Rule 497(c)
File No. 333-168727
PROSPECTUS
March 3, 2014
FIRST TRUST PREFERRED SECURITIES AND INCOME FUND CLASS TICKER SYMBOL
CLASS A FPEAX
CLASS C FPECX
CLASS F FPEFX
CLASS I FPEIX
CLASS R3 FPERX
FIRST TRUST/CONFLUENCE SMALL CAP VALUE FUND CLASS TICKER SYMBOL
CLASS A FOVAX
CLASS C FOVCX
CLASS I FOVIX
CLASS R3 FOVRX
FIRST TRUST SHORT DURATION HIGH INCOME FUND CLASS TICKER SYMBOL
CLASS A FDHAX
CLASS C FDHCX
CLASS I FDHIX
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The Securities and Exchange Commission has not approved or disapproved these
securities or passed upon the adequacy or accuracy of this prospectus. Any
representation to the contrary is a criminal offense.
NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE
TABLE OF CONTENTS
SECTION PAGE
First Trust Preferred Securities and Income Fund............................ 1
First Trust/Confluence Small Cap Value Fund................................. 6
First Trust Short Duration High Income Fund................................. 11
Additional Information on the Funds' Investment Objectives and Strategies... 16
Fund Investments............................................................ 17
Additional Risks of Investing in the Funds.................................. 22
Fund Organization........................................................... 29
Management of the Funds..................................................... 29
Share Classes............................................................... 32
Investment in Fund Shares................................................... 35
Account Services............................................................ 35
Redemption of Fund Shares................................................... 36
Dividends, Distributions and Taxes.......................................... 37
Federal Tax Matters......................................................... 37
Distribution and Service Plan............................................... 39
Net Asset Value............................................................. 40
Fund Service Providers...................................................... 41
Shareholder Inquiries....................................................... 41
Frequent Trading and Market Timing.......................................... 41
Total Return Information.................................................... 42
Financial Highlights........................................................ 43
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SUMMARY INFORMATION
First Trust Preferred Securities and Income Fund
INVESTMENT OBJECTIVE
The First Trust Preferred Securities and Income Fund (the "Fund") seeks to
provide current income and total return.
FEES AND EXPENSES OF THE FUND
This table describes the fees and expenses that you may pay if you buy and hold
shares of the Fund. You may qualify for sales charge discounts if you and your
family invest, or agree to invest in the future, at least $50,000 in the Fund or
in other First Trust mutual funds. More information about these and other
discounts, as well as eligibility requirements for each share class, is
available from your financial advisor and in "Share Classes" on page 32 of this
prospectus, "Investment in Fund Shares" on page 35 of this prospectus and
"Purchase and Redemption of Fund Shares" on page 59 of the Funds' statement of
additional information ("SAI").
SHAREHOLDER FEES
(fees paid directly from your investment)
------------------------------------------------------------------------------------------------------------------------
CLASS A CLASS C CLASS F CLASS I CLASS R3
------------------------------------------------------------------------------------------------------------------------
Maximum Sales Charge (Load)
Imposed on Purchases (as a percentage
of offering price) 4.50% None None None None
------------------------------------------------------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load)
(as a percentage of the lesser of purchase
price or redemption proceeds)(1) None 1.00% None None None
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Maximum Sales Charge (Load)
Imposed on Reinvested Dividends None None None None None
------------------------------------------------------------------------------------------------------------------------
Exchange Fee None None None None None
------------------------------------------------------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES
(expenses that you pay each year as a percentage of the value of your investment)
------------------------------------------------------------------------------------------------------------------------
CLASS A CLASS C CLASS F CLASS I CLASS R3
------------------------------------------------------------------------------------------------------------------------
Management Fee 0.80% 0.80% 0.80% 0.80% 0.80%
------------------------------------------------------------------------------------------------------------------------
Distribution and Service (12b-1) Fees 0.25% 1.00% 0.15% --% 0.50%
------------------------------------------------------------------------------------------------------------------------
Other Expenses 0.39% 0.37% 0.63% 0.43% 3.57%
------------------------------------------------------------------------------------------------------------------------
Total Annual Fund Operating Expenses 1.44% 2.17% 1.58% 1.23% 4.87%
------------------------------------------------------------------------------------------------------------------------
Fee Waivers and Expense Reimbursements(2) (0.04%) (0.02%) (0.28%) (--%) (3.22%)
------------------------------------------------------------------------------------------------------------------------
Total Annual Fund Operating Expenses
After Fee Waivers and Expense Reimbursements 1.40% 2.15% 1.30% 1.15% 1.65%
------------------------------------------------------------------------------------------------------------------------
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1 For Class A shares purchased at net asset value without a sales charge
because the purchase amount exceeded $1 million, where the financial
intermediary did not waive the sales commission, a contingent deferred
sales charge of 1% is imposed on any redemption within 12 months of
purchase. The contingent deferred sales charge on Class C shares applies
only to redemptions within 12 months of purchase.
2 The investment advisor and sub-advisor have agreed to waive fees and
reimburse expenses through February 28, 2015 so that Total Annual Fund
Operating Expenses (excluding 12b-1 distribution and service fees,
interest expenses, taxes, fees incurred in acquiring and disposing of
portfolio securities, and extraordinary expenses) do not exceed 1.15% of
the average daily net assets of any class of Fund shares. Total Annual
Fund Operating Expenses (excluding 12b-1 distribution and service fees,
interest expenses, taxes, fees incurred in acquiring and disposing of
portfolio securities, and extraordinary expenses) will not exceed 1.50%
from March 1, 2015 through February 28, 2024. Expense limitations may be
terminated or modified prior to their expiration only with the approval of
the Board of Trustees of the First Trust Series Fund (the "Trust").
1
First Trust Preferred Securities and Income Fund
EXAMPLE
The following example is intended to help you compare the cost of investing in
the Fund with the cost of investing in other mutual funds. The example assumes
that you invest $10,000 in the Fund for the time periods indicated. The example
also assumes that your investment has a 5% return each year and that the Fund's
annual operating expenses remain at current levels until February 28, 2015 and
then will not exceed 1.50% from March 1, 2015 until February 28, 2024. Although
your actual costs may be higher or lower, based on these assumptions your costs
would be:
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REDEMPTION NO REDEMPTION
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SHARE CLASS A C F I R3 A C F I R3
------------------------------------------------------------------------------------------------------------------------
1 Year $ 586 $ 318 $ 132 $ 117 $ 168 $ 586 $ 218 $ 132 $ 117 $ 168
------------------------------------------------------------------------------------------------------------------------
3 Years 880 676 462 380 582 880 676 462 380 582
------------------------------------------------------------------------------------------------------------------------
5 Years 1,197 1,162 825 665 1,034 1,197 1,162 825 665 1,034
------------------------------------------------------------------------------------------------------------------------
10 Years 2,092 2,501 1,846 1,479 2,289 2,092 2,501 1,846 1,479 2,289
------------------------------------------------------------------------------------------------------------------------
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PORTFOLIO TURNOVER
The Fund pays transaction costs, such as commissions, when it buys and sells
securities (or "turns over" its portfolio). A higher portfolio turnover rate may
indicate higher transaction costs and may result in higher taxes when Fund
shares are held in a taxable account. These costs, which are not reflected in
Annual Fund Operating Expenses or in the example, affect the Fund's performance.
During the most recent fiscal year, the Fund's portfolio turnover rate was 60%
of the average value of its portfolio.
PRINCIPAL INVESTMENT STRATEGIES
The Fund seeks to achieve its investment objective by investing, under normal
market conditions, at least 80% of its net assets (including investment
borrowings) in preferred securities and other securities with similar economic
characteristics. Securities that have economic characteristics that are similar
to preferred securities include certain debt instruments. Such debt instruments
are typically issued by corporations, generally in the form of interest bearing
notes, or by an affiliated business trust of a corporation, generally in the
form of (i) beneficial interests in subordinated debentures or similarly
structured securities or (ii) more senior debt securities that pay income and
trade in a manner similar to preferred securities. The Fund may also invest in
more traditional corporate debt securities and U.S. government securities.
Preferred securities generally pay fixed or adjustable-rate distributions to
investors and have preference over common stock in the payment of distributions
and the liquidation of a company's assets, but are generally junior to all forms
of the company's debt, including both senior and subordinated debt; therefore,
the risks and potential rewards of investing in the Fund may at times be similar
to the risks and potential rewards of investing in both equity funds and bond
funds. Because the issuers of preferred securities are often financial
companies, the Fund intends to concentrate (invest at least 25% of its net
assets) in the industry or group of industries that comprise the financial
sector, which may include banks, thrifts, brokerage firms, broker-dealers,
investment banks, finance companies, real estate investment trusts ("REITs") and
companies involved in the insurance industry.
Under normal market conditions, the Fund invests substantially all of its net
assets in investment grade securities. Investment grade quality securities are
those that, at the time of purchase, are rated at least "BBB-" or higher by
Standard & Poor's Ratings Group, a division of the McGraw Hill Companies, Inc.
("S&P"), or "Baa3" or higher by Moody's Investors Service, Inc. ("Moody's") or
comparably rated by another nationally recognized statistical rating
organization ("NRSRO") or, if unrated, determined by the investment sub-advisor
to be of comparable credit quality. In the event that a security is rated by
multiple NRSROs and receives different ratings, the Fund will treat the security
as being rated in the highest rating category received from an NRSRO.
Under normal market conditions, the Fund may invest up to 15% of its net assets
in cash and/or cash equivalents. The Fund may invest in securities issued by
companies domiciled in the United States, U.S. dollar-denominated depositary
receipts, U.S. dollar-denominated foreign securities and non-U.S.
dollar-denominated securities. The Fund may invest up to 15% of its net assets
in Rule 144A Securities. Rule 144A Securities are generally subject to resale
restrictions and may be illiquid.
2
First Trust Preferred Securities and Income Fund
The Fund is classified as "non-diversified" under the Investment Company Act of
1940, as amended (the "1940 Act") and as a result may invest a relatively high
percentage of its assets in a limited number of issuers. The Fund is only
limited as to the percentage of its assets which may be invested in the
securities of any one issuer by diversification requirements imposed by the
Internal Revenue Code of 1986, as amended (the "Code").
PRINCIPAL RISKS
You could lose money by investing in the Fund. There can be no assurance that
the Fund will achieve its investment objective. An investment in the Fund is not
a deposit of a bank and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other governmental agency.
CONCENTRATION RISK. A fund concentrated in a single industry or sector is likely
to present more risks than a fund that is broadly diversified over several
industries or sectors. Compared to the broad market, an individual industry or
sector may be more strongly affected by changes in the economic climate, broad
market shifts, moves in a particular dominant stock, or regulatory changes.
CREDIT RISK. Credit risk is the risk that an issuer of a security may be unable
or unwilling to make dividend, interest and principal payments when due and the
related risk that the value of a security may decline because of concerns about
the issuer's ability or willingness to make such payments. In addition, parties
to other financial contracts with the Fund could default on their obligations.
DEPOSITARY RECEIPTS RISK. Depositary receipts may be less liquid than the
underlying shares in their primary trading market. Any distributions paid to the
holders of depositary receipts are usually subject to a fee charged by the
depositary. Holders of depositary receipts may have limited voting rights, and
investment restrictions in certain countries may adversely impact the value of
depositary receipts because such restrictions may limit the ability to convert
shares into depositary receipts and vice versa. Such restrictions may cause
shares of the underlying issuer to trade at a discount or premium to the market
price of the depositary receipts.
FINANCIAL COMPANIES RISK. Financial companies are especially subject to the
adverse effects of economic recession, currency exchange rates, government
regulation, decreases in the availability of capital, volatile interest rates,
portfolio concentrations in geographic markets and in commercial and residential
real estate loans, and competition from new entrants in their fields of
business.
ILLIQUID SECURITIES RISK. Some securities held by the Fund may be illiquid.
Illiquid securities involve the risk that the securities will not be able to be
sold at the time desired by the Fund or at prices approximately the value at
which the Fund is carrying the securities on its books.
INCOME RISK. If interest rates fall, the income from the Fund's portfolio will
decline as the Fund invests the proceeds from new share sales, or from matured
or called debt securities, at interest rates that are below the portfolio's
current earnings rate.
INTEREST RATE RISK. Interest rate risk is the risk that the value of the
fixed-income securities held by the Fund will decline because of rising market
interest rates. Interest rate risk is generally lower for shorter term
investments and higher for longer term investments.
MARKET RISK. Market risk is the risk that a particular security owned by the
Fund or shares of the Fund in general may fall in value. Shares are subject to
market fluctuations caused by such factors as economic, political, regulatory or
market developments, changes in interest rates and perceived trends in
securities prices. Overall Fund share values could decline generally or could
underperform other investments.
NON-DIVERSIFICATION RISK. The Fund is classified as "non-diversified" under the
1940 Act. As a result, the Fund is only limited as to the percentage of its
assets which may be invested in the securities of any one issuer by the
diversification requirements imposed by the Code. The Fund may invest a
relatively high percentage of its assets in a limited number of issuers. As a
result, the Fund may be more susceptible to a single adverse economic or
regulatory occurrence affecting one or more of these issuers, experience
increased volatility and be highly concentrated in certain issuers.
NON-U.S. SECURITIES RISK. Non-U.S. securities are subject to higher volatility
than securities of domestic issuers due to possible adverse political, social or
economic developments; restrictions on foreign investment or exchange of
securities; lack of liquidity; currency exchange rates; excessive taxation;
government seizure of assets; different legal or accounting standards; and less
government supervision and regulation of exchanges in foreign countries.
PREFERRED SECURITIES RISK. Preferred securities combine some of the
characteristics of both common stocks and bonds. Preferred securities are
typically subordinated to bonds and other debt instruments in a company's
capital structure, in terms of priority to corporate income, and therefore will
be subject to greater credit risk than those debt instruments. Preferred
securities are also subject to credit risk, interest rate risk and income risk.
3
First Trust Preferred Securities and Income Fund
REIT RISK. The Fund invests in REITs, and as a result, the Fund is subject to
the risks associated with investing in real estate, which may include, but are
not limited to, fluctuations in the value of underlying properties; defaults by
borrowers or tenants; market saturation; changes in general and local operating
expenses; and other economic, political or regulatory occurrences affecting
companies in the real estate industry. In addition to risks related to
investments in real estate generally, investing in REITs involves certain other
risks related to their structure and focus, which include, but are not limited
to, dependency upon management skills, limited diversification, the risks of
locating and managing financing for projects, heavy cash flow dependency,
possible default by borrowers, the costs and potential losses of
self-liquidation of one or more holdings, the risk of a possible lack of
mortgage funds and associated interest rate risks, overbuilding, property
vacancies, increases in property taxes and operating expenses, changes in zoning
laws, losses due to environmental damages, changes in neighborhood values and
appeal to purchasers, the possibility of failing to maintain exemptions from
registration under the 1940 Act and, in many cases, relatively small market
capitalization, which may result in less market liquidity and greater price
volatility.
REITs are also subject to the risk that the real estate market may experience an
economic downturn generally, which may have a material effect on the real estate
in which the REITs invest and their underlying portfolio securities.
ANNUAL TOTAL RETURN
The bar chart and table below illustrate the calendar year return of the Fund's
Class A shares for the past two years as well as the average annual Fund returns
for the one year and since inception periods ended December 31, 2013. The bar
chart and table provide an indication of the risks of investing in the Fund by
showing changes in the Fund's performance from year-to-year and by showing how
the Fund's Class A shares' average annual total returns compare to those of a
broad-based securities market index. See "Total Return Information" for
additional performance information regarding the Fund. The Fund's performance
information is accessible on the Fund's website at www.ftportfolios.com.
Returns before taxes do not reflect the effects of any income or capital gains
taxes. All after-tax returns are calculated using the historical highest
individual federal marginal income tax rates and do not reflect the impact of
any state or local tax. Returns after taxes on distributions reflect the taxed
return on the payment of dividends and capital gains. Returns after taxes on
distributions and sale of shares assume you sold your shares at period end, and,
therefore, are also adjusted for any capital gains or losses incurred. After-tax
returns are shown for only Class A shares, and after-tax returns for other
Classes will vary. Returns for the market index do not include expenses, which
are deducted from Fund returns, or taxes.
Your own actual after-tax returns will depend on your specific tax situation and
may differ from what is shown here. After-tax returns are not relevant to
investors who hold Fund shares in tax-deferred accounts such as individual
retirement accounts (IRAs) or employee-sponsored retirement plans.
Imposition of the Fund's sales load is not reflected in the bar chart below. If
the sales load was reflected, returns would be less than those shown.
FIRST TRUST PREFERRED SECURITIES AND INCOME FUND--TOTAL RETURN ON CLASS A SHARES
[GRAPHIC OMITTED]
[DATA POINTS REPRESENTED IN BAR CHART]
Calendar Year Total Return as of 12/31
Year %
------ --------
2012 16.64%
2013 -4.49%
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4
First Trust Preferred Securities and Income Fund
During the two-year period ended December 31, 2013, the Fund's highest and
lowest calendar quarter returns were 6.75% and -5.29%, respectively, for the
quarters ended March 31, 2012 and September 30, 2013. The Fund's past
performance (before and after taxes) is not necessarily an indication of how the
Fund will perform in the future.
AVERAGE ANNUAL TOTAL RETURNS FOR THE FUND FOR THE PERIODS ENDED DECEMBER 31, 2013
1 Year Since Inception
Inception Date
Class A - Return Before Taxes -8.78% 3.75% 2/25/2011
Class C - Return Before Taxes -6.07% 4.72% 2/25/2011
Class F - Return Before Taxes -4.40% 5.68% 3/2/2011
Class I - Return Before Taxes -4.19% 6.00% 1/11/2011
Class R3 - Return Before Taxes -4.69% 4.99% 3/2/2011
Class A - Return After Taxes on Distributions -10.85% 1.55% 2/25/2011
Class A - Return After Taxes on Distributions and Sale of Shares -4.93% 2.04% 2/25/2011
Merrill Lynch Fixed Rate Preferred Securities Index -3.65% 4.05% 1/11/2011*
* Since Inception Index returns are based on inception date of the Class I shares.
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MANAGEMENT
INVESTMENT ADVISOR
First Trust Advisors L.P. ("First Trust" or the "Advisor")
INVESTMENT SUB-ADVISOR
Stonebridge Advisors LLC ("Stonebridge" or the "Sub-Advisor")
PORTFOLIO MANAGERS
The following persons are members of Stonebridge's investment committee and
serve as the portfolio managers of the Fund:
o Scott T. Fleming, President and Chief Investment Officer of
Stonebridge;
o Robert Wolf, Vice President, Senior Credit Analyst and Portfolio
Manager for Stonebridge; and
o Danielle Salters, Credit Analyst at Stonebridge.
Each portfolio manager has managed the Fund since 2011 except for Ms.
Salters, who joined Stonebridge in February 2012, when she began managing
the Fund.
PURCHASE AND SALE OF FUND SHARES
You may purchase, redeem or exchange shares of the Fund through a financial
advisor on any day the New York Stock Exchange ("NYSE") is open for business.
The minimum initial purchase or exchange into the Fund is $2,500 ($750 for a
Traditional/Roth IRA account; $500 for an Education IRA account; and $250 for
accounts opened through fee-based programs). The minimum subsequent investment
is $50. Class I shares are subject to higher minimums for certain investors and
Class R3 shares are not subject to any minimums. There are no minimums for
purchases or exchanges into the Fund through employer-sponsored retirement
plans.
TAX INFORMATION
The Fund's distributions will generally be taxed as ordinary income or capital
gains, unless you are investing through a tax-deferred arrangement, such as a
401(k) plan or an individual retirement account, in which case, your
distribution will be taxed upon withdrawal from the tax-deferred account.
Additionally, a sale of Fund shares is generally a taxable event.
PAYMENTS TO BROKER-DEALERS AND OTHER FINANCIAL INTERMEDIARIES
If you purchase the Fund through a broker-dealer or other financial intermediary
(such as a bank), First Trust and related companies may pay the intermediary for
the sale of Fund shares and related services. These payments may create a
conflict of interest by influencing the broker-dealer or other intermediary and
your salesperson to recommend the Fund over another investment. Ask your
salesperson or visit your financial intermediary's website for more information.
5
SUMMARY INFORMATION
First Trust/Confluence Small Cap Value Fund
INVESTMENT OBJECTIVE
The First Trust/Confluence Small Cap Value Fund (the "Fund") seeks to provide
long-term capital appreciation.
FEES AND EXPENSES OF THE FUND
This table describes the fees and expenses that you may pay if you buy and hold
shares of the Fund. You may qualify for sales charge discounts if you and your
family invest, or agree to invest in the future, at least $50,000 in the Fund or
in other First Trust mutual funds. More information about these and other
discounts, as well as eligibility requirements for each share class, is
available from your financial advisor and in "Share Classes" on page 32 of this
prospectus, "Investment in Fund Shares" on page 35 of this prospectus and
"Purchase and Redemption of Fund Shares" on page 59 of the
Funds' statement of additional information ("SAI").
SHAREHOLDER FEES
(fees paid directly from your investment)
----------------------------------------------------------------------------------------------------------
CLASS A CLASS C CLASS I CLASS R3
----------------------------------------------------------------------------------------------------------
Maximum Sales Charge (Load)
Imposed on Purchases (as a percentage
of offering price) 5.50% None None None
----------------------------------------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load)
(as a percentage of the lesser of purchase
price or redemption proceeds)(1) None 1.00% None None
----------------------------------------------------------------------------------------------------------
Maximum Sales Charge (Load)
----------------------------------------------------------------------------------------------------------
Imposed on Reinvested Dividends None None None None
----------------------------------------------------------------------------------------------------------
Exchange Fee None None None None
----------------------------------------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES
(expenses that you pay each year as a percentage of the value of your investment)
----------------------------------------------------------------------------------------------------------
CLASS A CLASS C CLASS I CLASS R3
----------------------------------------------------------------------------------------------------------
Management Fee 1.00% 1.00% 1.00% 1.00%
----------------------------------------------------------------------------------------------------------
Distribution and Service (12b-1) Fees 0.25% 1.00% --% 0.50%
----------------------------------------------------------------------------------------------------------
Other Expenses(2) 10.04% 8.45% 16.52% 1,638.63%
----------------------------------------------------------------------------------------------------------
Acquired Fund Fees and Expenses(2) 0.33% 0.33% 0.33% 0.33%
----------------------------------------------------------------------------------------------------------
Total Annual Fund Operating Expenses 11.62% 10.78% 17.85% 1,640.46%
----------------------------------------------------------------------------------------------------------
Fee Waivers and Expense Reimbursements(3) (9.69%) (8.10%) (16.17%) (1,638.28%)
----------------------------------------------------------------------------------------------------------
Total Annual Fund Operating Expenses
After Fee Waivers and Expense Reimbursements 1.93% 2.68% 1.68% 2.18%
----------------------------------------------------------------------------------------------------------
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1 For Class A shares purchased at net asset value without a sales charge
because the purchase amount exceeded $1 million, where the financial
intermediary did not waive the sales commission, a contingent deferred
sales charge of 1% is imposed on any redemption within 12 months of
purchase. The contingent deferred sales charge on Class C shares
applies only to redemptions within 12 months of purchase.
2 Acquired Fund Fees and Expenses are not taken into consideration in the
expense limitation because they are not Fund operating expenses, but
rather, are imputed fees and expenses.
3 The investment advisor and sub-advisor have agreed to waive fees and
reimburse expenses through February 28, 2015 so that Total Annual Fund
Operating Expenses (excluding 12b-1 distribution and service fees,
interest expenses, taxes, fees incurred in acquiring and disposing of
portfolio securities, and extraordinary expenses) do not exceed 1.35%
of the average daily net assets of any class of Fund shares. Total
Annual Fund Operating Expenses (excluding 12b-1 distribution and
service fees, interest expenses, taxes, fees incurred in acquiring and
disposing of portfolio securities, and extraordinary expenses) will not
exceed 1.70% from March 1, 2015 through February 28, 2024. Expense
limitations may be terminated or modified prior to their expiration
only with the approval of the Board of Trustees of the First Trust
Series Fund (the "Trust").
6
First Trust/Confluence Small Cap Value Fund
EXAMPLE
The following example is intended to help you compare the cost of investing in
the Fund with the cost of investing in other mutual funds. The example assumes
that you invest $10,000 in the Fund for the time periods indicated. The example
also assumes that your investment has a 5% return each year and that the Fund's
annual operating expenses remain at current levels until February 28, 2015 and
then will not exceed 1.70% from March 1, 2015 until February 28, 2024. Although
your actual costs may be higher or lower, based on these assumptions your costs
would be:
----------------------------------------------------------------------------------------------------------------
REDEMPTION NO REDEMPTION
----------------------------------------------------------------------------------------------------------------
SHARE CLASS A C I R3 A C I R3
----------------------------------------------------------------------------------------------------------------
1 Year $ 735 $ 371 $ 171 $ 221 $ 735 $ 271 $ 171 $ 221
----------------------------------------------------------------------------------------------------------------
3 Years 1,181 892 591 743 1,181 892 591 743
----------------------------------------------------------------------------------------------------------------
5 Years 1,663 1,550 1,050 1,303 1,663 1,550 1,050 1,303
----------------------------------------------------------------------------------------------------------------
10 Years 2,987 3,313 2,321 2,830 2,987 3,313 2,321 2,830
----------------------------------------------------------------------------------------------------------------
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PORTFOLIO TURNOVER
The Fund pays transaction costs, such as commissions, when it buys and sells
securities (or "turns over" its portfolio). A higher portfolio turnover rate may
indicate higher transaction costs and may result in higher taxes when Fund
shares are held in a taxable account. These costs, which are not reflected in
Annual Fund Operating Expenses or in the example, affect the Fund's performance.
During the most recent fiscal year, the Fund's portfolio turnover rate was 31%
of the average value of its portfolio.
PRINCIPAL INVESTMENT STRATEGIES
The Fund seeks to achieve its investment objective by investing, under normal
market conditions, at least 80% of its net assets (including investment
borrowings) in equity securities of U.S. listed companies with small market
capitalizations ("Small-Cap Companies") at the time of investment. Currently, a
company will be considered to be a Small-Cap Company if its market
capitalization at the time of purchase is within the range of companies in the
Russell 2000 Index or the S&P SmallCap 600 Index during the most recent 12-month
period (based on month-end data). Because market capitalization is measured at
the time of initial purchase, if the market capitalization of a company included
in the Fund grows above "small-cap," the Fund shall not be required to sell such
security solely because it is no longer a Small-Cap Company.
The portfolio managers seek to invest in Small-Cap Companies that in the
portfolio managers' opinion have produced solid returns over extended periods of
time. The portfolio managers' investment strategy is based on the rationale that
a company which creates superior value, reflected in above-average operating
returns, will ultimately have a stock price reflecting that superior
performance.
The portfolio managers follow a disciplined, research driven, investment process
which seeks to uncover companies trading at discounts to their intrinsic values.
By investing in stocks according to a value-based investment philosophy, the
portfolio managers seek to enhance the long-term growth potential while limiting
downside risk. Companies in which the portfolio managers invest are those that
the portfolio managers expect to create above-average growth in value relative
to their industries and to the overall market. These companies may include real
estate investment trusts ("REITs") and business development companies ("BDCs").
Once such a company is identified, an extensive valuation analysis is performed
to determine if its stock price reflects its underlying value.
PRINCIPAL RISKS
You could lose money by investing in the Fund. There can be no assurance that
the Fund will achieve its investment objective. An investment in the Fund is not
a deposit of a bank and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other governmental agency.
BDC RISK. The Fund may invest in BDCs which may carry risks similar to those of
a private equity or venture capital fund. BDCs are not redeemable at the option
of the shareholder and they may trade in the market at a discount to their net
asset value. The BDCs held by the Fund may employ the use of leverage their
portfolios through borrowings or the issuance of preferred stock. While leverage
7
First Trust/Confluence Small Cap Value Fund
often serves to increase the yield of a BDC, this leverage also subjects a BDC
to increased risks, including the likelihood of increased volatility and the
possibility that a BDC's common share income will fall if the dividend rate of
the preferred shares or the interest rate on any borrowings rises.
EQUITY SECURITIES RISK. The Fund invests in equity securities. The value of Fund
shares will fluctuate with changes in the value of these equity securities.
Equity securities prices fluctuate for several reasons, including changes in
investors' perceptions of the financial condition of an issuer or the general
condition of the relevant stock market, such as the current market volatility,
or when political or economic events affecting the issuers occur. In addition,
common stock prices may be particularly sensitive to rising interest rates, as
the cost of the capital rises and borrowing costs increase.
FINANCIAL COMPANIES RISK. Financial companies are especially subject to the
adverse effects of economic recession, currency exchange rates, government
regulation, decreases in the availability of capital, volatile interest rates,
portfolio concentrations in geographic markets and in commercial and residential
real estate loans, and competition from new entrants in their fields of
business.
INDUSTRIALS COMPANIES RISK. Industrials companies convert unfinished goods into
finished durables used to manufacture other goods or provide services. Some
industrials companies are involved in electrical equipment and components,
industrial products, manufactured housing and telecommunications equipment.
General risks of industrials companies include the general state of the economy,
intense competition, consolidation, domestic and international politics, excess
capacity and consumer demand and spending trends. In addition, they may also be
significantly affected by overall capital spending levels, economic cycles,
technical obsolescence, delays in modernization, labor relations, government
regulations and e-commerce initiatives.
MARKET CAPITALIZATION RISK. The Fund normally invests at least 80% of its assets
in Small-Cap Companies. Because the market capitalization is measured at the
time of its initial purchase, the Fund will not be forced to sell a stock
because the stock has exceeded or fallen below the market capitalization range.
Because of market movement, there can be no assurance that the securities held
by the Fund will stay within the given market capitalization range. As a result,
the Fund may be exposed to additional risk or investors may not be given the
opportunity to invest fully in a certain market capitalization range.
MARKET RISK. Market risk is the risk that a particular security owned by the
Fund or shares of the Fund in general may fall in value. Shares are subject to
market fluctuations caused by such factors as economic, political, regulatory or
market developments, changes in interest rates and perceived trends in
securities prices. Overall Fund share values could decline generally or could
underperform other investments.
REAL ESTATE INVESTMENT RISK. The Fund invests in companies in the real estate
industry, including REITs. Therefore, the Fund is subject to the risks
associated with investing in real estate, which may include, but are not limited
to, fluctuations in the value of underlying properties; defaults by borrowers or
tenants; market saturation; changes in general and local economic conditions;
decreases in market rates for rents; increases in competition, property taxes,
capital expenditures or operating expenses; and other economic, political or
regulatory occurrences affecting companies in the real estate industry.
REIT RISK. In addition to risks related to investments in real estate generally,
investing in REITs involves certain other risks related to their structure and
focus, which include, but are not limited to, dependency upon management skills,
limited diversification, the risks of locating and managing financing for
projects, heavy cash flow dependency, possible default by borrowers, the costs
and potential losses of self-liquidation of one or more holdings, the risk of a
possible lack of mortgage funds and associated interest rate risks,
overbuilding, property vacancies, increases in property taxes and operating
expenses, changes in zoning laws, losses due to environmental damages, changes
in neighborhood values and appeal to purchasers, the possibility of failing to
maintain exemptions from registration under the 1940 Act and, in many cases,
relatively small market capitalization, which may result in less market
liquidity and greater price volatility.
REITs are also subject to the risk that the real estate market may experience an
economic downturn generally, which may have a material effect on the real estate
in which the REITs invest and their underlying portfolio securities.
SMALL CAP RISK. The Fund invests in Small-Cap Companies. Such companies may be
more vulnerable to adverse general market or economic developments, and their
securities may be less liquid and may experience greater price volatility than
larger, more established companies as a result of several factors, including
limited trading volumes, products or financial resources, management
inexperience and dependence on a few key people, and less publicly available
information. Accordingly, such companies are generally subject to greater market
risk than larger, more established companies. The market movements of equity
securities issued by issuers with smaller capitalizations may be more abrupt or
erratic than the market movements of equity securities of larger, more
established companies or the stock market in general. Historically, smaller
capitalization companies have sometimes gone through extended periods when they
8
First Trust/Confluence Small Cap Value Fund
did not perform as well as larger companies. In addition, equity securities of
Small-Cap Companies may be less liquid than those of larger companies.
VALUE INVESTING RISK. The Fund focuses its investments on securities that the
portfolio managers believe are undervalued or inexpensive relative to other
investments. These types of securities may present risks in addition to the
general risks associated with investing in them. These securities generally are
selected on the basis of an issuer's business and economic fundamentals or the
securities' current and projected credit profiles, relative to current market
price. Such securities are subject to the risk of misestimating certain
fundamental factors. Disciplined adherence to a "value" investment mandate
during periods in which that style is "out of favor" can result in significant
underperformance relative to overall market indices and other managed investment
vehicles that pursue growth style investments and/or flexible style mandates.
ANNUAL TOTAL RETURN
The bar chart and table below illustrate the calendar year returns of the Fund's
Class A shares for the past two years as well as the average annual Fund returns
for the one year and since inception periods ended December 31, 2013. The bar
chart and table provide an indication of the risks of investing in the Fund by
showing changes in the Fund's performance from year-to-year and by showing how
the Fund's Class A shares' average annual total returns compare to those of two
broad-based securities market indices. See "Total Return Information" for
additional performance information regarding the Fund. The Fund's performance
information is accessible on the Fund's website at www.ftportfolios.com.
Returns before taxes do not reflect the effects of any income or capital gains
taxes. All after-tax returns are calculated using the historical highest
individual federal marginal income tax rates and do not reflect the impact of
any state or local tax. Returns after taxes on distributions reflect the taxed
return on the payment of dividends and capital gains. Returns after taxes on
distributions and sale of shares assume you sold your shares at period end, and,
therefore, are also adjusted for any capital gains or losses incurred. After-tax
returns are shown for only Class A shares, and after-tax returns for other
Classes will vary. Returns for the market index do not include expenses, which
are deducted from Fund returns, or taxes.
Your own actual after-tax returns will depend on your specific tax situation and
may differ from what is shown here. After-tax returns are not relevant to
investors who hold Fund shares in tax-deferred accounts such as individual
retirement accounts (IRAs) or employee-sponsored retirement plans.
Imposition of the Fund's sales load is not reflected in the bar chart below. If
the sales load was reflected, returns would be less than those shown.
FIRST TRUST/CONFLUENCE SMALL CAP VALUE FUND--TOTAL RETURNS ON CLASS A SHARES
[GRAPHIC OMITTED]
[DATA POINTS REPRESENTED IN BAR CHART]
Calendar Year Total Return as of 12/31
Year %
------ --------
2012 15.20%
2013 24.93%
|
During the two-year period ended December 31, 2013, the Fund's highest and
lowest calendar quarter returns were 8.91% and -1.33%, respectively, for the
quarters ended September 30, 2013 and June 30, 2012. The Fund's past performance
(before and after taxes) is not necessarily an indication of how the Fund will
perform in the future.
10
First Trust/Confluence Small Cap Value Fund
AVERAGE ANNUAL TOTAL RETURNS FOR THE FUND FOR THE PERIODS ENDED DECEMBER 31, 2013
1 Year Since Inception
Inception Date
Class A - Return Before Taxes 18.06% 10.32% 2/24/2011
Class C - Return Before Taxes 22.97% 10.31% 3/2/2011
Class I - Return Before Taxes 26.22% 12.90% 1/11/2011
Class R3 - Return Before Taxes 24.62% 11.38% 3/2/2011
Class A - Return After Taxes on Distributions 16.63% 9.63% 2/24/2011
Class A - Return After Taxes on Distributions and Sale of Shares 10.90% 7.85% 2/24/2011
Russell 2000(R) Value Index 34.52% 14.34% 1/11/2011*
Russell 2000(R) Index 38.82% 15.47% 1/11/2011*
* Since Inception Index returns are based on inception date of the Class I shares.
|
MANAGEMENT
INVESTMENT ADVISOR
First Trust Advisors L.P. ("First Trust" or the "Advisor")
INVESTMENT SUB-ADVISOR
Confluence Investment Management LLC ("Confluence" or the "Sub-Advisor")
PORTFOLIO MANAGERS
The following persons are members of Confluence's investment committee and
serve as the portfolio managers of the Fund:
o Mark Keller, CFA, Chief Executive Officer and Chief Investment
Officer of Confluence;
o Daniel Winter, CFA, Senior Vice President and Portfolio Manager of
Confluence;
o David Miyazaki, CFA, Senior Vice President and Portfolio Manager of
Confluence; and
o Chris Stein, Vice President and Portfolio Manager of Confluence.
Each portfolio manager has managed the Fund since 2011.
PURCHASE AND SALE OF FUND SHARES
You may purchase, redeem or exchange shares of the Fund through a financial
advisor on any day the New York Stock Exchange ("NYSE") is open for business.
The minimum initial purchase or exchange into the Fund is $2,500 ($750 for a
Traditional/Roth IRA account; $500 for an Education IRA account; and $250 for
accounts opened through fee-based programs). The minimum subsequent investment
is $50. Class I shares are subject to higher minimums for certain investors and
Class R3 shares are not subject to any minimums. There are no minimums for
purchases or exchanges into the Fund through employer-sponsored retirement
plans.
TAX INFORMATION
The Fund's distributions will generally be taxed as ordinary income or capital
gains, unless you are investing through a tax-deferred arrangement, such as a
401(k) plan or an individual retirement account, in which case, your
distribution will be taxed upon withdrawal from the tax-deferred account.
Additionally, a sale of Fund shares is generally a taxable event.
PAYMENTS TO BROKER-DEALERS AND OTHER FINANCIAL INTERMEDIARIES
If you purchase the Fund through a broker-dealer or other financial intermediary
(such as a bank), First Trust and related companies may pay the intermediary for
the sale of Fund shares and related services. These payments may create a
conflict of interest by influencing the broker-dealer or other intermediary and
your salesperson to recommend the Fund over another investment. Ask your
salesperson or visit your financial intermediary's website for more information.
10
SUMMARY INFORMATION
First Trust Short Duration High Income Fund
INVESTMENT OBJECTIVES
The First Trust Short Duration High Income Fund (the "Fund") seeks to provide a
high level of current income. As a secondary objective, the Fund seeks capital
appreciation.
FEES AND EXPENSES OF THE FUND
This table describes the fees and expenses that you may pay if you buy and hold
shares of the Fund. You may qualify for sales charge discounts if you and your
family invest, or agree to invest in the future, at least $50,000 in the Fund or
in other First Trust mutual funds. More information about these and other
discounts, as well as eligibility requirements for each share class, is
available from your financial advisor and in "Share Classes" on page 32 of this
prospectus, "Investment in Fund Shares" on page 35 of this prospectus and
"Purchase and Redemption of Fund Shares" on page 59 of the Funds' statement of
additional information ("SAI").
SHAREHOLDER FEES
(fees paid directly from your investment)
-----------------------------------------------------------------------------------------------------------
CLASS A CLASS C CLASS I
-----------------------------------------------------------------------------------------------------------
Maximum Sales Charge (Load)
Imposed on Purchases (as a percentage of offering price) 3.50% None None
-----------------------------------------------------------------------------------------------------------
Maximum Deferred Sales Charge (Load)
(as a percentage of the lesser of purchase
price or redemption proceeds)(1) None 1.00% None
-----------------------------------------------------------------------------------------------------------
Maximum Sales Charge (Load)
Imposed on Reinvested Dividends None None None
-----------------------------------------------------------------------------------------------------------
Exchange Fee None None None
-----------------------------------------------------------------------------------------------------------
ANNUAL FUND OPERATING EXPENSES
(expenses that you pay each year as a percentage of the value of your investment)
-----------------------------------------------------------------------------------------------------------
CLASS A CLASS C CLASS I
-----------------------------------------------------------------------------------------------------------
Management Fee 0.65% 0.65% 0.65%
-----------------------------------------------------------------------------------------------------------
Distribution and Service (12b-1) Fees 0.25% 1.00% --%
-----------------------------------------------------------------------------------------------------------
Other Expenses 0.64% 0.64% 0.64%
-----------------------------------------------------------------------------------------------------------
Total Annual Fund Operating Expenses 1.54% 2.29% 1.29%
-----------------------------------------------------------------------------------------------------------
Fee Waivers and Expense Reimbursements(2) (0.29)% (0.29)% (0.29)%
-----------------------------------------------------------------------------------------------------------
Total Annual Fund Operating Expenses
After Fee Waivers and Expense Reimbursements 1.25% 2.00% 1.00%
-----------------------------------------------------------------------------------------------------------
|
1 For Class A shares purchased at net asset value without a sales charge
because the purchase amount exceeded $1 million, where the financial
intermediary did not waive the sales commission, a contingent deferred
sales charge of 1% is imposed on any redemption within 12 months of
purchase. The contingent deferred sales charge on Class C shares
applies only to redemptions within 12 months of purchase.
2 The investment advisor has agreed to waive fees and reimburse expenses
through February 28, 2015 so that Total Annual Fund Operating Expenses
(excluding 12b-1 distribution and service fees, interest expenses,
taxes, fees incurred in acquiring and disposing of portfolio
securities, and extraordinary expenses) do not exceed 1.00% of the
average daily net assets of any class of Fund shares. Total Annual Fund
Operating Expenses (excluding 12b-1 distribution and service fees,
interest expenses, taxes, fees incurred in acquiring and disposing of
portfolio securities, and extraordinary expenses) will not exceed 1.35%
from March 1, 2015 through February 28, 2024. Expense limitations may
be terminated or modified prior to their expiration only with the
approval of the Board of Trustees of the First Trust Series Fund (the
"Trust").
11
First Trust Short Duration High Income Fund
EXAMPLE
The following example is intended to help you compare the cost of investing in
the Fund with the cost of investing in other mutual funds. The example assumes
that you invest $10,000 in the Fund for the time periods indicated. The example
also assumes that your investment has a 5% return each year and that the Fund's
annual operating expenses remain at current levels until February 28, 2015 and
then will not exceed 1.35% from March 1, 2015 until February 28, 2024. Although
your actual costs may be higher or lower, based on these assumptions your costs
would be:
----------------------------------------------------------------------------------------------------------------
REDEMPTION NO REDEMPTION
----------------------------------------------------------------------------------------------------------------
SHARE CLASS A C I A C I
----------------------------------------------------------------------------------------------------------------
1 Year $ 473 $ 303 $ 102 $ 473 $ 203 $ 102
----------------------------------------------------------------------------------------------------------------
3 Years 783 678 370 783 678 370
----------------------------------------------------------------------------------------------------------------
5 Years 1,124 1,190 670 1,124 1,190 670
----------------------------------------------------------------------------------------------------------------
10 Years 2,088 2,595 1,522 2,088 2,595 1,522
----------------------------------------------------------------------------------------------------------------
|
PORTFOLIO TURNOVER
The Fund pays transaction costs, such as commissions, when it buys and sells
securities (or "turns over" its portfolio). A higher portfolio turnover rate may
indicate higher transaction costs and may result in higher taxes when Fund
shares are held in a taxable account. These costs, which are not reflected in
Annual Fund Operating Expenses or in the example, affect the Fund's performance.
During the most recent fiscal year, the Fund's portfolio turnover rate was 89%
of the average value of its portfolio.
