counsel, First Trust Portfolios and Secretary
of Bond Wave LLC and Stonebridge Advisors LLC
------------------------------------------------------------ ---------------------------------------------------------
Kristi A. Maher, Assistant General Counsel Assistant General Counsel, First Trust Portfolios and
Associate (1995 to March 2004), Chapman and Cutler LLP
------------------------------------------------------------ ---------------------------------------------------------
Scott Hall, Managing Director Managing Director, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Andy Roggensack, Managing Director Managing Director, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Jon Carl Erickson, Senior Vice President Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Jason Henry, Senior Vice President Senior Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
David McGarel, Senior Vice President Senior Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Bob Porcellino, Senior Vice President Senior Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Mark Sullivan, Senior Vice President Senior Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Al Davis, Vice President Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
James P. Koeneman, Vice President Vice President, First Trust Portfolios since December
2003; President, Burr Oak Advisors, Inc., June 2000 to
December 2003
------------------------------------------------------------ ---------------------------------------------------------
Daniel J. Lindquist, Vice President Vice President, First Trust Portfolios since April 2004;
Chief Operating Officer, Mina Capital Management, LLC,
January 2004 to April 2004; Chief Operating Officer,
Samaritan Asset Management Services, Inc.
------------------------------------------------------------ ---------------------------------------------------------
Mitch Mohr, Vice President Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
David Pinsen, Vice President Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Jonathan Steiner, Vice President Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Walter E. Stubbings, Jr., Vice President Vice President, First Trust Portfolios since July 2004;
Assistant Vice President, Kansas City Life Insurance
Company, May 1999 to July 2004
------------------------------------------------------------ ---------------------------------------------------------
Rick Swiatek, Vice President Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Douglas Tichenor, Vice President Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Page 7
------------------------------------------------------------ ---------------------------------------------------------
Roger Testin, Vice President Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Kitty Collins, Assistant Vice President Assistant Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
Charles Bradley, Assistant Vice President Assistant Vice President, First Trust Portfolios
------------------------------------------------------------ ---------------------------------------------------------
b) Sub-Advisers. Fiduciary Asset Management LLC serves as an investment
sub-adviser of the Fund. Reference is made to: (i) the information set forth
under "Management of the Fund" in the Prospectus and "Sub-Adviser" in the
Statement of Additional Information; and (ii) the Form ADV of Fiduciary Asset
Management, LLC (File no. 801-46751) filed with the Commission, all of which are
incorporated herein by reference.
Item 31: Location of Accounts and Records.
First Trust Advisors L.P. maintains the Declaration of Trust, By-Laws, minutes
of trustees and shareholders meetings and contracts of the Registrant, all
advisory material of the investment adviser, all general and subsidiary ledgers,
journals, trial balances, records of all portfolio purchases and sales, and all
other required records.
Item 32: Management Services
Not applicable.
Item 33: Undertakings
1. Registrant undertakes to suspend the offering of its shares until it amends
its prospectus if (1) subsequent to the effective date of its Registration
Statement, the net asset value declines more than 10 percent from its net asset
value as of the effective date of the Registration Statement, or (2) the net
asset value increases to an amount greater than its net proceeds as stated in
the prospectus.
2. Not applicable.
3. Not applicable.
4. Not applicable.
5. The Registrant undertakes that:
a. For purposes of determining any liability under the Securities Act of 1933,
the information omitted from the form of prospectus filed as part of a
registration statement in reliance upon Rule 430A and contained in the form of
prospectus filed by the Registrant under Rule 497(h) under the Securities Act of
1933 shall be deemed to be part of the Registration Statement as of the time it
was declared effective.
b. For the purpose of determining any liability under the Securities Act of
1933, each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of the securities at that time shall be deemed to be
the initial bona fide offering thereof.
Page 8
6. The Registrant undertakes to send by first class mail or other means designed
to ensure equally prompt delivery, within two business days of receipt of a
written or oral request, any Statement of Additional Information.
Page 9
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in this City of Lisle, and State of Illinois, on the 18th day of
March, 2005.
ENERGY INCOME AND GROWTH FUND
By: /s/ James A. Bowen
------------------------------
James A. Bowen, President
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the date indicated.
------------------------ -------------------------------------- ----------------
Signature Title Date
------------------------ -------------------------------------- ----------------
/s/ James A. Bowen President, Chairman of the Board March 18, 2005
--------------------- and Trustee (Principal Executive
James A. Bowen Officer)
------------------------ -------------------------------------- ----------------
/s/ Mark R. Bradley Chief Financial Officer and March 18, 2005
--------------------- Treasurer (Principal Financial and
Mark R. Bradley Accounting Officer)
------------------------ -------------------------------------- ----------------
Richard E. Erickson* Trustee )
---------------------- ------------------------------- By: /s/ W. Scott Jardine
Thomas R. Kadlec* Trustee ) --------------------
---------------------- ------------------------------- W. Scott Jardine
Niel B. Nielson* Trustee ) Attorney-In-Fact
---------------------- ------------------------------- March 18, 2005
David M. Oster* Trustee )
---------------------- ------------------------------- -------------------------
* Original powers of attorney authorizing W. Scott Jardine and Eric F. Fess to
execute this Registration Statement, and Amendments thereto, for each of the
trustees of the Registrant on whose behalf this Registration Statement is filed,
were previously executed and are filed as an exhibit hereto.
Page 10
INDEX TO EXHIBITS
n. Consent of Independent Registered Public Accounting Firm.
s. Powers of Attorney
Page 11