PRINCIPAL INVESTMENT STRATEGIES
Under normal market conditions, the Fund invests at least 80% of its net assets
(including investment borrowings) in high yield debt securities and bank loans
that are rated below-investment grade or unrated. High yield debt securities are
below-investment grade debt securities, commonly known as "junk bonds." For
purposes of determining whether a security is below-investment grade, the lowest
available rating is used.
The Fund has a short duration investment strategy, which seeks to maintain,
under normal market conditions, a blended (or weighted average) portfolio
duration of three years or less. Duration is a mathematical calculation of the
average life of a debt security (or portfolio of debt securities) that serves as
a measure of its price risk. In general, each year of duration represents an
expected 1% change in the value of a security for every 1% immediate change in
interest rates. For example, if a portfolio of bank loans and fixed income
securities has an average duration of three years, its value can be expected to
fall about 3% if interest rates rise by 1%. Conversely, the portfolio's value
can be expected to rise about 3% if interest rates fall by 1%. As a result,
prices of instruments with shorter durations tend to be less sensitive to
interest rate changes than instruments with longer durations. As the value of a
security changes over time, so will its duration.
Bank loans have relatively low durations, i.e., close to zero, which means that
the interest rates on loans reset approximately every 30-90 days, on average,
however, the inclusion of London Interbank Offered Rate ("LIBOR") floors on
certain senior loans or other factors may cause interest rate duration to be
longer than 90 days. Accordingly, the Fund's investment in such securities will
likely reduce the blended duration of the portfolio and in turn the Fund's
overall interest rate sensitivity. "Average duration" is the measure of a debt
instrument's or a portfolio's price sensitivity with respect to changes in
market yields.
Under normal market conditions, the Fund may invest up to 15% of its net assets
in non-U.S. securities denominated in non-U.S. currencies. The Fund may also
invest in investment grade debt securities and convertible bonds.
PRINCIPAL RISKS
You could lose money by investing in the Fund. There can be no assurance that
the Fund will achieve its investment objectives. An investment in the Fund is
not a deposit of a bank and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other governmental agency.
12
First Trust Short Duration High Income Fund
BANK LOANS RISK. An investment in bank loans subjects the Fund to credit risk,
which is heightened for loans in which the Fund invests because companies that
issue such loans tend to be highly leveraged and thus are more susceptible to
the risks of interest deferral, default and/or bankruptcy. Senior floating rate
loans, in which the Fund invests, are usually rated below-investment grade but
may also be unrated. As a result, the risks associated with these loans are
similar to the risks of below-investment grade fixed income instruments. An
economic downturn would generally lead to a higher non-payment rate, and a
senior floating rate loan may lose significant market value before a default
occurs. Moreover, any specific collateral used to secure a senior floating rate
loan may decline in value or become illiquid, which would adversely affect the
loan's value. Unlike the securities markets, there is no central clearinghouse
for loan trades, and the loan market has not established enforceable settlement
standards or remedies for failure to settle. Therefore, portfolio transactions
in loans may have uncertain settlement time periods. Senior floating rate loans
are subject to a number of risks described elsewhere in this prospectus,
including liquidity risk and the risk of investing in below-investment grade
fixed income instruments. Furthermore, increases in interest rates may result in
greater volatility of senior floating rate loans and average interest rate
duration may fluctuate with movements in interest rates.
CONVERTIBLE BONDS RISK. The market values of convertible bonds tend to decline
as interest rates increase and, conversely, to increase as interest rates
decline. A convertible bond's market value also tends to reflect the market
price of the common stock of the issuing company.
CREDIT RISK. Credit risk is the risk that an issuer of a security may be unable
or unwilling to make dividend, interest and principal payments when due and the
related risk that the value of a security may decline because of concerns about
the issuer's ability or willingness to make such payments. Credit risk may be
heightened for the Fund because it invests a substantial portion of its net
assets in high yield or "junk" debt; such securities, while generally offering
higher yields than investment grade debt with similar maturities, involve
greater risks, including the possibility of dividend or interest deferral,
default or bankruptcy, and are regarded as predominantly speculative with
respect to the issuer's capacity to pay dividends or interest and repay
principal. Credit risk is heightened for loans in which the Fund invests because
companies that issue such loans tend to be highly leveraged and thus are more
susceptible to the risks of interest deferral, default and/or bankruptcy.
CURRENCY RISK. The Fund may hold investments that are denominated in non-U.S.
currencies, or in securities that provide exposure to such currencies, currency
exchange rates or interest rates denominated in such currencies. Changes in
currency exchange rates and the relative value of non-U.S. currencies will
affect the value of the Fund's investment and the value of your Fund shares.
Currency exchange rates can be very volatile and can change quickly and
unpredictably. As a result, the value of an investment in the Fund may change
quickly and without warning and you may lose money.
HIGH YIELD SECURITIES RISK. High yield securities, or "junk bonds," are subject
to greater market fluctuations and risk of loss than securities with higher
investment ratings. These securities are issued by companies that may have
limited operating history, narrowly focused operations, and/or other impediments
to the timely payment of periodic interest and principal at maturity. If the
economy slows down or dips into recession, the issuers of high yield securities
may not have sufficient resources to continue making timely payment of periodic
interest and principal at maturity. The market for high yield securities is
smaller and less liquid than that for investment grade securities. High yield
securities are generally not listed on a national securities exchange but trade
in the over-the-counter markets. Due to the smaller, less liquid market for high
yield securities, the bid-offer spread on such securities is generally greater
than it is for investment grade securities and the purchase or sale of such
securities may take longer to complete.
INCOME RISK. If interest rates fall, the income from the Fund's portfolio may
decline as the Fund generally holds floating rate debt that will adjust lower
with falling interest rates. For loans, interest rates typically reset every 30
to 90 days.
INTEREST RATE RISK. Interest rate risk is the risk that the value of the debt
securities held by the Fund will decline because of rising market interest
rates. Interest rate risk is generally lower for shorter term investments and
higher for longer term investments. Duration is a common measure of interest
rate risk, which measures a bond's expected life on a present value basis,
taking into account the bond's yield, interest payments and final maturity.
Duration is a reasonably accurate measure of a bond's price sensitivity to
changes in interest rates. The longer the duration of a bond, the greater the
bond's price sensitivity is to changes in interest rates.
LIQUIDITY RISK. The Fund invests a substantial portion of its assets in
lower-quality debt issued by companies that are highly leveraged. Lower-quality
debt tends to be less liquid than higher-quality debt. Moreover, smaller debt
issues tend to be less liquid than larger debt issues. If the economy
experiences a sudden downturn, or if the debt markets for such companies become
distressed, the Fund may have particular difficulty selling its assets in
sufficient amounts, at reasonable prices and in a sufficiently timely manner to
raise the cash necessary to meet any potentially heavy redemption requests by
Fund shareholders.
13
First Trust Short Duration High Income Fund
MARKET RISK. Market risk is the risk that a particular security owned by the
Fund or shares of the Fund in general may fall in value. Shares are subject to
market fluctuations caused by such factors as economic, political, regulatory or
market developments, changes in interest rates and perceived trends in
securities prices. Overall Fund share values could decline generally or could
underperform other investments.
NON-U.S. SECURITIES RISK. Non-U.S. securities are subject to higher volatility
than securities of domestic issuers due to possible adverse political, social or
economic developments; restrictions on foreign investment or exchange of
securities; lack of liquidity; currency exchange rates; excessive taxation;
government seizure of assets; different legal or accounting standards; and less
government supervision and regulation of exchanges in foreign countries.
PREPAYMENT RISK. Loans and other fixed income investments are subject to
prepayment risk. The degree to which borrowers prepay loans, whether as a
contractual requirement or at their election, may be affected by general
business conditions, the financial condition of the borrower and competitive
conditions among loan investors, among others. As such, prepayments cannot be
predicted with accuracy. Upon a prepayment, either in part or in full, the
actual outstanding debt on which the Fund derives interest income will be
reduced. The Fund may not be able to reinvest the proceeds received on terms as
favorable as the prepaid loan.
ANNUAL TOTAL RETURN
The bar chart and table below illustrate the calendar year return of the Fund's
Class A shares for the past year as well as the average annual Fund returns for
the one year and since inception periods ended December 31, 2013. The bar chart
and table provide an indication of the risks of investing in the Fund by showing
how the Fund's Class A shares' average annual total returns compare to those of
a specialized securities market index and two broad-based securities market
indices. See "Total Return Information" for additional performance information
regarding the Fund. The Fund's performance information is accessible on the
Fund's website at www.ftportfolios.com.
Returns before taxes do not reflect the effects of any income or capital gains
taxes. All after-tax returns are calculated using the historical highest
individual federal marginal income tax rates and do not reflect the impact of
any state or local tax. Returns after taxes on distributions reflect the taxed
return on the payment of dividends and capital gains. Returns after taxes on
distributions and sale of shares assume you sold your shares at period end, and,
therefore, are also adjusted for any capital gains or losses incurred. After-tax
returns are shown for only Class A shares, and after-tax returns for other
Classes will vary. Returns for the market index do not include expenses, which
are deducted from Fund returns, or taxes.
Your own actual after-tax returns will depend on your specific tax situation and
may differ from what is shown here. After-tax returns are not relevant to
investors who hold Fund shares in tax-deferred accounts such as individual
retirement accounts (IRAs) or employee-sponsored retirement plans.
Imposition of the Fund's sales load is not reflected in the bar chart below. If
the sales load was reflected, returns would be less than those shown.
FIRST TRUST SHORT DURATION HIGH INCOME FUND--TOTAL RETURN ON CLASS A SHARES
[GRAPHIC OMITTED]
[DATA POINTS REPRESENTED IN BAR CHART]
Calendar Year Total Return as of 12/31
Year %
------ --------
2013 7.43%
|
During the year ended December 31, 2013, the Fund's highest and lowest calendar
quarter returns were 3.78% and 0.23%, respectively, for the quarters ended March
31, 2013 and June 30, 2013. The Fund's past performance (before and after taxes)
is not necessarily an indication of how the Fund will perform in the future.
14
First Trust Short Duration High Income Fund
AVERAGE ANNUAL TOTAL RETURNS FOR THE FUND FOR THE PERIODS ENDED DECEMBER 31, 2013
1 Year Since Inception
Inception Date
Class A - Return Before Taxes 3.67% 4.05% 11/1/2012
Class C - Return Before Taxes 5.64% 6.48% 11/1/2012
Class I - Return Before Taxes 7.69% 7.55% 11/1/2012
Class A - Return After Taxes on Distributions 1.64% 2.17% 11/1/2012
Class A - Return After Taxes on Distributions and Sale of Shares 2.05% 2.24% 11/1/2012
Blended Benchmark + 6.36% 6.93% 11/1/2012*
BofA Merrill Lynch U.S. High Yield Master II Constrained Index 7.41% 8.35% 11/1/2012*
S&P/LSTA Leveraged Loan Index 5.29% 5.50% 11/1/2012*
+ The Blended Benchmark return is a 50/50 split between the BofA Merrill
Lynch U.S. High Yield Master II Constrained Index and the S&P/LSTA
Leveraged Loan Index returns.
* Since Inception Index returns are based on inception date of the Fund.
|
MANAGEMENT
INVESTMENT ADVISOR
First Trust Advisors L.P. ("First Trust" or the "Advisor")
PORTFOLIO MANAGERS
The following persons serve as the portfolio managers of the Fund:
o William Housey, Senior Vice President of First Trust;
o Scott D. Fries, Senior Vice President of First Trust; and
o Peter Fasone, Vice President of First Trust.
Each portfolio manager has managed the Fund since 2012.
PURCHASE AND SALE OF FUND SHARES
You may purchase, redeem or exchange shares of the Fund through a financial
advisor on any day the New York Stock Exchange ("NYSE") is open for business.
The minimum initial purchase or exchange into the Fund is $2,500 ($750 for a
Traditional/Roth IRA account; $500 for an Education IRA account; and $250 for
accounts opened through fee-based programs). The minimum subsequent investment
is $50. Class I shares are subject to higher minimums for certain investors.
There are no minimums for purchases or exchanges into the Fund through
employer-sponsored retirement plans.
TAX INFORMATION
The Fund's distributions will generally be taxed as ordinary income or capital
gains, unless you are investing through a tax-deferred arrangement, such as a
401(k) plan or an individual retirement account, in which case, your
distribution will be taxed upon withdrawal from the tax-deferred account.
Additionally, a sale of Fund shares is generally a taxable event.
PAYMENTS TO BROKER-DEALERS AND OTHER FINANCIAL INTERMEDIARIES
If you purchase the Fund through a broker-dealer or other financial intermediary
(such as a bank), First Trust and related companies may pay the intermediary for
the sale of Fund shares and related services. These payments may create a
conflict of interest by influencing the broker-dealer or other intermediary and
your salesperson to recommend the Fund over another investment. Ask your
salesperson or visit your financial intermediary's website for more information.
15
ADDITIONAL INFORMATION ON THE FUNDS' INVESTMENT OBJECTIVES AND STRATEGIES
Each Fund's investment objective(s) is/are fundamental and may not be changed
without approval by the holders of a majority of the outstanding voting
securities of such Fund. Unless an investment policy is identified as being
fundamental, all investment policies included in this prospectus and in the
Funds' SAI are non-fundamental and may be changed by the Board of Trustees (the
"Board") of the First Trust Series Fund (the "Trust"), of which each Fund is a
series, without shareholder approval. If there is a material change to a Fund's
principal investment strategies, you should consider whether such Fund remains
an appropriate investment for you.
The First Trust Preferred Securities and Income Fund (the "Preferred Fund") and
the First Trust/Confluence Small Cap Value Fund (the "Small Cap Fund") have each
adopted a non-fundamental investment policy pursuant to Rule 35d-1 under the
1940 Act (each a "Name Policy") whereby the Preferred Fund, under normal market
conditions, will invest at least 80% of its net assets (including investment
borrowings) in preferred securities and other securities with similar economic
characteristics. The Small Cap Fund, under normal market conditions, will invest
at least 80% of its net assets (including investment borrowings) in equity
securities of U.S. listed companies with small market capitalizations at the
time of investment. If the market capitalization of a company included in the
Small Cap Fund grows above "small-cap," the Small Cap Fund shall not be required
to sell such security. A Fund's Name Policy may be changed by the Board without
shareholder approval upon 60 days' prior written notice.
For the Small Cap Fund, Confluence seeks to invest in stocks of companies with
small market capitalizations that, in Confluence's opinion, have produced solid
returns over extended periods of time. Confluence deems a company to be suitable
if it possesses substantial competitive advantages, such as an ability to
maintain the pricing of its products and to operate in markets in which there
are considerable barriers against potential competitors. These competitive
advantages may include strong brand names, highly differentiated services or
products, dominant market share, flexible pricing power, protected technology or
specialized industrial skill set. These companies typically generate cash in
amounts that exceed their reinvestment needs and operating obligations with
managements that are predisposed to return such free cash flow to shareholders.
Desirable companies generally have senior management with large personal
investments in their companies' shares and that have proven track records of
value-enhanced capital allocation decisions.
Confluence defines risk as the probability of permanent loss of capital. To
protect against this risk, Confluence seeks quality businesses at attractive
valuations that are diversified across a variety of markets. In Confluence's
opinion, this discipline has the potential to help protect against losses, while
enhancing upside potential. Confluence may decide to sell a company's stock if,
in Confluence's opinion: (i) the share price reaches Confluence's estimate of
full valuation; (ii) the company's fundamentals deteriorate; (iii) more
attractive opportunities are identified-the least attractive or most overpriced
stock held may be sold to raise cash to fund the new purchase; or (iv) the
relative price performance trails its peer group or appropriate market index.
The Small Cap Fund may invest in securities of other investment companies,
including exchange-traded funds ("ETFs"), that invest primarily in securities of
Small-Cap Companies. Confluence generally expects that it may invest in such
other investment companies either during periods when it has large amounts of
uninvested cash or in anticipation of orderly purchases of securities of
Small-Cap Companies at prices Confluence considers to be reasonable. Securities
of such investment companies will be considered Small-Cap Companies for purposes
of the Small Cap Fund's Name Policy. Confluence may also use various investment
techniques to increase or decrease the Small Cap Fund's exposure to changing
security prices or other factors that affect security values. If Confluence's
strategies do not work as intended, the Small Cap Fund may not achieve its
investment objective.
The First Trust Short Duration High Income Fund (the "Short Duration Fund")
pursues its objectives by investing in debt securities and bank loans that are
rated below-investment grade or unrated at the time of purchase. In addition,
the Short Duration Fund may invest in other debt securities including
convertible bonds, senior floating rate loans, secured and unsecured loans,
second lien loans and other junior or bridge loans. Although many of the Short
Duration Fund's investments may consist of securities rated below-investment
grade, the Short Duration Fund reserves the right to invest in debt securities,
including senior floating rate loans, of any credit quality, maturity and
duration. The Short Duration Fund may also invest in investment grade debt
securities or preferred stocks. "Investment grade" is defined as those
securities that have a long-term credit rating of "BBB-" or higher by S&P, or
"Baa3" or higher by Moody's or comparably rated by another nationally recognized
statistical rating organization ("NRSRO"). The Short Duration Fund may also
invest in securities that are unrated by an NRSRO if such securities are of
comparable credit quality. The Short Duration Fund may also invest in securities
of other open-end or closed-end investment companies, including ETFs, that
invest primarily in securities of the types in which the Fund may invest
directly. Furthermore, the Short Duration Fund may invest in certain
derivatives, including, but not limited to, when-issued securities, forward
commitments, futures contracts and interest rate swaps. The Short Duration Fund
has a short duration investment strategy, which seeks to maintain, under normal
market conditions, a blended (or weighted average) portfolio duration of three
16
years or less. "Average duration" is the measure of a debt instrument's or a
portfolio's price sensitivity with respect to changes in market yields.
There is no guarantee that the Funds will achieve their investment objectives.
FUND INVESTMENTS
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Normally, the Funds may invest in securities with maturities of less than one
year or cash equivalents, or they may hold cash. The percentage of a Fund
invested in such holdings varies and depends on several factors, including
market conditions. For temporary defensive purposes and during periods of high
cash inflows or outflows, a Fund may depart from its principal investment
strategies and invest part or all of its assets in these securities or it may
hold cash. During such periods, the Fund may not be able to achieve its
investment objective(s). The Funds do not generally limit large inflows and
outflows, but may adopt a policy which seeks to reduce the impact of these flows
where First Trust has prior knowledge of them. A Fund may adopt a defensive
strategy when the Advisor believes securities in which the Fund normally invests
have elevated risks due to political or economic factors and in other
extraordinary circumstances. For more information on eligible short-term
investments, see the SAI.
PREFERRED FUND
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities. An investment in convertible
securities is not a principal investment strategy of the Fund. Convertible
securities combine the investment characteristics of bonds and common stocks.
Convertible securities typically consist of debt securities or preferred stock
that may be converted within a specified period of time (typically for the
entire life of the security) into a certain amount of common stock or other
equity security of the same or a different issuer at a predetermined price. They
also include debt securities with warrants or common stock attached and
derivatives combining the features of debt securities and equity securities.
Convertible securities entitle the holder to receive interest paid or accrued on
debt, or dividends paid or accrued on preferred stock, until the security
matures or is redeemed, converted or exchanged.
DEBT SECURITIES
The Fund may invest in a variety of debt securities, including corporate debt
securities and U.S. government securities. Corporate debt securities are
fixed-income securities issued by businesses to finance their operations. Notes,
bonds, debentures and commercial paper are the most common types of corporate
debt securities, with the primary difference being their maturities and secured
or unsecured status. Commercial paper has the shortest term and is usually
unsecured. Certain debt securities held by the Fund may include debt instruments
that have economic characteristics that are similar to preferred securities,
which shall be included in the 80% requirement for purposes of the Name Policy.
Such debt instruments are typically issued by corporations, generally in the
form of interest bearing notes, or by an affiliated business trust of a
corporation, generally in the form of (i) beneficial interests in subordinated
debentures or similarly structured securities or (ii) more senior debt
securities that pay income and trade in a manner similar to preferred
securities. Such debt instruments that have economic characteristics similar to
preferred securities include, trust preferred securities, hybrid trust preferred
securities and senior notes/baby bonds.
TRUST PREFERRED SECURITIES -- Trust preferred securities combine features of
corporate debt securities and preferred stock. The securities generally pay
quarterly income. U.S. issues usually have long maturities, while foreign issues
are normally perpetual. The creation of a trust preferred generally begins with
a company establishing a Delaware limited business trust. The trust issues
preferred securities to the public and uses the proceeds to purchase junior
subordinated debentures from that company. The terms of the debentures are
essentially the same as the terms of the preferred securities. Trust preferreds
represent the "preferred" interest in trusts that hold junior subordinated
deferrable debentures of the issuer. The parent may then use the proceeds for
general corporate purposes.
The issuer of trust preferred securities are generally able to defer or skip
payments for up to five years without being in default. In the event that the
issuer skips or defers a payment, the holder of the security is generally still
subject to taxation on the missed payments.
HYBRID TRUST PREFERRED SECURITIES -- Hybrid trust preferred securities have many
characteristics that are similar to traditional trust preferred securities. The
following items are some of the distinguishing features found in most hybrid
structures.
o The securities have long-term maturities (a minimum of 30 years) or
are perpetual. They typically rank senior to common shares and perpetual
preferred shares, and junior to senior debt and trust preferred
securities.
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o In most cases, the issuer is allowed to defer the coupon payments for
up to 10 years, provided certain conditions are met. The investor would
still face tax liability on the skipped payments. In perpetual
structures issued by foreign corporations, the issuer can generally skip
a payment for an unlimited period without being in default, and the
investor faces no tax liability on the skipped payments.
o Some of the $25 par securities have mandatory payment deferral
provisions that list objective financial criteria that would require the
issuer to skip a coupon payment. Such provisions remove some of
management's discretion in deciding to skip a payment.
o Most cumulative issues have an Alternative Payment Mechanism ("APM")
in the event that the issuer cannot meet its coupon payments. At certain
times, the issuer may issue new common stock to finance the deferred
payment. In many cases, the APM becomes mandatory after five years of
payment deferment.
o Most hybrid securities have "replacement language" that requires an
issue to be replaced with a security of equal or greater equity credit.
The language can be in the form of either a replacement capital
covenant, or stated intent.
o Some hybrid securities have replacement capital covenants that can
determine when the security will be redeemed. The replacement capital
covenants limit the issuer to raising funds to redeem the securities at
the 30-year scheduled date only by issuing new securities with equal or
greater equity content than the maturing issue. If the issuer is unable
to do so when the scheduled maturity date arrives, the security remains
outstanding until the final maturity. In many cases, the coupon on the
security turns from fixed to floating in the period between the
scheduled and final maturity date.
SENIOR NOTES/BABY BONDS -- Senior notes, also called baby bonds, are bonds
designed to trade like preferred securities. They trade in $25 par amounts, pay
quarterly interest, and are typically callable five years after issuance. Unlike
the other structures, the issuer generally cannot skip or defer payments on
senior notes without entering into default. These bonds rank higher in the
capital structure than hybrids, trusts preferreds and traditional preferreds.
The payments on senior notes/baby bonds are generally cumulative, in that the
issuer must make good on all missed payments before making any payout on a
junior ranking security such as a hybrid, trust preferred, or perpetual
preferred security.
U.S. GOVERNMENT SECURITIES -- U.S. government securities include U.S. Treasury
obligations and securities issued or guaranteed by various agencies of the U.S.
government, or by various instrumentalities which have been established or
sponsored by the U.S. government. U.S. Treasury obligations are backed by the
"full faith and credit" of the U.S. government. Securities issued or guaranteed
by federal agencies and U.S. government sponsored instrumentalities may or may
not be backed by the full faith and credit of the U.S. government.
OTHER DEBT SECURITIES -- The broad category of corporate debt securities
includes debt issued by U.S. and non-U.S. companies of all kinds, including
those with small-, mid- and large-capitalizations. Corporate debt may be rated
investment-grade or below investment-grade and may carry fixed or floating rates
of interest. The Preferred Fund may also invest in senior loans, second lien
loans, loan participations, payment-in-kind securities, zero coupon bonds, bank
certificates of deposit, fixed-time deposits, bankers acceptances, U.S.
government securities or fixed-income securities issued by non-U.S. governments
denominated in U.S. dollars.
FINANCIAL COMPANY SECURITIES
The Fund invests at least 25% of its assets in the securities of financial
companies. Financial companies include, but are not limited to, companies
involved in activities such as banking, mortgage finance, consumer finance,
specialized finance, investment banking and brokerage, asset management and
custody, corporate lending, insurance, and financial investment, and real
estate, including, but not limited to, REITs.
HEDGING
The Fund may use futures, interest rate swaps, total return swaps, credit
default swaps, options and other derivative instruments and may short certain
securities to hedge some of the risks of its investments in securities, as a
substitute for a position in the underlying asset, to reduce transaction costs,
to maintain full market exposure (which means to adjust the characteristics of
their investments to more closely approximate those of the markets in which they
invest), to manage cash flows or to preserve capital. The use of such
instruments is not a principal investment strategy of the Fund.
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in securities and other
instruments that are, at the time of investment, illiquid (determined using the
Securities and Exchange Commission's ("SEC") standard applicable to investment
companies, i.e. securities that cannot be disposed of within seven days in the
ordinary course of business at approximately the amount at which the Fund has
valued the securities). For this purpose, illiquid securities may include, but
are not limited to, restricted securities (securities the disposition of which
18
is restricted under the federal securities laws); securities that may only be
resold pursuant to Rule 144A under the Securities Act of 1933, as amended (the
"Securities Act"), that are deemed to be illiquid; and certain repurchase
agreements.
NON-U.S. INVESTMENTS
The Fund may invest in U.S. dollar-denominated depositary receipts, U.S.
dollar-denominated foreign securities and non-U.S. dollar-denominated
securities.
PREFERRED SECURITIES
The Fund invests in preferred securities. Preferred securities generally pay
fixed or adjustable-rate dividends or interest to investors and have preference
over common stock in the payment of dividends or interest and the liquidation of
a company's assets, which means that a company typically must pay dividends or
interest on its preferred securities before paying any dividends on its common
stock. Preferred securities are generally junior to all forms of the company's
debt, including both senior and subordinated debt.
While some preferred securities are issued with a final maturity date, others
are perpetual in nature. In certain instances, a final maturity date may be
extended and/or the final payment of principal may be deferred at the issuer's
option for a specified time without any adverse consequence to the issuer. No
redemption can typically take place unless all cumulative payment obligations to
preferred security investors have been met, although issuers may be able to
engage in open-market repurchases without regard to any cumulative dividends or
interest payable. A portion of the portfolio may include investments in
non-cumulative preferred securities, whereby the issuer does not have an
obligation to make up any arrearages to holders of such securities. Should an
issuer default on its obligations under such a security, the amount of income
earned by the Fund may be adversely affected.
Preferred securities may be issued by trusts or other special purpose entities
established by operating companies, and therefore may not be direct obligations
of operating companies. At the time a trust or special purpose entity sells its
preferred securities to investors, the trust or special purpose entity generally
purchases debt of the operating company (with terms comparable to those of the
trust or special purpose entity securities). The trust or special purpose
entity, as the holder of the operating company's debt, has priority with respect
to the operating company's earnings and profits over the operating company's
common shareholders, but is typically subordinated to other classes of the
operating company's debt. Typically a preferred share has a rating that is below
that of its corresponding operating company's senior debt securities due to its
subordinated nature.
SMALL CAP FUND
BUSINESS DEVELOPMENT COMPANIES
BDCs are a type of closed-end fund regulated under the 1940 Act that typically
invest in and lend to small and medium-sized private and certain public
companies that may not have access to public equity markets for capital raising.
BDCs invest in such diverse industries as healthcare, chemical and
manufacturing, technology and service companies. BDCs are unique in that at
least 70% of their investments must be made in private and certain public U.S.
businesses, and BDCs are required to make available significant managerial
assistance to their portfolio companies. Unlike corporations, BDCs are not taxed
on income distributed to their shareholders provided they comply with the
applicable requirements of the Code. BDCs, which are required to distribute
substantially all of their income to investors in order to not be subject to
entity level taxation, often offer a yield advantage over other types of
securities. The Fund will indirectly bear its proportionate share of any
management and other expenses, and of any performance based or incentive fees,
charged by the BDCs in which it invests, in addition to the expenses paid by the
Fund.
INVESTMENT COMPANIES
The Fund may invest in securities of other open-end or closed-end investment
companies, including exchange-traded funds, that invest primarily in securities
of the types in which the Fund may invest directly. The Fund may invest in the
securities of ETFs in excess of the limits imposed under the 1940 Act pursuant
to exemptive orders obtained by such ETFs and their sponsors from the SEC. ETFs
trade on a securities exchange and their shares may, at times, trade at a
premium or discount to their net asset value.
As a shareholder in an investment company, the Fund will bear its ratable share
of such investment company's expenses, and would remain subject to payment of
the investment company's advisory and administrative fees with respect to assets
so invested. Shareholders would therefore be subject to duplicative expenses to
the extent the Fund invests in other investment companies. In addition, the Fund
will incur brokerage costs when purchasing and selling shares of ETFs and
19
closed-end investment companies. Closed-end investment companies may be
leveraged, in which case the value and/or yield of their shares will tend to be
more volatile than shares of unleveraged funds.
REAL ESTATE INVESTMENT TRUSTS
REITs are financial vehicles that pool investors' capital to purchase or finance
real estate. REITs are companies that often actively manage income-generating
commercial real estate. Some REITs make or invest in loans and other obligations
that are secured by real estate collateral. Most REITs are publicly traded and
are generally a highly liquid method of investing in real estate. REITs are a
creation of the tax law. REITs essentially operate as a corporation or business
trust with the advantage of exemption from corporate income taxes provided the
REIT satisfies certain requirements.
REITs are generally categorized as equity REITs, mortgage REITs or hybrid REITs.
Equity REITs invest in and own properties, and thus are responsible for the
equity or value of their real estate assets. Their revenues come principally
from their properties' rents. Mortgage REITs deal in investment and ownership of
property mortgages. These REITs loan money for mortgages to owners of real
estate or purchase existing mortgages or mortgage-backed securities. Their
revenues are generated primarily by the interest that they earn on the mortgage
loans. Hybrid REITs combine the investment strategies of equity REITs and
mortgage REITs by investing in both properties and mortgages.
SMALL-CAP EQUITY SECURITIES
Under normal market conditions, the Fund invests at least 80% of its net assets
(including investment borrowings) in equity securities of U.S. listed Small-Cap
Companies at the time of investment. Equity securities include common stocks;
preferred securities; warrants to purchase common stocks or preferred
securities; securities convertible into common stocks or preferred securities;
and other securities with equity characteristics.
SHORT DURATION FUND
BANK LOANS
The Fund invests in bank loans, including senior secured bank loans, unsecured
and/or subordinated bank loans, loan participations and unfunded contracts. The
Fund may invest in such loans by purchasing assignments of all or a portion of
loans or loan participations from third parties. These loans are made by or
issued to corporations primarily to finance acquisitions, refinance existing
debt, support organic growth, or pay out dividends, and are typically originated
by large banks and are then syndicated out to institutional investors as well as
to other banks. Bank loans typically bear interest at a floating rate although
some loans pay a fixed rate. Due to their subordination in the borrower's
capital structure, unsecured and/or subordinated loans involve a higher degree
of overall risk than senior bank loans of the same borrower. Unfunded contracts
are commitments by lenders (such as the Fund) to loan an amount in the future or
that is due to be contractually funded in the future.
Senior floating rate loans are typically rated below-investment grade. Senior
floating rate loans hold a first lien priority and typically pay interest at
rates which are determined periodically on the basis of a floating base lending
rate, primarily the LIBOR, plus a premium. Senior floating rate loans are
typically made to U.S. and, to a limited extent, non-U.S. corporations,
partnerships and other business entities which operate in various industries and
geographical regions. Borrowers may obtain these loans to, among other reasons,
refinance existing debt and for acquisitions, dividends, leveraged buyouts, and
general corporate purposes.
CONVERTIBLE BONDS
The Fund may invest in convertible bonds. Convertible bonds combine the
investment characteristics of bonds and common stocks. Convertible bonds
typically consist of debt securities or preferred stock that may be converted
within a specified period of time (typically for the entire life of the
security) into a certain amount of common stock or other equity security of the
same or a different issuer at a predetermined price. They also include debt
securities with warrants or common stock attached and derivatives combining the
features of debt securities and equity securities. Convertible bonds entitle the
holder to receive interest paid or accrued on debt, or dividends paid or accrued
on preferred stock, until the security matures or is redeemed, converted or
exchanged.
CORPORATE DEBT SECURITIES
The Fund may invest in corporate debt securities issued by U.S. and non-U.S.
companies of all kinds, including those with small, mid and large
capitalizations. Corporate debt securities are fixed income securities issued by
businesses to finance their operations. Notes, bonds, debentures and commercial
paper are the most common types of corporate debt securities, with the primary
difference being their maturities and secured or unsecured status. Commercial
paper has the shortest term and is usually unsecured. Corporate debt may be
rated investment grade or below-investment grade and may carry fixed, floating
or hybrid rates of interest.
20
DERIVATIVES
The Fund may use futures, total return swaps, non-U.S. currency swaps, loan
credit default swaps, credit default swaps, options, puts, calls and other
derivative instruments to seek to enhance return, to hedge some of the risks of
its investments in securities, as a substitute for a position in the underlying
asset, to reduce transaction costs, to maintain full market exposure (which
means to adjust the characteristics of its investments to more closely
approximate those of the markets in which it invests), to manage cash flows, to
limit exposure to losses due to changes to non-U.S. currency exchange rates or
to preserve capital.
The Fund will comply with the regulatory requirements of the SEC and the
Commodity Futures Trading Commission ("CFTC") with respect to coverage of
options and futures positions by registered investment companies and, if the
guidelines so require, will earmark or set aside cash, U.S. government
securities, high grade liquid debt securities and/or other liquid assets
permitted by the SEC and CFTC in a segregated custodial account in the amount
prescribed (or take such other actions permitted by law). Securities earmarked
or 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.
HIGH YIELD DEBT
The Fund invests primarily in debt instruments (e.g., bonds, loans and
convertible bonds) that are rated below-investment grade, or unrated securities
deemed by the Advisor to be of comparable quality. Debt rated below-investment
grade is commonly referred to as high yield or "junk" debt. For purposes of
determining whether a security is below-investment grade, the lowest available
rating will be considered. High yield debt may be issued by companies without
long track records of sales and earnings, or by issuers that have questionable
credit strength. High yield debt and comparable unrated debt securities: (a)
will likely have some quality and protective characteristics that, in the
judgment of the rating agency evaluating the instrument, are outweighed by large
uncertainties or major risk exposures to adverse conditions; and (b) are
predominantly speculative with respect to the issuer's capacity to pay dividends
or interest and repay principal in accordance with the terms of the obligation.
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in securities and other
instruments that are, at the time of investment, illiquid (determined using the
SEC's standard applicable to investment companies, i.e., securities that cannot
be disposed of by the Fund within seven days in the ordinary course of business
at approximately the amount at which the Fund has valued the securities). For
this purpose, illiquid securities may include, but are not limited to, certain
restricted securities (securities the disposition of which is restricted under
the federal securities laws), certain securities that may only be resold
pursuant to Rule 144A under the Securities Act that are deemed to be illiquid,
and certain repurchase agreements.
INVESTMENT COMPANIES
The Fund may invest in securities of other open-end or closed-end investment
companies, including exchange-traded funds, that invest primarily in securities
of the types in which the Fund may invest directly. The Fund may invest in the
securities of ETFs in excess of the limits imposed under the 1940 Act pursuant
to exemptive orders obtained by such ETFs and their sponsors from the SEC. ETFs
trade on a securities exchange and their shares may, at times, trade at a
premium or discount to their net asset value.
As a shareholder in an investment company, the Fund will bear its ratable share
of such investment company's expenses, and would remain subject to payment of
the investment company's advisory and administrative fees with respect to assets
so invested. Shareholders would therefore be subject to duplicative expenses to
the extent the Fund invests in other investment companies. In addition, the Fund
will incur brokerage costs when purchasing and selling shares of ETFs and
closed-end investment companies. Closed-end investment companies may be
leveraged, in which case the value and/or yield of their shares will tend to be
more volatile than shares of unleveraged funds.
MORTGAGE-BACKED SECURITIES
The Fund may invest in mortgage-backed securities. Mortgage-backed securities
represent direct or indirect participations in, or are secured by and payable
from, mortgage loans secured by real property and can include single- and
multi-class pass-through securities and collateralized mortgage obligations.
Mortgage-backed securities are based on different types of mortgages, including
those on commercial real estate or residential properties. These securities
often have stated maturities of up to thirty years when they are issued,
depending upon the length of the mortgages underlying the securities.
NON-U.S. INVESTMENTS
The Fund may invest up to 15% of its net assets in non-U.S. securities
denominated in non-U.S. currencies. Non-U.S. debt securities in which the Fund
may invest include debt securities issued or guaranteed by companies organized
under the laws of countries other than the United States (including emerging
markets), debt securities issued or guaranteed by foreign, national, provincial,
21
state, municipal or other governments with taxing authority or by their agencies
or instrumentalities and debt obligations of supranational governmental entities
such as the World Bank or European Union. These debt securities may be U.S.
dollar-denominated or non-U.S. dollar-denominated. Non-U.S. debt securities also
include U.S. dollar-denominated debt obligations, such as "Yankee Dollar"
obligations, of foreign issuers and of supra-national government entities.
Yankee Dollar obligations are U.S. dollar-denominated obligations issued in the
U.S. capital markets by foreign corporations, banks and governments. Foreign
debt securities also may be traded on foreign securities exchanges or in
over-the-counter capital markets. To the extent the Fund invests in such
instruments, the value of the assets of the Fund as measured in U.S. dollars
will be affected by changes in exchange rates. Generally, the Fund's currency
exchange transactions will be conducted on a spot (i.e., cash) basis at the spot
rate prevailing in the currency exchange market. The cost of the Fund's currency
exchange transactions will generally be the difference between the bid and offer
spot rate of the currency being purchased or sold. In order to protect against
uncertainty in the level of future currency exchange rates, the Fund is
authorized to enter into various currency exchange transactions.
PREFERRED SECURITIES
The Fund may invest in preferred securities. Preferred securities, which
generally pay fixed or adjustable rate dividends or interest to investors, have
preference over common stock in the payment of dividends or interest and the
liquidation of a company's assets. This means that a company typically must pay
dividends or interest on its preferred securities before paying any dividends on
its common stock. Preferred securities are generally junior to all forms of the
company's debt, including both senior and subordinated debt.
PORTFOLIO HOLDINGS
A description of the policies and procedures with respect to the disclosure of
each Fund's portfolio securities is included in the Funds' SAI and on the Funds'
website at www.ftportfolios.com.
ADDITIONAL RISKS OF INVESTING IN THE FUNDS
Risk is inherent in all investing. Investing in the Funds involves risk,
including the risk that you may lose all or part of your investment. There can
be no assurance that a Fund will meet its stated objective(s). Before you
invest, you should consider the following risks in addition to the Principal
Risks set forth above in this prospectus.
BORROWING AND LEVERAGE RISKS. If a Fund borrows money, it must pay interest and
other fees, which will reduce the Fund's returns if such costs exceed the
returns on the portfolio securities purchased or retained with such borrowings.
Any such borrowings are intended to be temporary. However, under certain market
conditions, including periods of low demand or decreased liquidity, such
borrowings might be outstanding for longer periods of time. As prescribed by the
1940 Act, a Fund will be required to maintain specified asset coverage of at
least 300% with respect to any bank borrowing immediately following such
borrowing. The Fund may be required to dispose of assets on unfavorable terms if
market fluctuations or other factors reduce the Fund's asset coverage to less
than the prescribed amount.
In addition, when the Preferred Fund invests in certain derivative securities,
including, but not limited to, when issued securities, forward commitments,
futures contracts and interest rate swaps, it is effectively leveraging its
investments. Certain investments or trading strategies that involve leverage can
exaggerate changes in the net asset value of the Preferred Fund's shares and can
result in losses that exceed the amount originally invested.
CURRENT MARKET CONDITIONS RISK. Domestic and international markets have
experienced a period of decreased economic activity across all sectors of the
world economy, and unemployment remains at increased levels. These market
conditions began with problems in the financial sector, many of which were
caused by defaults on "subprime" mortgages and mortgage-backed securities. These
market conditions increase the risk that the value of a Fund's assets may be
subject to steep declines or increased volatility due to changes in performance
or perception of the issuers.
INFLATION RISK. Inflation risk is the risk that the value of assets or income
from investments will be less in the future as inflation decreases the value of
money. As inflation increases, the value of a Fund's assets can decline as can
the value of the Funds' distributions. Common stock prices may be particularly
sensitive to rising interest rates, as the cost of capital rises and borrowing
costs increase.
ISSUER SPECIFIC CHANGES RISK. The value of an individual security or particular
type of security can be more volatile than the market as a whole and can perform
differently from the value of the market as a whole.
MANAGEMENT RISK. Each Fund is subject to management risk because it has an
actively managed portfolio. The Advisor or each Sub-Advisor will apply
investment techniques and risk analyses in making investment decisions for each
Fund, but there can be no guarantee that the Funds will achieve their investment
objective(s).
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MARKET MAKER RISK. If a Fund has lower average daily trading volumes, it may
rely on a small number of third-party market makers to provide a market for the
purchase and sale of shares. Any trading halt or other problem relating to the
trading activity of these market makers could result in a dramatic change in the
spread between a Fund's net asset value and the price at which a Fund's shares
are trading on the Exchange which could result in a decrease in value of such
Fund's shares.
PREFERRED FUND
CONVERTIBLE SECURITIES RISK. Convertible securities have characteristics of both
equity and debt securities and, as a result, are exposed to certain additional
risks. The market values of convertible securities tend to decline as interest
rates increase and, conversely, to increase as interest rates decline. However,
a convertible security's market value also tends to reflect the market price of
the common stock of the issuing company, particularly when the stock price is
greater than the convertible security's conversion price (i.e., the
predetermined price or exchange ratio at which the convertible security can be
converted or exchanged for the underlying common stock). Convertible securities
are also exposed to the risk that an issuer is unable to meet its obligation to
make dividend or principal payments when due as a result of changing financial
or market conditions. Convertible securities generally offer lower interest or
dividend yields than non-convertible debt securities of similar credit quality
because of their potential for capital appreciation. Mandatory convertible
securities are a subset of convertible securities. The conversion of such
securities is not optional, and the conversion price at maturity is based solely
upon the market price of the underlying common stock, which may be significantly
less than par or the price (above or below par) paid. Mandatory convertible
securities generally are subject to a greater risk of loss of value than
securities convertible at the option of the holder.
CURRENCY RISK. In addition to the risks described above in "Principal Risks --
Currency Risk," an investment in non-U.S. securities involves risk due to
currency exchange rates. Changes in currency exchange rates may affect the
Fund's net asset value, the value of dividends and interest earned, and gains
and losses realized on the sale of securities. An increase in the strength of
the U.S. dollar relative to other currencies may cause the value of the Fund to
decline. Certain non-U.S. currencies may be particularly volatile, and non-U.S.
governments may intervene in the currency markets, causing a decline in value or
liquidity in the Fund's non-U.S. holdings whose value is tied to the affected
non-U.S. currency.
DEPENDENCE ON KEY PERSONNEL RISK. The Sub-Advisor is dependent upon the
experience and expertise of Messrs. Scott Fleming and Robert Wolf and Ms.
Danielle Salters in providing advisory services with respect to the Fund's
investments. If the Sub-Advisor were to lose the services of any of these
individuals, its ability to service the Fund could be adversely affected. There
can be no assurance that a suitable replacement could be found for any of
Messrs. Fleming or Wolf or Ms. Salters in the event of their death, resignation,
retirement or inability to act on behalf of the Sub-Advisor.
DEPOSITARY RECEIPTS RISK. In addition to the risks above in "Principal Risks --
Depositary Receipts Risk," an investment in depositary receipts involves further
risks due to certain features of Depositary Receipts. Depositary receipts are
usually in the form of American Depositary Receipts ("ADRs") or Global
Depositary Receipts ("GDRs"). ADRs are U.S. dollar-denominated receipts
representing shares of foreign-based corporations. ADRs are issued by U.S. banks
or trust companies, and entitle the holder to all dividends and capital gains
that are paid out on the underlying foreign shares. GDRs are similar to ADRs,
but are shares of foreign-based corporations generally issued by international
banks in one or more markets around the world. ADRs or GDRs may be less liquid
than the underlying shares in their primary trading market. Any distributions
paid to the holders of depositary receipts, whether ADRs or GDRs, are usually
subject to a fee charged by the depositary.
Holders of depositary receipts may have limited voting rights pursuant to a
deposit agreement between the underlying issuer and the depositary. In certain
cases, the depositary will vote the shares deposited with it as directed by the
underlying issuer's board of directors. Furthermore, investment restrictions in
certain countries may adversely impact the value of depositary receipts because
such restrictions may limit the ability to convert equity shares into depositary
receipts and vice versa. Such restrictions may cause equity shares of the
underlying issuer to trade at a discount or premium to the market price of the
depositary receipt. Moreover, if depositary receipts are converted into shares,
the laws in certain countries may limit the ability of a non-resident to trade
the shares and to reconvert the shares to depositary receipts.
Depositary receipts may be "sponsored" or "unsponsored." Sponsored depositary
receipts are established jointly by a depositary and the underlying issuer,
whereas unsponsored depositary receipts may be established by a depositary
without participation by the underlying issuer. Holders of unsponsored
depositary receipts generally bear all the costs associated with establishing
the unsponsored depositary receipts. In addition, the issuers of the securities
underlying unsponsored depositary receipts are not obligated to disclose
material information in the United States and, therefore, there may be less
information available regarding such issuers and there may not be a correlation
between such information and the market value of the depositary receipts.
Depositary receipts may be unregistered and unlisted. The Fund's investments may
also include depositary receipts that are not purchased in the public markets
and are restricted securities that can be offered and sold only to "qualified
institutional buyers" under Rule 144A under the Securities Act. Moreover, if
adverse market conditions were to develop during the period between the Fund's
23
decision to sell these types of depositary receipts and the point at which the
Fund is permitted or able to sell such security, the Fund might obtain a price
less favorable than the price that prevailed when it decided to sell.
DERIVATIVES RISK. The use of derivatives presents risks different from, and
possibly greater than, the risks associated with investing directly in
traditional securities. Among the risks presented are market risk, credit risk,
management risk and liquidity risk. The use of derivatives can lead to losses
because of adverse movements in the price or value of the underlying asset,
index or rate, which may be magnified by certain features of the derivatives. In
addition, when the Fund invests in certain derivative securities, including, but
not limited to, when issued securities, forward commitments, futures contracts
and interest rate swaps, they are effectively leveraging their investments,
which could result in exaggerated changes in the net asset value of the Fund's
shares and can result in losses that exceed the amount originally invested. The
success of the Sub-Advisor's derivatives strategies will depend on its ability
to assess and predict the impact of market or economic developments on the
underlying asset, index or rate and the derivative itself, without the benefit
of observing the performance of the derivative under all possible market
conditions. Liquidity risk exists when a security cannot be purchased or sold at
the time desired, or cannot be purchased or sold without adversely affecting the
price.
FINANCIAL COMPANIES RISK. In addition to the risks described above in "Principal
Risks -- Financial Companies Risk," an investment in financial companies
involves additional risks not set forth above. Negative developments relating to
the subprime mortgage market have adversely affected credit and capital markets
worldwide and reduced the willingness of lenders to extend credit, making
borrowing on favorable terms more difficult. In addition, the liquidity of
certain debt instruments has been reduced or eliminated due to the lack of
available market makers. Banks and thrifts face increased competition from
nontraditional lending sources as regulatory changes permit new entrants to
offer various financial products. Regulatory changes could cause business
disruptions or result in significant loss of revenue, and there can be no
assurance as to the actual impact that these laws and their regulations will
have on the financial markets.
FIXED-INCOME SECURITIES RISK. An investment in the Fund also involves risk
associated with an investment in fixed-income securities including the risk that
certain of the securities in the Fund may not have the benefit of covenants that
would prevent the issuer from engaging in capital restructurings or borrowing
transactions in connection with corporate acquisitions, leveraged buyouts or
restructurings which could have the effect of reducing the ability of the issuer
to meet its payment obligations and might result in increased credit risk. In
addition, certain of the securities may be redeemed or prepaid by the issuer,
resulting in lower interest payments received by the Fund and reduced
distributions to shareholders.
ILLIQUID SECURITIES RISK. In addition to the risks described above in "Principal
Risks -- Illiquid Securities Risk," an investment in the Fund involves further
risk due to the fact that the Fund may invest a substantial portion of its
assets in lower-quality debt instruments issued by companies that are highly
leveraged. Lower-quality debt tends to be less liquid than higher-quality debt.
If the economy experiences a sudden downturn, or if the debt markets for such
companies become distressed, the Fund may have particular difficulty selling its
assets in sufficient amounts, at reasonable prices and in a sufficiently timely
manner to raise the cash necessary to meet any potentially heavy redemption
requests by Fund shareholders. In such event, there would be a greater chance
that the Fund may be forced to curtail or suspend redemptions, in which case you
might experience a delay or inability to liquidate your investment at the
desired time or in the desired amount.
INTEREST RATE RISK. In addition to the risks described above in "Principal Risks
-- Interest Rate Risk," the value of the Fund's fixed-rate income may decline if
market interest rates rise. Interest rate risk is generally lower for
shorter-term investments and higher for longer-term investments. Duration is a
common measure of interest rate risk. Duration measures a bond's expected life
on a present value basis, taking into account the bond's yield, interest
payments and final maturity. Duration is a reasonably accurate measure of a
bond's price sensitivity to changes in interest rates. The longer the duration
of a bond, the greater the bond's price sensitivity is to changes in interest
rates.
NON-U.S. SECURITIES RISK. In addition to the risks described above in "Principal
Risks -- Non-U.S. Securities Risk," an investment in securities of non-U.S.
companies involves risk not associated with domestic issuers. Non-U.S. countries
may impose higher withholding taxes on dividends and interest than the United
States. Non-U.S. countries may also impose limitations on the use of or transfer
of portfolio assets. Enforcing legal rights may be more difficult, expensive and
time consuming in non-U.S. countries, and investors may force unique problems
enforcing claims against non-U.S. governments.
PREFERRED SECURITIES RISK. In addition to the risks described above in
"Principal Risks -- Preferred Securities Risk," an investment in preferred
securities involves the further risks not associated with an investment in
common stocks set forth below.
o Limited Voting Rights. Generally, holders of preferred securities
(such as the Fund) have no voting rights with respect to the issuing
company unless preferred dividends have been in arrears for a specified
number of periods, at which time the preferred security holders may
elect a number of directors to the issuer's board. Generally, once the
issuer pays all the arrearages, the preferred security holders no longer
have voting rights.
24
o Special Redemptions Rights. In certain circumstances, an issuer of
preferred securities may redeem the securities prior to a specified
date. For instance, for certain types of preferred securities, a
redemption may be triggered by a change in federal income tax or
securities laws. As with call provisions, a special redemption by the
issuer may negatively impact the return of the security held by the
Fund.
o Deferral. Preferred securities may include provisions that permit the
issuer, at its discretion, to defer distributions for a stated period
without any adverse consequences to the issuer. If the Fund owns a
preferred security that is deferring its distributions, the Fund may be
required to report income for federal income tax purposes although it
has not yet received such income in cash.
o Subordination. Preferred securities are subordinated to bonds and
other debt instruments in a company's capital structure in terms of
priority to corporate income and liquidation payments and therefore will
be subject to greater credit risk than those debt instruments.
o Liquidity. Preferred securities may be substantially less liquid than
many other securities, such as common stocks or U.S. government
securities.
TRUST PREFERRED SECURITIES RISK. Unlike preferred stocks, distributions from
trust preferred securities are treated as interest rather than dividends for
federal income tax purposes and therefore, are not eligible for the dividends
received deduction and do not constitute qualified dividend income.
Distributions on trust preferred securities will be made only if interest
payments on the related interest-bearing notes of the operating company are
made. Because a corporation issuing the interest-bearing notes may defer
interest payments on these instruments for up to 20 consecutive quarters, if
such election is made distributions will not be made on the trust preferred
securities during the deferral period. Further, certain tax or regulatory events
may trigger the redemption of the interest-bearing notes by the issuing
corporation and result in prepayment of the trust preferred securities prior to
their stated maturity date.
SMALL CAP FUND
BUSINESS DEVELOPMENT COMPANY RISK. In addition to the risks described above in
"Principal Risks -- BDC Risk," the Fund may invest in BDCs which may carry risks
similar to those of a private equity or venture capital fund. Securities that
are not publicly registered may be difficult to value and may be difficult to
sell at a price representative of their intrinsic value. Small and medium-sized
companies also may have fewer lines of business so that changes in any one line
of business may have a greater impact on the value of their stock than is the
case with a larger company. An investment in BDCs is also subject to additional
risks, including management's ability to meet the fund's investment objective,
and to manage the fund's portfolio when the underlying securities are redeemed
or sold, during periods of market turmoil and as investors' perceptions
regarding the funds or their underlying investments change. BDCs are not
redeemable at the option of the shareholder and they may trade in the market at
a discount to their net asset value.
The BDCs included in the Fund may employ the use of leverage in their portfolios
through borrowings or the issuance of preferred stock. While leverage often
serves to increase the yield of a BDC, this leverage also subjects a BDC to
increased risks, including the likelihood of increased volatility and the
possibility that a BDC's common share income will fall if the dividend rate of
the preferred shares or the interest rate on any borrowings rises.
EQUITY SECURITIES RISK. In addition to the risks described above in "Principal
Risks -- Equity Securities Risk," equity securities may decline significantly in
price over short or extended periods of time, and such declines may occur in the
equity market as a whole, or they may occur in only a particular country,
company, industry or sector of the market.
DEPENDENCE ON KEY PERSONNEL RISK. The Sub-Advisor is dependent upon the
experience and expertise of Messrs. Mark Keller, Daniel Winter, David Miyazaki
and Chris Stein in providing advisory services with respect to the Fund's
investments. If the Sub-Advisor were to lose the services of any of these
portfolio managers, its ability to service the Fund could be adversely affected.
There can be no assurance that a suitable replacement could be found for any of
Messrs. Keller, Winter, Miyazaki and Stein in the event of their death,
resignation, retirement or inability to act on behalf of the Advisor.
ISSUER SPECIFIC CHANGES RISK. The value of an individual security or particular
type of security can be more volatile than the market as a whole and can perform
differently from the value of the market as a whole.
OTHER INVESTMENT COMPANIES RISK. If the Fund invests in other investment
companies, Fund shareholders bear both their proportionate share of Fund
expenses and, indirectly, the expenses of the other investment companies. Also,
the other investment companies are subject to the risks of the underlying
securities that they hold. In addition, the Fund will incur brokerage costs when
purchasing and selling shares of ETFs and closed-end investment companies.
Closed-end investment companies may be leveraged, in which case the value and/or
yield of their shares will tend to be more volatile than shares of unleveraged
funds. In addition, for index-based ETFs, the performance of an ETF may diverge
25
from the performance of such index (commonly known as tracking error). Moreover,
shares of closed-end investment companies and ETFs may be sold at a discount
from their net asset value.
REIT RISK. In addition to the risks described above in "Principal Risks -- REIT
Investment Risk," an investment in REITs also involves certain risks, which
include, among others, adverse changes in national, state or local real estate
conditions (such as the turmoil experienced since 2007 in the residential and
commercial real estate markets); obsolescence of properties; changes in the
availability, cost and terms of mortgage funds; and the impact of changes in
environmental laws. In addition, a REIT that fails to comply with federal tax
requirements affecting REITs may be subject to federal income taxation, or the
federal tax requirement that a REIT distribute substantially all of its net
income to its shareholders may result in a REIT having insufficient capital for
future expenditures. The value of a REIT can depend on the structure of and cash
flow generated by the REIT. In addition, like investment companies, REITs have
expenses, including advisory and administration fees, that are paid by their
shareholders. As a result, you will absorb duplicate levels of fees when the
Fund invests in REITs. In addition, REITs are subject to certain provisions
under federal tax law. The failure of a company to qualify as a REIT could have
adverse consequences for the Fund, including significantly reducing return to
the Fund on its investment in such company.
SHORT DURATION FUND
BANK LOANS RISK. In addition to the risks described above in "Principal Risks --
Bank Loans Risk," the bank loans in which the Fund invests may not (i) be rated
at the time of investment, (ii) be registered with the SEC, (iii) be listed on a
securities exchange or (iv) have sufficient collateral securing the loan or the
collateral may not be available in the event of bankruptcy. In addition, the
amount of public information available with respect to such loans may be less
extensive than that available for more widely rated, registered and
exchange-listed securities. Because no active trading market may exist for some
of the loans in which the Fund may invest, such loans may be illiquid and more
difficult to value than more liquid instruments for which a trading market does
exist. Because the interest rates of floating-rate loans in which the Fund
invests may reset frequently, if market interest rates fall, the loans' interest
rates will be reset to lower levels, potentially reducing the Fund's income.
Unlike the securities markets, there is no central clearinghouse for loan
trades, and the loan market has not established enforceable settlement standards
or remedies for failure to settle. Therefore, portfolio transactions in loans
may have uncertain settlement time periods.
First Trust or its affiliates may participate in the primary and secondary
market for loans. Because of limitations imposed by applicable law, the presence
of such affiliates in the loan market may restrict the Fund's ability to acquire
some loans or affect the timing or price of loan acquisitions. Also, because
First Trust may wish to invest in the publicly-traded securities of an obligor,
the Fund may not have access to material non-public information regarding the
obligor to which other investors have access.
CONVERTIBLE BONDS RISK. In addition to the risks described above in "Principal
Risks -- Convertible Bonds Risk," convertible bonds have characteristics of both
equity and debt securities and, as a result, are exposed to certain additional
risks. The market values of convertible bonds tend to decline as interest rates
increase and, conversely, to increase as interest rates decline. However, a
convertible bond's market value also tends to reflect the market price of the
common stock of the issuing company, particularly when the stock price is
greater than the convertible bond's conversion price (i.e., the predetermined
price or exchange ratio at which the convertible bond can be converted or
exchanged for the underlying common stock). Convertible bonds are also exposed
to the risk that an issuer is unable to meet its obligation to make dividend or
principal payments when due as a result of changing financial or market
conditions. Convertible bonds generally offer lower interest or dividend yields
than non-convertible debt securities of similar credit quality because of their
potential for capital appreciation.
Mandatory convertible bonds are a subset of convertible bonds. The conversion of
such securities is not optional, and the conversion price at maturity is based
solely upon the market price of the underlying common stock, which may be
significantly less than par or the price (above or below par) paid. Mandatory
convertible bonds generally are subject to a greater risk of loss of value than
securities convertible at the option of the holder.
CREDIT RISK. In addition to the risks described above in "Principal Risks --
Credit Risk," credit risk is the risk that an issuer of a debt instrument may be
unable or unwilling to make dividend, interest and/or principal payments when
due and the related risk that the value of an instrument may decline because of
concerns about the issuer's ability or unwillingness to make such payments. High
yield and comparable unrated debt securities, while generally offering higher
yields than investment grade debt with similar maturities, involve greater
risks, including the possibility of dividend or interest deferral, default or
bankruptcy, and are regarded as predominantly speculative with respect to the
issuer's capacity to pay dividends or interest and repay principal. Credit risk
is heightened for loans in which the Fund invests because companies that issue
such loans tend to be highly leveraged and thus are more susceptible to the
risks of interest deferral, default and/or bankruptcy.
26
CURRENCY RISK. In addition to the risks described above in "Principal Risks --
Currency Risk," an investment in non-U.S. securities denominated in foreign
currencies involves further risk due to currency exchange rates. Changes in
currency exchange rates may affect the Fund's net asset value, the value of
dividends and interest earned, and gains and losses realized on the sale of
securities. An increase in the strength of the U.S. dollar relative to other
currencies may cause the value of the Fund to decline. Certain non-U.S.
currencies may be particularly volatile, and non-U.S. governments may intervene
in the currency markets, causing a decline in value or liquidity in the Fund's
non-U.S. holdings whose value is tied to the affected non-U.S. currency.
DEPENDENCE ON KEY PERSONNEL RISK. The Advisor is dependent upon the experience
and expertise of Messrs. William Housey, Scott D. Fries and Peter Fasone in
providing advisory services with respect to the Fund's investments. If the
Advisor were to lose the services of any of these individuals, its ability to
service the Fund could be adversely affected. There can be no assurance that a
suitable replacement could be found for any of Messrs. Housey, Fries or Fasone
in the event of their death, resignation, retirement or inability to act on
behalf of the Advisor.
DERIVATIVES RISK. The use of derivatives presents risks different from, and
possibly greater than, the risks associated with investing directly in
traditional securities. Among the risks presented are market risk, credit risk,
management risk and liquidity risk. The use of derivatives can lead to losses
because of adverse movements in the price or value of the underlying asset,
index or rate, which may be magnified by certain features of the derivatives. In
addition, when the Fund invests in certain derivative securities, including, but
not limited to, when-issued securities, forward commitments and futures
contracts, it is effectively leveraging its investments, which could result in
exaggerated changes in the net asset value of the Fund's shares and can result
in losses that exceed the amount originally invested. The success of the
Advisor's derivatives strategies will depend on its ability to assess and
predict the impact of market or economic developments on the underlying asset,
index or rate and the derivative itself, without the benefit of observing the
performance of the derivative under all possible market conditions. Liquidity
risk exists when a security cannot be purchased or sold at the time desired, or
cannot be purchased or sold without adversely affecting the price.
HIGH YIELD SECURITIES RISK. In addition to the risks described above in
"Principal Risks -- High Yield Securities Risk," the Fund's investment in high
yield, high risk, fixed rate, domestic and foreign obligations, or "junk"
securities, may entail increased credit risks (as discussed below) and the risk
that the value of Fund's assets will decline, and may decline precipitously,
with increases in interest rates. In recent years there have been wide
fluctuations in interest rates and thus in the value of fixed rate obligations
generally. Securities such as those included in the Fund are, under most
circumstances, subject to greater market fluctuations and risk of loss of income
and principal than are investments in lower-yielding, higher-rated securities,
and their value may decline precipitously because of increases in interest
rates. A slowdown in the economy, or a development adversely affecting an
issuer's creditworthiness, may result in the issuer being unable to maintain
earnings or sell assets at the rate and at the prices, respectively, that are
required to produce sufficient cash flow to meet its interest and principal
requirements. For an issuer that has outstanding both senior commercial bank
debt and subordinated high yield, high risk securities, an increase in interest
rates will increase that issuer's interest expense insofar as the interest rate
on the bank debt is fluctuating. Many leveraged issuers enter into interest rate
protection agreements to fix or cap the interest rate on a large portion of
their bank debt, which reduces exposure to increasing rates, but reduces the
benefit to the issuer of declining rates. The Advisor cannot predict future
economic policies or their consequences or therefore, the course or extent of
any similar market fluctuations in the future.
INCOME RISK. In addition to the risks described above in "Principal Risks --
Income Risk," the income earned from the Fund's portfolio may decline because of
falling market interest rates. This can result because the Fund may hold
floating rate debt that will adjust lower with falling interest rates. For
loans, interest rates typically reset every 30 to 90 days.
INTEREST RATE RISK. In addition to the risks described above in "Principal Risks
-- Interest Rate Risk," the value of the Fund's investment in debt securities
may decline because of rising market interest rates. Interest rate risk is
generally lower for shorter-term investments and higher for longer-term
investments. Duration is a common measure of interest rate risk. Duration
measures a bond's expected life on a present value basis, taking into account
the bond's yield, interest payments and final maturity. Duration is a reasonably
accurate measure of a bond's price sensitivity to changes in interest rates. The
longer the duration of a bond, the greater the bond's price sensitivity is to
changes in interest rates.
LIQUIDITY RISK. In addition to the risks described above in "Principal Risks --
Liquidity Risk," the Fund invests a substantial portion of its assets in
lower-quality debt instruments issued by companies that are highly leveraged.
Lower-quality debt tends to be less liquid than higher-quality debt. If the
economy experiences a sudden downturn, or if the debt markets for such companies
become distressed, the Fund may have particular difficulty selling its assets in
sufficient amounts, at reasonable prices and in a sufficiently timely manner to
raise the cash necessary to meet any potentially heavy redemption requests by
Fund shareholders. In such event, there would be a greater chance that the Fund
may be forced to curtail or suspend redemptions, in which case an investor might
experience a delay or inability to liquidate its/his/her investment at the
desired time or in the desired amount.
27
MORTGAGE-BACKED SECURITIES RISK. The Fund may invest in mortgage-backed
securities. Mortgage-backed securities may have less potential for capital
appreciation than comparable fixed income securities, due to the likelihood of
increased prepayments of mortgages as interest rates decline. If the Fund buys
mortgage-backed securities at a premium, mortgage foreclosures and prepayments
of principal by mortgagors (which usually may be made at any time without
penalty) may result in some loss of the Fund's principal investment to the
extent of the premium paid. Alternatively, in a rising interest rate
environment, the value of mortgage-backed securities may be adversely affected
when payments on underlying mortgages do not occur as anticipated, resulting in
the extension of the security's effective maturity and the related increase in
interest rate sensitivity of a longer-term instrument. In addition,
mortgage-backed securities are subject to the credit risk associated with the
performance of the underlying mortgage properties. In certain instances,
third-party guarantees or other forms of credit support can reduce the credit
risk.
NEW FUND RISK. The Fund currently has fewer assets than larger funds, and like
other relatively new funds, large inflows and outflows may impact the Fund's
market exposure for limited periods of time. This impact may be positive or
negative, depending on the direction of market movement during the period
affected. The Fund does not generally limit large inflows and outflows, but may
adopt a policy which seeks to reduce the impact of these flows where First Trust
has prior knowledge of them.
NON-U.S. SECURITIES RISK. In addition to the risks described above in "Principal
Risks -- Non-U.S. Securities Risk," an investment in securities of non-U.S.
companies involves risk not associated with domestic issuers. Non-U.S. countries
may impose higher withholding taxes on dividends and interest than the United
States. Non-U.S. countries may also impose limitations on the use of or transfer
of portfolio assets. Enforcing legal rights may be more difficult, expensive and
time consuming in non-U.S. countries, and investors may force unique problems
enforcing claims against non-U.S. governments.
OTHER INVESTMENT COMPANIES RISK. If the Fund invests in other investment
companies, Fund shareholders bear both their proportionate share of Fund
expenses and, indirectly, the expenses of the other investment companies. Also,
the other investment companies are subject to the risks of the underlying
securities that they hold. In addition, the Fund will incur brokerage costs when
purchasing and selling shares of ETFs and closed-end investment companies.
Closed-end investment companies may be leveraged, in which case the value and/or
yield of their shares will tend to be more volatile than shares of unleveraged
funds. In addition, for index-based ETFs, the performance of an ETF may diverge
from the performance of such index (commonly known as tracking error). Moreover,
shares of closed-end investment companies and ETFs may be sold at a discount
from their net asset value.
PREFERRED SECURITIES RISK. Preferred securities combine some of the
characteristics of both common stocks and bonds. An investment in preferred
securities involves the further risks not associated with an investment in
common stocks set forth below.
o Limited Voting Rights. Generally, holders of preferred securities
(such as the Fund) have no voting rights with respect to the issuing
company unless preferred dividends have been in arrears for a specified
number of periods, at which time the preferred security holders may
elect a number of directors to the issuer's board. Generally, once the
issuer pays all the arrearages, the preferred security holders no longer
have voting rights.
o Special Redemptions Rights. In certain circumstances, an issuer of
preferred securities may redeem the securities prior to a specified
date. For instance, for certain types of preferred securities, a
redemption may be triggered by a change in federal income tax or
securities laws. As with call provisions, a special redemption by the
issuer may negatively impact the return of the security held by the
Fund.
o Deferral. Preferred securities may include provisions that permit the
issuer, at its discretion, to defer distributions for a stated period
without any adverse consequences to the issuer. If the Fund owns a
preferred security that is deferring its distributions, the Fund may be
required to report income for federal income tax purposes although it
has not yet received such income in cash.
o Subordination. Preferred securities are subordinated to bonds and
other debt instruments in a company's capital structure in terms of
priority to corporate income and liquidation payments and therefore will
be subject to greater credit risk than those debt instruments.
o Liquidity. Preferred securities may be substantially less liquid than
many other securities, such as common stocks or U.S. government
securities.
PREPAYMENT RISK. In addition to the risks described above in "Principal Risks --
Prepayment Risk," during periods of falling interest rates, an issuer of a loan
may exercise its right to pay principal on an obligation earlier than expected.
This may result in the Fund reinvesting proceeds at lower interest rates,
resulting in a decline in the Fund's income.
28
FUND ORGANIZATION
Each Fund is a series of the Trust, an investment company registered under the
1940 Act. Each Fund is treated as a separate fund with its own investment
objective(s) and policies. The Trust is organized as a Massachusetts business
trust. The Trust's Board is responsible for the overall management and direction
of the Trust. The Board elects the Trust's officers and approves all significant
agreements, including those with First Trust, the Sub-Advisors, the custodians,
the transfer agents and the fund administration and accounting agents.
MANAGEMENT OF THE FUNDS
First Trust Advisors L.P. ("First Trust" or the "Advisor"), 120 East Liberty
Drive, Wheaton, Illinois 60187, is the investment advisor to the Funds. In this
capacity, First Trust is responsible for managing the investments of the Short
Duration Fund and overseeing each Sub-Advisor in the investment of its Fund's
assets, managing each Fund's business affairs and providing certain clerical,
bookkeeping and other administrative services.
First Trust is a limited partnership with one limited partner, Grace Partners of
DuPage L.P., and one general partner, The Charger Corporation. Grace Partners of
DuPage L.P. is a limited partnership with one general partner, The Charger
Corporation, and a number of limited partners. The Charger Corporation is an
Illinois corporation controlled by James A. Bowen, the Chief Executive Officer
of First Trust and Chairman of the Board of the Trust. First Trust discharges
its responsibilities subject to the policies of the Board.
First Trust serves as advisor or sub-advisor to 13 mutual fund portfolios, 9
exchange-traded funds consisting of 82 series and 14 closed-end funds and is
also the portfolio supervisor of certain unit investment trusts sponsored by
First Trust Portfolios L.P. ("FTP"), an affiliate of First Trust, 120 East
Liberty Drive, Wheaton, Illinois 60187. FTP specializes in the underwriting,
trading and distribution of unit investment trusts and other securities. FTP is
the principal underwriter of the shares of the Funds.
MANAGEMENT FEES
For providing management services, the Funds pay First Trust an annual fund
management fee of 0.80% of average daily net assets for the Preferred Fund,
1.00% of average daily net assets for the Small Cap Fund and 0.65% of average
daily net assets for the Short Duration Fund. Information regarding the Board's
approval of the continuation of the Preferred Fund's and the Small Cap Fund's
investment management agreement and sub-advisory agreement are available in such
Fund's Annual Report for the fiscal year ended October 31, 2013. Information
regarding the Board's approval of the Short Duration Fund's investment
management agreement is available in such Fund's Semi-Annual Report for the
period ended April 30, 2013.
Each Fund pays for its own operating expenses such as custodial, transfer agent,
administrative, accounting and legal fees; brokerage commissions; distribution
and service fees; any extraordinary expenses; and its portion of the Trust's
operating expenses. First Trust and each Sub-Advisor have agreed to limit fees
and/or pay expenses to the extent necessary through February 28, 2015, to
prevent each Fund's Total Annual Operating Expenses (excluding 12b-1
distribution and service fees, interest expense, taxes, fees incurred in
acquiring and disposing of portfolio securities, and extraordinary expenses)
from exceeding 1.15% of the average daily net assets of any class of shares of
the Preferred Fund, 1.35% of the average daily net assets of any class of shares
of the Small Cap Fund and 1.00% of the average daily net assets of any class of
shares of the Short Duration Fund. From March 1, 2015 through February 28, 2024,
the Total Annual Operating Expenses (excluding 12b-1 distribution and service
fees, interest expense, taxes, fees incurred in acquiring and disposing of
portfolio securities, and extraordinary expenses) will not exceed 1.50% of the
average daily net assets of any class of shares of the Preferred Fund, 1.70% of
the average daily net assets of any class of shares of the Small Cap Fund and
1.35% of the daily net assets of any class of shares of the Short Duration Fund.
Expenses borne by First Trust and each Sub-Advisor are subject to reimbursement
by such Fund for up to three years from the date the fee or expense was
incurred, but no reimbursement payment will be made by such Fund at any time if
it would result in the Fund's expenses exceeding the expense limitation in
effect at the time the fee was waived or expense was borne by First Trust and
any Sub-Advisor. Acquired Fund Fees and Expenses are not taken into
consideration in the expense limitation because they are not Fund operating
expenses, but rather, are imputed fees and expenses.
PREFERRED FUND
The Preferred Fund and First Trust have retained Stonebridge, an affiliate of
First Trust, to serve as the Fund's investment sub-advisor. Stonebridge is a
niche asset management firm that manages portfolios of preferred securities for
investors. Stonebridge, formed in December 2004, serves as investment advisor or
portfolio supervisor to investment portfolios with approximately $3.46 billion
in assets which it managed or supervised as of December 31, 2013. A portion of
these assets are contained in investments sponsored by FTP, for which
Stonebridge acts as sub-portfolio supervisor.
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To implement the investment strategy, Stonebridge utilizes a repeatable and
consistent investment process that centers on security selection. The process
for security selection that it practices encompasses relative value analysis,
fundamental credit analysis and market technical analysis. This process allows
Stonebridge to source securities in the preferred asset class based on
attributes such as credit quality, yield and capital structure positioning while
also focusing on equally important market technicals such as trading volumes,
liquidity and pricing inefficiencies.
New investments are presented to the Stonebridge investment committee and
thoroughly vetted before inclusion into the portfolio. Investment risk factors
and compliance considerations are included in the vetting process. Once an
investment decision has been approved by the investment committee, the portfolio
managers will look to act upon that investment decision.
The members of Stonebridge's investment committee for the Preferred Fund are
Scott T. Fleming, Robert Wolf and Danielle Salters who serve as the Preferred
Fund's portfolio managers and share responsibilities for the day-to-day
management of the Preferred Fund's investment portfolio.
o Scott T. Fleming serves as President and Chief Investment Officer of
Stonebridge. Prior to founding Stonebridge, Mr. Fleming co-founded
Spectrum Asset Management, Inc., an investment advisor that specializes
in preferred securities asset management for institutional clients and
mutual funds. During his 13-year tenure there, he served as Chairman of
the Board of Directors, Chief Financial Officer and Chief Investment
Officer. Mr. Fleming previously served as Vice President, Portfolio
Manager for DBL Preferred Management, Inc. in New York City. There he
managed over $300 million of institutional assets with a strategy
specializing in preferred securities. Mr. Fleming received a BS in
Accounting from Bentley College in Waltham, MA and his MBA in Finance
from Babson College in Wellesley, MA.
o Robert Wolf serves as Vice President, Portfolio Manager and Senior
Credit Analyst of Stonebridge. Mr. Wolf brings 13 years of fixed-income
experience to Stonebridge. His primary focus is in analyzing both
investment grade and below investment grade securities, where he has
developed a rigorous approach to credit and industry analysis. Prior to
joining Stonebridge, Mr. Wolf was a high yield fixed-income research
analyst at Lehman Brothers. In this role, his responsibilities included
detailed credit analysis across multiple sectors, relative value
analysis, and developing trade recommendations for Lehman's High Yield
proprietary trading effort. Mr. Wolf previously worked for Lehman
Brothers Commercial Mortgage-Backed Securities (CMBS) trading desk as a
credit analyst where he provided in-depth analysis of CMBS transactions
and the underlying Commercial Real Estate. Mr. Wolf received his BS
degree in Chemistry from Villanova University in 1999 and his MBA in
Finance from the New York University Stern School of Business in 2004.
o Danielle Salters, CFA, serves as Credit Analyst for Stonebridge. Ms.
Salters has five years of investment management experience of which four
years have been focused on fixed income. Previous functions have
included fundamental credit research, relative value analysis and
trading. Prior to beginning at Stonebridge, Ms. Salters was Portfolio
Analyst at a boutique asset manager where she focused on high yield
credit analysis and portfolio analytics for a hedge fund and
institutional client. Previously, Ms. Salters was employed by UBS
Financial Services, Inc. where she worked in Taxable Fixed Income Sales
and, later, served as the Fixed Income Specialist to a Portfolio
Manager. Ms. Salters received a BA in economics from Duke University in
2007 and is a CFA Charterholder.
Additional information about the portfolio managers' compensation, other
accounts managed by the portfolio managers and the portfolio managers' ownership
of securities in the Preferred Fund is provided in the SAI.
SMALL CAP FUND
The Small Cap Fund and First Trust have retained Confluence to serve as the
Fund's investment sub-advisor. Confluence is a St. Louis, Missouri based, SEC
registered investment advisor founded in December 2007, specializing in equity
portfolio management, asset allocation portfolio management and alternative
investment management.
The Confluence value-oriented investment team formerly with A.G. Edwards has a
track record dating back to 1994 and has more than $2.3 billion in assets under
management or supervision as of December 31, 2013.
Confluence's investment philosophy is driven by focused research and portfolio
management to achieve long-term, risk-adjusted returns. Confluence employs a
long-term, value-oriented, bottom-up approach to investing. Its proprietary
investment research focuses on determining the intrinsic value of an investment
opportunity. Through its research process, Confluence determines the intrinsic
value of an investment opportunity and look to invest at a significant discount
to intrinsic value, providing investments with a margin of safety.
30
Mark Keller, Daniel Winter, David Miyazaki and Chris Stein serve as the Small
Cap Fund's portfolio managers and share responsibilities for the day-to-day
management of the Small Cap Fund's investment portfolio. The core investment
team is led by Mark Keller.
o Mark Keller, serves as Chief Executive Officer and Chief Investment
Officer of Confluence. Mr. Keller has more than 30 years of investment
experience, with a focus on value-oriented equity analysis and
management. From 1994 to May 2008, he was the Chief Investment Officer
of Gallatin Asset Management, and its predecessor organization, A.G.
Edwards Asset Management, the investment management arm of A.G. Edwards,
Inc. From 1999 to 2008, Mr. Keller was Chairman of the A.G. Edwards
Investment Strategy Committee, which set investment policy and
established asset allocation models for the entire organization.
Mr. Keller began his career with A.G. Edwards in 1978, serving as an
equity analyst for the firm's Securities Research Department from 1979
to 1994. During his last five years in Securities Research, Mr. Keller
was Equity Strategist and manager of the firm's Focus List. Mr. Keller
was a founding member of the A.G. Edwards Investment Strategy Committee,
on which he served over 20 years, the last 10 years of which as Chairman
of the Committee. Mr. Keller was a Senior Vice President of A.G. Edwards
& Sons and of Gallatin Asset Management, and was a member of the Board
of Directors of both companies. Mr. Keller received a Bachelor of Arts
from Wheaton College (Illinois) and is a CFA charterholder.
o Daniel Winter, serves as Senior Vice President and Portfolio Manager
of Confluence. Prior to joining Confluence in May 2008, Mr. Winter
served as a Portfolio Manager and Analyst with Gallatin Asset
Management, the investment management arm of A.G. Edwards, Inc. While at
Gallatin, Mr. Winter chaired the portfolio management team responsible
for the firm's six value-oriented equity strategies. His
responsibilities also included directing the strategy implementation and
trading execution for the equity portfolios. Additionally, Mr. Winter
co-managed the First Trust/Gallatin Specialty Finance and Financial
Opportunities Fund (NYSE: FGB), a closed-end fund whose primary focus
was on Business Development Companies, a role he continues in his
current capacity at Confluence.
Mr. Winter also served as a portfolio manager for the Cyclical Growth
ETF Portfolio and the Cyclical Growth and Income ETF Portfolio which
were offered through variable annuities. He was also a member of the
firm's Allocation Advisor Committee which oversaw the A.G. Edwards
exchange-traded fund focused strategies. Prior to joining the firm's
Asset Management division in 1996, Mr. Winter served as a portfolio
manager for A.G. Edwards Trust Company. Mr. Winter earned a Bachelor of
Arts in business management from Eckerd College and a Master of Business
Administration from Saint Louis University. Mr. Winter is a CFA
charterholder.
o David Miyazaki, serves as Senior Vice President and Portfolio Manager
of Confluence. Prior to joining Confluence in May 2008, Mr. Miyazaki
served as a Portfolio Manager and Analyst with Gallatin Asset
Management, the investment management arm of A.G. Edwards, Inc. Mr.
Miyazaki was responsible for separately managed accounts invested in
individual stocks with a value discipline. He also co-managed the First
Trust/Gallatin Specialty Finance and Financial Opportunities Fund (NYSE:
FGB), a closed-end fund, as well as A.G. Edwards' ETF-based asset
allocation program. In addition to portfolio management, Mr. Miyazaki
served as a member of the A.G. Edwards Investment Strategy Committee. As
a strategist, he was responsible for the firm's quantitative asset
allocation models, including its Cyclical Asset Allocation program.
Prior to joining A.G. Edwards in 1999, Mr. Miyazaki was a Portfolio
Manager at Koch Industries in Wichita, Kansas, where he managed a
short-term interest rate arbitrage portfolio. Previously, he was an
Analyst at Prudential Capital Group in Dallas, Texas, a group that
managed the world's largest portfolio of private placement debt. Prior
to that, Mr. Miyazaki worked as a Mortgage Bond Trader at Barre &
Company, also in Dallas. Mr. Miyazaki received a Bachelor of Business
Administration from Texas Christian University and is a CFA
charterholder.
o Chris Stein serves as Vice President and Portfolio Manager of
Confluence. Mr. Stein joined Confluence in August 2008. Previously, Mr.
Stein served as a Portfolio Manager and Analyst with Gallatin Asset
Management, the investment management arm of A.G. Edwards, Inc. Mr.
Stein was part of the portfolio management team responsible for
Gallatin's Large Cap Value, Small Cap Value, Equity Income, Value
Opportunities and All Cap Global separately managed accounts. His
analytical coverage was primarily focused on companies within the
consumer discretionary sector. Additionally, Mr. Stein assisted the A.G.
Edwards Trust Company in constructing and managing individual stock
portfolios. Prior to joining the Asset Management division in 2001, Mr.
Stein was an associate analyst covering the media and entertainment
sector for A.G. Edwards' securities research. Prior to joining A.G.
Edwards in 1998, he was a financial consultant with Renaissance
Financial. Mr. Stein earned a Bachelor of Science in Accounting and a
Bachelor of Science in Finance from the University of Dayton. Mr. Stein
also received a Master of Business Administration from St. Louis
University.
31
Additional information about the portfolio managers' compensation, other
accounts managed by the portfolio managers and the portfolio managers' ownership
of securities in the Small Cap Fund is provided in the SAI.
SHORT DURATION FUND
To implement the investment strategy, the Advisor combines a rigorous
fundamental credit selection process with top down relative value analysis when
selecting investment opportunities. The Advisor believes that an evolving
investment environment offers varying degrees of investment risk opportunities
in the high yield, bank loan, and derivative and fixed income instrument
markets. In order to capitalize on attractive investments and effectively manage
potential risk, the Advisor believes that the combination of thorough and
continuous credit analysis, market evaluation, diversification and the ability
to reallocate investments among senior and subordinated debt and derivatives is
critical to achieving higher risk-adjusted returns. Fundamental analysis
involves the evaluation of industry trends, management quality, collateral
adequacy, and the consistency of corporate cash flows. The key considerations of
portfolio construction include liquidity, diversification, relative value
assessment, and ongoing monitoring. Through fundamental credit analysis the
Advisor believes it can position the Short Duration Fund's portfolio in bank
loans and high yield securities that offer an attractive risk adjusted return
profile. Moreover, such fundamental credit analysis may result in a higher
credit quality portfolio when compared to a benchmark.
The portfolio managers of the Short Duration Fund are William Housey, Scott D.
Fries and Peter Fasone, and they share responsibilities for the day-to-day
management of the Fund's investment portfolio.
o William Housey, CFA, joined First Trust in June 2010 as Senior
Portfolio Manager and has 17 years of investment experience. Mr. Housey
is a Senior Vice President of First Trust. Prior to joining First Trust,
Mr. Housey was at Morgan Stanley/Van Kampen Funds, Inc. for 11 years and
served as Executive Director and Co-Portfolio Manager. Mr. Housey has
extensive experience in portfolio management of both leveraged and
unleveraged credit products, including Senior Loans, high yield bonds,
credit derivatives and corporate restructurings. Mr. Housey received a
BS in Finance from Eastern Illinois University and an MBA in Finance and
Management and Strategy from Northwestern University's Kellogg School of
Business. He holds the FINRA Series 7, Series 52 and Series 63 licenses
and the Chartered Financial Analyst designation. He is a member of the
CFA Institute and the CFA Society of Chicago.
o Scott D. Fries, CFA, joined First Trust in June 2010 as a Portfolio
Manager and has 19 years of investment industry experience. Mr. Fries is
a Senior Vice President of First Trust. Prior to joining First Trust,
Mr. Fries spent 15 years at Morgan Stanley/Van Kampen Funds, Inc, where
he most recently served as Executive Director and Co-Portfolio Manager
of Institutional Separately Managed Accounts. Mr. Fries received a BA
in International Business from Illinois Wesleyan University and an
MBA in Finance from DePaul University. Mr. Fries holds the Chartered
Financial Analyst designation. He is a member of the CFA Institute and
the CFA Society of Chicago.
o Peter Fasone, CFA, joined First Trust in December 2011 as a Senior
Credit Analyst and has 28 years of industry experience, most recently as
Senior Global Credit Analyst with BNP Paribas Asset Management. He is a
Vice President of First Trust. Since 1996, his focus has been primarily
on investing in high yield and investment grade bonds for total return
and structured credit portfolios. Prior to BNP, Mr. Fasone served as
Portfolio Manager and Senior Analyst for Fortis Investments. From 2001
to 2008 he was Vice President and Senior Analyst at ABN AMRO Asset
Management where he assumed a leadership role in designing and
implementing a disciplined investment process for ABN's $1 billion
global high yield fund. Mr. Fasone received a BS degree from Arizona
State University and an MBA from DePaul University. He holds the
Chartered Financial Analyst designation and the Certified Public
Accountant designation. He is a member of the CFA Institute and the CFA
Society of Chicago.
Additional information about the portfolio managers' compensation, other
accounts managed by the portfolio managers and the portfolio managers' ownership
of securities in the Short Duration Fund is provided in the SAI.
SHARE CLASSES
The Preferred Fund offers five classes of shares: Class A, Class C, Class F,
Class I and Class R3. The Small Cap Fund offers four classes of shares: Class A,
Class C, Class I and Class R3. The Short Duration Fund offers three classes of
shares: Class A, Class C and Class I. Each class represents an interest in the
same portfolio of investments but with a different combination of sales charges,
fees, eligibility requirements and other features. Consult with your financial
intermediary representative for additional information on whether the shares are
an appropriate investment choice. A Fund may not be available through certain of
these intermediaries and not all financial intermediaries offer all classes of
shares. Contact your financial intermediary or refer to your plan documents for
instructions on how to purchase, exchange, or redeem shares. With certain
limited exceptions, the Funds are available only to U.S. citizens or residents.
32
Please refer to the SAI for more information about Class A, Class C, Class F,
Class I and Class R3 shares, including more detailed program descriptions and
eligibility requirements. If your financial intermediary offers more than one
class of shares, you should carefully consider which class of shares to
purchase. Certain classes have higher expenses than other classes, which may
lower the return on your investment. Additional information is also available
from your financial intermediary.
CLASS A SHARES
You can purchase Class A shares at the offering price, which is the net asset
value per share plus an up-front sales charge. The sales charge may be waived,
as described in "Class A Sales Charge Waivers." Class A shares are also subject
to an annual service fee of 0.25% of a Fund's average daily net assets
attributable to Class A shares, which compensates your financial advisor and
other entities for providing ongoing service to you. FTP retains the up-front
sales charge and the service fee on accounts with no financial intermediary of
record. The up-front Class A sales charges for the Fund are as
follows:
----------------------------------------------------------------------------------------------------------------------------------
SALES CHARGE SALES CHARGE MAXIMUM
AS % AS % FINANCIAL INTERMEDIARY
OF PUBLIC OF NET AMOUNT COMMISSION AS % OF
OFFERING PRICE INVESTED PUBLIC OFFERING PRICE
SHORT SHORT SHORT
PREFERRED SMALL CAP DURATION PREFERRED SMALL CAP DURATION PREFERRED SMALL CAP DURATION
FUND FUND FUND FUND FUND FUND FUND FUND FUND
AMOUNT OF PURCHASE
-----------------------------------------------------------------------------------------------------------------------------------
Less than $50,000 4.50% 5.50% 3.50% 4.71% 5.73% 3.62% 4.00% 5.00% 3.00%
-----------------------------------------------------------------------------------------------------------------------------------
$50,000 but less than $100,000 4.25% 4.75% 3.25% 4.43% 4.97% 3.35% 3.75% 4.25% 2.75%
-----------------------------------------------------------------------------------------------------------------------------------
$100,000 but less than $250,000 3.50% 4.00% 2.50% 3.62% 4.21% 2.56% 3.00% 3.50% 2.00%
-----------------------------------------------------------------------------------------------------------------------------------
$250,000 but less than $500,000 2.75% 3.75% 1.75% 2.82% 3.96% 1.78% 2.50% 3.50% 1.50%
-----------------------------------------------------------------------------------------------------------------------------------
$500,000 but less than $1,000,000 2.25% 3.25% 1.25% 2.30% 3.45% 1.26% 2.00% 3.00% 1.00%
-----------------------------------------------------------------------------------------------------------------------------------
$1,000,000 and over* -- -- -- -- -- -- 1.00% 1.00% 1.00%
------------------------------------------------------------------------------------------------------------------------------------
|
* You can purchase $1 million or more of Class A shares at net asset value
without an up-front sales charge. First Trust pays financial intermediaries
of record a commission equal to 1.00% of the first $2.5 million, plus 0.50%
of the next $2.5 million, plus 0.25% of the amount over $5 million. Unless
the financial intermediary waived the commission, you may be assessed a
contingent deferred sales charge of 1.00% if you redeem any of your shares
within 12 months of purchase. The contingent deferred sales charge is
calculated on the lower of your purchase price or your redemption proceeds.
You do not pay a contingent deferred sales charge on any Class A shares you
purchase by reinvesting dividends.
For purposes of determining whether you qualify for a reduced sales charge as
set forth in the table above, you may include purchases by (i) you, (ii) your
spouse (or legal equivalent if recognized under local law) and your children
under 21 years of age, and (iii) a corporation, partnership or sole
proprietorship that is 100% owned by any of the persons in (i) or (ii). In
addition, a trustee or other fiduciary can count all shares purchased for a
single trust, estate or other single fiduciary account that has multiple
accounts (including one or more employee benefit plans of the same employer).
See the SAI for more information.
CLASS C SHARES
You can purchase Class C shares at the offering price, which is the net asset
value per share without any up-front sales charge. Class C shares are subject to
annual distribution and service fees of 1.00% of a Fund's average daily net
assets attributable to Class C shares. The annual 0.25% service fee compensates
your financial advisor for providing ongoing service to you. The annual 0.75%
distribution fee compensates FTP for paying your financial advisor an ongoing
sales commission as well as an advance of the first year's service and
distribution fees. FTP retains the service and distribution fees on accounts
with no financial intermediary of record. If you redeem your shares within 12
months of purchase, you will normally pay a 1.00% CDSC, which is calculated on
the lower of your purchase price or your redemption proceeds. You do not pay a
CDSC on any Class C shares you purchase by reinvesting dividends.
The Funds have established a limit to the amount of Class C shares that may be
purchased by an individual investor. See the SAI for more information.
CLASS F SHARES
You can purchase Class F shares of the Preferred Fund at the offering price,
which is the net asset value per share without any up-front sales charge. Class
F shares are subject to an annual service fee of 0.15% of the Preferred Fund's
average daily net assets attributable to Class F shares. The annual service fee
compensates your financial advisor for providing ongoing service to you. Class F
shares generally are available to investors participating in fee-based advisory
programs that have (or whose trading agents have) an agreement with FTP and to
33
investors who are clients of certain registered investment advisors that have an
agreement with FTP, if it deems appropriate. See the SAI for more information.
CLASS I SHARES
You can purchase Class I shares at the offering price, which is the net asset
value per share without any up-front sales charge. Class I shares are not
subject to sales charges or ongoing service or distribution fees. Class I shares
have lower ongoing expenses than the other classes. Class I shares are available
for purchase in an amount of $1 million or more, or using dividends and capital
gains distributions on Class I shares. Class I shares may also be purchased by
the following categories of investors:
o Certain employees, officers, directors and affiliates of First Trust,
Stonebridge and Confluence.
o Certain financial intermediary personnel.
o Certain bank or broker affiliated trust departments, pursuant to an
agreement.
o Certain employer-sponsored retirement plans.
o Certain additional categories of investors, including certain
advisory accounts of First Trust and its affiliates, and qualifying
clients of investment advisors, financial planners, or other financial
intermediaries that charge periodic or asset-based fees for their
services.
See the SAI for more information.
CLASS R3 SHARES
You can purchase Class R3 shares at the offering price, which is the net asset
value per share without any up-front sales charge. Class R3 shares are subject
to annual distribution and service fees of 0.50% of each Fund's average daily
net assets attributable to Class R3 shares. The annual 0.25% service fee
compensates your financial advisor for providing ongoing service to you. The
annual 0.25% distribution fee compensates FTP for paying your financial advisor
an ongoing sales commission as well as an advance of the first year's service
and distribution fees. Class R3 shares are available for purchase by certain
qualified retirement plans that have an agreement with FTP to utilize Class R3
shares in certain investment products or programs, as well as traditional and
Roth IRAs, Coverdell Education Savings Accounts, SEPs, SAR SEPs, or simple IRAs.
See the SAI for more information.
CLASS A SALES CHARGE WAIVERS
Class A shares of the Funds may be purchased at net asset value without a sales
charge as follows:
o Purchases of $1,000,000 or more.
o Reinvestment of distributions from Class A Shares of a Fund.
o Reinvestment of First Trust non-ETF open-end fund ("First Trust
Mutual Fund") distributions.
o Purchases by officers, trustees and former trustees of the First
Trust Mutual Funds, as well as full-time and retired employees of First
Trust, any parent company of First Trust, and subsidiaries thereof, and
such employees' immediate family members (as defined in the SAI).
o Purchases by any person who, for at least the last 90 days, has been
an officer, director, or full-time employee of any financial
intermediary or any such person's immediate family member.
o Purchases by bank or broker-affiliated trust departments investing
funds over which they exercise exclusive discretionary investment
authority and that are held in a fiduciary, agency, advisory, custodial,
or similar capacity.
o Purchases made by investors purchasing on a periodic fee, asset based
fee, or no transaction fee basis through a broker-dealer sponsored
mutual fund purchase program; and clients of investment advisors,
financial planners, or other financial intermediaries that charge
periodic or asset-based fees for their services.
You may need to provide a Fund or your financial advisor information or records,
such as account statements, in order to verify your eligibility for a sales
charge waiver (or reduction as set forth in the table above in "Share
Classes--Class A Shares"). This may include account statements of family members
and information regarding First Trust Mutual Fund shares held in accounts with
other financial advisors. You or your financial advisor must notify First Trust
at the time of each purchase if you are eligible for any of these programs that
result in a sales charge waiver or reduction. The Funds may modify or
discontinue these programs at any time.
34
Right of Accumulation. You may purchase Class A shares of each Fund at a reduced
sales charge determined by aggregating the dollar amount of the new purchase
(measured by the offering price) and the total prior day's net asset value (net
amount invested) of all eligible shares (as set forth herein) and applying the
sales charge applicable to such aggregate amount. Shares eligible for
aggregation include Class A shares of such Fund and other First Trust Mutual
Funds then held by (i) you, (ii) your spouse (or legal equivalent if recognized
under local law) and your children under 21 years of age, and (iii) a
corporation, partnership or sole proprietorship that is 100% owned by any of the
persons in (i) or (ii). In order for your purchases and holdings to be
aggregated for purposes of qualifying for such discount, they must have been
made through one financial intermediary and you must provide sufficient
information to your financial intermediary at the time of initial purchase of
shares that qualify for the rights of accumulation to permit verification that
the purchase qualifies for the reduced sales charge. The right of accumulation
is subject to modification or discontinuance at any time with respect to all
shares purchased thereafter.
Letter of Intent. You can also reduce the sales charge on the purchase of Class
A shares by signing a Letter of Intent indicating your intention to purchase
$50,000 or more of Class A shares (including Class A shares in other First Trust
funds) over a 13-month period. The term of the Letter of Intent will commence
upon the date you sign the Letter. In order to apply purchases towards the
intended amount, you must refer to such Letter when placing all orders.
When calculating the applicable sales charge to a purchase pursuant to a Letter
of Intent, the amount of investment for purposes of applying the sales load
schedule includes: (i) the historical cost (what you actually paid for the
shares at the time of purchase, including any sales charges) of all Class A
shares acquired during the term of the Letter of Intent; minus (ii) the value of
any redemptions of Class A shares made during the term of the Letter of Intent.
Each investment made during the period receives the reduced sales charge
applicable to the total amount of the investment goal. A portion of shares
purchased may be held in escrow to pay for any applicable sales charge. If the
goal is not achieved within the period, you must pay the difference between the
sales charges applicable to the purchases made and the charges previously paid,
or an appropriate number of escrowed shares will be redeemed. Please contact
your financial intermediary to obtain a Letter of Intent application.
INVESTMENT IN FUND SHARES
Shares of the Funds may be purchased on any business day, which is any day the
NYSE is open for business. Generally, the NYSE is closed on weekends and
national holidays. The share price you pay depends on when the transfer agent
receives your order. Orders received before the close of trading on a business
day (normally, 4:00 p.m. Eastern time) will receive that day's closing share
price; otherwise, you will receive the next business day's price.
Preferred Fund, Small Cap Fund and Short Duration Fund shares may be purchased
only through a financial intermediary. The Funds have authorized one or more
financial intermediaries, or the designees of such intermediaries, to receive
purchase and redemption orders on the Funds' behalf. The Funds will be deemed to
have received a purchase or redemption order when an authorized financial
intermediary, or the designee of an authorized financial intermediary, receives
the order.
A financial intermediary, such as a financial advisor or broker, is paid for
providing investment advice and services, either from a Fund sales charges and
fees or by charging you a separate fee in lieu of a sales charge. Financial
intermediaries may charge a service fee in connection with the purchase or
redemption of a Fund shares. Service fees typically are fixed dollar amounts and
are in addition to the sales and other charges described in this prospectus and
the SAI. For more information, please contact your financial intermediary.
INVESTMENT MINIMUMS
The minimum initial purchase or exchange into each of the Funds is $2,500
($750 for a Traditional/Roth IRA account; $500 for an Education IRA account;
and $250 for accounts opened through fee based programs). Subsequent investments
must be in amounts of $50 or more. Class I shares are subject to higher minimums
for certain investors and Class R3 shares are not subject to any minimums.
There are no minimums for purchases or exchanges into the Funds through
employer-sponsored retirement plans. The Funds reserve the right to reject
purchase or exchange orders and to waive or increase the minimum investment
requirements.
ACCOUNT SERVICES
The following is a description of additional account services available to
investors at no additional cost. Investors can call First Trust at (888)
373-5776 for copies of the necessary forms, or they may be obtained from a
financial intermediary.
35
EXCHANGING SHARES
Shares of each of the Funds may be exchanged into an identically registered
account for the same class of another First Trust Mutual Fund available in your
state. The exchange must meet the minimum purchase requirements of the fund into
which you are exchanging. You may also, under certain limited circumstances,
exchange between certain classes of shares of the same Fund, subject to the
payment of any applicable CDSC. Please consult the SAI for details.
The Funds may change or cancel their exchange policy at any time upon 60 days'
notice. The Funds reserve the right to revise or suspend the exchange privilege,
limit the amount or number of exchanges, or reject any exchange. See "Frequent
Trading and Market Timing" below.
Because an exchange between Funds is treated for tax purposes as a purchase and
sale, any gain may be subject to tax. An exchange between classes of shares of
the same Fund may not be considered a taxable event. Please consult a tax
advisor about the tax consequences of exchanging your shares.
REINVESTMENT PRIVILEGE
If shares of the Funds are redeemed, you may reinvest all or part of your
redemption proceeds in such Fund up to one year later without incurring any
additional charges. You may only reinvest into the same share class you
redeemed. The reinvestment privilege does not extend to Class A shares or Class
C shares, where the redemption of the shares triggered the payment of a CDSC.
This reinvestment privilege may be used only once for any redemption.
REDEMPTION OF FUND SHARES
An investor may redeem shares on any business day. Investors will receive the
share price next determined after your Fund has received a redemption request.
Redemption requests must be received before the close of trading on the NYSE
(normally, 4:00 p.m. Eastern time) in order to receive that day's price. Your
Fund will normally mail a check the next business day after a redemption request
is received, but in no event more than seven days after a request is received.
If you are selling shares purchased recently with a check, your redemption
proceeds will not be mailed until your check has cleared, which may take up to
ten days from your purchase date.
Your Fund shares must be redeemed through your financial intermediary. A
financial intermediary may charge a fee for this service.
CONTINGENT DEFERRED SALES CHARGE
If Class A or Class C shares that are subject to a CDSC are redeemed, an
investor may be assessed a CDSC. When an investor is subject to a CDSC, your
Fund will first redeem any shares that are not subject to a CDSC, and then
redeem the shares owned for the longest period of time, unless requested
otherwise. No CDSC is imposed on shares bought through the reinvestment of
dividends and capital gains. The CDSC holding period is calculated on a monthly
basis and begins on the first day of the month in which the purchase was made.
When you redeem shares subject to a CDSC, the CDSC is calculated on the lower of
your purchase price or redemption proceeds, deducted from your redemption
proceeds, and paid to FTP. The CDSC may be waived under certain special
circumstances as described in the SAI.
INVOLUNTARY REDEMPTION
From time to time, the Funds may establish minimum account size requirements.
The Funds reserve the right to liquidate your account upon 30 days' written
notice if the value of your account falls below an established minimum. Accounts
may be involuntarily redeemed when the value of the account falls below the
minimum either because of redemptions or because of market action. The Funds
have set a minimum balance of $100 unless you have an active First Trust
reinvestment account. You will not be assessed a CDSC on an involuntary
redemption.
REDEMPTIONS IN-KIND
The Funds generally pay redemption proceeds in cash. Under unusual conditions
that make cash payment unwise and for the protection of existing shareholders,
the Funds may pay all or a portion of your redemption proceeds in securities or
other Fund assets. Although it is unlikely that your shares would be redeemed
in-kind, you would probably have to pay brokerage costs to sell the securities
distributed to you, as well as taxes on any capital gains from that sale. See
the SAI for additional information.
MEDALLION SIGNATURE GUARANTEE PROGRAM
Non-financial transactions, including establishing or modifying certain services
such as changing bank information on an account, will require a signature
guarantee or signature verification from a Medallion Signature Guarantee Program
36
member or other acceptable form of authentication from a financial institution
source. In addition to the situations described above, the Short Duration Fund
reserves the right to require a signature guarantee, or another acceptable form
of signature verification, in other instances based on the circumstances of a
particular situation.
A signature guarantee assures that a signature is genuine and protects
shareholders from unauthorized account transfers. Banks, savings and loan
associations, trust companies, credit unions, broker-dealers and member firms of
a national securities exchange may guarantee signatures. Call your financial
intermediary to determine if it has this capability. A notary public is not an
acceptable signature guarantor. Proceeds from a written redemption request will
be sent to you by check unless another form of payment is requested.
DIVIDENDS, DISTRIBUTIONS AND TAXES
Dividends from net investment income, if any, are declared daily and paid
monthly by the Preferred Fund and Short Duration Fund, and declared and paid
semi-annually by the Small Cap Fund. Each Fund distributes its net realized
capital gains, if any, to shareholders at least annually.
Each Fund automatically reinvests your dividends in additional Fund shares
unless you request otherwise. You may request to have your dividends paid to you
by check, deposited directly into your bank account, paid to a third party, sent
to an address other than your address of record or reinvested in shares of
another First Trust Mutual Fund. For further information, contact your financial
advisor or call First Trust at (888) 373-5776.
FEDERAL TAX MATTERS
This section summarizes some of the main U.S. federal income tax consequences of
owning shares of the Funds. This section is current as of the date of this
prospectus. Tax laws and interpretations change frequently, and these summaries
do not describe all of the tax consequences to all taxpayers. For example, these
summaries generally do not describe your situation if you are a corporation, a
non-U.S. person, a broker-dealer, or other investor with special circumstances.
In addition, this section does not describe your state, local or non-U.S. tax
consequences.
This federal income tax summary is based in part on the advice of counsel to the
Funds. The Internal Revenue Service could disagree with any conclusions set
forth in this section. In addition, counsel to the Funds was not asked to
review, and has not reached a conclusion with respect to, the federal income tax
treatment of the assets to be included in the Funds. This may not be sufficient
for you to use for the purpose of avoiding penalties under federal tax law.
As with any investment, you should seek advice based on your individual
circumstances from your own tax advisor.
FUND STATUS
Each Fund intends to continue to qualify as a "regulated investment company"
under the federal tax laws. If a Fund qualifies as a regulated investment
company and distributes its income as required by the tax law, the Fund
generally will not pay federal income taxes.
DISTRIBUTIONS
The Funds' distributions are generally taxable. After the end of each year, you
will receive a tax statement that separates the distributions of a Fund into two
categories, ordinary income distributions and capital gains dividends. Ordinary
income distributions are generally taxed at your ordinary tax rate, however, as
further discussed below, certain ordinary income distributions received from the
Fund may be taxed at the capital gains tax rates. Generally, you will treat all
capital gains dividends as long-term capital gains regardless of how long you
have owned your shares. To determine your actual tax liability for your capital
gains dividends, you must calculate your total net capital gain or loss for the
tax year after considering all of your other taxable transactions, as described
below. In addition, the Funds may make distributions that represent a return of
capital for tax purposes and thus will generally not be taxable to you; however,
such distributions may reduce basis, which could result in you having to pay
higher taxes in the future when shares are sold, even if you sell the shares at
a loss from your original investment. The tax status of your distributions from
a Fund is not affected by whether you reinvest your distributions in additional
shares or receive them in cash. The income from a Fund that you must take into
account for federal income tax purposes is not reduced by amounts used to pay a
deferred sales fee, if any. The tax laws may require you to treat distributions
made to you in January as if you had received them on December 31 of the
previous year.
Under the "Health Care and Education Reconciliation Act of 2010," income from a
Fund may also be subject to a new 3.8% "Medicare tax" imposed for taxable years
beginning after 2012. This tax will generally apply to your net investment
income if your adjusted gross income exceeds certain threshold amounts, which
are $250,000 in the case of married couples filing joint returns and $200,000 in
the case of single individuals.
37
DIVIDENDS RECEIVED DEDUCTION
A corporation that owns shares generally will not be entitled to the dividends
received deduction with respect to many dividends received from the Fund because
the dividends received deduction is generally not available for distributions
from regulated investment companies. However, certain ordinary income dividends
on shares that are attributable to qualifying dividends received by the Funds
from certain corporations may be reported by the Funds as being eligible for the
dividends received deduction.
CAPITAL GAINS AND LOSSES AND CERTAIN ORDINARY INCOME DIVIDENDS If you are an
individual, the maximum stated marginal federal tax rate for net capital gain is
generally 20% for taxpayers in the 39.6% tax bracket, 15% for taxpayers in the
25%, 28%, 33% and 35% tax brackets and 0% for taxpayers in the 10% and 15% tax
brackets. Some capital gains dividends may be taxed at a maximum stated tax rate
of 25%. Capital gains may also be subject to the Medicare tax described above.
Net capital gain equals net long-term capital gain minus net short-term capital
loss for the taxable year. Capital gain or loss is long-term if the holding
period for the asset is more than one year and is short-term if the holding
period for the asset is one year or less. You must exclude the date you purchase
your shares to determine your holding period. However, if you receive a capital
gain dividend from a Fund and sell your shares at a loss after holding it for
six months or less, the loss will be recharacterized as long-term capital loss
to the extent of the capital gain dividend received. The tax rates for capital
gains realized from assets held for one year or less are generally the same as
for ordinary income. The Code treats certain capital gains as ordinary income in
special situations.
Ordinary income dividends received by an individual shareholder from a regulated
investment company such as the Funds are generally taxed at the same rates that
apply to net capital gain (as discussed above), provided certain holding period
requirements are satisfied and provided the dividends are attributable to
qualifying dividends received by the Funds themselves. Dividends from REITs and
foreign corporations are qualifying dividends only in limited circumstances. The
Funds will provide notice to their shareholders of the amount of any
distribution which may be taken into account as a dividend which is eligible for
the capital gains tax rates.
SALE OF SHARES
If you sell or redeem your shares, you will generally recognize a taxable gain
or loss. To determine the amount of this gain or loss, you must subtract your
tax basis in your shares from the amount you receive in the transaction. Your
tax basis in your shares is generally equal to the cost of your shares,
generally including sales charges. In some cases, however, you may have to
adjust your tax basis after you purchase your shares.
NON-U.S. TAX CREDIT
Because the Funds invest in non-U.S. securities, the tax statement that you
receive may include an item showing non-U.S. taxes the Funds paid to other
countries. In this case, dividends taxed to you will include your share of the
taxes your Fund paid to other countries. You may be able to deduct or receive a
tax credit for your share of these taxes.
NON-U.S. INVESTORS
If you are a non-U.S. investor (i.e., an investor other than a U.S. citizen or
resident or a U.S. corporation, partnership, estate or trust), you should be
aware that, generally, subject to applicable tax treaties, distributions from a
Fund will be characterized as dividends for federal income tax purposes (other
than dividends which a Fund properly reports as capital gain dividends) and will
be subject to U.S. federal income taxes, including withholding taxes, subject to
certain exceptions described below. However, distributions received by a
non-U.S. investor from a Fund that are properly reported by a Fund as capital
gain dividends may not be subject to U.S. federal income taxes, including
withholding taxes, provided that a Fund makes certain elections and certain
other conditions are met. In the case of dividends with respect to taxable years
of a Fund beginning prior to 2014, distributions from a Fund that are properly
reported by such Fund as an interest-related dividend attributable to certain
interest income received by the Fund or as a short-term capital gains dividend
attributable to certain net short-term capital gains income received by such
Fund may not be subject to U.S. federal income taxes, including withholding
taxes when received by certain foreign investors, provided that a Fund makes
certain elections and certain other conditions are met.
Distributions after June 30, 2014 may be subject to a U.S. withholding tax of
30% in the case of distributions to (i) certain non-U.S. financial institutions
that have not entered into an agreement with the U.S. Treasury to collect and
disclose certain information and are not resident in a jurisdiction that has
entered into such an agreement with the U.S. Treasury and (ii) certain other
non-U.S. entities that do not provide certain certifications and information
about the entity's U.S. owners. Dispositions of shares by such persons may be
subject to such withholding after December 31, 2016.
38
INVESTMENTS IN CERTAIN NON-U.S. CORPORATIONS
If a Fund holds an equity interest in any PFICs, which are generally certain
non-U.S. corporations that receive at least 75% of their annual gross income
from passive sources (such as interest, dividends, certain rents and royalties
or capital gains) or that hold at least 50% of their assets in investments
producing such passive income, a Fund could be subject to U.S. federal income
tax and additional interest charges on gains and certain distributions with
respect to those equity interests, even if all the income or gain is timely
distributed to its shareholders. A Fund will not be able to pass through to its
shareholders any credit or deduction for such taxes. A Fund may be able to make
an election that could ameliorate these adverse tax consequences. In this case,
a Fund would recognize as ordinary income any increase in the value of such PFIC
shares, and as ordinary loss any decrease in such value to the extent it did not
exceed prior increases included in income. Under this election, a Fund might be
required to recognize in a year income in excess of its distributions from PFICs
and its proceeds from dispositions of PFIC stock during that year, and such
income would nevertheless be subject to the distribution requirement and would
be taken into account for purposes of the 4% excise tax. Dividends paid by PFICs
are not treated as qualified dividend income.
DISTRIBUTION AND SERVICE PLAN
FTP serves as the selling agent and distributor of the Funds' shares. In this
capacity, FTP manages the offering of the Funds' shares and is responsible for
all sales and promotional activities. In order to reimburse FTP for its costs in
connection with these activities, including compensation paid to financial
intermediaries, the Funds have adopted a distribution and service plan under
Rule 12b-1 under the 1940 Act. See "Share Classes" for a description of the
distribution and service fees paid under this plan.
FTP receives a service fee for Class A, Class C, Class F and Class R3 shares to
compensate financial intermediaries, including FTP, for providing ongoing
account services to shareholders. These services may include establishing and
maintaining shareholder accounts, answering shareholder inquiries, and providing
other personal services to shareholders. Under the plan, FTP receives a
distribution fee for Class C and Class R3 shares for providing compensation to
financial intermediaries, including FTP, in connection with the distribution of
shares. These fees also compensate FTP for other expenses, including printing
and distributing prospectuses to persons other than shareholders, and preparing,
printing and distributing advertising and sales literature and reports to
shareholders used in connection with the sale of shares. Because these fees are
paid out of a Fund's assets on an ongoing basis, over time these fees will
increase the cost of your investment and may cost you more than paying other
types of sales charges. Long-term holders of Class C, Class F and Class R3
shares may pay more in Rule 12b-1 fees than the economic equivalent of the
maximum front-end sales charge permitted under the Financial Industry Regulatory
Authority Conduct Rules.
OTHER PAYMENTS TO FINANCIAL INTERMEDIARIES
In addition to the sales commissions and certain payments related to 12b-1
distribution and service fees paid by FTP to financial intermediaries as
previously described, First Trust or its affiliates may from time to time make
additional payments, out of their own resources, to certain financial
intermediaries that sell shares of First Trust Mutual Funds in order to promote
the sales and retention of fund shares by those firms and their customers. The
amounts of these payments vary by financial intermediary and, with respect to a
given firm, are typically calculated by reference to the amount of the firm's
recent gross sales of First Trust Mutual Fund shares and/or total assets of
First Trust Mutual Funds held by the firm's customers. The level of payments
that First Trust is willing to provide to a particular financial intermediary
may be affected by, among other factors, the firm's total assets held in and
recent net investments into First Trust Mutual Funds, the firm's level of
participation in First Trust Mutual Fund sales and marketing programs, the
firm's compensation program for its registered representatives who sell fund
shares and provide services to fund shareholders, and the asset class of the
First Trust Mutual Funds for which these payments are provided. First Trust or
its affiliates may also make payments to financial intermediaries in connection
with sales meetings, due diligence meetings, prospecting seminars and other
meetings at which First Trust or its affiliates promotes its products and
services. First Trust may also make payments to certain financial intermediaries
for certain administrative services, including record keeping and sub-accounting
of shareholder accounts pursuant to a sub-transfer agency, omnibus account
service or sub-accounting agreement. All fees payable by First Trust under this
category of services may be charged back to the Funds, subject to approval by
the Board.
In connection with the availability of First Trust Mutual Funds within selected
mutual fund no transaction fee institutional platforms and fee based wrap
programs (together, "Platform Programs") at certain financial intermediaries,
First Trust or an affiliate also makes payments out of its own assets to those
firms as compensation for certain recordkeeping, shareholder communications and
other account administration services provided to First Trust Mutual Fund
shareholders who own their fund shares in these Platform Programs. These
payments are in addition to the 12b-1 service fee and any applicable omnibus
sub-accounting fees paid to these firms with respect to these services by the
First Trust Mutual Funds out of Fund assets.
39
NET ASSET VALUE
The net asset value is determined for each class of shares of each Fund as of
the close of trading (normally 4:00 p.m., Eastern time) on each day the NYSE is
open for business. Net asset value for each class is calculated for each Fund by
taking the market price of the Fund's total assets attributable to such class,
including interest or dividends accrued but not yet collected, less all
liabilities attributable to such class, and dividing such amount by the total
number of shares of the class outstanding. The result, rounded to the nearest
cent, is the net asset value per share. Differences in net asset value of each
class of a Fund's shares are generally expected to be due to the daily expense
accruals of the specified distribution and service fees and transfer agency
costs applicable to such class of shares and the differential in the dividends
that may be paid on each class of shares. All valuations are subject to review
by the Board or its delegate.
Each Fund's investments are valued at market value or, in the absence of market
value with respect to any portfolio securities, at fair value in accordance with
valuation procedures adopted by the Board and in accordance with the 1940 Act.
Portfolio securities listed on any exchange other than the NASDAQ(R) Stock
Market LLC ("NASDAQ(R)") or the London Stock Exchange Alternative Investment
Market ("AIM") are valued at the last sale price on the exchange on which they
are principally traded. Securities listed on the NASDAQ(R) or the AIM are valued
at the official closing price. Portfolio securities traded on more than one
securities exchange are valued at the last sale price or official closing price,
as applicable, 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 are valued at the
mean of the bid and the asked prices, if available, and otherwise at the closing
bid price. Senior loan securities are generally valued by a pricing service.
Certain securities may not be able to be priced by pre-established pricing
methods. Such securities may be valued by the Board or its delegate at fair
value. The use of fair value pricing by the Funds is governed by valuation
procedures adopted by the Board and in accordance with the provisions of the
1940 Act. These securities generally include, but are not limited to, restricted
securities (securities which may not be publicly sold without registration under
the Securities Act) for which a pricing service is unable to provide a market
price; securities whose trading has been formally suspended; a security whose
market price is not available from a pre-established pricing source; a security
with respect to which an event has occurred that is likely to materially affect
the value of the security after the market has closed but before the calculation
of the net asset value of each class of shares of the Fund or make it difficult
or impossible to obtain a reliable market quotation; and a security whose price,
as provided by the pricing service, does not reflect the security's "fair
value." As a general principle, the current "fair value" of a security would
appear to be the amount which the owner might reasonably expect to receive for
the security upon its current sale. The use of fair value prices by the Funds
generally results in the prices used by the Funds that may differ from the
current market quotations or official closing prices on the applicable exchange.
A variety of factors may be considered in determining the fair value of such
securities. See the SAI for details. Valuing a Fund's securities using fair
value pricing will result in using prices for those securities that may differ
from current market valuations.
Because foreign securities exchanges may be open on different days than the days
during which an investor may purchase or sell the shares of a Fund, the value of
such Fund's securities may change on the days when investors are not able to
purchase or sell the shares of such Fund.
Fixed-income securities will be valued by the fund accounting agent using a
pricing service. Fixed-income securities with a remaining maturity of 60 days or
less when purchased will be valued at cost adjusted for amortization of premiums
and accretion of discounts. When price quotes are not available, fair market
value is based on prices of comparable securities.
Repurchase agreements will be valued as follows: Overnight repurchase agreements
will be valued at cost. Term repurchase agreements (i.e., those whose maturity
exceeds seven days) will be valued by the pricing committee at the average of
the bid quotations obtained daily from at least two recognized dealers.
Currency-linked notes, credit-linked notes and other similar instruments will be
valued by a Fund by using a pricing service or, if the pricing service does not
provide a value, by quotes provided by the selling dealer or financial
institution. When price quotes are not available, fair market value is based on
prices of comparable securities. Absent a material difference between the exit
price for these instruments and the market rates for similar instruments,
currency-linked notes, credit-linked notes, etc. will be valued at the exit
price.
40
Interest rate swaps, credit default swaps, currency-linked notes and other
similar instruments will be valued by a Fund by using a pricing service or, if
the pricing service does not provide a value, by quotes provided by the selling
dealer or financial institution. When price quotes are not available, fair
market value is based on prices of comparable securities. Absent a material
difference between the exit price for a particular swap and the market rates for
similar transactions, the swap will be valued at the exit price.
FUND SERVICE PROVIDERS
Brown Brothers Harriman & Co. is the administrator, custodian and fund
accounting agent for the Preferred Fund and the Small Cap Fund. BNY Mellon
Investment Servicing (US) Inc. is the transfer agent for the Preferred Fund and
the Small Cap Fund and is the administrator, fund accounting agent and transfer
agent for the Short Duration Fund. The Bank of New York Mellon Corporation is
the custodian for the Short Duration Fund. Chapman and Cutler LLP, 111 West
Monroe Street, Chicago, Illinois 60603, serves as legal counsel to the Funds.
SHAREHOLDER INQUIRIES
All inquiries regarding the Funds should be directed to the Trust, c/o BNY
Mellon Investment Servicing (US) Inc., P.O. Box 9788, Providence, Rhode Island
02940, or by calling (888) 373-5776.
FREQUENT TRADING AND MARKET TIMING
Each Fund is intended for long-term investment and should not be used for
excessive trading. Excessive trading in a Fund's shares can disrupt portfolio
management, lead to higher operating costs and cause other operating
inefficiencies for a Fund. However, a Fund is also mindful that shareholders may
have valid reasons for periodically purchasing and redeeming a Fund shares.
Accordingly, the Trust has adopted a Frequent Trading Policy that seeks to
balance a Fund's need to prevent excessive trading in Fund shares while offering
investors the flexibility in managing their financial affairs to make periodic
purchases and redemptions of a Fund's shares.
The Trust's Frequent Trading Policy generally limits an investor to two "round
trip" trades within a 90-day period. A "round trip" is the purchase and
subsequent redemption of a Fund's shares, including by exchange. Each side of a
round trip may be comprised of either a single transaction or a series of
closely spaced transactions. The Trust may also suspend the trading privileges
of any investor who makes a round trip within a 30-day period if the purchase
and redemption are of substantially similar dollar amounts.
Each Fund primarily receives share purchase and redemption orders through third
party financial intermediaries, some of whom rely on the use of omnibus
accounts. An omnibus account typically includes multiple investors and provides
a Fund only with a net purchase or redemption amount on any given day where
multiple purchases, redemptions and exchanges of shares occur in the account.
The identity of individual purchasers, redeemers and exchangers whose orders are
aggregated in omnibus accounts, and the size of their orders, will generally not
be known by a Fund. Despite a Fund's efforts to detect and prevent frequent
trading, such Fund may be unable to identify frequent trading because the
netting effect in omnibus accounts often makes it more difficult to identify
frequent traders. FTP, the Funds' distributor, has entered into agreements with
financial intermediaries that maintain omnibus accounts with the Funds' transfer
agent. Under the terms of these agreements, the financial intermediaries
undertake to cooperate with FTP in monitoring purchase, exchange and redemption
orders by their customers in order to detect and prevent frequent trading in a
Fund through such accounts. Technical limitations in operational systems at such
intermediaries or at FTP may also limit a Fund's ability to detect and prevent
frequent trading. In addition, the Trust may permit certain financial
intermediaries, including broker-dealer and retirement plan administrators,
among others, to enforce their own internal policies and procedures concerning
frequent trading. Such policies may differ from the Trust's Frequent Trading
Policy and may be approved for use in instances where a Fund reasonably believes
that the intermediary's policies and procedures effectively discourage
inappropriate trading activity. Shareholders holding their accounts with such
intermediaries may wish to contact the intermediary for information regarding
its frequent trading policy. Although the Trust does not knowingly permit
frequent trading, it cannot guarantee that it will be able to identify and
restrict all frequent trading activity.
The Trust reserves the right in its sole discretion to waive unintentional or
minor violations (including transactions below certain dollar thresholds) if
it determines that doing so would not harm the interests of the respective
Fund's shareholders. In addition, certain categories of redemptions may be
excluded from the application of the Frequent Trading Policy, as described in
more detail in the statement of additional information. These include, among
others, redemptions pursuant to systematic withdrawal plans, redemptions in
connection with the total disability or death of the investor, involuntary
redemptions by operation of law, redemptions in payment of account or plan fees,
and certain redemptions by retirement plans, including redemptions in connection
with qualifying loans or hardship withdrawals, termination of plan
participation, return of excess contributions, and required minimum
distributions. The Trust may also modify or suspend the Frequent Trading Policy
without notice during periods of market stress or other unusual circumstances.
The Trust reserves the right to impose restrictions on purchases or exchanges
that are more restrictive than those stated above if it determines, in its sole
discretion, that a transaction or a series of transactions involves market
timing or excessive trading that may be detrimental to Fund shareholders. The
Trust also reserves the right to reject any purchase order, including exchange
41
purchases, for any reason. For example, the Trust may refuse purchase orders if
a Fund would be unable to invest the proceeds from the purchase order in
accordance with such Fund's investment policies and/or objective(s), or if such
Fund would be adversely affected by the size of the transaction, the frequency
of trading in the account or various other factors. For more information about
the Trust's Frequent Trading Policy and its enforcement, see "Purchase and
Redemption of Fund Shares -- Frequent Trading Policy" in the SAI.
TOTAL RETURN INFORMATION
The information presented for each Fund is for the period indicated. The total
returns would have been lower if certain fees had not been waived and expenses
reimbursed by First Trust.
"Average annual total returns" represent the average annual change in the value
of a investment over the period indicated. "Cumulative total returns" represent
the total change in value of an investment over the period indicated.
The returns shown in the table below assume reinvestment of all dividend
distributions and do not reflect the deduction of taxes that a shareholder would
pay on Fund distributions or the redemption or sale of shares of a Fund.
The investment return and principal value of shares of a Fund will vary with
changes in market conditions. Shares of a Fund may be worth more or less than
their original cost when they are redeemed or sold in the market. A Fund's
past performance does not predict future results.
First Trust Preferred Securities and Income Fund
A SHARES C SHARES F SHARES I SHARES R3 SHARES
Inception Inception Inception Inception Inception
(2/25/2011) (2/25/2011) (3/2/2011) (1/11/2011) (3/2/2011)
through 10/31/2013 through 10/31/2013 through 10/31/2013 through 10/31/2013 through 10/31/2013
SINCE SINCE SINCE SINCE SINCE
1 YEAR INCEPTION 1 YEAR INCEPTION 1 YEAR INCEPTION 1 YEAR INCEPTION 1 YEAR INCEPTION
AVERAGE ANNUAL TOTAL RETURNS
Without sales charge -4.36% 5.81% -5.03% 5.09% -4.32% 6.04% -4.06% 6.38% -4.61% 5.32%
With sales charge -8.66% 4.01% -5.94% 5.09% -- -- -- -- -- --
|
First Trust/Confluence Small Cap Value Fund
A SHARES C SHARES I SHARES R3 SHARES
Inception Inception Inception Inception
(2/24/2011) (3/2/2011) (1/11/2011) (3/2/2011)
through 10/31/2013 through 10/31/2013 through 10/31/2013 through 10/31/2013
SINCE SINCE SINCE SINCE
1 YEAR INCEPTION 1 YEAR INCEPTION 1 YEAR INCEPTION 1 YEAR INCEPTION
AVERAGE ANNUAL TOTAL RETURNS
Without sales charge 26.16% 12.03% 25.11% 9.74% 26.85% 12.43% 25.75% 10.85%
With sales charge 19.22% 9.69% 24.11% 9.74% -- -- -- --
|
First Trust Short Duration High Income Fund
A SHARES C SHARES I SHARES
Inception Inception Inception
(11/1/2012) (11/1/2012) (11/1/2012)
through through through
10/31/2013 10/31/2013 10/31/2013
SINCE INCEPTION SINCE INCEPTION SINCE INCEPTION
CUMULATIVE TOTAL RETURNS
Without sales charge 7.87% 7.04% 8.11%
With sales charge 4.07% 6.04% --
|
42
FINANCIAL HIGHLIGHTS
The financial highlights table is intended to help you understand each Fund's
financial performance for the period shown. Certain information reflects
financial results for a single Share of each Fund. The total returns represent
the rate that an investor would have earned (or lost) on an investment in a Fund
(assuming reinvestment of all dividends and distributions). The information for
the period indicated has been derived from financial statements audited by
Deloitte & Touche LLP whose report, along with each Fund's financial statements,
is included in each Fund's Annual Report to Shareholders dated October 31, 2013
and is incorporated by reference in the Funds' SAI, which is available upon
request.
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
FIRST TRUST PREFERRED SECURITIES AND INCOME FUND
YEAR YEAR PERIOD
ENDED ENDED ENDED
10/31/2013 10/31/2012 10/31/2011 (a)
---------------- ---------------- ----------------
CLASS A SHARES
Net asset value, beginning of period $ 22.42 $ 20.10 $ 20.26
------------ ------------ ------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) 0.98 (b) 0.89 (b) 0.79
Net realized and unrealized gain (loss) (1.91) 2.55 (0.11)
------------ ------------ ------------
Total from investment operations (0.93) 3.44 0.68
------------ ------------ ------------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (0.98) (1.12) (0.84)
Net realized gain (0.09) (0.00) (c) --
Return of capital (0.15) -- --
------------ ------------ ------------
Total distributions (1.22) (1.12) (0.84)
------------ ------------ ------------
Net asset value, end of period $ 20.27 $ 22.42 $ 20.10
============ ============ ============
TOTAL RETURN (d) (4.36)% 17.60% 3.45%
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 90,286 $ 83,717 $ 6,932
Ratio of total expenses to average net assets 1.44% 1.83% 6.68% (e)
Ratio of net expenses to average net assets 1.40% 1.40% 1.40% (e)
Ratio of net investment income (loss) to average net assets 4.52% 4.13% 4.68% (e)
Portfolio turnover rate 60% 60% 88%
(a) Class A Shares commenced operations on February 25, 2011.
(b) Based on average shares outstanding.
(c) Amount is less than $0.01.
(d) Assumes reinvestment of all distributions for the period and does not
include payment of the maximum sales charge of 4.50% or contingent
deferred sales charge (CDSC). On purchases of $1 million or more, a
CDSC of 1% may be imposed on certain redemptions made within twelve
months of purchase. If the sales charges were included, total returns
would be lower. These returns include Rule 12b-1 service fees of 0.25%
and do not reflect the deduction of taxes that a shareholder would pay on
Fund distributions or the redemption of Fund shares. The total returns
would have been lower if certain fees had not been waived and expenses
reimbursed by the investment advisor. Total return is calculated for the
time period presented and is not annualized for periods of less than one
year.
(e) Annualized
|
43
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
FIRST TRUST PREFERRED SECURITIES AND INCOME FUND
YEAR YEAR PERIOD
ENDED ENDED ENDED
10/31/2013 10/31/2012 10/31/2011 (a)
---------------- ---------------- ----------------
CLASS C SHARES
Net asset value, beginning of period $ 22.45 $ 20.13 $ 20.26
------------ ------------ ------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) 0.83 (b) 0.73 (b) 0.69
Net realized and unrealized gain (loss) (1.93) 2.55 (0.08)
------------ ------------ ------------
Total from investment operations (1.10) 3.28 0.61
------------ ------------ ------------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (0.84) (0.96) (0.74)
Net realized gain (0.08) (0.00) (c) --
Return of capital (0.13) -- --
------------ ------------ ------------
Total distributions (1.05) (0.96) (0.74)
------------ ------------ ------------
Net asset value, end of period $ 20.30 $ 22.45 $ 20.13
============ ============ ============
TOTAL RETURN (d) (5.03)% 16.70% 3.08%
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 55,376 $ 36,681 $ 2,720
Ratio of total expenses to average net assets 2.17% 2.66% 8.03% (e)
Ratio of net expenses to average net assets 2.15% 2.15% 2.15% (e)
Ratio of net investment income (loss) to average net assets 3.81% 3.36% 4.10% (e)
Portfolio turnover rate 60% 60% 88%
(a) Class C Shares commenced operations on February 25, 2011.
(b) Based on average shares outstanding.
(c) Amount is less than $0.01.
(d) Assumes reinvestment of all distributions for the period and does not
include payment of the maximum CDSC of 1%, charged on certain
redemptions made within one year of purchase. If the sales charge was
included, total return would be lower. These returns include combined
Rule 12b-1 distribution and service fees of 1% and do not reflect the
deduction of taxes that a shareholder would pay on Fund distributions
or the redemption of Fund shares. The total returns would have been
lower if certain fees had not been waived and expenses reimbursed by
the investment advisor. Total return is calculated for the time
period presented and is not annualized for periods of less than one
year.
(e) Annualized.
|
YEAR YEAR PERIOD
ENDED ENDED ENDED
10/31/2013 10/31/2012 10/31/2011 (a)
---------------- ---------------- ----------------
CLASS F SHARES
Net asset value, beginning of period $ 22.59 $ 20.12 $ 20.25
------------ ------------ ------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) 1.02 (b) 0.89 (b) 0.70
Net realized and unrealized gain (loss) (1.95) 2.72 (0.07)
------------ ------------ ------------
Total from investment operations (0.93) 3.61 0.63
------------ ------------ ------------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (1.01) (1.14) (0.76)
Net realized gain (0.08) (0.00) (c) --
Return of capital (0.15) -- --
------------ ------------ ------------
Total distributions (1.24) (1.14) (0.76)
------------ ------------ ------------
Net asset value, end of period $ 20.42 $ 22.59 $ 20.12
============ ============ ============
TOTAL RETURN (d) (4.32)% 18.47% 3.17%
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 3,735 $ 4,012 $ 1
Ratio of total expenses to average net assets 1.58% 3.71% 233.60% (e)
Ratio of net expenses to average net assets 1.30% 1.30% 1.30% (e)
Ratio of net investment income (loss) to average net assets 4.63% 4.09% 5.21% (e)
Portfolio turnover rate 60% 60% 88%
(a) Class F Shares were initially seeded and commenced operations on March 2, 2011.
(b) Based on average shares outstanding.
(c) Amount is less than $0.01.
(d) Assumes reinvestment of all distributions for the period. These
returns include Rule 12b-1 service fees of 0.15% and do not reflect
the deduction of taxes that a shareholder would pay on Fund
distributions or the redemption of Fund shares. The total returns
would have been lower if certain fees had not been waived and
expenses reimbursed by the investment advisor. Total return is
calculated for the time period presented and is not annualized for
periods of less than one year.
(e) Annualized.
|
44
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
FIRST TRUST PREFERRED SECURITIES AND INCOME FUND
YEAR YEAR PERIOD
ENDED ENDED ENDED
10/31/2013 10/31/2012 10/31/2011 (a)
---------------- ---------------- ----------------
CLASS I SHARES
Net asset value, beginning of period $ 22.47 $ 20.15 $ 20.00
------------ ------------ ------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) 1.04 (b) 0.92 (b) 0.82
Net realized and unrealized gain (loss) (1.91) 2.57 0.21
------------ ------------ ------------
Total from investment operations (0.87) 3.49 1.03
------------ ------------ ------------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (1.03) (1.17) (0.88)
Net realized gain (0.09) (0.00) (c) --
Return of capital (0.15) -- --
------------ ------------ ------------
Total distributions (1.27) (1.17) (0.88)
------------ ------------ ------------
Net asset value, end of period $ 20.33 $ 22.47 $ 20.15
============ ============ ============
TOTAL RETURN (d) (4.06)% 17.84% 5.21%
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 58,700 $ 45,432 $ 439
Ratio of total expenses to average net assets 1.23% 1.46% 22.09% (e)
Ratio of net expenses to average net assets 1.15% 1.15% 1.15% (e)
Ratio of net investment income (loss) to average net assets 4.79% 4.20% 5.12% (e)
Portfolio turnover rate 60% 60% 88%
(a) Class I Shares were initially seeded on December 16, 2010 and commenced
operations on January 11, 2011.
(b) Based on average shares outstanding.
(c) Amount is less than $0.01.
(d) Assumes reinvestment of all distributions for the period. These
returns do not reflect the deduction of taxes that a shareholder
would pay on Fund distributions or the redemption of Fund shares. The
total returns would have been lower if certain fees had not been
waived and expenses reimbursed by the investment advisor. Total
return is calculated for the time period presented and is not
annualized for periods of less than one year.
(e) Annualized.
|
YEAR YEAR PERIOD
ENDED ENDED ENDED
10/31/2013 10/31/2012 10/31/2011 (a)
---------------- ---------------- ----------------
CLASS R3 SHARES
Net asset value, beginning of period $ 22.41 $ 20.11 $ 20.25
------------ ------------ ------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) 0.93 (b) 0.80 (b) 0.61
Net realized and unrealized gain (loss) (1.92) 2.56 (0.07)
------------ ------------ ------------
Total from investment operations (0.99) 3.36 0.54
------------ ------------ ------------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (0.92) (1.06) (0.68)
Net realized gain (0.10) (0.00) (c) --
Return of capital (0.14) -- --
------------ ------------ ------------
Total distributions (1.16) (1.06) (0.68)
------------ ------------ ------------
Net asset value, end of period $ 20.26 $ 22.41 $ 20.11
============ ============ ============
TOTAL RETURN (d) (4.61)% 17.19% 2.74%
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 478 $ 615 $ 1
Ratio of total expenses to average net assets 4.87% 11.51% 301.79% (e)
Ratio of net expenses to average net assets 1.65% 1.65% 1.90% (e)
Ratio of net investment income (loss) to average net assets 4.25% 3.66% 4.62% (e)
Portfolio turnover rate 60% 60% 88%
(a) Class R3 Shares were initially seeded and commenced operations on March 2, 2011.
(b) Based on average shares outstanding.
(c) Amount is less than $0.01.
(d) Assumes reinvestment of all distributions for the period. These
returns include combined Rule 12b-1 distribution and service fees of
0.50% effective December 15, 2011, and 0.75 prior to December 15,
2011, and do not reflect the deduction of taxes that a shareholder
would pay on Fund distributions or the redemption of Fund shares. The
total returns would have been lower if certain fees had not been
waived and expenses reimbursed by the investment advisor. Total
return is calculated for the time period presented and is not
annualized for periods of less than one year.
(e) Annualized.
|
45
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
FIRST TRUST/CONFLUENCE SMALL CAP VALUE FUND
YEAR YEAR PERIOD
ENDED ENDED ENDED
10/31/2013 10/31/2012 10/31/2011 (a)
---------------- ---------------- ----------------
CLASS A SHARES
Net asset value, beginning of period $ 21.58 $ 19.54 $ 20.10
------------ ------------ ------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) (b) 0.10 0.23 0.03
Net realized and unrealized gain (loss) 5.46 1.85 (0.59)
------------ ------------ ------------
Total from investment operations 5.56 2.08 (0.56)
------------ ------------ ------------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (0.27) (0.04) --
Net realized gain (0.10) -- --
------------ ------------ ------------
Total distributions (0.37) (0.04) --
------------ ------------ ------------
Net asset value, end of period $ 26.77 $ 21.58 $ 19.54
=========== ============ ============
TOTAL RETURN (c) 26.16% 10.61% (2.79)%
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 1,288 $ 651 $ 218
Ratio of total expenses to average net assets 11.29% 23.94% 60.42% (d)
Ratio of net expenses to average net assets 1.60% 1.60% 1.60% (d)
Ratio of net investment income (loss) to average net assets 0.42% 1.10% 0.26% (d)
Portfolio turnover rate 31% 11% 21%
(a) Class A Shares commenced operations on February 24, 2011.
(b) Per share amounts have been calculated using the average share method.
(c) Assumes reinvestment of all distributions for the period and does not include
payment of the maximum sales charge of 5.50% or contingent deferred sales charge
(CDSC). On purchases of $1 million or more, a CDSC of 1% may be imposed on
certain redemptions made within twelve months of purchase. If the sales charges
were included, total returns would be lower. These returns include Rule 12b-1
service fees of 0.25% and do not reflect the deduction of taxes that a shareholder
would pay on Fund distributions or the redemption of Fund shares. The total return
would have been lower if certain fees had not been waived and expenses reimbursed
by the investment advisor. Total return is calculated for the time period presented and
is not annualized for periods of less than one year.
(d) Annualized.
|
YEAR YEAR PERIOD
ENDED ENDED ENDED
10/31/2013 10/31/2012 10/31/2011 (a)
---------------- ---------------- ----------------
CLASS C SHARES
Net asset value, beginning of period $ 20.59 $ 18.81 $ 20.10
------------ ------------ ------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) (b) (0.10) 0.05 (0.07)
Net realized and unrealized gain (loss) 5.23 1.73 (1.22)
------------ ------------ ------------
Total from investment operations 5.13 1.78 (1.29)
------------ ------------ ------------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (0.11) -- --
Net realized gain (0.10) -- --
------------ ------------ ------------
Total distributions (0.21) -- --
------------ ------------ ------------
Net asset value, end of period $ 25.51 $ 20.59 $ 18.81
=========== ============ ============
TOTAL RETURN (c) 25.11% 9.46% (6.42)%
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 1,956 $ 615 $ 8
Ratio of total expenses to average net assets 10.45% 26.69% 98.09% (d)
Ratio of net expenses to average net assets 2.35% 2.35% 2.35% (d)
Ratio of net investment income (loss) to average net assets (0.43)% 0.25% (0.54)% (d)
Portfolio turnover rate 31% 11% 21%
(a) Class C Shares commenced operations on March 2, 2011.
(b) Per share amounts have been calculated using the average share method.
(c) Assumes reinvestment of all distributions for the period and does not
include payment of the maximum CDSC of 1%, charged on certain
redemptions made within one year of purchase. If the sales charge was
included, total return would be lower. These returns include combined
Rule 12b-1 distribution fees and service fees of 1% and do not
reflect the deduction of taxes that a shareholder would pay on Fund
distributions or the redemption of Fund shares. The total return
would have been lower if certain fees had not been waived and
expenses reimbursed by the investment advisor. Total return is
calculated for the time period presented and is not annualized for
periods of less than one year.
(d) Annualized
|
46
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
FIRST TRUST/CONFLUENCE SMALL CAP VALUE FUND
YEAR YEAR PERIOD
ENDED ENDED ENDED
10/31/2013 10/31/2012 10/31/2011 (a)
---------------- ---------------- ----------------
CLASS I SHARES
Net asset value, beginning of period $ 21.81 $ 19.58 $ 20.00
------------ ------------ ------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) (b) 0.16 0.26 0.07
Net realized and unrealized gain (loss) 5.60 2.05 (0.49)
------------ ------------ ------------
Total from investment operations 5.76 2.31 (0.42)
------------ ------------ ------------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (0.32) (0.08) --
Net realized gain (0.10) -- --
------------ ------------ ------------
Total distributions (0.42) (0.08) --
------------ ------------ ------------
Net asset value, end of period $ 27.15 $ 21.81 $ 19.58
=========== ============ ============
TOTAL RETURN (c) 26.85% 11.85% (2.10)%
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 276 $ 141 $ 164
Ratio of total expenses to average net assets 17.52% 41.80% 103.62% (d)
Ratio of net expenses to average net assets 1.35% 1.35% 1.35% (d)
Ratio of net investment income (loss) to average net assets 0.66% 1.28% 0.43% (d)
Portfolio turnover rate 31% 11% 21%
(a) Class I Shares were initially seeded on December 16, 2010 and commenced
operations on January 11, 2011.
(b) Per share amounts have been calculated using the average share method.
(c) Assumes reinvestment of all distributions for the period. This return
does not reflect the deduction of taxes that a shareholder would pay
on Fund distributions or the redemption of Fund shares. The total
return would have been lower if certain fees had not been waived and
expenses reimbursed by the investment advisor. Total return is
calculated for the time period presented and is not annualized for
periods of less than one year.
(d) Annualized.
|
YEAR YEAR PERIOD
ENDED ENDED ENDED
10/31/2013 10/31/2012 10/31/2011 (a)
---------------- ---------------- ----------------
CLASS R3 SHARES
Net asset value, beginning of period $ 21.04 $ 19.03 $ 20.10
------------ ------------ ------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) (b) 0.06 0.15 (0.04)
Net realized and unrealized gain (loss) 5.29 1.86 (1.03)
------------ ------------ ------------
Total from investment operations 5.35 2.01 (1.07)
------------ ------------ ------------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (0.21) -- --
Net realized gain (0.10) -- --
------------ ------------ ------------
Total distributions (0.31) -- --
------------ ------------ ------------
Net asset value, end of period $ 26.08 $ 21.04 $ 19.03
=========== ============ ============
TOTAL RETURN (c) 25.75% 10.56% (5.32)%
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 1 $ 1 $ 1
Ratio of total expenses to average net assets 1,640.13% 2,717.44% 297.34% (d)
Ratio of net expenses to average net assets 1.85% 1.88% 2.10% (d)
Ratio of net investment income (loss) to average net assets 0.24% 0.75% (0.32)%(d)
Portfolio turnover rate 31% 11% 21%
(a) Class R3 Shares were initially seeded and commenced operations on March 2,2011.
(b) Per share amounts have been calculated using the average share method.
(c) Assumes reinvestment of all distributions for the period. These
returns include combined Rule 12b-1 distribution fees and service
fees of 0.50% effective December 15, 2011 and 0.75% prior to December
15, 2011 and do not reflect the deduction of taxes that a shareholder
would pay on Fund distributions or the redemption of Fund shares. The
total return would have been lower if certain fees had not been
waived and expenses reimbursed by the investment advisor. Total
return is calculated for the time period presented and is not
annualized for periods of less than one year.
(d) Annualized
|
47
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
FIRST TRUST SHORT DURATION HIGH INCOME FUND
PERIOD
ENDED
10/31/2013 (a)
---------------
CLASS A SHARES
Net asset value, beginning of period $ 20.00
----------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) (b) 0.65
Net realized and unrealized gain (loss) 0.90
----------
Total from investment operations 1.55
----------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (0.70)
Return of capital (0.17)
----------
Total distributions (0.87)
----------
Net asset value, end of period $ 20.68
==========
TOTAL RETURN (c) 7.87% (d)
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 44,819
Ratio of total expenses to average net assets 1.54% (e)
Ratio of net expenses to average net assets 1.25% (e)
Ratio of net investment income (loss) to average net assets 3.20% (e)
Portfolio turnover rate 89%
(a) Class A Shares were initially seeded and commenced operations on November 1, 2012.
(b) Per share amounts have been calculated using the average share method.
(c) Assumes reinvestment of all distributions for the period and does not
include payment of the maximum sales charge of 3.50% or contingent
deferred sales charge (CDSC). On purchases of $1 million or more, a
CDSC of 1% may be imposed on certain redemptions made within twelve
months of purchase. If the sales charges were included, total returns would be
lower. These returns include Rule 12b-1 service fees of 0.25% and do not
reflect the deduction of taxes that a shareholder would pay on Fund
distributions or the redemption of Fund shares. The total return would
have been lower if certain fees had not been waived and expenses reimbursed
by the investment advisor. Total return is calculated for the time period
presented and is not annualized for periods of less than one year.
(d) The Fund received reimbursements from First Trust Advisors L.P. (the
"Advisor") in the amount of $1,079. The reimbursements from the
Advisor represent less than $0.01 per share and had no effect on the
total return of the Class A Shares.
(e) Annualized.
|
PERIOD
ENDED
10/31/2013 (a)
---------------
CLASS C SHARES
Net asset value, beginning of period $ 20.00
----------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) (b) 0.50
Net realized and unrealized gain (loss) 0.89
----------
Total from investment operations 1.39
----------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (0.59)
Return of capital (0.14)
----------
Total distributions (0.73)
----------
Net asset value, end of period $ 20.66
==========
TOTAL RETURN (c) 7.04% (d)
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 13,522
Ratio of total expenses to average net assets 2.29% (e)
Ratio of net expenses to average net assets 2.00% (e)
Ratio of net investment income (loss) to average net assets 2.45% (e)
Portfolio turnover rate 89%
(a) Class C Shares were initially seeded and commenced operations on November 1, 2012.
(b) Per share amounts have been calculated using the average share method.
(c) Assumes reinvestment of all distributions for the period and does not
include payment of the maximum CDSC of 1% charged on certain
redemptions made within one year of purchase. If the sales charges
were included, total returns would be lower. These returns include
combined Rule 12b-1 distribution and service fees of 1% and do not
reflect the deduction of taxes that a shareholder would pay on Fund
distributions or the redemption of Fund shares. The total returns
would have been lower if certain fees had not been waived and
expenses reimbursed by the investment advisor. Total return is
calculated for the time period presented and is not annualized for
periods of less than one year.
(d) The Fund received reimbursements from First Trust Advisors L.P.
(the "Advisor") in the amount of $1,079. The reimbursements from
the Advisor represent less than $0.01 per share and had no effect
on the total return of the Class C Shares.
(e) Annualized.
|
48
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
FIRST TRUST SHORT DURATION HIGH INCOME FUND
PERIOD
ENDED
10/31/2013 (a)
---------------
CLASS I SHARES
Net asset value, beginning of period $ 20.00
----------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) (b) 0.70
Net realized and unrealized gain (loss) 0.90
----------
Total from investment operations 1.60
----------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (0.74)
Return of capital (0.18)
----------
Total distributions (0.92)
----------
Net asset value, end of period $ 20.68
==========
TOTAL RETURN (c) 8.11% (d)
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 43,395
Ratio of total expenses to average net assets 1.29% (e)
Ratio of net expenses to average net assets 1.00% (e)
Ratio of net investment income (loss) to average net assets 3.45% (e)
Portfolio turnover rate 89%
(a) Class I Shares were initially seeded and commenced operations on November 1, 2012.
(b) Per share amounts have been calculated using the average share method.
(c) Assumes reinvestment of all distributions for the period. These
returns do not reflect the deduction of taxes that a shareholder
would pay on Fund distributions or the redemption of Fund shares. The
total returns would have been lower if certain fees had not been
waived and expenses reimbursed by the investment advisor. Total
return is calculated for the time period presented and is not
annualized for periods of less than one year.
(d) The Fund received reimbursements from First Trust Advisors L.P.
(the "Advisor") in the amount of $1,079. The reimbursements from the
Advisor represent less than $0.01 per share and had no effect on the
total return of the Class I Shares.
(e) Annualized.
|
49
FIRST TRUST
First Trust Preferred Securities and Income Fund
First Trust/Confluence Small Cap Value Fund
First Trust Short Duration High Income Fund
FOR MORE INFORMATION
For more detailed information on the Funds, several additional sources of
information are available to you. The SAI, incorporated by reference into this
prospectus, contains detailed information on the Funds' policies and operation.
Additional information about the Funds' investments is available in the annual
and semi-annual reports to shareholders. In the Funds' annual reports, you will
find a discussion of the market conditions and investment strategies that
significantly impacted the Funds' performance during the last fiscal year. The
Funds' most recent SAI, annual or semi-annual reports and certain other
information are available free of charge by calling a Fund at (800) 621-1675, on
the Funds' website at www.ftportfolios.com or through your financial advisor.
Shareholders may call the toll-free number above with any inquiries.
You may obtain this and other information regarding the Funds, including the
Codes of Ethics adopted by First Trust, FTP and the Trust, directly from the
Securities and Exchange Commission (the "SEC"). Information on the SEC's website
is free of charge. Visit the SEC's online EDGAR database at http://www.sec.gov
or in person at the SEC's Public Reference Room in Washington, D.C., or call the
SEC at (202) 551-8090 for information on the Public Reference Room. You may also
request information regarding the Funds by sending a request (along with a
duplication fee) to the SEC's Public Reference Section, 100 F Street, N.E.,
Washington, D.C. 20549-1520 or by sending an electronic request to
publicinfo@sec.gov.
First Trust Portfolios L.P.
120 East Liberty Drive, Suite 400
Wheaton, Illinois 60187
(888) 373-5776 SEC File #: 333-168727
www.ftportfolios.com 811-22452
STATEMENT OF ADDITIONAL INFORMATION
INVESTMENT COMPANY ACT FILE NO. 811-22452
FIRST TRUST SERIES FUND
FIRST TRUST PREFERRED SECURITIES AND INCOME FUND TICKER SYMBOL
CLASS A FPEAX
CLASS C FPECX
CLASS F FPEFX
CLASS I FPEIX
CLASS R3 FPERX
FIRST TRUST/CONFLUENCE SMALL CAP VALUE FUND TICKER SYMBOL
CLASS A FOVAX
CLASS C FOVCX
CLASS I FOVIX
CLASS R3 FOVRX
FIRST TRUST SHORT DURATION HIGH INCOME FUND TICKER SYMBOL
CLASS A FDHAX
CLASS C FDHCX
CLASS I FDHIX
|
DATED MARCH 3, 2014
This Statement of Additional Information ("SAI") is not a prospectus. It
should be read in conjunction with the prospectus dated March 3, 2014 as it may
be revised from time to time (the "Prospectus"), for First Trust Preferred
Securities and Income Fund, First Trust/Confluence Small Cap Value Fund and
First Trust Short Duration High Income Fund (each a "Fund," and collectively,
the "Funds"), each a series of First Trust Series Fund (the "Trust").
Capitalized terms used herein that are not defined have the same meaning as in
the Prospectus, unless otherwise noted. A copy of the Prospectus may be obtained
without charge by writing to the Trust's distributor, First Trust Portfolios
L.P., 120 East Liberty Drive, Suite 400, Wheaton, Illinois 60187, or by calling
toll free at (800) 621-1675.
TABLE OF CONTENTS
GENERAL DESCRIPTION OF THE TRUST AND THE FUNDS.................................1
INVESTMENT OBJECTIVES AND POLICIES.............................................3
INVESTMENT STRATEGIES..........................................................5
INVESTMENT RISKS..............................................................23
MANAGEMENT OF THE FUNDS.......................................................29
SUB-ADVISORS..................................................................43
BROKERAGE ALLOCATIONS.........................................................50
CUSTODIANS, ADMINISTRATORS, FUND ACCOUNTANTS AND TRANSFER AGENTS..............53
ADDITIONAL INFORMATION........................................................55
PROXY VOTING POLICIES AND PROCEDURES..........................................57
PURCHASE AND REDEMPTION OF FUND SHARES........................................59
DISTRIBUTION AND SERVICE PLAN.................................................70
FEDERAL TAX MATTERS...........................................................73
DETERMINATION OF NET ASSET VALUE..............................................79
DIVIDENDS AND DISTRIBUTIONS...................................................80
MISCELLANEOUS INFORMATION.....................................................81
FINANCIAL STATEMENTS..........................................................81
FUND BENEFICIAL OWNERSHIP TABLE..............................................A-1
INSTITUTIONAL SHAREHOLDER SERVICES INC. 2014 U.S. PROXY VOTING CONCISE
GUIDELINES ..................................................................B-1
CONFLUENCE INVESTMENT MANAGEMENT LLC PROXY VOTING POLICIES AND
PROCEDURES.................................................................. C-1
STONEBRIDGE ADVISORS LLC PROXY VOTING POLICIES...............................D-1
STANDARD & POOR'S CREDIT RATING DEFINITIONS..................................E-1
|
The audited financial statements for the Funds' most recent fiscal year
appear in the Funds' Annual Report to Shareholders dated October 31, 2013, which
was filed with the Securities and Exchange Commission ("SEC") on January 3,
2014. The financial statements from such Annual Report are incorporated herein
by reference. The Annual Reports are available without a charge by calling (800)
621-1675 or by visiting the SEC's website at http://www.sec.gov.
GENERAL DESCRIPTION OF THE TRUST AND THE FUNDS
The Trust was organized as a Massachusetts business trust on July 9, 2010
and is authorized to issue an unlimited number of shares in one or more series
or "funds." The Trust is an open-end management investment company, registered
under the Investment Company Act of 1940, as amended (the "1940 Act"). The Trust
currently offers shares in three series, First Trust Preferred Securities and
Income Fund, a non-diversified series, and First Trust/Confluence Small Cap
Value Fund and First Trust Short Duration High Income Fund, each a diversified
series.
This SAI relates to the Funds. Each Fund as a series of the Trust
represents a beneficial interest in a separate portfolio of securities and other
assets, with its own objective(s) and policies.
The Board of Trustees of the Trust (the "Board of Trustees" or the
"Trustees") has the right to establish additional series in the future, to
determine the preferences, voting powers, rights and privileges thereof and to
modify such preferences, voting powers, rights and privileges without
shareholder approval. Shares of any series may also be divided into one or more
classes at the discretion of the Trustees.
The Trust or any series or class thereof may be terminated at any time by
the Board of Trustees upon written notice to the shareholders.
Each share has one vote with respect to matters upon which a shareholder
vote is required consistent with the requirements of the 1940 Act and the rules
promulgated thereunder. Shares of all series of the Trust vote together as a
single class except as otherwise required by the 1940 Act, or if the matter
being voted on affects only a particular series, and, if a matter affects a
particular series differently from other series, the shares of that series will
vote separately on such matter. The Trust's Declaration of Trust (the
"Declaration") requires a shareholder vote only on those matters where the 1940
Act requires a vote of shareholders and otherwise permits the Trustees to take
actions without seeking the consent of shareholders. For example, the
Declaration gives the Trustees broad authority to approve reorganizations
between a Fund and another entity or the sale of all or substantially all of a
Fund's assets, or the termination of the Trust or any Fund without shareholder
approval if the 1940 Act would not require such approval.
The Declaration provides that by becoming a shareholder of a Fund, each
shareholder shall be expressly held to have agreed to be bound by the provisions
of the Declaration. The Declaration may, except in limited circumstances, be
amended by the Trustees in any respect without a shareholder vote. The
Declaration provides that the Trustees may establish the number of Trustees and
that vacancies on the Board of Trustees may be filled by the remaining Trustees,
except when election of Trustees by the shareholders is required under the 1940
Act. Trustees are then elected by a plurality of votes cast by shareholders at a
meeting at which a quorum is present. The Declaration also provides that
Trustees may be removed, with or without cause, by a vote of shareholders
holding at least two-thirds of the voting power of the Trust, or by a vote of
two-thirds of the remaining Trustees. The provisions of the Declaration relating
to the election and removal of Trustees may not be amended without the approval
of two-thirds of the Trustees.
-1-
The holders of Fund shares are required to disclose information on direct
or indirect ownership of Fund shares as may be required to comply with various
laws applicable to the Funds or as the Trustees may determine, and ownership of
Fund shares may be disclosed by a Fund if so required by law or regulation. In
addition, pursuant to the Declaration, the Trustees may, in their discretion,
require the Trust to redeem shares held by any shareholder for any reason under
terms set by the Trustees. The Declaration provides a detailed process for the
bringing of derivative actions by shareholders in order to permit legitimate
inquiries and claims while avoiding the time, expense, distraction and other
harm that can be caused to a Fund or its shareholders as a result of spurious
shareholder demands and derivative actions. Prior to bringing a derivative
action, a demand must first be made on the Trustees. The Declaration details
various information, certifications, undertakings and acknowledgements that must
be included in the demand. Following receipt of the demand, the Trustees have a
period of 90 days, which may be extended by an additional 60 days, to consider
the demand. If a majority of the Trustees who are considered independent for the
purposes of considering the demand determine that maintaining the suit would not
be in the best interests of a Fund, the Trustees are required to reject the
demand and the complaining shareholder may not proceed with the derivative
action unless the shareholder is able to sustain the burden of proof to a court
that the decision of the Trustees not to pursue the requested action was not a
good faith exercise of their business judgment on behalf of such Fund. In making
such a determination, a Trustee is not considered to have a personal financial
interest by virtue of being compensated for his or her services as a Trustee. If
a demand is rejected, the complaining shareholder will be responsible for the
costs and expenses (including attorneys' fees) incurred by a Fund in connection
with the consideration of the demand under a number of circumstances. If a
derivative action is brought in violation of the Declaration, the shareholder
bringing the action may be responsible for the Fund's costs, including
attorneys' fees. The Declaration also provides that any shareholder bringing an
action against a Fund waives the right to trial by jury to the fullest extent
permitted by law.
The Trust is not required to and does not intend to hold annual meetings
of shareholders.
Under Massachusetts law applicable to Massachusetts business trusts,
shareholders of such a trust may, under certain circumstances, be held
personally liable as partners for its obligations. However, the Declaration
contains an express disclaimer of shareholder liability for acts or obligations
of the Trust and requires that notice of this disclaimer be given in each
agreement, obligation or instrument entered into or executed by the Trust or the
Trustees. The Declaration further provides for indemnification out of the assets
and property of the Trust for all losses and expenses of any shareholder held
personally liable for the obligations of the Trust. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which both inadequate insurance existed and the
Trust or a Fund itself was unable to meet its obligations.
The Declaration further provides that a Trustee acting in his or her
capacity as Trustee is not personally liable to any person other than the Trust
or its shareholders, for any act, omission, or obligation of the Trust. The
Declaration requires the Trust to indemnify any persons who are or who have been
Trustees, officers or employees of the Trust for any liability for actions or
failure to act except to the extent prohibited by applicable federal law. In
making any determination as to whether any person is entitled to the advancement
-2-
of expenses in connection with a claim for which indemnification is sought, such
person is entitled to a rebuttable presumption that he or she did not engage in
conduct for which indemnification is not available. The Declaration provides
that any Trustee who serves as chair of the Board of Trustees or of a committee
of the Board of Trustees, lead independent Trustee, or audit committee financial
expert, or in any other similar capacity will not be subject to any greater
standard of care or liability because of such position.
The Funds are advised by First Trust Advisors L.P. (the "Advisor" or
"First Trust"). The First Trust Preferred Securities and Income Fund is
sub-advised by Stonebridge Advisors LLC ("Stonebridge" or a "Sub-Advisor"). The
First Trust/Confluence Small Cap Value Fund is sub-advised by Confluence
Investment Management LLC ("Confluence" or a "Sub-Advisor").
INVESTMENT OBJECTIVES AND POLICIES
The Prospectus describes the investment objectives and policies of the
Funds. The following supplements the information contained in the Prospectus
concerning the investment objectives and policies of the Funds.
Each Fund is subject to the following fundamental policies, which may not
be changed without approval of the holders of a majority of the outstanding
voting securities (as such term is defined in the 1940 Act) of the Fund:
(1) A Fund may not issue senior securities, except as permitted
under the 1940 Act.
(2) A Fund may not borrow money, except as permissible under the
1940 Act.
(3) The Funds will not underwrite the securities of other issuers
except to the extent a Fund may be considered an underwriter under the
Securities Act of 1933, as amended (the "1933 Act"), in connection with
the purchase and sale of portfolio securities.
(4) A Fund will not purchase or sell real estate or interests
therein, unless acquired as a result of ownership of securities or other
instruments (but this shall not prohibit a Fund from purchasing or selling
securities or other instruments backed by real estate or of issuers
engaged in real estate activities).
(5) A Fund may not make loans to other persons, except through (i)
the purchase of debt securities permissible under a Fund's investment
policies, (ii) repurchase agreements, or (iii) the lending of portfolio
securities, provided that no such loan of portfolio securities may be made
by such Fund if, as a result, the aggregate of such loans would exceed
33-1/3% of the value of the Fund's total assets.
(6) A Fund may not purchase or sell physical commodities unless
acquired as a result of ownership of securities or other instruments (but
this shall not prevent a Fund from purchasing or selling options, futures
-3-
contracts, forward contracts or other derivative instruments, or from
investing in securities or other instruments backed by physical
commodities).
(7) A Fund may not invest 25% or more of the value of its net
assets in securities of issuers in any one industry. This restriction does
not apply to obligations issued or guaranteed by the U.S. government, its
agencies or instrumentalities. For the First Trust Preferred Securities
and Income Fund, this restriction does not apply to financial companies,
accordingly, the First Trust Preferred Securities and Income Fund will
concentrate its investments in the industry or group of industries which
comprise the financial sector.
(8) With respect to 75% of their total assets, the First
Trust/Confluence Small Cap Value Fund and First Trust Short Duration High
Income Fund may not purchase the securities of any issuer (except
securities issued or guaranteed by the United States government or any
agency or instrumentality thereof) if, as a result, (i) more than 5% of
the Fund's total assets would be invested in securities of that issuer, or
(ii) the Fund would hold more than 10% of the outstanding voting
securities of that issuer.
For purposes of applying restriction (1) above, under the 1940 Act as
currently in effect, a Fund is not permitted to issue senior securities, except
that a Fund may borrow from any bank if immediately after such borrowing the
value of such Fund's total assets is at least 300% of the principal amount of
all of the Fund's borrowings (i.e., the principal amount of the borrowings may
not exceed 33 1/3% of the Fund's total assets). In the event that such asset
coverage shall at any time fall below 300% the applicable Fund shall, within
three days thereafter (not including Sundays and holidays), reduce the amount of
its borrowings to an extent that the asset coverage of such borrowing shall be
at least 300%. The fundamental investment limitations set forth above limit a
Fund's ability to engage in certain investment practices and purchase securities
or other instruments to the extent permitted by, or consistent with, applicable
law. As such, these limitations will change as the statute, rules, regulations
or orders (or, if applicable, interpretations) change, and no shareholder vote
will be required or sought.
Except for restriction (2), if a percentage restriction is adhered to at
the time of investment, a later increase in percentage resulting from a change
in market value of the investment or the total assets will not constitute a
violation of that restriction. With respect to restriction (2), if the
limitations are exceeded as a result of a change in market value then the Fund
will reduce the amount of borrowings within three days thereafter to the extent
necessary to comply with the limitations (not including Sundays and holidays).
Each Fund's investment objectives and the foregoing fundamental policies
of each Fund may not be changed without the affirmative vote of the majority of
the outstanding voting securities of the respective Fund. The 1940 Act defines a
majority vote as the vote of the lesser of (i) 67% or more of the voting
securities represented at a meeting at which more than 50% of the outstanding
securities are represented; or (ii) more than 50% of the outstanding voting
securities.
-4-
Certain matters under the 1940 Act which must be submitted to a vote of
the holders of the outstanding voting securities of a series or class, shall not
be deemed to have been effectively acted upon unless approved by the holders of
a majority of the outstanding voting shares of each series or class affected by
such matter.
Each of the First Trust Preferred Securities and Income Fund and First
Trust/Confluence Small Cap Value Fund has adopted a non-fundamental investment
policy pursuant to Rule 35d-1 under the 1940 Act (the "Name Policy") whereby the
First Trust Preferred Securities and Income Fund, under normal market
conditions, will invest at least 80% of its net assets (including investment
borrowings) in preferred securities and other securities with similar economic
characteristics. The First Trust/Confluence Small Cap Value Fund, under normal
market conditions, will invest at least 80% of its net assets (including
investment borrowings) in equity securities of U.S. listed companies with small
market capitalizations at the time of investment. Accordingly, if the market
capitalization of a company included in the First Trust/Confluence Small Cap
Value Fund grows above "small cap," the Fund shall not be required to sell such
security. The Name Policy may be changed by the Board of Trustees without
shareholder approval upon 60 days' prior written notice.
In addition to the foregoing fundamental policies, the Funds are also
subject to strategies and policies discussed herein which, unless otherwise
noted, are non-fundamental restrictions and policies and may be changed by the
Board of Trustees.
INVESTMENT STRATEGIES
The following information supplements the discussion of the Funds'
investment objectives, policies and strategies that appear in the Funds'
Prospectus.
TYPES OF INVESTMENTS
Warrants: The Funds may invest in warrants. Warrants acquired by a Fund
entitle it to buy common stock from the issuer at a specified price and time.
They do not represent ownership of the securities but only the right to buy
them. Warrants are subject to the same market risks as stocks, but may be more
volatile in price. A Fund's investment in warrants will not entitle it to
receive dividends or exercise voting rights and will become worthless if the
warrants cannot be profitably exercised before their expiration date.
Delayed-Delivery Transactions: The Funds may from time to time purchase
securities on a "when-issued" or other delayed-delivery basis. The price of
securities purchased in such transactions is fixed at the time the commitment to
purchase is made, but delivery and payment for the securities take place at a
later date. Normally, the settlement date occurs within 45 days of the purchase.
During the period between the purchase and settlement, a Fund does not remit
payment to the issuer, no interest is accrued on debt securities and dividend
-5-
income is not earned on equity securities. Delayed-delivery commitments involve
a risk of loss if the value of the security to be purchased declines prior to
the settlement date, which risk is in addition to the risk of a decline in value
of a Fund's other assets. While securities purchased in delayed-delivery
transactions may be sold prior to the settlement date, the Funds intend to
purchase such securities with the purpose of actually acquiring them. At the
time a Fund makes the commitment to purchase a security in a delayed-delivery
transaction, it will record the transaction and reflect the value of the
security in determining its net asset value. The Funds do not believe that net
asset value will be adversely affected by purchases of securities in
delayed-delivery transactions.
The Funds will earmark or maintain in a segregated account cash, U.S.
government securities, and high-grade liquid debt securities equal in value to
commitments for delayed-delivery securities. Such earmarked or segregated
securities will mature or, if necessary, be sold on or before the settlement
date. When the time comes to pay for delayed-delivery securities, a Fund will
meet its obligations from then-available cash flow, sale of the securities
earmarked or held in the segregated account as described above, sale of other
securities, or, although it would not normally expect to do so, from the sale of
the delayed-delivery securities themselves (which may have a market value
greater or less than a Fund's payment obligation).
Although the Prospectus and this SAI describe certain permitted methods of
segregating assets or otherwise "covering" certain transactions, such
descriptions are not all-inclusive. A Fund may segregate against or cover such
transactions using other methods permitted under the 1940 Act, the rules and
regulations thereunder, or orders issued by the SEC thereunder. For these
purposes, interpretations and guidance provided by the SEC staff may be taken
into account.
Illiquid Securities: The Funds may invest in illiquid securities (i.e.
securities that cannot be disposed of by a Fund within seven days in the
ordinary course of business at approximately the amount at which such Fund has
valued the securities). For purposes of this restriction, illiquid securities
include, but are not limited to, restricted securities (securities the
disposition of which is restricted under the federal securities laws),
securities that may only be resold pursuant to Rule 144A under the 1933 Act but
that are deemed to be illiquid; and repurchase agreements with maturities in
excess of seven days. However, a Fund will not acquire illiquid securities if,
as a result, such securities would comprise more than 15% of the value of a
Fund's net assets. The Board of Trustees or its delegate has the ultimate
authority to determine, to the extent permissible under the federal securities
laws, which securities are liquid or illiquid for purposes of this 15%
limitation. The Board of Trustees has delegated to the Advisor or the
Sub-Advisors the day-to-day determination of the illiquidity of any equity or
fixed-income security, although it has retained oversight for such
determinations. With respect to Rule 144A securities, the Advisor and the
Sub-Advisors consider factors such as (i) the nature of the market for a
security (including the institutional private resale market, the frequency of
trades and quotes for the security, the number of dealers willing to purchase or
sell the security, the amount of time normally needed to dispose of the
security, the method of soliciting offers and the mechanics of transfer), (ii)
the terms of certain securities or other instruments allowing for the
disposition to a third party or the issuer thereof (e.g., certain repurchase
obligations and demand instruments), and (iii) other permissible relevant
factors.
Restricted securities may be sold only in privately negotiated
transactions or in a public offering with respect to which a registration
statement is in effect under the 1933 Act. Where registration is required, a
Fund may be obligated to pay all or part of the registration expenses and a
considerable period may elapse between the time of the decision to sell and the
-6-
time the Fund may be permitted to sell a security under an effective
registration statement. If, during such a period, adverse market conditions were
to develop, a Fund might obtain a less favorable price than that which prevailed
when it decided to sell. Illiquid securities will be priced at fair value as
determined in good faith under procedures adopted by the Board of Trustees. If,
through the appreciation of illiquid securities or the depreciation of liquid
securities, a Fund should be in a position where more than 15% of the value of
its net assets are invested in illiquid securities, including restricted
securities which are not readily marketable, the Fund will take such steps as is
deemed advisable, if any, to protect liquidity.
Fixed Income Investments and Cash Equivalents: Normally, the Funds invest
substantially all of their assets to meet their investment objectives;
however, for temporary or defensive purposes, the Funds may invest in fixed
income investments and cash equivalents in order to provide income, liquidity
and preserve capital.
Fixed income investments and cash equivalents held by each Fund may
include, without limitation, the types of investments set forth below.
(1) A Fund may invest in U.S. government securities, including
bills, notes and bonds differing as to maturity and rates of interest,
which are either issued or guaranteed by the U.S. Treasury or by U.S.
government agencies or instrumentalities. U.S. government securities
include securities that are issued or guaranteed by the United States
Treasury, by various agencies of the U.S. government, or by various
instrumentalities that have been established or sponsored by the U.S.
government. U.S. Treasury securities are backed by the "full faith and
credit" of the United States. Securities issued or guaranteed by federal
agencies and U.S. government-sponsored instrumentalities may or may not be
backed by the full faith and credit of the United States. Some of the U.S.
government agencies that issue or guarantee securities include the
Export-Import Bank of the United States, Farmers Home Administration,
Federal Housing Administration, Maritime Administration, Small Business
Administration and The Tennessee Valley Authority. An instrumentality of
the U.S. government is a government agency organized under Federal charter
with government supervision. Instrumentalities issuing or guaranteeing
securities include, among others, Federal Home Loan Banks, the Federal
Land Banks, Central Bank for Cooperatives, Federal Intermediate Credit
Banks and FNMA. In the case of those U.S. government securities not backed
by the full faith and credit of the United States, the investor must look
principally to the agency or instrumentality issuing or guaranteeing the
security for ultimate repayment, and may not be able to assert a claim
against the United States itself in the event that the agency or
instrumentality does not meet its commitment. The U.S. government, its
agencies and instrumentalities do not guarantee the market value of their
securities, and consequently, the value of such securities may fluctuate.
In addition, each Fund may invest in sovereign debt obligations of
non-U.S. countries. A sovereign debtor's willingness or ability to repay
principal and interest in a timely manner may be affected by a number of
factors, including its cash flow situation, the extent of its non-U.S.
reserves, the availability of sufficient non-U.S. exchange on the date a
-7-
payment is due, the relative size of the debt service burden to the
economy as a whole, the sovereign debtor's policy toward principal
international lenders and the political constraints to which it may be
subject.
(2) A Fund may invest in certificates of deposit issued against
funds deposited in a bank or savings and loan association. Such
certificates are for a definite period of time, earn a specified rate of
return, and are normally negotiable. If such certificates of deposit are
non-negotiable, they will be considered illiquid securities and be subject
to a Fund's 15% restriction on investments in illiquid securities.
Pursuant to the certificate of deposit, the issuer 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 $250,000;
therefore, certificates of deposit purchased by a Fund may not be fully
insured. A Fund may only invest in certificates of deposit issued by U.S.
banks with at least $1 billion in assets.
(3) A 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.
(4) A Fund may invest in repurchase agreements, which involve
purchases of debt securities with counterparties that are deemed by First
Trust to present acceptable credit risks. In such an action, at the time a
Fund purchases the security, it simultaneously agrees to resell and
redeliver the security to the seller, who also simultaneously agrees to
buy back the security at a fixed price and time. This assures a
predetermined yield for a 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 a Fund to invest
temporarily available cash. A 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 a Fund may invest. Repurchase agreements may be considered loans to
the seller, collateralized by the underlying securities. The risk to a
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 affected Fund is entitled to sell the underlying
collateral. If the value of the collateral declines after the agreement is
entered into, however, and if the seller defaults under a repurchase
agreement when the value of the underlying collateral is less than the
repurchase price, a Fund could incur a loss of both principal and
interest. The portfolio managers monitor 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 portfolio managers do 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 a Fund. If the seller were to
be subject to a federal bankruptcy proceeding, the ability of a Fund to
liquidate the collateral could be delayed or impaired because of certain
provisions of the bankruptcy laws.
-8-
(5) A 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.
(6) A Fund may invest in commercial paper, which are 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 the notes. However, they are redeemable
by a Fund at any time. A Fund's portfolio managers will consider the
financial condition of the corporation (e.g., earning power, cash flow and
other liquidity ratios) and will continuously monitor the corporation's
ability to meet all of its financial obligations, because a Fund's
liquidity might be impaired if the corporation were unable to pay
principal and interest on demand. A Fund may invest in commercial paper
only if its has received the highest rating from at least one nationally
recognized statistical rating organization or, if unrated, judged by First
Trust to be of comparable quality.
(7) A Fund may invest in shares of money market funds, as
consistent with its investment objectives and policies. Shares of money
market funds are subject to management fees and other expenses of those
funds. Therefore, investments in money market funds will cause the Fund to
bear proportionately the costs incurred by the money market funds'
operations. At the same time, a Fund will continue to pay its own
management fees and expenses with respect to all of its assets, including
any portion invested in the shares of other investment companies. Although
money market funds that operate in accordance with Rule 2a-7 under the
1940 Act seek to preserve a $1.00 share price, it is possible for the Fund
to lose money by investing in money market funds.
Preferred Stock and Trust Preferred Securities: The First Trust Preferred
Securities and Income Fund invests primarily in preferred securities. Certain of
the preferred securities in which the Fund invests are traditional preferred
stocks which issue dividends that qualify for the dividend received deduction
under which "qualified" domestic corporations are able to exclude a percentage
of the dividends received from their taxable income.
Certain of the preferred securities in which the Fund invests are
preferred stock that does not issue dividends that qualify for the dividends
received deduction for eligible investors ("non-DRD preferred stock") and debt
instruments that are similar in many respects to preferred securities (such debt
instruments and non-DRD preferred stock are often referred to as "hybrid
securities") that do not qualify for the dividends received deduction or issue
qualified dividend income. Pursuant to the dividends received deduction,
corporations may generally deduct 70% of the dividend income they receive.
Corporate shareholders of a regulated investment company like the Funds
generally are permitted to claim a deduction with respect to that portion of
their distributions attributable to amounts received by the regulated investment
company that qualify for the dividends received deduction. However, not all
preferred securities pay dividends that are eligible for the dividends received
-9-
deduction. Any corporate shareholder who otherwise would qualify for the
dividends received deduction should assume that none of the distributions it
receives from the Funds will qualify for the dividends received deduction.
These types of hybrid securities typically offer additional yield spread
versus other types of preferred securities due to this lack of special tax
treatment. Hybrid securities are typically issued by corporations, generally in
the form of interest bearing notes or preferred securities, or by an affiliated
business trust of a corporation, generally in the form of (i) beneficial
interests in subordinated debentures or similarly structured securities or (ii)
more senior debt securities that pay income and trade in a manner similar to
preferred securities. The hybrid securities market consists of both fixed and
adjustable coupon rate securities that are either perpetual in nature or have
stated maturity dates. The hybrid securities market is divided into the "$25
par" and the "institutional" segments. The $25 par segment is typified by
securities that are listed on the New York Stock Exchange (the "NYSE"), which
trade and are quoted "flat", i.e., without accrued dividend income, and which
are typically callable at par value five years after their original issuance
date. The institutional segment is typified by $1,000 par value securities that
are not exchange-listed, which trade and are quoted on an "accrued income"
basis, and which typically have a minimum of 10 years of call protection (at
premium prices) from the date of their original issuance.
Hybrid securities are typically junior and fully subordinated liabilities
of an issuer or the beneficiary of a guarantee that is junior and fully
subordinated to the other liabilities of the guarantor. In addition, hybrid
securities typically permit an issuer to defer the payment of income for
eighteen months or more without triggering an event of default. Generally, the
deferral period is five years or more. Because of their subordinated position in
the capital structure of an issuer, the ability to defer payments for extended
periods of time without adverse consequence to the issuer, and certain other
features (such as restrictions on common dividend payments by the issuer or
ultimate guarantor when cumulative payments on the non-DRD preferred securities
have not been made), these hybrid securities are often treated as close
substitutes for traditional preferred stock, both by issuers and investors.
Hybrid securities have many of the key characteristics of equity due to their
subordinated position in an issuer's capital structure and because their quality
and value are heavily dependent on the profitability of the issuer rather than
on any legal claims to specific assets or cash flows.
Hybrid securities include but are not limited to: trust originated
preferred securities, monthly income preferred securities, quarterly income bond
securities, quarterly income debt securities, quarterly income preferred
securities, corporate trust securities, public income notes, and other trust
preferred securities.
Hybrid securities are typically issued with a final maturity date,
although some are perpetual in nature. In certain instances, a final maturity
date may be extended and/or the final payment of principal may be deferred at
the issuer's option for a specified time without any adverse consequence to the
issuer. No redemption can typically take place unless all cumulative payment
obligations have been met, although issuers may be able to engage in open-market
repurchases without regard to any cumulative dividends payable. A portion of the
portfolio may include investments in non-cumulative preferred securities,
whereby the issuer does not have an obligation to make up any arrearages to its
-10-
shareholders. Should an issuer default on its obligations under such a security,
the amount of dividends the Fund pays may be adversely affected.
Many hybrid securities are issued by a trust or other special purpose
entities established by operating companies, and are not a direct obligation of
an operating company. At the time a trust or special purpose entity sells its
preferred securities to investors, the trust or special purpose entity purchases
debt of the operating company (with terms comparable to those of the trust or
special purpose entity securities), which enables the operating company to
deduct for tax purposes the interest paid on the debt held by the trust or
special purpose entity. The trust or special purpose entity is generally
required to be treated as transparent for federal income tax purposes such that
the holders of the non-DRD preferred securities are treated as owning beneficial
interests in the underlying debt of the operating company. Accordingly, payments
of the non-DRD preferred securities are treated as interest rather than
dividends for federal income tax purposes and, as such, are not eligible for the
dividends received deduction. The trust or special purpose entity in turn would
be a holder of the operating company's debt and would have priority with respect
to the operating company's earnings and profits over the operating company's
common shareholders, but would typically be subordinated to other classes of the
operating company's debt. Typically a non-DRD preferred share has a rating that
is slightly below that of its corresponding operating company's senior debt
securities.
Non-U.S. Investments: The Funds may invest in non-U.S. securities, which
may include securities denominated in non-U.S. currencies. Non-U.S. debt
securities in which a Fund may invest include debt securities issued or
guaranteed by companies organized under the laws of countries other than the
United States (including emerging markets), debt securities issued or guaranteed
by foreign, national, provincial, state, municipal or other governments with
taxing authority or by their agencies or instrumentalities and debt obligations
of supranational governmental entities such as the World Bank or European Union.
Non-U.S. debt securities also include U.S. dollar-denominated debt obligations,
such as "Yankee Dollar" obligations, of foreign issuers and of supra-national
government entities. Yankee Dollar obligations are U.S. dollar-denominated
obligations issued in the U.S. capital markets by foreign corporations, banks
and governments. Foreign debt securities also may be traded on foreign
securities exchanges or in OTC capital markets. The Funds' non-U.S. investments
may be denominated in currencies other than the U.S. dollar. To the extent a
Fund invests in such instruments, the value of the assets of the Fund as
measured in U.S. dollars will be affected by changes in exchange rates.
Generally, a Fund's currency exchange transactions will be conducted on a spot
(i.e., cash) basis at the spot rate prevailing in the currency exchange market.
The cost of a Fund's currency exchange transactions will generally be the
difference between the bid and offer spot rate of the currency being purchased
or sold. In order to protect against uncertainty in the level of future currency
exchange rates, the Funds are authorized to enter into various currency exchange
transactions.
High-Yield Securities: The First Trust Short Duration High Income Fund
will invest in securities that are rated below-investment grade at the time of
purchase. The ratings of a rating agency represent its opinion as to the quality
of securities it undertakes to rate. Ratings are not absolute standards of
quality; consequently, securities with the same maturity, duration, coupon, and
rating may have different yields. For purposes of determining whether a security
-11-
is below-investment grade, the lowest available rating will be considered. If a
security owned by the Fund is subsequently downgraded, the Fund will not be
required to dispose of such security. If a downgrade occurs, the Advisor will
consider what action, including the sale of such security, is in the best
interests of the Fund. The Credit Rating Definitions as published by Standard &
Poor's, a division of The McGraw Hill Companies, Inc., are set forth in Appendix
E to this SAI.
Because the risk of default is higher for below-investment grade
securities than investment grade securities, the Advisor's research and credit
analysis will be an especially important part of managing securities of this
type. The Advisor will attempt to identify those issuers of below-investment
grade securities whose financial condition the Advisor believes are adequate to
meet future obligations or who have improved or are expected to improve in the
future. The Advisor's analysis focuses on relative values based on such factors
as interest or dividend coverage, asset coverage, earnings prospects and the
experience and managerial strength of the issuer.
Corporate Bonds: The First Trust Short Duration High Income Fund may
invest in corporate bonds. Corporate bonds, a type of fixed-income security,
are debt obligations issued by corporations. Corporate bonds are generally used
by corporations to borrow money from investors. Corporate bonds may be either
secured or unsecured. Collateral used for secured debt includes, but is not
limited to, real property, machinery, equipment, accounts receivable, stocks,
bonds or notes. If a corporate bond is unsecured, it is known as a debenture.
Holders of corporate bonds, as creditors, have a prior legal claim over common
and preferred stockholders as to both income and assets of the issuer for the
principal and interest due them and may have a prior claim over other creditors
if liens or mortgages are involved. Interest on corporate bonds may be fixed or
floating, or the securities may be zero coupon fixed-income securities which pay
no interest. Interest on corporate bonds is typically paid semi-annually and is
fully taxable to the holder of the bonds. Corporate bonds contain elements of
both interest rate risk and credit risk. The market value of a corporate bond
generally may be expected to rise and fall inversely with changes in interest
rates and may also be affected by the credit rating of the issuer, the issuer's
performance and perceptions of the issuer in the marketplace. Corporate bonds
usually yield more than government or agency bonds due to their credit risk.
Loans: The First Trust Short Duration High Income Fund may invest in fixed
and floating rate loans ("Loans"). Loans may include senior floating rate loans
("Senior Loans") and secured and unsecured loans, second lien or more junior
loans and bridge loans ("Junior Loans"). Loans are typically arranged through
private negotiations between borrowers in the United States or in foreign or
emerging markets which may be corporate issuers or issuers of sovereign debt
obligations ("Obligors") and one or more financial institutions and other
lenders ("Lenders"). The Fund may invest in Loans by purchasing assignments of
all or a portion of Loans ("Assignments") or Loan participations
("Participations") from third parties.
The Fund has direct rights against the Obligor on the Loan when it
purchases an Assignment. Assignments are arranged through private negotiations
between potential assignees and potential assignors. With respect to
Participations, typically, the Fund will have a contractual relationship only
with the Lender and not with the Obligor. The agreement governing Participations
-12-
may limit the rights of the Fund to vote on certain changes which may be made to
the Loan agreement, such as waiving a breach of a covenant. However, the holder
of a Participation will generally have the right to vote on certain fundamental
issues such as changes in principal amount, payment dates and interest rate.
Participations may entail certain risks relating to the creditworthiness of the
parties from which the participations are obtained.
A Loan is typically originated, negotiated and structured by a U.S. or
foreign commercial bank, insurance company, finance company or other financial
institution (the "Agent") for a group of Loan investors.
The Agent typically administers and enforces the Loan on behalf of the other
Loan investors in the syndicate. The Agent's duties may include responsibility
for the collection of principal and interest payments from the
Obligor and the apportionment of these payments to the credit of all Loan
investors. The Agent is also typically responsible for monitoring compliance
with the covenants contained in the Loan agreement based upon reports prepared
by the Obligor. In addition, an institution, typically but not always the Agent,
holds any collateral on behalf of the Loan investors. In the event of a default
by the Obligor, it is possible, though unlikely, that the Fund could receive a
portion of the borrower's collateral. If the Fund receives collateral other than
cash, any proceeds received from liquidation of such collateral will be
available for investment as part of the Fund's portfolio.
In the process of buying, selling and holding Senior Loans, the Fund may
receive and/or pay certain fees. These fees are in addition to interest payments
received and may include facility fees, commitment fees, commissions and
prepayment penalty fees. When the Fund buys or sells a Loan it may pay a fee. In
certain circumstances, the Fund may receive a prepayment penalty fee upon
prepayment of a Loan.
There may be instances in which the Fund is required to vote upon
amendments to certain of the Loans in which it invests. In these cases, the Fund
will attempt to ensure that such amendments are voted consistently and solely in
the best interests of the Fund.
Additional Information Concerning Senior Loans: Senior Loans typically
hold the most senior position in the capital structure of the Obligor, are
typically secured with specific collateral and have a claim on the assets and/or
stock of the Obligor that is senior to that held by subordinated debtholders and
shareholders of the Obligor. Collateral for Senior Loans may include (i) working
capital assets, such as accounts receivable and inventory; (ii) tangible fixed
assets, such as real property, buildings and equipment; (iii) intangible assets,
such as trademarks and patent rights; and/or (iv) security interests in shares
of stock of subsidiaries or affiliates.
Derivatives: To the extent disclosed in the Prospectus, the Funds may
invest in futures, total return swaps, non-U.S. currency swaps, loan credit
default swaps, credit default swaps, options, puts, calls and other derivative
instruments to seek to enhance return, to hedge some of the risks of its
investments in securities, as a substitute for a position in the underlying
asset, to reduce transaction costs, to maintain full market exposure (which
means to adjust the characteristics of its investments to more closely
approximate those of the markets in which it invests), to manage cash flows, to
limit exposure to losses due to changes to non-U.S. currency exchange rates or
to preserve capital.
-13-
Pooled Investment Vehicles: The Funds may invest in other pooled
investment vehicles, including open-end or closed-end investment companies,
other exchange-traded funds ("ETFs") and business development companies that
invest primarily in securities of the types in which the Fund may invest
directly. As a shareholder in a pooled investment vehicle, the Fund will bear
its ratable share of that vehicle's expenses, and would remain subject to
payment of the Fund's management fees with respect to assets so invested.
Shareholders would therefore be subject to duplicative expenses to the extent
the Fund invests in other pooled investment vehicles. In addition, the Fund will
incur brokerage costs when purchasing and selling shares of ETFs. Other pooled
investment vehicles may be leveraged, and the net asset value and market value
of their securities will therefore be more volatile and the yield to
shareholders will tend to fluctuate more than the yield of unleveraged pooled
investment vehicles.
PORTFOLIO TURNOVER
The Funds buy and sell portfolio securities in the normal course of their
investment activities. The proportion of a Fund's investment portfolio that is
bought and sold during a year is known as a Fund's portfolio turnover rate. A
turnover rate of 100% would occur, for example, if a Fund bought and sold
securities valued at 100% of its net assets within one year. A high portfolio
turnover rate could result in the payment by a Fund of increased brokerage
costs, expenses and taxes. The portfolio turnover rates for the Funds for the
fiscal years ended October 31, 2012 and October 31, 2013 are set forth in the
table below.
PORTFOLIO TURNOVER RATE
FISCAL YEAR ENDED FISCAL YEAR ENDED
FUND OCTOBER 31, 2012 OCTOBER 31, 2013
First Trust Preferred Securities and
Income Fund 60% 60%
First Trust/Confluence Small Cap Value
Fund 11% 31%
First Trust Short Duration High Income
Fund N/A 89%
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HEDGING STRATEGIES
General Description of Hedging Strategies
The Funds may engage in hedging activities. First Trust or A Fund's
Sub-Advisor may cause the Fund to utilize a variety of financial instruments,
including options, forward contracts, futures contracts (hereinafter referred to
-14-
as "Futures" or "Futures Contracts"), options on Futures Contracts and shorting
strategies and swap agreements to attempt to hedge each Fund's holdings. The use
of Futures is not a part of a principal investment strategy of the Funds.
Hedging or derivative instruments on securities generally are used to
hedge against price movements in one or more particular securities positions
that a Fund owns or intends to acquire. Such instruments may also be used to
"lock-in" realized but unrecognized gains in the value of portfolio securities.
Hedging instruments on stock indices, in contrast, generally are used to hedge
against price movements in broad equity market sectors in which a Fund has
invested or expects to invest. 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 can also reduce the opportunity for gain by offsetting the positive
effect of favorable price movements in the hedged investments. The use of
hedging instruments is subject to applicable regulations of the SEC, the several
options and futures exchanges upon which they are traded, the Commodity Futures
Trading Commission (the "CFTC") and various state regulatory authorities. In
addition, a Fund's ability to use hedging instruments may be limited by tax
considerations.
General Limitations on Futures and Options Transactions
Each Fund limits its direct investments in Futures, options on Futures and
swaps to the extent necessary for the Advisor to claim the exclusion from
regulation as a "commodity pool operator" with respect to each Fund under CFTC
Rule 4.5, as such rule may be amended from time to time. Under Rule 4.5 as
currently in effect, each Fund limits its trading activity in Futures, option on
Futures and swaps (excluding activity for "bona fide hedging purposes," as
defined by the CFTC) such that it meets one of the following tests: (i)
aggregate initial margin and premiums required to establish its Futures, options
on Futures and swap positions do not exceed 5% of the liquidation value of the
Fund's portfolio, after taking into account unrealized profits and losses on
such positions; or (ii) aggregate net notional value of its Futures, options on
Futures and swap positions does not exceed 100% of the liquidation value of the
Fund's portfolio, after taking into account unrealized profits and losses on
such positions.
The Advisor has filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with respect to each Fund with
the National Futures Association, the Futures industry's self-regulatory
organization. The Funds will not enter into Futures Contracts and options
transactions if more than 30% of their net assets would be committed to such
instruments.
If a Fund were no longer able to claim the exclusion, the Advisor would be
required to register as a "commodity pool operator," and the Fund and the
Advisor would be subject to regulation under the Commodity Exchange Act (the
"CEA").
Asset Coverage for Futures and Options Positions
The Funds will comply with the regulatory requirements of the SEC and the
CFTC with respect to coverage of options and Futures positions by registered
investment companies and, if the guidelines so require, will earmark or set
-15-
aside cash, U.S. government securities, high grade liquid debt securities and/or
other liquid assets permitted by the SEC and CFTC in a segregated custodial
account in the amount prescribed. Securities earmarked or 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.
Stock Index Options
The Funds may purchase stock index options, sell stock index options in
order to close out existing positions, and/or write covered options on stock
indices for hedging purposes. Stock index options are put options and call
options on various stock indices. In most respects, they are identical to listed
options on common stocks. The primary difference between stock options and index
options occurs when index options are exercised. In the case of stock options,
the underlying security, common stock, is delivered. However, upon the exercise
of an index option, settlement does not occur by delivery of the securities
comprising the stock index. The option holder who exercises the index option
receives an amount of cash if the closing level of the stock index upon which
the option is based is greater than, in the case of a call, or less than, in the
case of a put, the exercise price of the option. This amount of cash is equal to
the difference between the closing price of the stock index and the exercise
price of the option expressed in dollars times a specified multiple.
A stock index fluctuates with changes in the market values of the stocks
included in the index. For example, some stock index options are based on a
broad market index, such as the S&P 500 Index or the Value Line(R) Composite
Index or a more narrow market index, such as the S&P 100 Index. Indices may also
be based on an industry or market segment. Options on stock indices are
currently traded on the following exchanges: the Chicago Board Options Exchange,
NYSE Amex Options, The NASDAQ(R) Stock Market ("NASDAQ(R)") and the Philadelphia
Stock Exchange.
The Funds' use of stock index options is subject to certain risks.
Successful use by a Fund of options on stock indices will be subject to the
ability its Sub-Advisor to correctly predict movements in the directions of the
stock market. This requires different skills and techniques than predicting
changes in the prices of individual securities. In addition, a Fund's ability to
effectively hedge all or a portion of the securities in its portfolio, in
anticipation of or during a market decline through transactions in put options
on stock indices, depends on the degree to which price movements in the
underlying index correlate with the price movements of the securities held by
the Fund. Inasmuch as the Funds' securities will not duplicate the components of
an index, the correlation will not be perfect. Consequently, a Fund will bear
the risk that the prices of its securities being hedged will not move in the
same amount as the prices of its put options on the stock indices. It is also
possible that there may be a negative correlation between the index and a Fund's
securities, which would result in a loss on both such securities and the options
on stock indices acquired by the Fund.
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
-16-
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 stock index
options involves the risk that the premium and transaction costs paid by a Fund
in purchasing an option will be lost as a result of unanticipated movements in
prices of the securities comprising the stock index on which the option is
based.
Certain Considerations Regarding Options
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 a
Fund is unable to close out a call option on securities that it has written
before the option is exercised, a Fund may be required to purchase the optioned
securities in order to satisfy its obligation under the option to deliver such
securities. If a 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 option in order to realize any profit and would incur transaction
costs upon the purchase and sale of the underlying securities.
The writing and purchasing of options is a highly specialized activity,
which involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. 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 Funds.
Futures Contracts
The Funds may enter into Futures Contracts, including index Futures as a
hedge against movements in the equity markets, in order to hedge against changes
on securities held or intended to be acquired by a Fund or for other purposes
permissible under the CEA. A Fund's hedging may include sales of Futures as an
offset against the effect of expected declines in stock prices and purchases of
Futures as an offset against the effect of expected increases in stock prices.
The Funds 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 national Futures exchanges and are
standardized as to maturity date and underlying financial instrument. The
principal interest rate Futures exchanges in the United States are the Chicago
Board of Trade and the Chicago Mercantile Exchange. Futures exchanges and
trading are regulated under the CEA by the CFTC.
An interest rate Futures Contract provides for the future sale by one
party and purchase by another party of a specified amount of a specific
financial instrument (e.g., a debt security) or currency for a specified price
at a designated date, time and place. An index Futures Contract is an agreement
pursuant to which the parties agree to take or make delivery of an amount of
cash equal to the difference between the value of the index at the close of the
last trading day of the contract and the price at which the index Futures
Contract was originally written. Transaction costs are incurred when a Futures
Contract is bought or sold and margin deposits must be maintained. A Futures
Contract may be satisfied by delivery or purchase, as the case may be, of the
instrument or by payment of the change in the cash value of the index. More
-17-
commonly, Futures Contracts are closed out prior to delivery by entering into an
offsetting transaction in a matching Futures Contract. Although the value of an
index might be a function of the value of certain specified securities, no
physical delivery of those securities is made. 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
a Fund will be able to enter into an offsetting transaction with respect to a
particular Futures Contract at a particular time. If a Fund is not able to enter
into an offsetting transaction, a Fund will continue to be required to maintain
the margin deposits on the Futures Contract.
Margin is the amount of funds that must be deposited by a Fund with its
custodian in a segregated account in the name of the Futures commission merchant
in order to initiate Futures trading and to maintain a Fund's open positions in
Futures Contracts. A margin deposit is intended to ensure a 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. Futures Contracts are customarily purchased and sold on margins that
may range upward from less than 5% of the value of the Futures Contract being
traded.
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 a Fund. In computing daily net asset value, a Fund
will mark to market the current value of its open Futures Contracts. The Funds
expect to earn interest income on their margin deposits.
Because of the low margin deposits required, Futures 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 Future 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, a 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.
Most U.S. Futures exchanges limit the amount of fluctuation permitted in
Futures Contract prices during a single trading day. The day limit establishes
the maximum amount that the price of a Futures Contract may vary either up or
down from the previous day's settlement price at the end of a trading session.
-18-
Once the daily limit has been reached in a particular type of Futures Contract,
no trades may be made on that day at a price beyond that limit. The daily limit
governs only price movement during a particular trading day and therefore does
not limit potential losses, because the limit may prevent the liquidation of
unfavorable positions. Futures Contract prices have occasionally moved to the
daily limit for several consecutive trading days with little or no trading,
thereby preventing prompt liquidation of Futures positions and subjecting some
investors to substantial losses.
There can be no assurance that a liquid market will exist at a time when a
Fund seeks to close out a Futures position. A Fund would continue to be required
to meet margin requirements until the position is closed, possibly resulting in
a decline in the Fund's net asset value. 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.
A public market exists in Futures Contracts covering a number of indices,
including but not limited to, the S&P 500 Index, the S&P 100 Index, the
NASDAQ-100 Index(R), the Value Line(R) Composite Index and the NYSE Composite
Index(R).
Options on Futures
The Funds may also purchase or write put and call options on Futures
Contracts and enter into closing transactions with respect to such options to
terminate an existing position. A Futures option gives the holder the right, in
return for the premium paid, to assume a long position (call) or short position
(put) in a Futures Contract at a specified exercise price prior to the
expiration of the option. Upon exercise of a call option, the holder acquires a
long position in the Futures Contract and the writer is assigned the opposite
short position. In the case of a put option, the opposite is true. Prior to
exercise or expiration, a Futures option may be closed out by an offsetting
purchase or sale of a Futures option of the same series.
The Funds may use options on Futures Contracts in connection with hedging
strategies. Generally, these strategies would be applied under the same market
and market sector conditions in which the Funds use put and call options on
securities or indices. The purchase of put options on Futures Contracts is
analogous to the purchase of puts on securities or indices so as to hedge a
Fund's securities holdings against the risk of declining market prices. The
writing of a call option or the purchasing of a put option on a Futures Contract
constitutes a partial hedge against declining prices of securities which are
deliverable upon exercise of the Futures Contract. If the price at expiration of
a written call option is below the exercise price, a Fund will retain the full
amount of the option premium which provides a partial hedge against any decline
that may have occurred in a Fund's holdings of securities. If the price when the
option is exercised is above the exercise price, however, a Fund will incur a
loss, which may be offset, in whole or in part, by the increase in the value of
the securities held by a Fund that were being hedged. Writing a put option or
purchasing a call option on a Futures Contract serves as a partial hedge against
an increase in the value of the securities a Fund intends to acquire.
-19-
As with investments in Futures Contracts, the Funds are required to
deposit and maintain margin with respect to put and call options on Futures
Contracts written by them. Such margin deposits will vary depending on the
nature of the underlying Futures Contract (and the related initial margin
requirements), the current market value of the option, and other Futures
positions held by a Fund. A Fund will earmark or set aside in a segregated
account at such Fund's custodian, liquid assets, such as cash, U.S. government
securities or other high-grade liquid debt obligations equal in value to the
amount due on the underlying obligation. Such segregated assets will be
marked-to-market daily, and additional assets will be earmarked or placed in the
segregated account whenever the total value of the earmarked or segregated
assets falls below the amount due on the underlying obligation.
The risks associated with the use of options on Futures Contracts include
the risk that the Funds may close out its position as a writer of an option only
if a liquid secondary market exists for such options, which cannot be assured. A
Fund's successful use of options on Futures Contracts depends on its Advisor's
or Sub-Advisor's ability to correctly predict the movement in prices of Futures
Contracts and the underlying instruments, which may prove to be incorrect. In
addition, there may be imperfect correlation between the instruments being
hedged and the Futures Contract subject to the option. For additional
information, see "Futures Contracts." Certain characteristics of the Futures
market might increase the risk that movements in the prices of Futures Contracts
or options on Futures Contracts might not correlate perfectly with movements in
the prices of the investments being hedged. For example, all participants in the
Futures and options on Futures Contracts markets are subject to daily variation
margin calls and might be compelled to liquidate Futures or options on Futures
Contracts positions whose prices are moving unfavorably to avoid being subject
to further calls. These liquidations could increase the price volatility of the
instruments and distort the normal price relationship between the Futures or
options and the investments being hedged. Also, because of initial margin
deposit requirements, there might be increased participation by speculators in
the Futures markets. This participation also might cause temporary price
distortions. In addition, activities of large traders in both the Futures and
securities markets involving arbitrage, "program trading," and other investment
strategies might result in temporary price distortions.
Swap Agreements
A swap is a financial instrument that typically involves the exchange of
cash flows between two parties on specified dates (settlement dates), where the
cash flows are based on agreed-upon prices, rates, indices, etc. The nominal
amount on which the cash flows are calculated is called the notional amount.
Swaps are individually negotiated and structured to include exposure to a
variety of different types of investments or market factors, such as interest
rates, 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 a Fund. If a swap
-20-
agreement calls for payments by a 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 a fixed maturity date that will be agreed
upon by the parties. 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. A 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 Funds'
gains or losses. In order to reduce the risk associated with leveraging, a Fund
may cover its current obligations under swap agreements according to guidelines
established by the SEC. If a Fund enters into a swap agreement on a net basis,
it will earmark 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 a Fund enters
into a swap agreement on other than a net basis, it will earmark 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 stock, stock index or basket of stocks in return for a
specified interest rate. By entering into an equity index swap, for example, the
index receiver can gain exposure to stocks making up the index of securities
without actually purchasing those stocks. 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 return on the interest rate that a Fund will be committed to
pay.
Interest Rate Swaps. Interest rate swaps are financial instruments that
involve the exchange of one type of interest rate for another type of interest
rate cash flow on specified dates in the future. Some of the different types of
interest rate swaps are "fixed-for floating rate swaps," "termed basis swaps"
and "index amortizing swaps." Fixed-for floating rate swaps involve the exchange
of fixed interest rate cash flows for floating rate cash flows. Termed basis
swaps entail cash flows to both parties based on floating interest rates, where
the interest rate indices are different. Index amortizing swaps are typically
fixed-for floating swaps where the notional amount changes if certain conditions
are met. Like a traditional investment in a debt security, a Fund could lose
money by investing in an interest rate swap if interest rates change adversely.
For example, if a Fund enters into a swap where it agrees to exchange a floating
rate of interest for a fixed rate of interest, the Fund may have to pay more
money than it receives. Similarly, if a Fund enters into a swap where it agrees
to exchange a fixed rate of interest for a floating rate of interest, the Fund
may receive less money than it has agreed to pay.
Currency Swaps. A currency swap is an agreement between two parties in
which one party agrees to make interest rate payments in one currency and the
-21-
other promises to make interest rate payments in another currency. The Fund may
enter into a currency swap when it has one currency and desires a different
currency. Typically the interest rates that determine the currency swap payments
are fixed, although occasionally one or both parties may pay a floating rate of
interest. Unlike an interest rate swap, however, the principal amounts are
exchanged at the beginning of the contract and returned at the end of the
contract. Changes in non-U.S. exchange rates and changes in interest rates, as
described above, may negatively affect currency swaps.
Credit Default Swaps. A credit default swap is similar to an insurance
contract in that it provides the buyer with protection against specific risks.
Most often, corporate bond investors buy credit default swaps for protection
against a default by the issuer of the corporate bond, but these flexible
instruments can be used in many ways to customize exposure to corporate credit.
Credit default swap agreements can mitigate risks in bond investing by
transferring a given risk from one party to another without transferring the
underlying bond or other credit asset. In a credit default swap agreement, one
party "sells" risk and the counterparty "buys" that risk. The "seller" of credit
risk, who also tends to own the underlying credit asset, pays a periodic fee to
the risk "buyer." In return, the risk "buyer" agrees to pay the "seller" a set
amount if there is a default, or a credit event.
The Fund's use of credit default swap agreements exposes the Funds to
additional risks, including but not limited to, the credit and liquidity risk of
a counterparty. If the credit quality of any such counterparty deteriorates,
such counterparty may default on its obligations to make payments under the swap
agreement. A Fund may also be exposed to liquidity risk because the market for
credit default swaps are relatively illiquid and the Fund will generally not be
permitted to terminate or assign its credit default swaps without the consent of
the related counterparty and accordingly may not be able to terminate or assign
such credit default swaps in a timely fashion and for a fair price, potentially
restricting its ability to take advantage of market opportunities.
Short Sales
The Funds may take short positions in securities, which are often referred
to as "short sales." A short sale is a sale of a security a Fund has borrowed,
with the expectation that the security will underperform the market. To settle
the short sale transaction, the Fund buys the same security at a later date and
returns it to the lender of the security. The Fund makes money on a short
position if the market price of the security goes down after the short sale or
if the market price of the securities it buys with the proceeds of the short
sale increases more than that of the security sold short. Conversely, if the
price of the security sold short goes up after the short sale, the Fund loses
money because it has to pay more to replace the borrowed security than it
received when it sold the security short. Short-selling is considered "leverage"
and may involve substantial risk.
-22-
INVESTMENT RISKS
Common Stock
An investment in the First Trust/Confluence Small Cap Value Fund should be
made with an understanding of the risks which an investment in common stocks
entails, including the risk that the financial condition of the issuers of the
equity securities or the general condition of the common stock market may worsen
and the value of the equity securities and therefore the value of the Fund may
decline. The Fund may not be an appropriate investment for those who are unable
or unwilling to assume the risks involved generally with an equity investment.
The past market and earnings performance of any of the equity securities
included in the Fund is not predictive of their future performance. Common
stocks are especially susceptible to general stock market movements and to
volatile increases and decreases of value as market confidence in and
perceptions of the issuers change. These perceptions are based on unpredictable
factors including expectations regarding government, economic, monetary and
fiscal policies, inflation and interest rates, economic expansion or
contraction, and global or regional political, economic or banking crises. First
Trust cannot predict the direction or scope of any of these factors.
Shareholders of common stocks have rights to receive payments from the issuers
of those common stocks that are generally subordinate to those of creditors of,
or holders of debt obligations or preferred stocks of, such issuers.
Shareholders of common stocks of the type held by the Fund have a right to
receive dividends only when and if, and in the amounts, declared by the issuer's
board of directors and have a right to participate in amounts available for
distribution by the issuer only after all other claims on the issuer have been
paid. Common stocks do not represent an obligation of the issuer and, therefore,
do not offer any assurance of income or provide the same degree of protection of
capital as do debt securities. The issuance of additional debt securities or
preferred stock will create prior claims for payment of principal, interest and
dividends which could adversely affect the ability and inclination of the issuer
to declare or pay dividends on its common stock or the rights of holders of
common stock with respect to assets of the issuer upon liquidation or
bankruptcy. The value of common stocks is subject to market fluctuations for as
long as the common stocks remain outstanding, and thus the value of the equity
securities in the Fund will fluctuate over the life of the Fund and may be more
or less than the price at which they were purchased by the Fund. The equity
securities held in the Fund may appreciate or depreciate in value (or pay
dividends) depending on the full range of economic and market influences
affecting these securities, including the impact of the Fund's purchase and sale
of the equity securities and other factors.
Holders of common stocks incur more risk than holders of preferred stocks
and debt obligations because common stockholders, as owners of the entity, have
generally inferior rights to receive payments from the issuer in comparison with
the rights of creditors of, or holders of debt obligations or preferred stocks
issued by, the issuer. Cumulative preferred stock dividends must be paid before
common stock dividends and any cumulative preferred stock dividend omitted is
added to future dividends payable to the holders of cumulative preferred stock.
Preferred stockholders are also generally entitled to rights on liquidation
which are senior to those of common stockholders.
-23-
Preferred Securities and Trust Preferred Securities Risk
There are special risks associated with investing in preferred securities,
including risks related to deferral, noncumulative dividends, subordination,
liquidity, limited voting rights and special redemption rights. Trust preferred
securities are limited-life preferred securities typically issued by
corporations, generally in the form of interest-bearing notes or preferred
securities issued by an affiliated business trust of a corporation whose only
assets are generally in the form of beneficial interests in subordinated
debentures or similarly structured securities. Dividend payments on the trust
preferred securities generally coincide with interest payments on the underlying
obligations. Trust preferred securities generally have a yield advantage over
traditional preferred securities, but unlike preferred securities, distributions
are treated as interest rather than dividends for federal income tax purposes
and therefore, are not eligible for the dividends received deduction and do not
constitute qualified dividend income. Trust preferred securities prices
fluctuate for several reasons including changes in investors' perception of the
financial condition of an issuer or the general economic condition of the market
for trust preferred securities, or when political or economic events affecting
the issuers occur. Trust preferred securities are also sensitive to interest
rate fluctuations, as the cost of capital rises and borrowing costs increase in
a rising interest rate environment and the risk that a trust preferred security
may be called for redemption in a falling interest rate environment. Certain of
the other risks unique to trust preferred securities include: (i) distributions
on trust preferred securities will be made only if interest payments on the
interest-bearing notes, preferred securities or subordinated debentures are
made; (ii) a corporation issuing the interest-bearing notes, preferred
securities or subordinated debentures may defer interest payments on these
instruments for up to 20 consecutive quarters and if such election is made,
distributions will not be made on the trust preferred securities during the
deferral period; (iii) certain tax or regulatory events may trigger the
redemption of the interest-bearing notes, preferred securities or subordinated
debentures by the issuing corporation and result in prepayment of the trust
preferred securities prior to their stated maturity date; (iv) future
legislation may be proposed or enacted that may prohibit the corporation from
deducting its interest payments on the interest-bearing notes, preferred
securities or subordinated debentures for tax purposes, making redemption of
these instruments likely; (v) a corporation may redeem the interest bearing
notes, preferred securities or subordinated debentures in whole at any time or
in part from time to time on or after a stated call date; (vi) trust preferred
securities holders have very limited voting rights; and (vii) payment of
interest on the interest-bearing notes, preferred securities or subordinated
debentures, and therefore distributions on the trust preferred securities, is
dependent on the financial condition of the issuing corporation.
High-Yield Securities Risk
The securities that the First Trust Short Duration High Income Fund
invests in may not be rated by a Nationally Recognized Statistical Rating
Organization ("NRSRO"), may not be registered with the SEC or any state
securities commission and will not be listed on any national securities
exchange. To the extent that such high-yield securities are rated, they
typically will be rated below-investment grade and are subject to an increased
risk of default in the payment of principal and interest as well as other risks.
-24-
Risk Factors of Loan Assignments and Participations
Loans are subject to the risks associated with debt obligations in general
including interest rate risk, credit risk and market risk. When a loan is
acquired from a lender, the risk includes the credit risk associates with the
obligor of the underlying loan. The First Trust Short Duration High Income Fund
may incur additional credit risk when the Fund acquires a participation in a
loan from another lender because the Fund must assume the risk of insolvency or
bankruptcy of the other lender from which the loan was acquired. To the extent
that loans involve obligors in foreign or emerging markets, such loans are
subject to the risks associated with foreign investments or investments in
emerging markets in general.
Non-U.S. Securities Risk
An investment in non-U.S. securities involves risks in addition to the
usual risks inherent in domestic investments, including currency risk. The value
of a non-U.S. security in U.S. dollars tends to decrease when the value of the
U.S. dollar rises against the non-U.S. currency in which the security is
denominated and tends to increase when the value of the U.S. dollar falls
against such currency. Non-U.S. securities are affected by the fact that in many
countries there is less publicly available information about issuers than is
available in the reports and ratings published about companies in the United
States and companies may not be subject to uniform accounting, auditing and
financial reporting standards. Other risks inherent in non-U.S. investments
include expropriation; confiscatory taxation; withholding taxes on dividends and
interest; less extensive regulation of non-U.S. brokers, securities markets and
issuers; diplomatic developments; and political or social instability. Non-U.S.
economies may differ favorably or unfavorably from the U.S. economy in various
respects, and many non-U.S. securities are less liquid and their prices tend to
be more volatile than comparable U.S. securities. From time to time, non-U.S.
securities may be difficult to liquidate rapidly without adverse price effects.
Liquidity Risk
Whether or not the equity securities in a Fund are listed on a securities
exchange, the principal trading market for certain of the equity securities in
the Fund may be in the OTC market. As a result, the existence of a liquid
trading market for the equity securities may depend on whether dealers will make
a market in the equity securities. There can be no assurance that a market will
be made for any of the equity securities, that any market for the equity
securities will be maintained or that there will be sufficient liquidity of the
equity securities in any markets made. The price at which the equity securities
are held in a Fund will be adversely affected if trading markets for the equity
securities are limited or absent.
Real Estate Investment Trust ("REIT") Risk
REITs are financial vehicles that pool investors' capital to purchase or
finance real estate. REITs may concentrate their investments in specific
geographic areas or in specific property types, e.g., hotels, shopping malls,
residential complexes and office buildings. The market value of REIT shares and
the ability of the REITs to distribute income may be adversely affected by
-25-
several factors, including rising interest rates; changes in the national, state
and local economic climate and real estate conditions; perceptions of
prospective tenants of the safety, convenience and attractiveness of the
properties; the ability of the owners to provide adequate management,
maintenance and insurance; the cost of complying with the Americans with
Disabilities Act; increased competition from new properties; the impact of
present or future environmental legislation and compliance with environmental
laws; changes in real estate taxes and other operating expenses; adverse changes
in governmental rules and fiscal policies; adverse changes in zoning laws; and
other factors beyond the control of the issuers of the REITs. In addition,
distributions received by a Fund from REITs may consist of dividends, capital
gains and/or return of capital. Many of these distributions however will not
generally qualify for favorable treatment as qualified dividend income.
Depositary Receipts Risk
A Fund may hold securities of certain non-U.S. companies in the form of
depositary receipts ("Depositary Receipts"). Depositary Receipts may not
necessarily be denominated in the same currency as the underlying securities
into which they may be converted. American Depositary Receipts ("ADRs") are
receipts typically issued by an American bank or trust company that evidence
ownership of underlying securities issued by a foreign corporation. European
Depositary Receipts ("EDRs") are receipts issued by a European bank or trust
company evidencing ownership of securities issued by a foreign corporation. New
York shares are typically issued by a company incorporated in the Netherlands
and represent a direct interest in the company. Unlike traditional depositary
receipts, New York share programs do not involve custody of the Dutch shares of
the company. Global Depositary Receipts ("GDRs") are receipts issued throughout
the world that evidence a similar arrangement. ADRs, EDRs and GDRs may trade in
foreign currencies that differ from the currency the underlying security for
each ADR, EDR or GDR principally trades in. Global shares are the actual
(ordinary) shares of a non-U.S. company which trade both in the home market and
the United States. Generally, ADRs and New York shares, in registered form, are
designed for use in the U.S. securities markets. EDRs, in registered form, are
used to access European markets. GDRs, in registered form, are tradable both in
the United States and in Europe and are designed for use throughout the world.
Global shares are represented by the same share certificate in the United States
and the home market. Separate registrars in the United States and the home
country are maintained. In most cases, purchases occurring on a U.S. exchange
would be reflected on the U.S. registrar. Global shares may also be eligible to
list on exchanges in addition to the United States and the home country. The
Funds may hold unsponsored Depositary Receipts. The issuers of unsponsored
Depositary Receipts are not obligated to disclose material information in the
United States; therefore, there may be less information available regarding such
issuers and there may not be a correlation between such information and the
market value of the Depositary Receipts.
Passive Foreign Investment Companies Risk
A Fund may invest in companies that are considered to be "passive foreign
investment companies" ("PFICs"), which are generally certain non-U.S.
corporations that receive at least 75% of their annual gross income from passive
sources (such as interest, dividends, certain rents and royalties or capital
-26-
gains) or that hold at least 50% of their assets in investments producing such
passive income. Therefore, the Fund could be subject to U.S. federal income tax
and additional interest charges on gains and certain distributions with respect
to those equity interests, even if all the income or gain is distributed to its
shareholders in a timely manner. The Fund will not be able to pass through to
its shareholders any credit or deduction for such taxes.
ADDITIONAL RISKS OF INVESTING IN THE FUNDS
Derivatives Risk
The use of derivatives presents risks different from, and possibly greater
than, the risks associated with investing directly in traditional securities.
Among the risks presented are market risk, credit risk, management risk and
liquidity risk. The use of derivatives can lead to losses because of adverse
movements in the price or value of the underlying asset, index or rate, which
may be magnified by certain features of the derivatives. In addition, when a
Fund invests in certain derivative securities, including, but not limited to,
when-issued securities, forward commitments, futures contracts and interest rate
swaps, they are effectively leveraging their investments, which could result in
exaggerated changes in the net asset value of the Fund's shares and can result
in losses that exceed the amount originally invested. The success of a
Sub-Advisor's derivatives strategies will depend on its ability to assess and
predict the impact of market or economic developments on the underlying asset,
index or rate and the derivative itself, without the benefit of observing the
performance of the derivative under all possible market conditions. Liquidity
risk exists when a security cannot be purchased or sold at the time desired, or
cannot be purchased or sold without adversely affecting the price.
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 Funds 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 portfolio
manager's ability to predict movements of the securities, currencies, and
commodities markets, which may require different skills than predicting
changes in the prices of individual securities. There can be no assurance
that any particular strategy adopted will succeed. A decision to engage in
a derivative transaction will reflect the portfolio managers' judgment
that the derivative transaction will provide value to a Fund and its
shareholders and is consistent with a Fund's objectives, investment
limitations, and operating policies. In making such a judgment, the
portfolio managers will analyze the benefits and risks of the derivative
transactions and weigh them in the context of a Fund's overall investments
and investment objectives.
-27-
(2) Credit Risk. Credit risk is the risk that a loss may be
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 ("OTC") 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 Funds 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
Funds. The Funds will enter into transactions in derivative instruments
only with counterparties that First Trust 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 writing a call option, 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. The effectiveness of hedges using
instruments on indices will depend, in part, on the degree of correlation
between price movements in the index and the price movements in the
investments being hedged.
(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 very
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 Funds might be required by applicable regulatory
requirements to maintain assets as "cover," maintain segregated accounts,
and/or make margin payments when they take positions in derivative
instruments involving obligations to third parties (i.e., instruments
other than purchase options). If a Fund is unable to close out its
positions in such instruments, it might be required to continue to
maintain such assets or accounts or make such payments until the position
expires, matures, or is closed out. These requirements might impair a
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 a Fund sell a
portfolio security at a disadvantageous time. A 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
-28-
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 a 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.
MANAGEMENT OF THE FUNDS
TRUSTEES AND OFFICERS
The general supervision of the duties performed for the Funds under the
investment management agreement and sub-advisory agreements is the
responsibility of the Board of Trustees. There are five Trustees of the Trust,
one of whom is an "interested person" (as the term is defined in the 1940 Act)
and four of whom are Trustees who are not officers or employees of First Trust
or any of its affiliates ("Independent Trustees"). The Trustees set broad
policies for the Funds, choose the Trust's officers and hire the Trust's
investment advisor and sub-advisors. The officers of the Trust manage its day to
day operations and are responsible to the Trust's Board of Trustees. The
following is a list of the Trustees and officers of the Trust and a statement of
their present positions and principal occupations during the past five years,
the number of portfolios each Trustee oversees and the other directorships they
have held during the past five years, if applicable. Each Trustee has been
elected for an indefinite term. The officers of the Trust serve indefinite
terms. Each Trustee, except for James A. Bowen, is an Independent Trustee. Mr.
Bowen is deemed an "interested person" (as that term is defined in the 1940 Act)
("Interested Trustee") of the Trust due to his position as Chief Executive
Officer of First Trust, investment advisor to the Funds.
-29-
OTHER
NUMBER OF TRUSTEESHIPS
PORTFOLIOS OR
IN THE DIRECTORSHIPS
FIRST TRUST HELD BY
TERM OF OFFICE AND FUND COMPLEX TRUSTEE DURING
NAME, ADDRESS POSITION AND YEAR FIRST ELECTED PRINCIPAL OCCUPATIONS OVERSEEN BY THE PAST
AND DATE OF BIRTH OFFICES WITH TRUST OR APPOINTED DURING PAST 5 YEARS TRUSTEE 5 YEARS
Trustee who is an Interested
Person of the Trust
----------------------------
James A. Bowen(1) Chairman of the o Indefinite term Chief Executive Officer 108 Portfolios None
120 East Liberty Drive, Board and Trustee (December 2010 to Present),
Suite 400 President (until December
Wheaton, IL 60187 o Since inception 2010), First Trust Advisors
D.O.B.: 09/55 L.P. and First Trust
Portfolios L.P.; Chairman
of the Board of Directors,
BondWave LLC (Software
Development
Company/Investment Advisor)
and Stonebridge Advisors
LLC (Investment Advisor)
Independent Trustees
----------------------------
Richard E. Erickson Trustee o Indefinite term Physician; President, 108 Portfolios None
c/o First Trust Advisors L.P. Wheaton Orthopedics;
120 East Liberty Drive, Co-owner and Co-Director
Suite 400 o Since inception (January 1996 to May 2007),
Wheaton, IL 60187 Sports Med Center for
D.O.B.: 04/51 Fitness; Limited Partner,
Gundersen Real Estate
Limited Partnership;
Member, Sportsmed LLC
Thomas R. Kadlec Trustee o Indefinite term President (March 2010 to 108 Portfolios Director of
c/o First Trust Advisors L.P. Present), Senior Vice ADM Investor
120 East Liberty Drive, o Since inception President and Chief Services, Inc.
Suite 400 Financial Officer (May 2007 and ADM
Wheaton, IL 60187 to March 2010), Vice Investor
D.O.B.: 11/57 President and Chief Services
Financial Officer (1990 to International
May 2007), ADM Investor
Services, Inc. (Futures
Commission Merchant)
Robert F. Keith Trustee o Indefinite term President (2003 to 108 Portfolios Director of
c/o First Trust Advisors L.P. Present), Hibs Enterprises Trust Company
120 East Liberty Drive, o Since inception (Financial and Management of Illinois
Suite 400 Consulting)
Wheaton, IL 60187
D.O.B.: 11/56
Niel B. Nielson Trustee o Indefinite term President and Chief 108 Portfolios Director of
c/o First Trust Advisors L.P. Executive Officer (July Covenant
120 East Liberty Drive, o Since inception 2012 to Present), Dew Transport Inc.
Suite 400 Learning LLC (Educational
Wheaton, IL 60187 Products and Services);
D.O.B.: 03/54 President (June 2002 to
June 2012), Covenant
College
-30-
|
OTHER
NUMBER OF TRUSTEESHIPS
PORTFOLIOS OR
IN THE DIRECTORSHIPS
FIRST TRUST HELD BY
TERM OF OFFICE AND FUND COMPLEX TRUSTEE DURING
NAME, ADDRESS POSITION AND YEAR FIRST ELECTED PRINCIPAL OCCUPATIONS OVERSEEN BY THE PAST
AND DATE OF BIRTH OFFICES WITH TRUST OR APPOINTED DURING PAST 5 YEARS TRUSTEE 5 YEARS
Officers of the Trust
----------------------------
Mark R. Bradley President and o Indefinite term Chief Financial Officer, N/A N/A
120 East Liberty Drive, Chief Executive Chief Operating Officer
Suite 400 Officer (December 2010 to Present),
Wheaton, IL 60187 o President and First Trust Advisors L.P.
D.O.B.: 11/57 Chief Executive and First Trust Portfolios
Officer since L.P.; Chief Financial
January 2012; Officer, BondWave LLC
Treasurer and Chief (Software Development
Financial Officer Company/Investment Advisor)
(inception to and Stonebridge Advisors
January 2012) LLC (Investment Advisor)
James M. Dykas Treasurer, Chief o Indefinite term Controller (January 2011 to N/A N/A
120 East Liberty Drive, Financial Officer Present), Senior Vice
Suite 400 and Chief o Treasurer, Chief President (April 2007 to
Wheaton, IL 60187 Accounting Financial Officer Present), First Trust
D.O.B.: 01/66 Officer and Chief Advisors L.P. and First
Accounting Officer Trust Portfolios L.P.
since January 2012;
Assistant Treasurer
(inception to
January 2012)
W. Scott Jardine Secretary and o Indefinite term General Counsel, First N/A N/A
120 East Liberty Drive, Chief Legal Trust Advisors L.P. and
Suite 400 Officer o Since inception First Trust Portfolios
Wheaton, IL 60187 L.P.; Secretary and General
D.O.B.: 05/60 Counsel, BondWave LLC
(Software Development
Company/Investment Advisor)
and Secretary, Stonebridge
Advisors LLC (Investment
Advisor)
Daniel J. Lindquist Vice President o Indefinite term Managing Director (July N/A N/A
120 East Liberty Drive, 2012 to Present), Senior
Suite 400 o Since inception Vice President (September
Wheaton, IL 60187 2005 July 2012), First
D.O.B.: 02/70 Trust Advisors L.P. and
First Trust Portfolios L.P.
Kristi A. Maher Assistant o Indefinite term Deputy General Counsel, N/A N/A
120 East Liberty Drive, Secretary and First Trust Advisors L.P.
Suite 400 Chief Compliance o Assistant Secretary and First Trust Portfolios
Wheaton, IL 60187 Officer since inception L.P.
D.O.B.: 12/66
o Chief Compliance
Officer since
January 2011
|
(1) Mr. Bowen is deemed an "interested person" of the Trust due to his
position as Chief Executive Officer of First Trust, investment
advisor of the Funds.
-31-
UNITARY BOARD LEADERSHIP STRUCTURE
Each Trustee serves as a trustee of all open-end and closed-end funds in
the First Trust Fund Complex (as defined below), which is known as a "unitary"
board leadership structure. Each Trustee currently serves as a trustee of the
Trust, First Trust Variable Insurance Trust and First Defined Portfolio Fund,
LLC, open-end funds with 12 portfolios advised by First Trust; First Trust
Senior Floating Rate Income Fund II, Macquarie/First Trust Global
Infrastructure/Utilities Dividend & Income Fund, First Trust Energy Income and
Growth Fund, First Trust Enhanced Equity Income Fund, First Trust/Aberdeen
Global Opportunity Income Fund, First Trust Mortgage Income Fund, First Trust
Strategic High Income Fund II, First Trust/Aberdeen Emerging Opportunity Fund,
First Trust Specialty Finance and Financial Opportunities Fund, First Trust
Dividend and Income Fund, First Trust High Income Long/Short Fund, First Trust
Energy Infrastructure Fund, First Trust MLP and Energy Income Fund and First
Trust Intermediate Duration Preferred & Income Fund, closed-end funds advised by
First Trust; and the First Trust Exchange-Traded Fund, First Trust
Exchange-Traded Fund II, First Trust Exchange-Traded Fund III, First Trust
Exchange Traded Fund IV, First Trust Exchange Traded Fund V, First Trust
Exchange Traded Fund VI, First Trust Exchange Traded Fund VII, First Trust
Exchange-Traded AlphaDEX(R) Fund and First Trust Exchange-Traded AlphaDEX(R)
Fund II, exchange-traded funds with 82 portfolios advised by First Trust (each a
"First Trust Fund" and collectively, the "First Trust Fund Complex"). None of
the Trustees who are not "interested persons" of the Trust, nor any of their
immediate family members, has ever been a director, officer or employee of, or
consultant to, First Trust, First Trust Portfolios L.P. or their affiliates.
The management of the Funds, including general supervision of the duties
performed for the Funds under the investment management agreements between the
Trust, on behalf of the Funds, and the Advisor, is the responsibility of the
Board of Trustees. The Trustees of the Trust set broad policies for the Funds,
choose the Trust's officers, and hire the Funds' investment advisor,
sub-advisors and other service providers. The officers of the Trust manage the
day-to-day operations and are responsible to the Trust's Board. The Trust's
Board is composed of four Independent Trustees and one Interested Trustee. The
Interested Trustee, James A. Bowen, serves as the Chairman of the Board for each
fund in the First Trust Fund Complex.
The same five persons serve as Trustees on the Trust's Board and on the
Boards of all other First Trust Funds. The unitary board structure was adopted
for the First Trust Funds because of the efficiencies it achieves with respect
to the governance and oversight of the First Trust Funds. Each First Trust Fund
is subject to the rules and regulations of the 1940 Act (and other applicable
securities laws), which means that many of the First Trust Funds face similar
issues with respect to certain of their fundamental activities, including risk
management, portfolio liquidity, portfolio valuation and financial reporting.
Because of the similar and often overlapping issues facing the First Trust
Funds, the Board of the First Trust Funds believes that maintaining a unitary
board structure promotes efficiency and consistency in the governance and
oversight of all First Trust Funds and reduces the costs, administrative burdens
and possible conflicts that may result from having multiple boards. In adopting
a unitary board structure, the Trustees seek to provide effective governance
through establishing a board the overall composition of which will, as a body,
possesses the appropriate skills, diversity, independence and experience to
oversee the Funds' business.
-32-
Annually, the Board reviews its governance structure and the committee
structures, their performance and functions and reviews any processes that would
enhance Board governance over the Funds' business. The Board has determined that
its leadership structure, including the unitary board and committee structure,
is appropriate based on the characteristics of the funds it serves and the
characteristics of the First Trust Fund Complex as a whole.
In order to streamline communication between the Advisor and the
Independent Trustees and create certain efficiencies, the Board has a Lead
Independent Trustee who is responsible for: (i) coordinating activities of the
Independent Trustees; (ii) working with the Advisor, Fund counsel and the
independent legal counsel to the Independent Trustees to determine the agenda
for Board meetings; (iii) serving as the principal contact for and facilitating
communication between the Independent Trustees and the Funds' service providers,
particularly the Advisor; and (iv) any other duties that the Independent
Trustees may delegate to the Lead Independent Trustee. The Lead Independent
Trustee is selected by the Independent Trustees and serves a three year term or
until his successor is selected.
The Board has established four standing committees (as described below)
and has delegated certain of its responsibilities to those committees. The Board
and its committees meet frequently throughout the year to oversee the Funds'
activities, review contractual arrangements with and performance of service
providers, oversee compliance with regulatory requirements, and review Fund
performance. The Independent Trustees are represented by independent legal
counsel at all Board and committee meetings (other than meetings of the
Executive Committee). Generally, the Board acts by majority vote of all the
Trustees, including a majority vote of the Independent Trustees if required by
applicable law.
Commencing January 1, 2014, the three committee Chairmen and the Lead
Independent Trustee rotate every three years in serving as Chairman of the Audit
Committee, the Nominating and Governance Committee or the Valuation Committee,
or as Lead Independent Trustee. The Lead Independent Trustee and the immediate
past Lead Independent Trustee also serve on the Executive Committee with the
Interested Trustee.
The four standing committees of the First Trust Fund Complex are: the
Executive Committee (and Pricing and Dividend Committee), the Nominating and
Governance Committee, the Valuation Committee and the Audit Committee. The
Executive Committee, which meets between Board meetings, is authorized to
exercise all powers of and to act in the place of the Board of Trustees to the
extent permitted by the Trust's Declaration of Trust and By Laws. Such Committee
is also responsible for the declaration and setting of dividends. Mr. Kadlec,
Mr. Bowen and Mr. Keith are members of the Executive Committee. During the last
fiscal year, the Executive Committee held five meetings.
The Nominating and Governance Committee is responsible for appointing and
nominating non-interested persons to the Trust's Board of Trustees. Messrs.
Erickson, Kadlec, Keith and Nielson are members of the Nominating and Governance
Committee. If there is no vacancy on the Board of Trustees, the Board will not
actively seek recommendations from other parties, including shareholders. The
Board of Trustees adopted a mandatory retirement age of 72 for Trustees, beyond
which age Trustees are ineligible to serve. The Committee will not consider new
trustee candidates who are 72 years of age or older. When a vacancy on the Board
of Trustees occurs and nominations are sought to fill such vacancy, the
-33-
Nominating and Governance Committee may seek nominations from those sources it
deems appropriate in its discretion, including shareholders of the applicable
Fund. To submit a recommendation for nomination as a candidate for a position on
the Board of Trustees, shareholders of the applicable Fund shall mail such
recommendation to W. Scott Jardine, Secretary, at the Trust's address, 120 East
Liberty Drive, Suite 400, Wheaton, Illinois 60187. Such recommendation shall
include the following information: (i) evidence of Fund ownership of the person
or entity recommending the candidate (if a Fund shareholder); (ii) a full
description of the proposed candidate's background, including their education,
experience, current employment and date of birth; (iii) names and addresses of
at least three professional references for the candidate; (iv) information as to
whether the candidate is an "interested person" in relation to the Fund, as such
term is defined in the 1940 Act, and such other information that may be
considered to impair the candidate's independence; and (v) any other information
that may be helpful to the Committee in evaluating the candidate. If a
recommendation is received with satisfactorily completed information regarding a
candidate during a time when a vacancy exists on the Board or during such other
time as the Nominating and Governance Committee is accepting recommendations,
the recommendation will be forwarded to the Chairman of the Nominating and
Governance Committee and the counsel to the Independent Trustees.
Recommendations received at any other time will be kept on file until such time
as the Nominating and Governance Committee is accepting recommendations, at
which point they may be considered for nomination. During the last fiscal year,
the Nominating and Governance Committee held four meetings.
The Valuation Committee is responsible for the oversight of the pricing
procedures of each Fund. Messrs. Erickson, Kadlec, Keith and Nielson are members
of the Valuation Committee. During the last fiscal year, the Valuation Committee
held four meetings.
The Audit Committee is responsible for overseeing each 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, Kadlec, Keith and Nielson serve on the Audit
Committee. During the last fiscal year, the Audit Committee held eleven
meetings.
EXECUTIVE OFFICERS
The executive officers of each Fund hold the same positions with each fund
in the First Trust Fund Complex (representing 108 portfolios) as they hold with
the Funds.
RISK OVERSIGHT
As part of the general oversight of the Funds, the Board is involved in
the risk oversight of the Funds. The Board has adopted and periodically reviews
policies and procedures designed to address each Fund's risks. Oversight of
investment and compliance risk, including oversight of any sub-advisors, is
performed primarily at the Board level in conjunction with the Advisor's
investment oversight group and the Trust's Chief Compliance Officer ("CCO").
Oversight of other risks also occurs at the committee level. The Advisor's
-34-
investment oversight group reports to the Board at quarterly meetings regarding,
among other things, Fund performance and the various drivers of such performance
. The Board reviews reports on the Funds' and the service providers' compliance
policies and procedures at each quarterly Board meeting and receives an annual
report from the CCO regarding the operations of the Funds' and the service
providers' compliance program. In addition, the Independent Trustees meet
privately each quarter with the CCO. The Audit Committee reviews with the
Advisor each Fund's major financial risk exposures and the steps the Advisor has
taken to monitor and control these exposures, including each Fund's risk
assessment and risk management policies and guidelines. The Audit Committee
also, as appropriate, reviews in a general manner the processes other Board
committees have in place with respect to risk assessment and risk management.
The Nominating and Governance Committee monitors all matters related to the
corporate governance of the Funds. The Valuation Committee monitors valuation
risk and compliance with the Funds' Valuation Procedures and oversees the
pricing services and actions by the Advisor's Pricing Committee with respect to
the valuation of portfolio securities.
Not all risks that may affect the Funds can be identified nor can controls
be developed to eliminate or mitigate their occurrence or effects. It may not be
practical or cost effective to eliminate or mitigate certain risks, the
processes and controls employed to address certain risks may be limited in their
effectiveness, and some risks are simply beyond the reasonable control of the
Funds or the Advisor or other service providers. Moreover, it is necessary to
bear certain risks (such as investment related risks) to achieve a Fund's goals.
As a result of the foregoing and other factors, the Funds' ability to manage
risk is subject to substantial limitations.
BOARD DIVERSIFICATION AND TRUSTEE QUALIFICATIONS
As described above, the Nominating and Governance Committee of the Board
oversees matters related to the nomination of Trustees. The Nominating and
Governance Committee seeks to establish an effective Board with an appropriate
range of skills and diversity, including, as appropriate, differences in
background, professional experience, education, vocations, and other individual
characteristics and traits in the aggregate. Each Trustee must meet certain
basic requirements, including relevant skills and experience, time availability,
and if qualifying as an Independent Trustee, independence from the Advisor,
sub-advisors, underwriters or other service providers, including any affiliates
of these entities.
Listed below for each current Trustee are the experiences, qualifications
and attributes that led to the conclusion, as of the date of this SAI, that each
current Trustee should serve as a trustee in light of the Funds' business and
structure.
Richard E. Erickson, M.D., is an orthopedic surgeon and President of
Wheaton Orthopedics. He also has been a co-owner and director of a fitness
center and a limited partner of two real estate companies. Dr. Erickson has
served as a Trustee of each First Trust Fund since its inception. Dr. Erickson
has also served as the Lead Independent Trustee and on the Executive Committee
(2008 - 2009), Chairman of the Nominating and Governance Committee (2003 -
-35-
2007), Chairman of the Audit Committee (2012 - 2013) and Chairman of the
Valuation Committee (June 2006 - 2007 and 2010 - 2011) of the First Trust Funds.
He currently serves as Chairman of the Nominating and Governance Committee of
the First Trust Funds.
Thomas R. Kadlec is President of ADM Investor Services Inc. ("ADMIS"), a
futures commission merchant and wholly-owned subsidiary of the Archer Daniels
Midland Company ("ADM"). Mr. Kadlec has been employed by ADMIS and its
affiliates since 1990 in various accounting, financial, operations and risk
management capacities. Mr. Kadlec serves on the boards of several international
affiliates of ADMIS and is a member of ADM's Integrated Risk Committee, which is
tasked with the duty of implementing and communicating enterprise-wide risk
management. Mr. Kadlec has served as a Trustee of each First Trust Fund, except
First Defined Portfolio Fund, LLC, since its inception. He has served as a
Trustee of First Defined Portfolio Fund, LLC since 2004. Mr. Kadlec also served
on the Executive Committee from the organization of the first First Trust
closed-end fund in 2003 until he was elected as the first Lead Independent
Trustee in December 2005, serving as such through 2007. He also served as
Chairman of the Valuation Committee (2008 - 2009), Chairman of the Audit
Committee (2010 - 2011) and Chairman of the Nominating and Governance Committee
(2012 - 2013) and he currently serves as Lead Independent Trustee and on the
Executive Committee (since January 1, 2014) of the First Trust Funds.
Robert F. Keith is President of Hibs Enterprises, a financial and
management consulting firm. Mr. Keith has been with Hibs Enterprises since 2003.
Prior thereto, Mr. Keith spent 18 years with ServiceMaster and Aramark,
including three years as President and COO of ServiceMaster Consumer Services,
where he led the initial expansion of certain products overseas, five years as
President and COO of ServiceMaster Management Services and two years as
President of Aramark ServiceMaster Management Services. Mr. Keith is a certified
public accountant and also has held the positions of Treasurer and Chief
Financial Officer of ServiceMaster, at which time he oversaw the financial
aspects of ServiceMaster's expansion of its Management Services division in to
Europe, the Middle East and Asia. Mr. Keith has served as a Trustee of the First
Trust Funds since June 2006. Mr. Keith has also served as the Chairman of the
Audit Committee (2008 - 2009) and Chairman of the Nominating and Governance
Committee (2010 - 2011) of the First Trust Funds. He served as Lead Independent
Trustee and on the Executive Committee (2012 - 2013) and currently serves on the
Executive Committee (since January 31, 2014) and as Chairman of the Valuation
Committee (since January 1, 2014) of the First Trust Funds.
Niel B. Nielson, Ph.D., has served as the President and Chief Executive
Officer of Dew Learning LLC (a global provider of digital and on-line
educational products and services) since 2012. Mr. Nielson formerly served as
President of Covenant College (2002 - 2012), and as a partner and trader (of
options and Futures Contracts for hedging options) for Ritchie Capital Markets
Group (1996 - 1997), where he held an administrative management position at this
proprietary derivatives trading company. He also held prior positions in new
business development for ServiceMaster Management Services Company, and in
personnel and human resources for NationsBank of North Carolina, N.A. and
Chicago Research and Trading Group, Ltd. ("CRT"). His international experience
includes serving as a director of CRT Europe, Inc. for two years, directing out
of London all aspects of business conducted by the U.K. and European subsidiary
of CRT. Prior to that, Mr. Nielson was a trader and manager at CRT in Chicago.
-36-
Mr. Nielson has served as a Trustee of each First Trust Fund since its inception
and of the First Trust Funds since 1999. Mr. Nielson has also served as the
Chairman of the Audit Committee (2003 - 2006), Chairman of the Valuation
Committee (2007 - 2008), Chairman of the Nominating and Governance Committee
(2008 - 2009) and Lead Independent Trustee and a member of the Executive
Committee (2010 - 2011). He currently serves as Chairman of the Audit Committee
(since January 1, 2014) of the First Trust Funds.
James A. Bowen is Chief Executive Officer of First Trust Advisors L.P. and
First Trust Portfolios L.P. Mr. Bowen is involved in the day-to-day management
of the First Trust Funds and serves on the Executive Committee. He has over 27
years of experience in the investment company business in sales, sales
management and executive management. Mr. Bowen has served as a Trustee of each
First Trust Fund since its inception and of the First Trust Funds since 1999.
Each Independent Trustee is paid a fixed annual retainer of $125,000 per
year and an annual per fund fee of $4,000 for each closed-end fund or other
actively managed fund and $1,000 for each index fund in the First Trust Fund
Complex. The fixed annual retainer is allocated pro rata among each fund in the
First Trust Fund Complex based on net assets. Additionally, the Lead Independent
Trustee is paid $15,000 annually, the Chairman of the Audit Committee is paid
$10,000 annually, and each of the Chairmen of the Nominating and Governance
Committee and the Valuation Committee is paid $5,000 annually to serve in such
capacities, with such compensation allocated pro rata among each fund in the
First Trust Fund Complex based on net assets. Trustees are also reimbursed by
the investment companies in the First Trust Fund Complex for travel and
out-of-pocket expenses incurred in connection with all meetings.
The following table sets forth the compensation (including reimbursement
for travel and out-of-pocket expenses) paid by the Funds and the First Trust
Fund Complex to each of the Independent Trustees for the fiscal year ended
October 31, 2013 and the calendar year ended December 31, 2013, respectively.
The Trust has no retirement or pension plans. The officers and Trustee who are
"interested persons" as designated above serve without any compensation from the
Trust. The Trust has no employees. Its officers are compensated by First Trust.
TOTAL COMPENSATION FROM TOTAL COMPENSATION FROM
NAME OF TRUSTEE THE FUNDS(1) THE FIRST TRUST FUND COMPLEX(2)
Richard E. Erickson $14,229 $306,162
Thomas R. Kadlec $14,122 $299,500
Robert F. Keith $14,298 $310,300
Niel B. Nielson $14,195 $304,334
--------------------
|
(1) The compensation paid by the Funds to the Independent Trustees for
the fiscal year ended October 31, 2013 for services to the Funds of
the Trust.
(2) The total compensation paid to the Independent Trustees for the
calendar year ended December 31, 2013 for services to the 12
portfolios of the Trust, First Defined Portfolio Fund, LLC and First
Trust Variable Insurance Trust, open-end funds; 14 closed-end funds;
and 79 series of the First Trust Exchange-Traded Fund, First Trust
Exchange-Traded Fund II, First Trust Exchange-Traded Fund III, First
Trust Exchange-Traded Fund IV, First Trust Exchange-Traded Fund V,
First Trust Exchange-Traded Fund VI, First Trust Exchange-Traded Fund
VII, First Trust Exchange-Traded AlphaDEX(R) Fund and First Trust
Exchange-Traded AlphaDEX(R) Fund II, all advised by First Trust.
-37-
The following table sets forth the dollar range of equity securities
beneficially owned by the Trustees in the Funds and in other funds overseen by
the Trustees in the First Trust Fund Complex as of December 31, 2013:
DOLLAR RANGE OF EQUITY SECURITIES IN ANY FUND
Aggregate Dollar Range of Equity
Securities in All Registered
Dollar Range of Equity Investment Companies Overseen by
Securities in any Fund Trustee in the First Trust Fund
(Number of Shares Held) Complex
Interested Trustee
James A. Bowen None $10,001 - $50,000
Independent Trustees
Richard E. Erickson None Over $100,000
Thomas R. Kadlec None Over $100,000
Robert F. Keith None Over $100,000
Niel B. Nielson None Over $100,000
|
As of December 31, 2013, the Independent Trustees of the Trust and
immediate family members do not own beneficially or of record any class of
securities of an investment advisor or principal underwriter of the Funds or any
person directly or indirectly controlling, controlled by, or under common
control with an investment advisor or principal underwriter of the Funds.
As of December 31, 2013 the officers and Trustees, in the aggregate, owned
less than 1% of the shares of each Fund.
The table set forth as Appendix A shows the percentage ownership of each
shareholder or "group" (as that term is used in Section 13(d) of the Securities
Exchange Act of 1934, as amended (the "1934 Act")) who, as of December 31, 2013,
owned of record, or is known by the Trust to have owned of record or
beneficially, 5% or more of the shares of a Fund. A control person is one who
owns, either directly or indirectly, more than 25% of the voting securities of a
Fund or acknowledges the existence of control. A party that controls a Fund may
be able to significantly influence the outcome of any item presented to
shareholders for approval.
-38-
Information as to beneficial ownership is based on the securities position
listing reports as of January 31, 2014. The Funds do not have any knowledge of
who the ultimate beneficiaries are of the shares.
Investment Advisor. First Trust, 120 East Liberty Drive, Suite 400,
Wheaton, Illinois 60187, is the investment advisor to the Funds. First Trust is
a limited partnership with one limited partner, Grace Partners of DuPage L.P.,
and one general partner, The Charger Corporation. Grace Partners of DuPage L.P.
is a limited partnership with one general partner, The Charger Corporation, and
a number of limited partners. The Charger Corporation is an Illinois corporation
controlled by James A. Bowen, Chief Executive Officer of First Trust. First
Trust discharges its responsibilities subject to the policies of the Board of
Trustees.
First Trust provides investment tools and portfolios for advisors and
investors. First Trust is committed to theoretically sound portfolio
construction and empirically verifiable investment management approaches. Its
asset management philosophy and investment discipline are deeply rooted in the
application of intuitive factor analysis and model implementation to enhance
investment decisions.
First Trust acts as investment advisor for the Funds. First Trust also
oversees the Sub-Advisors in the investment and reinvestment of the assets of
the First Trust Preferred Securities and Income Fund and First Trust/Confluence
Small Cap Value Fund, and manages the investment and reinvestment of the assets
of the First Trust Short Duration High Income Fund. First Trust also administers
the Trust's business affairs, provides office facilities and equipment and
certain clerical, bookkeeping and administrative services, and permits any of
its officers or employees to serve without compensation as Trustees or officers
of the Trust if elected to such positions.
Pursuant to an investment management agreement (the "Investment Management
Agreement") between First Trust and the Trust, the First Trust Preferred
Securities and Income Fund has agreed to pay an annual management fee equal to
0.80% of its average daily net assets, the First Trust/Confluence Small Cap
Value Fund has agreed to pay an annual management fee equal to 1.00% of its
average daily net assets and the First Trust Short Duration High Income Fund has
agreed to pay an annual management fee equal to 0.65% of its average daily net
assets.
Each Fund is responsible for all its expenses, including the investment
advisory fees, costs of transfer agency, custody, fund administration, legal,
audit and other services, interest, taxes, brokerage commissions and other
expenses connected with executions of portfolio transactions, any distribution
fees or expenses and extraordinary expenses. Until a Fund's Expense Cap
Termination Date set forth below, First Trust and the applicable Sub-Advisor (if
any), have agreed to waive fees and/or pay Fund expenses to the extent necessary
to prevent the operating expenses of the Fund (excluding 12b-1 distribution and
service fees, interest expenses, taxes, fees incurred in acquiring and disposing
of portfolio securities, and extraordinary expenses) from exceeding 1.15% of
average daily net assets of any class of shares of First Trust Preferred
Securities and Income Fund, 1.35% of average daily net assets of any class of
shares of the First Trust/Confluence Small Cap Value Fund, and 1.00% of average
-39-
daily net assets of any class of shares of the First Trust Short Duration High
Income Fund (the "Expense Cap") until February, 28 2015 (the "Expense Cap
Termination Date"). Acquired fund fees and expenses, if any, are not taken into
consideration in the expense limitation because they are not Fund operating
expenses, but rather, are imputed fees and expenses. From March 1, 2015 through
February 28, 2024 the Expense Cap for each Fund will not exceed the limits set
forth in the table below. Expenses borne and fees waived by First Trust and the
Sub-Advisors are subject to reimbursement by the Funds up to three years from
the date the fee or expense was incurred, but no reimbursement payment will be
made by a Fund at any time if it would result in such Fund's expenses exceeding
its Expense Cap in place at the time the expense was borne or the fee was waived
by First Trust and the Sub-Advisor.
FUND EXPENSE CAP
Preferred Securities and Income Fund 1.50%
Small Cap Value Fund 1.70%
Short Duration High Income Fund 1.35%
|
Under the Investment Management Agreement, First Trust 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 First Trust in the performance of its
obligations and duties, or by reason of its reckless disregard of its
obligations and duties. The Investment Management Agreement continues until two
years after the initial issuance of Fund shares and thereafter only if approved
annually by the Board of Trustees, including a majority of the Independent
Trustees. The Investment Management Agreement terminates automatically upon
assignment and is terminable at any time without penalty as to a Fund by the
Board of Trustees, including a majority of the Independent Trustees, or by vote
of the holders of a majority of the Fund's outstanding voting securities on 60
days' written notice to First Trust, or by First Trust on 60 days' written
notice to the applicable Fund.
The following table sets forth the management fees (net of fee waivers and
expense reimbursements, where applicable) paid by each Fund and the fees waived
and expenses reimbursed by First Trust for the specified periods.
-40-
AMOUNT OF MANAGEMENT FEES (NET OF
FEE WAIVERS AND EXPENSE AMOUNT OF FEES WAIVED AND EXPENSES
REIMBURSEMENTS BY FIRST TRUST) REIMBURSED BY FIRST TRUST
JANUARY 11, FISCAL YEAR FISCAL YEAR JANUARY 11, FISCAL YEAR FISCAL YEAR
2011 TO ENDED ENDED 2011 TO ENDED ENDED
OCTOBER 31, OCTOBER 31, OCTOBER 31, OCTOBER 31, OCTOBER 31, OCTOBER 31,
FUND 2011 2012 2013 2011 2012 2013
First Trust Preferred
Securities and Income
Fund $0 $183,592 $1,702,281 $219,802 $320,165 $134,127
First Trust/Confluence
Small Cap Value Fund $0 $0 $0 $169,849 $273,946 $236,557
First Trust Short
Duration High Income N/A N/A $140,420 N/A N/A $116,236
Fund
|
Leveraged Finance Team. The following persons are members of the First
Trust Leveraged Finance Team (the "Leveraged Finance Team") and serve as the
portfolio managers of the First Trust Short Duration High Income Fund. There are
currently three members of the Leveraged Finance Team, as follows:
POSITION WITH LENGTH OF SERVICE PRINCIPAL OCCUPATION
NAME FIRST TRUST WITH FIRST TRUST DURING PAST FIVE YEARS
William Housey, CFA Senior Vice President, Since June 2010 Senior Vice President, Senior
Senior Portfolio Manager Portfolio Manager (June 2010
to Present), First Trust
Advisors L.P. and First Trust
Portfolios L.P.; Executive
Director and Co-Portfolio
Manager, Van Kampen Funds,
Inc.
Scott D. Fries, CFA Senior Vice President, Since June 2010 Vice President, Portfolio
Portfolio Manager Manager, First Trust Advisors
L.P. and First Trust
Portfolios L.P.; Co-Portfolio
Manager of Institutional
Separately Managed Account,
Van Kampen Funds, Inc.
Peter Fasone, CFA Vice President, Portfolio Since December 2011 Senior Vice President, Senior
Manager Portfolio Manager (December
2010 to Present), Senior
Global Credit Analyst with BNP
Paribas Asset Management
|
-41-
William Housey, CFA, Senior Vice President, Senior Portfolio Manager.
Mr. Housey joined First Trust Advisors in June 2010 as the Senior Portfolio
Manager for the Leveraged Finance Investment Team and has 17 years of investment
experience. Prior to joining First Trust, Mr. Housey was at Morgan Stanley
Investment Management and its wholly owned subsidiary, Van Kampen Funds, Inc.
for 11 years where he last served as Executive Director and Co-Portfolio
Manager. Mr. Housey has extensive experience in the portfolio management of both
leveraged and unleveraged credit products, including senior loans, high-yield
bonds, credit derivatives and corporate restructurings. Mr. Housey received a
B.S. in Finance from Eastern Illinois University and an M.B.A. in Finance as
well as Management and Strategy from Northwestern University's Kellogg School of
Business. He also holds the FINRA Series 7, Series 52 and Series 63 licenses.
Mr. Housey also holds the Chartered Financial Analyst designation. He is a
member of the CFA Institute and the CFA Society of Chicago. Mr. Housey also
serves on the Village of Glen Ellyn, IL Police Pension Board.
Scott D. Fries, CFA, Senior Vice President, Portfolio Manager. Mr. Fries
joined First Trust Advisors in June 2010 as Portfolio Manager in the Leveraged
Finance Investment Team and has 19 years of investment industry experience.
Prior to joining First Trust, Mr. Fries spent 15 years at Morgan Stanley/Van
Kampen Funds, Inc. where he most recently served as Executive Director and
Co-Portfolio Manager of Institutional Separately Managed Accounts. Mr. Fries
received a B.A. in International Business from Illinois Wesleyan University and
an M.B.A. in Finance from DePaul University. Mr. Fries holds the Chartered
Financial Analyst designation. He is a member of the CFA Institute and the CFA
Society of Chicago.
Peter Fasone, CFA, Vice President, Portfolio Manager. Mr. Fasone joined
First Trust Advisors in December 2011. He serves as a Portfolio Manager and has
28 years of industry experience, most recently as Senior Global Credit Analyst
with BNP Paribas Asset Management. Since 1996, his focus has been primarily on
investing in high yield and investment grade bonds for total return and
structured credit portfolios. Prior to BNP, Mr. Fasone served as Portfolio
Manager and Senior Analyst for Fortis Investments. From 2001 to 2008 he was Vice
President and Senior Analyst at ABN AMRO Asset Management where he assumed a
leadership role in designing and implementing a disciplined investment process
for ABN's $1 billion global high yield fund. Mr. Fasone received a B.S. degree
from Arizona State University and an M.B.A. degree from DePaul University's
Kellstadt Graduate School of Business. He holds a Chartered Financial Analyst
designation and a Certified Public Accountant designation. He is a member of the
CFA Institute and the CFA Society of Chicago.
No member of the Leveraged Finance Team beneficially owns any shares of
the Funds, other than Mr. Housey, who beneficially owns shares of the Short
Duration High Income Fund in the $1-$10,000 range.
Compensation. The portfolio managers are compensated with an industry
competitive salary and a year-end discretionary bonus based on client service,
asset growth and the performance of the Fund. Each portfolio manager's
performance is formally evaluated annually based on a variety of factors. Bonus
compensation is primarily a function of the firm's overall annual profitability
and the individual portfolio manager's contribution as measured by the overall
investment performance of client portfolios in the strategy the portfolio
manager manages relative to the strategy's general benchmark.
Other Accounts Managed. In addition to the First Trust Short Duration High
Income Fund, as of December 31, 2013, the Leveraged Finance Team portfolio
managers are also primarily responsible for the day-to-day portfolio management
of the following accounts:
-42-
REGISTERED OTHER POOLED
INVESTMENT INVESTMENT
COMPANIES VEHICLES OTHER ACCOUNTS
NUMBER OF NUMBER OF NUMBER OF
LEVERAGED FINANCE ACCOUNTS ACCOUNTS ACCOUNTS
TEAM MEMBER ($ ASSETS) ($ ASSETS) ($ ASSETS)
William Housey
4 ($946,829,307) 1 ($36,881,784) N/A
Scott D. Fries
4 ($946,829,307) 1 ($36,881,784) N/A
Peter Fasone
1 ($92,573,585) N/A N/A
--------------------
|
None of the accounts managed by the Leveraged Finance Team pay an advisory
fee that is based upon the performance of the account. In addition, First Trust
believes that there are no material conflicts of interest that may arise in
connection with the Leveraged Finance Team's management of the First Trust Short
Duration High Income Fund's investments and the investments of the other
accounts managed by the Leveraged Finance Team. However, because the investment
strategy of the First Trust Short Duration High Income Fund and the investment
strategies of many of the other accounts managed by the Leveraged Finance Team
are based on fairly mechanical investment processes, the Leveraged Finance Team
may recommend that certain clients sell and other clients buy a given security
at the same time. In addition, because the investment strategies of the First
Trust Short Duration High Income Fund and other accounts managed by the
Leveraged Finance Team generally result in the clients investing in readily
available securities, First Trust believes that there should not be material
conflicts in the allocation of investment opportunities between the First Trust
Short Duration High Income Fund and other accounts managed by the Leveraged
Finance Team.
SUB-ADVISORS
STONEBRIDGE ADVISORS LLC
Stonebridge Advisors LLC acts as the First Trust Preferred Securities and
Income Fund's sub-investment advisor pursuant to a sub-investment advisory
agreement with the Advisor and the Trust on behalf of the Fund. Stonebridge is a
Delaware limited liability company with principal offices located at 187 Danbury
Road, Wilton, Connecticut. Stonebridge is owned 51% by an affiliate of the
Advisor and 48% by Stonebridge Asset Management LLP. Stonebridge is a registered
investment advisor under the Investment Advisers Act of 1940, as amended (the
"Advisers Act"), and had approximately $3.46 billion of assets which it managed
or supervised as of December 31, 2013. Stonebridge is a research-driven firm
whose personnel have longstanding experience in investing in preferred
securities. Set forth below is information regarding the key executives of
Stonebridge who will select and monitor the portfolio or provide managerial or
executive support to the Fund.
-43-
Portfolio Managers
Scott T. Fleming, Robert Wolf and Danielle Salters have primary
responsibility for the day-to-day management and implementation of investment
strategies of the Fund.
o Scott T. Fleming serves as President and CIO of Stonebridge. Prior to
founding Stonebridge, Mr. Fleming co-founded Spectrum Asset Management,
Inc., an investment advisor that specializes in preferred securities
asset management for institutional clients. During his 13-year tenure
there, he served as Chairman of the Board of Directors, Chief Financial
Officer and Chief Investment Officer. Mr. Fleming previously served as
Vice President, Portfolio Manager for DBL Preferred Management, Inc. in
New York City. There he managed over $300 million of institutional
assets with a strategy specializing in preferred securities. Mr.
Fleming received his BS in Accounting from Bentley College in Waltham,
MA and his MBA in Finance from Babson College in Wellesley, MA.
o Robert Wolf serves as Vice President, Portfolio Manager and Senior
Credit Analyst of Stonebridge. Mr. Wolf brings 14 years of fixed-income
experience to Stonebridge. His primary focus is in analyzing both
investment-grade and non investment-grade securities, where he has
developed a rigorous approach to credit and industry analysis. Prior to
joining Stonebridge, Mr. Wolf was a high yield fixed-income research
analyst at Lehman Brothers. In this role, his responsibilities included
detailed credit analysis across multiple sectors, relative value
analysis, and developing trade recommendations for Lehman's High-Yield
proprietary trading effort. Mr. Wolf previously worked for Lehman
Brothers Commercial Mortgage-Backed Securities (CMBS) trading desk as a
credit analyst where he provided in-depth analysis of CMBS transactions
and the underlying Commercial Real Estate. Mr. Wolf received his BS
degree in Chemistry from Villanova University in 1999 and his MBA in
Finance from the New York University Stern School of Business in 2004.
o Danielle Salters serves as Associate Portfolio Manager and Credit
Analyst for Stonebridge. Ms. Salters has six years of investment
management experience of which five years have been focused on fixed
income. Previous functions have included fundamental credit research,
relative value analysis and trading. Prior to beginning at Stonebridge,
Ms. Salters was Portfolio Analyst at a boutique asset manager where she
focused on high-yield credit analysis and portfolio analytics for a
hedge fund and institutional client. Previously, Ms. Salters was
employed by UBS Financial Services, Inc. where she worked in Taxable
Fixed Income Sales and, later, served as the Fixed Income Specialist to
a Portfolio Manager. Ms. Salters received a B.A. in economics from Duke
University in 2007 and holds a Chartered Financial Analyst designation.
As of January 31, 2014, the Stonebridge portfolio managers did not own any
shares of the Funds.
-44-
Compensation. The portfolio managers are compensated with an industry
competitive salary and a year-end discretionary bonus based on client service,
asset growth and the performance of the Fund. Each portfolio manager's
performance is formally evaluated annually based on a variety of factors. Bonus
compensation is primarily a function of the firm's overall annual profitability
and the individual portfolio manager's contribution as measured by the overall
investment performance of client portfolios in the strategy the portfolio
manager manages relative to the strategy's general benchmark.
Other Accounts Managed. In addition to the First Trust Preferred
Securities and Income Fund, as of December 31, 2013, the Stonebridge portfolio
managers are also primarily responsible for the day-to-day portfolio management
of the following accounts:
NUMBER OF ASSETS OF
$ ASSETS ACCOUNTS WITH ACCOUNTS
PORTFOLIO TYPE OF ACCOUNT NUMBER OF (IN PERFORMANCE WITH PERFORMANCE
MANAGER MANAGED ACCOUNTS MILLIONS) BASED FEES BASED FEES
Scott T. Fleming
Retail SMA 157 160.67 N/A N/A
Registered Investment
Companies 1 2035.08 N/A N/A
Other Pooled Investment
Vehicles N/A N/A N/A N/A
Other Accounts N/A N/A N/A N/A
Robert Wolf
Retail SMA 1017 502.97 N/A N/A
Registered Investment
Companies 1 53.93 N/A N/A
Other Pooled Investment
Vehicles 1425 211.15 N/A N/A
Other Accounts N/A N/A N/A N/A
Danielle Salters
Retail SMA 511 227.68 N/A N/A
Registered Investment
Companies 1 179.26 N/A N/A
Other Pooled Investment
Vehicles N/A N/A N/A N/A
Other Accounts N/A N/A N/A N/A
|
CONFLUENCE INVESTMENT MANAGEMENT LLC
Confluence acts as the First Trust/Confluence Small Cap Value Fund's
sub-investment advisor pursuant to a sub-investment advisory agreement with
First Trust and the Trust on behalf of the Fund. Confluence is an SEC registered
investment advisor with principal offices located at 349 Marshall Avenue, St.
Louis, Missouri.
Investment professionals with Confluence have more than 200 years combined
financial experience and 80 years of portfolio management experience. The
-45-
value-oriented investment team formerly with A.G. Edwards has a track record
dating back to 1994 and has more than $2.3 billion in assets under management
and supervision as of December 31, 2013.
The core investment team is led by Mark Keller who has managed more than
$8 billion of assets across various equity and asset allocation strategies while
at A.G. Edwards. Confluence's investment philosophy is driven by focused
research and portfolio management to achieve long-term, risk-adjusted returns.
Confluence employs a long-term, value-oriented, bottom-up approach to investing.
Their proprietary investment research focuses on determining the intrinsic value
of an investment opportunity. Through their research process, Confluence
determines the intrinsic value of an investment opportunity and look to invest
at a significant discount to intrinsic value, providing investments with a
margin of safety.
Portfolio Managers
Mark Keller, Daniel Winter, David Miyazaki and Chris Stein have primary
responsibility for the day-to-day management and implementation of investment
strategies of the Fund.
o Mark Keller, serves as Chief Executive Officer and Chief Investment
Officer of Confluence. Mr. Keller has more than 30 years of
investment experience, with a focus on value-oriented equity analysis
and management. From 1994 to May 2008, he was the Chief Investment
Officer of Gallatin Asset Management and its predecessor
organization, A.G. Edwards Asset Management, the investment
management arm of A.G. Edwards, Inc. From 1999 to 2008, Mr. Keller
was Chairman of the A.G. Edwards Investment Strategy Committee, which
set investment policy and established asset allocation models for the
entire organization.
Mr. Keller began his career with A.G. Edwards in 1978, serving as an
equity analyst for the firm's Securities Research Department from 1979 to
1994. During his last five years in Securities Research, Mr. Keller was
Equity Strategist and manager of the firm's Focus List. Mr. Keller was a
founding member of the A.G. Edwards Investment Strategy Committee, on
which he served over 20 years, the last 10 years of which as Chairman of
the Committee. Mr. Keller was a Senior Vice President of A.G. Edwards &
Sons and of Gallatin Asset Management, and was a member of the Board of
Directors of both companies. Mr. Keller received a Bachelor of Arts from
Wheaton College (Illinois) and is a CFA charterholder.
o Daniel Winter, serves as Senior Vice President and Portfolio Manager
of Confluence. Prior to joining Confluence in May 2008, Mr. Winter
served as a Portfolio Manager and Analyst with Gallatin Asset
Management, the investment management arm of A.G. Edwards, Inc. While
at Gallatin, Mr. Winter chaired the portfolio management team
responsible for the firm's six value-oriented equity strategies. His
responsibilities also included directing the strategy implementation
and trading execution for the equity portfolios. Additionally, Mr.
Winter co-managed the First Trust/Gallatin Specialty Finance and
Financial Opportunities Fund (NYSE: FGB) closed-end fund whose
primary focus was on Business Development Companies.
-46-
Mr. Winter also served as a portfolio manager for the Cyclical Growth ETF
Portfolio and the Cyclical Growth and Income ETF Portfolio which were
offered through variable annuities. He was also a member of the firm's
Allocation Advisor Committee which oversaw the A.G. Edwards exchange
traded fund focused strategies. Prior to joining the firm's Asset
Management division in 1996, Mr. Winter served as a portfolio manager for
A.G. Edwards Trust Company. Mr. Winter earned a Bachelor of Arts in
business management from Eckerd College and a Master of Business
Administration from Saint Louis University. Mr. Winter is a CFA
charterholder.
o David Miyazaki, serves as Senior Vice President and Portfolio Manager of
Confluence. Prior to joining Confluence in May 2008, Mr. Miyazaki served
as a Portfolio Manager and Analyst with Gallatin Asset Management, the
investment management arm of A.G. Edwards, Inc. Mr. Miyazaki was
responsible for separately managed accounts invested in individual stocks
with a value discipline. He also co-managed the First Trust/Gallatin
Specialty Finance and Financial Opportunities Fund (NYSE: FGB) closed-end
fund, as well as A.G. Edwards' ETF-based asset allocation program. In
addition to portfolio management, Mr. Miyazaki served as a member of the
A.G. Edwards Investment Strategy Committee. As a strategist, he was
responsible for the firm's quantitative asset allocation models, including
its Cyclical Asset Allocation program. Prior to joining A.G. Edwards in
1999, Mr. Miyazaki was a Portfolio Manager at Koch Industries in Wichita,
Kansas, where he managed a short-term interest rate arbitrage portfolio.
Previously, he was an Analyst at Prudential Capital Group in Dallas,
Texas, a group that managed the world's largest portfolio of private
placement debt. Prior to that, Mr. Miyazaki worked as a Mortgage Bond
Trader at Barre & Company, also in Dallas. Mr. Miyazaki received a
Bachelor of Business Administration from Texas Christian University and is
a CFA charterholder.
o Chris Stein serves as Vice President and Portfolio Manager of Confluence.
Mr. Stein joined Confluence in August 2008. Previously, Mr. Stein served
as a Portfolio Manager and Analyst with Gallatin Asset Management, the
investment management arm of A.G. Edwards, Inc. Mr. Stein was part of the
portfolio management team responsible for Gallatin's Large Cap Value,
Small Cap Value, Equity Income, Value Opportunities and All Cap Global
separately managed accounts. His analytical coverage was primarily focused
on companies within the consumer discretionary sector. Additionally, Mr.
Stein assisted the A.G. Edwards Trust Company in constructing and managing
individual stock portfolios. Prior to joining the Asset Management
division in 2001, Mr. Stein was an associate analyst covering the media
and entertainment sector for A.G. Edwards' securities research. Prior to
joining A.G. Edwards in 1998, he was a financial consultant with
Renaissance Financial. Mr. Stein earned a Bachelor of Science in
Accounting and a Bachelor of Science in Finance from the University of
Dayton. Mr. Stein also received a Master of Business Administration from
St. Louis University.
The following table indicates as of December 31, 2013, the value within
the indicated range, of shares beneficially owned by the portfolio managers in
the First Trust/Confluence Small Cap Value Fund. For purposes of this table, the
following letters indicate the range listed next to each letter:
-47-
A - $0
B - $1 - $10,000
C - $10,001 - $50,000
D - $50,001 - $100,000
E - $100,001 - $500,000
F - $500,001 - $1,000,000
G - More than $1 million
NAME OF PORTFOLIO MANAGER DOLLAR RANGE OF EQUITY SECURITIES
BENEFICIALLY OWNED IN FUND MANAGED
Mark Keller C
Daniel Winter C
David Miyazaki B
Chris Stein C
|
Compensation. The portfolio managers are compensated with an industry
competitive salary and a year-end discretionary bonus based on client service,
asset growth and the performance of the applicable Fund. Each portfolio
manager's performance is formally evaluated annually based on a variety of
factors. Bonus compensation is primarily a function of the firm's overall annual
profitability and the individual portfolio manager's contribution as measured by
the overall investment performance of client portfolios in the strategy the
portfolio manager manages relative to the strategy's general benchmark.
Other Accounts Managed. In addition to the First Trust/Confluence Small
Cap Value Fund, as of December 31, 2013, the Confluence portfolio managers are
also primarily responsible for the day-to-day portfolio management of the
following accounts:
NUMBER OF ASSETS OF
$ ASSETS ACCOUNTS WITH ACCOUNTS WITH
NUMBER OF (IN PERFORMANCE PERFORMANCE
PORTFOLIO MANAGER TYPE OF ACCOUNT MANAGED ACCOUNTS MILLIONS) BASED FEES BASED FEES
Mark Keller
Registered Investment 2 145.4 0 0
Companies
Other Pooled Investment 0 0 0 0
Vehicles
Other Accounts 5715 1805.4 0 0
Daniel Winter
Registered Investment 2 145.4 0 0
Companies
Other Pooled Investment 0 0 0 0
Vehicles
Other Accounts 4656 1526.9 0 0
-48-
|
David Miyazaki
Registered Investment 2 154.4 0 0
Companies
Other Pooled Investment 0 0 0 0
Vehicles
Other Accounts 5715 1805.4 0 0
Chris Stein
Registered Investment 0 0 0 0
Companies
Other Pooled Investment 0 0 0 0
Vehicles
Other Accounts 4656 1526.9 0 0
|
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-Advisors 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 Funds.
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-Advisors have adopted procedures for allocating
portfolio transactions across multiple accounts.
With respect to securities transactions for the Funds, the Sub-Advisors
determine 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 a Sub-Advisor acts as sub-advisor,
other pooled investment vehicles that are not registered mutual funds, and other
accounts managed for organizations and individuals), the Sub-Advisor may be
limited by the client with respect to the selection of brokers or may be
instructed to direct trades through a particular broker. In these cases, trades
for a Fund in a particular security may be placed separately from, rather than
aggregated with, such other accounts. Having separate transactions with respect
to a security may temporarily affect the market price of the security or the
execution of the transaction, or both, to the possible detriment of the Fund or
other account(s) involved.
The Sub-Advisors, the Advisor and the Funds have adopted certain
compliance procedures which are designed to address these types of conflicts.
However, there is no guarantee that such procedures will detect each and every
situation in which a conflict arises.
The Sub-Advisory Agreements. The Sub-Advisors, subject to the Board of
Trustees' and Advisor's supervision, provide the applicable Funds with
discretionary investment services. Specifically, the Sub-Advisors are
responsible for managing the investments of the respective Fund in accordance
with the Fund's investment objectives, policies and restrictions as provided
in the Prospectus and this SAI, as may be subsequently changed by the Board of
Trustees and communicated to a Sub-Advisor in writing. The Sub-Advisors further
agree to conform to all applicable laws and regulations of the SEC in all
material respects and to conduct its activities under the Sub-Advisory
-49-
Agreements in all material respects in accordance with applicable regulations of
any governmental authority pertaining to its investment advisory services. In
the performance of their duties, the Sub-Advisors will in all material respects
satisfy any applicable fiduciary duties they may have to a Fund, will monitor
the Fund's investments, and will comply with the provisions of the Declaration
of Trust and By-Laws, as amended from time to time, and the stated investment
objectives, policies and restrictions of the Fund. The Sub-Advisors are
responsible for effecting all security transactions for the Funds' assets. The
Sub-Advisory Agreements provides that the Sub-Advisors shall not be liable for
any loss suffered by the Funds or the Advisor (including, without limitation, by
reason of the purchase, sale or retention of any security) in connection with
the performance of a Sub-Advisor's duties under the Sub-Advisory Agreement,
except for a loss resulting from willful misfeasance, bad faith or gross
negligence on the part of the Sub-Advisor in performance of its duties under
such Sub-Advisory Agreement, or by reason of its reckless disregard of its
obligations and duties under such Sub-Advisory Agreement.
The Sub-Advisory Agreement for a Fund may be terminated without the
payment of any penalty by First Trust, the Board of Trustees, or a majority of
the outstanding voting securities of the Fund (as defined in the 1940 Act), upon
60 days' written notice to the Sub-Advisor.
All fees and expenses are accrued daily and deducted before payment of
dividends to investors. The Sub-Advisory Agreement for each applicable Fund has
been approved by the Board of Trustees, including a majority of the Independent
Trustees, and the initial shareholder of the Fund.
BROKERAGE ALLOCATIONS
Each Sub-Advisor (and First Trust for the First Trust Short Duration High
Income Fund) is responsible for decisions to buy and sell securities for the
applicable Fund and for the placement of such 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 each Sub-Advisor and First Trust to
seek the best execution at the best security price available with respect to
each transaction, and with respect to brokered transactions in light of the
overall quality of brokerage and research services provided to the Sub-Advisor
and/or First Trust and its clients. The best price to a 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 a 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 Funds may
pay mark-ups on principal transactions. In selecting broker/dealers and in
negotiating commissions, each Sub-Advisor and/or First Trust considers, among
other things, the firm's reliability, the quality of its execution services on a
continuing basis and its financial condition. Fund portfolio transactions may be
effected with broker/dealers who have assisted investors in the purchase of
shares.
-50-
Section 28(e) of the 1934 Act permits an investment advisor, under certain
circumstances, to cause an account to pay a broker or dealer who supplies
brokerage and research services a commission for effecting a transaction in
excess of the amount of commission another broker or dealer would have charged
for effecting the transaction. Brokerage and research services include (a)
furnishing advice as to the value of securities, the advisability of investing,
purchasing or selling securities, and the availability of securities or
purchasers or sellers of securities; (b) furnishing analyses and reports
concerning issuers, industries, securities, economic factors and trends,
portfolio strategy, and the performance of accounts; and (c) effecting
securities transactions and performing functions incidental thereto (such as
clearance, settlement, and custody). Such brokerage and research services are
often referred to as "soft dollars" or "commission sharing agreements."
Currently, neither First Trust nor any Sub-Advisor uses soft dollars or
commission sharing agreements, but may do so in the future.
As an investment advisor, each Sub-Advisor has an obligation to seek best
execution of trades in a manner intended, considering the circumstances, to
secure that combination of net price and execution that will maximize the value
of the Sub-Advisor's investment decisions for the benefit of its clients.
Subject to the Sub-Advisors' duty to seek best execution, each Sub-Advisor's
selection of brokers may be affected by its receipt of research services.
The Sub-Advisors may use client commissions (i) to acquire third party
research, including the eligible portion of certain "mixed use" research
products, and (ii) for proprietary research provided by brokers participating in
the execution process, including access to the brokers' traders and analysts,
access to conferences and company management, and the provision of market
information.
When a Sub-Advisor receives research products and services in return for
client brokerage, it relieves the Sub-Advisor of the expense it would otherwise
bear of paying for those items with its own funds, which may provide an
incentive to the Sub-Advisor to select a particular broker-dealer or electronic
communication network that will provide it with research products or services.
However, the Sub-Advisors choose those broker-dealers it believes are best
able to provide the best combination of net price and execution in each
transaction. Each Sub-Advisor uses client brokerage from accounts managed by an
investment team for research used by that team. Because virtually all orders are
aggregated across all accounts in a strategy for execution by a single broker,
all participating accounts, including the Funds, generally will pay the same
commission rate for trades and will share pro rata in the costs for the
research, except for certain governmental clients that are subject to legal
restrictions on the use of their commissions to pay for third-party research
products and services (in which case the Sub-advisor pays for such products and
services from its own funds).
Notwithstanding the foregoing, in selecting brokers, the Sub-Advisors or
First Trust may in the future 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 a Sub-Advisor or First
Trust determines in good faith that the amount of such commissions is reasonable
-51-
in relation to the value of the research information and brokerage services
provided by such broker to the Sub-Advisor, First Trust or the Trust. In
addition, the Sub-Advisors and/or First Trust must determine that the research
information received in this manner provides the applicable Fund with benefits
by supplementing the research otherwise available to such Fund. The Investment
Management Agreement and the Sub-Advisory Agreement provide that such higher
commissions will not be paid by a Fund unless the Advisor or Sub-Advisor
determines in good faith that the amount is reasonable in relation to the
services provided. The investment advisory fees paid by the Funds to First Trust
under the Investment Management Agreement would not be reduced as a result of
receipt by the Sub-Advisor of research services.
The Sub-Advisors and First Trust place portfolio transactions for other
advisory accounts advised by them, and research services furnished by firms
through which a Fund effects its securities transactions may be used by the
Sub-Advisor or First Trust in servicing all of its accounts; not all of such
services may be used by the Sub-Advisor or First Trust in connection with the
Fund. The Sub-Advisors and First Trust believe it is not possible to measure
separately the benefits from research services to each of the accounts
(including the applicable Fund) advised by it. 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, each Sub-Advisor and
First Trust believe such costs to a Fund will not be disproportionate to the
benefits received by the Fund on a continuing basis. The Sub-Advisors and First
Trusts seek to allocate portfolio transactions equitably whenever concurrent
decisions are made to purchase or sell securities by the applicable 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 a Sub-Advisor and First Trust are the respective investment
objectives, 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.
BROKERAGE COMMISSIONS
The following table sets forth the aggregate amount of brokerage
commissions paid by each Fund for the specified periods.
AGGREGATE AMOUNT OF
BROKERAGE COMMISSIONS
JANUARY 11, 2011 TO FISCAL YEAR ENDED FISCAL YEAR ENDED
FUND OCTOBER 31, 2011 OCTOBER 31, 2012 OCTOBER 31, 2013
First Trust Preferred $12,962 $57,077 $57,075
Securities and Income Fund
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|
First Trust/Confluence Small $201 $376 $1,012
Cap Value Fund
First Trust Short Duration High N/A N/A N/A
Income Fund
|
CUSTODIANS, ADMINISTRATORS, FUND ACCOUNTANTS AND TRANSFER AGENTS
Custodian, Administrator and Fund Accountant. Brown Brothers Harriman and
Co. ("BBH"), as custodian for First Trust Preferred Securities and Income Fund
and First Trust/Confluence Small Cap Value Fund pursuant to a Custodian
Agreement, holds the Funds' assets. The Bank of New York Mellon Corporation
("BNYM"), as custodian for First Trust Short Duration High Income Fund pursuant
to a Custodian Agreement, holds the Fund's assets. Also, pursuant to an
Administrative Agency Agreement, BNY Mellon Investment Servicing(US) Inc.
("BNY"), as Administrator and Fund Accountant for First Trust Short Duration
High Income Fund and BBH, as Administrator and Fund Accountant for First Trust
Preferred Securities and Income Fund and First Trust/Confluence Small Cap Value
Fund, provide certain administrative and accounting services to the applicable
Funds, including maintaining the Funds' books of account, records of the Funds'
securities transactions and certain other books and records; acting as liaison
with the Funds' independent registered public accounting firm by providing such
accountant with various audit-related information with respect to the Funds; and
providing other continuous accounting and administrative services.
Pursuant to the Administrative Agency Agreements, the Trust on behalf of
each Fund has agreed to indemnify the Administrator for certain liabilities,
including certain liabilities arising under the federal securities laws, unless
such loss or liability results from negligence or willful misconduct in the
performance of its duties.
Pursuant to the Fund Administration and Accounting Agreements between BBH,
BNY and the Trust, each Fund has agreed to pay such compensation as is mutually
agreed from time to time and such out-of-pocket expenses as incurred by BBH and
BNY in the performance of their duties.
AGGREGATE AMOUNT PAID TO ADMINISTRATOR
JANUARY 11, 2011 TO FISCAL YEAR ENDED FISCAL YEAR ENDED
FUND OCTOBER 31, 2011 OCTOBER 31, 2012 OCTOBER 31, 2013
First Trust Preferred $16,903 $51,638 $103,866
Securities and Income Fund
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|
First Trust/Confluence Small $16,822 $52,387 $22,472
Cap Value Fund
First Trust Short Duration High N/A N/A $48,872
Income Fund
|
Transfer Agent. BNY serves as the Funds' transfer agent pursuant to a
Mutual Fund Services Agreement for Transfer Agency Services. Its principal
address is 301 Bellevue Parkway, Wilmington, Delaware 19809.
Shares of the Funds may be purchased through certain financial companies
who are agents of the Funds for the limited purpose of completing purchases and
sales. For services provided by such a company with respect to Fund shares held
by that company on behalf of its customers pursuant to a sub-transfer agency,
omnibus account service or sub-accounting agreement, the Funds may pay a fee to
such financial service companies for record keeping and sub-accounting services
provided to their customers.
Distributor. First Trust Portfolios L.P., an affiliate of First Trust, is
the distributor ("FTP" or the "Distributor") and principal underwriter of the
shares of the Funds. Its principal address is 120 East Liberty Drive, Suite 400,
Wheaton, Illinois 60187.
FTP serves as the principal underwriter of the shares of the Funds
pursuant to a "best efforts" arrangement as provided by a distribution agreement
with the Trust (the "Distribution Agreement"). Pursuant to the Distribution
Agreement, the Trust appointed FTP to be its agent for the distribution of the
Funds' shares on a continuous offering basis. FTP sells shares to or through
brokers, dealers, banks or other qualified financial intermediaries
(collectively referred to as "Dealers"), or others, in a manner consistent with
the then effective registration statement of the Trust for the Funds. Pursuant
to the Distribution Agreement, FTP, at its own expense, finances certain
activities incident to the sale and distribution of the Funds' shares, including
printing and distributing of prospectuses and statements of additional
information to other than existing shareholders, the printing and distributing
of sales literature, advertising and payment of compensation and giving of
concessions to Dealers. FTP receives for its services the excess, if any, of the
sales price of the Funds' shares less the net asset value of those shares, and
remits a majority or all of such amounts to the Dealers who sold the shares; FTP
may act as such a Dealer. First Trust Portfolios also receives compensation
pursuant to a distribution plan adopted by the Trust pursuant to Rule 12b-1 and
described herein under "Distribution and Service Plan." FTP receives any
contingent deferred sales charges ("CDSCs") imposed on redemptions of shares,
but any amounts as to which a reinstatement privilege is not exercised are set
off against and reduce amounts otherwise payable to FTP pursuant to the
distribution plan.
The following table sets forth the amount of underwriting commissions paid
by the Funds to the Distributor and the amount of compensation on redemptions
and repurchases received by the Distributor for the specified periods.
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UNDERWRITING COMMISSIONS RETAINED BY COMPENSATION ON REDEMPTIONS AND
DISTRIBUTOR REPURCHASES
JANUARY FISCAL FISCAL JANUARY FISCAL FISCAL
11, 2011 YEAR YEAR 11, 2011 YEAR YEAR
TO ENDED ENDED TO ENDED ENDED
OCTOBER OCTOBER OCTOBER OCTOBER OCTOBER OCTOBER
FUND 31, 2011 31, 2012 31, 2013 31, 2013 31, 2012 31, 2011
First Trust Preferred $17,964 $112,390 $66,618 $57 $4,693 $23,193
Securities and Income Fund
First Trust/Confluence Small $262 $2,352 $1,650 $0 $5 $0
Cap Value Fund
Fist Trust Short Duration High N/A N/A $13,120 N/A N/A $2,537
Income Fund
|
The Advisor may, from time to time and from its own resources, pay, defray
or absorb costs relating to distribution, including payments out of its own
resources to the Distributor, or to otherwise promote the sale of shares. The
Advisor's available resources to make these payments may include profits from
advisory fees received from the Funds. The services the Advisor may pay for
include, but are not limited to, advertising and attaining access to certain
conferences and seminars, as well as being presented with the opportunity to
address investors and industry professionals through speeches and written
marketing materials.
ADDITIONAL INFORMATION
Book Entry Only System. The following information supplements and should
be read in conjunction with the Prospectus.
DTC Acts as Securities Depository for Fund Shares. Shares of the Funds are
represented by securities registered in the name of The Depository Trust Company
("DTC") or its nominee, Cede & Co., and deposited with, or on behalf of, DTC.
DTC, a limited-purpose trust company, was created to hold securities of
its participants (the "DTC Participants") and to facilitate the clearance and
settlement of securities transactions among the DTC Participants in such
securities through electronic book-entry changes in accounts of the DTC
Participants, thereby eliminating the need for physical movement of securities
or certificates. DTC Participants include securities brokers and dealers, banks,
trust companies, clearing corporations and certain other organizations, some of
whom (and/or their representatives) own DTC. More specifically, DTC is owned by
a number of its DTC Participants and by the New York Stock Exchange (the "NYSE")
and FINRA. Access to the DTC system is also available to others such as banks,
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brokers, dealers and trust companies that clear through or maintain a custodial
relationship with a DTC Participant, either directly or indirectly (the
"Indirect Participants").
Beneficial ownership of shares is limited to DTC Participants, Indirect
Participants and persons holding interests through DTC Participants and Indirect
Participants. Ownership of beneficial interests in shares (owners of such
beneficial interests are referred to herein as "Beneficial Owners") is shown on,
and the transfer of ownership is effected only through, records maintained by
DTC (with respect to DTC Participants) and on the records of DTC Participants
(with respect to Indirect Participants and Beneficial Owners that are not DTC
Participants). Beneficial Owners will receive from or through the DTC
Participant a written confirmation relating to their purchase and sale of
shares.
Conveyance of all notices, statements and other communications to
Beneficial Owners is effected as follows. Pursuant to a letter agreement between
DTC and the Trust, DTC is required to make available to the Trust upon request
and for a fee to be charged to the Trust a listing of the shares of the Funds
held by each DTC Participant. The Trust shall inquire of each such DTC
Participant as to the number of Beneficial Owners holding shares, directly or
indirectly, through such DTC Participant. The Trust shall provide each such DTC
Participant with copies of such notice, statement or other communication, in
such form, number and at such place as such DTC Participant may reasonably
request, in order that such notice, statement or communication may be
transmitted by such DTC Participant, directly or indirectly, to such Beneficial
Owners. In addition, the Trust shall pay to each such DTC Participants a fair
and reasonable amount as reimbursement for the expenses attendant to such
transmittal, all subject to applicable statutory and regulatory requirements.
Fund distributions shall be made to DTC or its nominee, as the registered
holder of all Fund shares. DTC or its nominee, upon receipt of any such
distributions, shall immediately credit DTC Participants' accounts with payments
in amounts proportionate to their respective beneficial interests in shares of
the Funds as shown on the records of DTC or its nominee. Payments by DTC
Participants to Indirect Participants and Beneficial Owners of shares held
through such DTC Participants will be governed by standing instructions and
customary practices, as is now the case with securities held for the accounts of
customers in bearer form or registered in a "street name," and will be the
responsibility of such DTC Participants.
The Trust has no responsibility or liability for any aspect of the records
relating to or notices to Beneficial Owners, or payments made on account of
beneficial ownership interests in such shares, or for maintaining, supervising
or reviewing any records relating to such beneficial ownership interests, or for
any other aspect of the relationship between DTC and the DTC Participants or the
relationship between such DTC Participants and the Indirect Participants and
Beneficial Owners owning through such DTC Participants.
DTC may decide to discontinue providing its service with respect to shares
at any time by giving reasonable notice to the Trust and discharging its
responsibilities with respect thereto under applicable law. Under such
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circumstances, the Trust shall take action to find a replacement for DTC to
perform its functions at a comparable cost.
PROXY VOTING POLICIES AND PROCEDURES
The Board has delegated to First Trust the proxy voting responsibilities
for the First Trust Short Duration High Income Fund and has directed First Trust
to vote proxies consistent with the Fund's best interests. First Trust has
engaged the services of ISS Governance Services, a division of RiskMetrics
Group, Inc. ("ISS"), to make recommendations to First Trust on the voting of
proxies relating to securities held by the Fund. If First Trust manages the
assets of a company or its pension plan and any of First Trust's clients hold
any securities of that company, First Trust will vote proxies relating to such
company's securities in accordance with the ISS recommendations to avoid any
conflict of interest. While these guidelines are not intended to be
all-inclusive, they do provide guidance on First Trust's general voting
policies. The ISS Proxy Voting Guidelines are attached hereto as Appendix B.
The Board of Trustees has delegated to Confluence the proxy voting
responsibilities for the First Trust/Confluence Small Cap Value Fund and has
directed Confluence to vote proxies consistent with the Fund's best interests.
Confluence's Proxy Voting Policies and Procedures are set forth in Appendix C.
The Board of Trustees has delegated to Stonebridge the proxy voting
responsibilities for the First Trust Preferred Securities and Income Fund and
has directed Stonebridge to vote proxies consistent with the Fund's best
interests. Stonebridge's Proxy Voting Policies and Procedures are set forth in
Appendix D.
Information regarding how the Funds voted proxies relating to portfolio
securities during the most recent 12-month period ended June 30, is available
upon request and without charge on the Funds' website at
http://www.ftportfolios.com, by calling (800) 621-1675 or by accessing the SEC's
website at http://www.sec.gov.
Quarterly Portfolio Schedule. The Trust is required to disclose, after its
first and third fiscal quarters, the complete schedule of each Fund's portfolio
holdings with the SEC on Form N-Q. Forms N-Q for the Trust are available on the
SEC's website at http://www.sec.gov. The Funds' Forms N-Q may also be reviewed
and copied at the SEC's Public Reference Room in Washington, D.C. and
information on the operation of the Public Reference Room may be obtained by
calling 1-800-SEC-0330. The Trust's Forms N-Q will be available without charge,
upon request, by calling (800) 621-1675 or by writing to First Trust Portfolios
L.P., 120 East Liberty Drive, Suite 400, Wheaton, Illinois 60187.
Policy Regarding Disclosure of Portfolio Holdings. The Trust has adopted a
policy regarding the disclosure of portfolio holdings (the "Disclosure Policy").
The purpose of the Disclosure Policy is to outline the Funds' policies and
procedures with respect to the disclosure of portfolio holdings in order to
comply with SEC requirements.
A listing of the portfolio holdings of the Funds generally shall not be
provided to any person, including any investor of the Funds, until such time as
the portfolio holdings have been filed with the SEC on Form N-Q or Form N-CSR,
as applicable, and posted on the Funds' website. Any person, including any
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investor of the Funds that requests a listing of the Funds' portfolio holdings,
shall be provided with the portfolio holdings list most recently made publicly
available pursuant to this Disclosure Policy (and/or portfolio holdings as of
earlier periods that previously have been made publicly available, if
requested).
Neither the Funds, the Advisor, the Sub-Advisors nor any other party shall
receive any compensation whatsoever in connection with the disclosure of
information about the Funds' portfolio securities.
The Funds may on occasion release certain nonpublic portfolio information
to selected parties if (i) the Trust's Chief Compliance Officer determines such
disclosure is consistent with a legitimate business purpose of a Fund; and (ii)
the recipient is subject to a duty of confidentiality with respect to the
information, including a duty not to trade on the nonpublic information. In this
connection, selective disclosure of portfolio holdings will be made on an
ongoing basis in the normal course of investment and administrative operations
to service providers, which, to the best of the Funds' knowledge, include proxy
voting services (including ISS), fund accountants, custodians and transfer
agents, as well as their financial printers and mailing service (including BBH
and BNYM (the custodians), BNY (the transfer agent), GComm, Fitzgerald Marketing
Communications and Broadridge Financial Solutions, Inc.), performance
attribution vendors (including Factset Research Systems), tracking agencies
(including Lipper, Inc., Morningstar, Inc., Standard & Poor s and Thomson
Financial), accounting and auditing services (including Deloitte & Touche LLP)
and legal counsel to the Funds, the Independent Trustees or investment advisor
(including Vedder Price P.C. and Chapman and Cutler LLP). All such third parties
shall be bound by a Code of Ethics or similar insider trading policy or
confidentiality agreement or duty prohibiting their use of any portfolio
holdings information in an improper manner.
The Disclosure Policy will be monitored by the Trust's Chief Compliance
Officer. Any violations of the Disclosure Policy will be reported by the Trust's
Chief Compliance Officer to the Trust's Board of Trustees at the next regularly
scheduled board meeting.
These procedures were designed to ensure that disclosure of information
about portfolio securities is in the best interests of the Funds, including the
procedures to address conflicts between the interests of Fund shareholders, on
the one hand, and those of the Funds' Advisor; Sub-Advisors; the Distributor; or
any affiliated person of the Funds, their Advisor, or their principal
underwriter, on the other.
Codes of Ethics. In order to mitigate the possibility that the Funds will
be adversely affected by personal trading, the Trust, First Trust, the
Sub-Advisors and the Distributor have adopted Codes of Ethics under Rule 17j-1
of the 1940 Act. These Codes of Ethics contain policies restricting securities
trading in personal accounts of the officers, Trustees and others who normally
come into possession of information on portfolio transactions. Personnel subject
to the Codes of Ethics may invest in securities that may be purchased or held by
the Funds; however, the Codes of Ethics require that each transaction in such
securities be reviewed by the Chief Compliance Officer or his or her designee.
These Codes of Ethics are on public file with, and are available from, the SEC.
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PURCHASE AND REDEMPTION OF FUND SHARES
As described in the Prospectus, the Funds provide you with alternative
ways of purchasing Fund shares based upon your individual investment needs and
preferences.
Each class of shares of a Fund represents an interest in the same
portfolio of investments. Each class of shares is identical in all respects
except that each class bears its own class expenses, including distribution and
service expenses, and each class has exclusive voting rights with respect to any
distribution or service plan applicable to its shares. As a result of the
differences in the expenses borne by each class of shares, net income per share,
dividends per share and net asset value per share will vary among each Fund's
classes of shares. There are no conversion, preemptive or other subscription
rights.
Shareholders of each class will share expenses proportionately for
services that are received equally by all shareholders. A particular class of
shares will bear only those expenses that are directly attributable to that
class, where the type or amount of services received by a class varies from one
class to another. For example, class-specific expenses generally will include
distribution and service fees for those classes that pay such fees.
The minimum initial investment is $2,500 per Fund share class ($750 for a
Traditional/Roth IRA account, $500 for an Education IRA account and $250 for
accounts opened through fee-based programs). There are no minimums for purchases
or exchanges into the Funds through employer-sponsored retirement plans. Class I
shares have a minimum investment of $1 million for certain investors. Subsequent
investments have a minimum of $50. The Funds reserve the right to reject
purchase orders and to waive or increase the minimum investment requirements.
The expenses to be borne by specific classes of shares may include (i)
transfer agency fees attributable to a specific class of shares, (ii) printing
and postage expenses related to preparing and distributing materials such as
shareholder reports, prospectuses and proxy statements to current shareholders
of a specific class of shares, (iii) SEC and state securities registration fees
incurred by a specific class of shares, (iv) the expense of administrative
personnel and services required to support the shareholders of a specific class
of shares, (v) litigation or other legal expenses relating to a specific class
of shares, (vi) Trustees' fees or expenses incurred as a result of issues
relating to a specific class of shares, (vii) accounting expenses relating to a
specific class of shares and (viii) any additional incremental expenses
subsequently identified and determined to be properly allocated to one or more
classes of shares.
CLASS A SHARES
Class A shares may be purchased at a public offering price equal to the
applicable net asset value per share plus an up-front sales charge imposed at
the time of purchase as set forth in the Prospectus.
Shareholders may qualify for a reduced sales charge, or the sales charge
may be waived in its entirety, as described below. Class A shares also are
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subject to an annual service fee of 0.25%. See "Distribution and Service Plans."
Set forth below is an example of the method of computing the offering price of
the Class A shares of each Fund. The example assumes a purchase on October 31,
2013 of Class A shares of each Fund aggregating less than $50,000 subject to the
schedule of sales charges set forth in the Prospectus at a price based upon the
net asset value of the Class A shares.
First Trust Preferred Securities and Income Fund
Net Asset Value per Share.............. $ 20.27
Per Share Sales Charge--4.50% of public
offering price....................... 0.96
-------------------------------------------------------
Per Share Offering Price to the Public. $ 21.23
|
First Trust/Confluence Small Cap Value Fund
Net Asset Value per Share.......... $ 26.77
Per Share Sales Charge--5.50% of public
offering price................... 1.56
---------------------------------------------------------
Per Share Offering Price to the Public $ 28.33
|
First Trust Short Duration High Income Fund
Net Asset Value per Share.......... $ 20.68
Per Share Sales Charge--3.50% of public
offering price................... 0.75
---------------------------------------------------------
Per Share Offering Price to the Public $ 21.43
|
The Fund receives the entire net asset value of all Class A shares that
are sold.
ELIMINATION OF UP-FRONT SALES CHARGE ON CLASS A SHARES
Class A shares of the Funds may be purchased at net asset value without a
sales charge by the following categories of investors:
o investors purchasing $1,000,000 or more (FTP may pay financial
intermediaries on Class A sales of $1 million and above up to
1.00% of the purchase amounts);
o officers, trustees and former trustees of the First Trust non-ETF
open-end funds ;
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o bona fide, full-time and retired employees of First Trust and FTP,
and subsidiaries thereof, or their immediate family members
(immediate family members are defined as their spouses, parents,
children, grandparents, grandchildren, parents-in-law, sons-and
daughters-in-law, siblings, a sibling's spouse, and a spouse's
siblings);
o any person who, for at least the last 90 days, has been an
officer, director or bona fide employee of any financial
intermediary, or their immediate family members;
o bank or broker-affiliated trust departments investing funds over
which they exercise exclusive discretionary investment authority
and that are held in a fiduciary, agency, advisory, custodial or
similar capacity;
o investors purchasing on a periodic fee, asset-based fee or no
transaction fee basis through a broker-dealer sponsored mutual
fund purchase program; and
o clients of investment advisors, financial planners or other
financial intermediaries that charge periodic or asset-based fees
for their services.
Any Class A shares purchased pursuant to a special sales charge waiver
must be acquired for investment purposes and on the condition that they will not
be transferred or resold except through redemption by the Funds. You or your
financial advisor must notify FTP or the Funds' transfer agent whenever you make
a purchase of Class A shares of any Fund that you wish to be covered under these
special sales charge waivers.
Class A shares of the Funds may be issued at net asset value without a
sales charge in connection with the acquisition by the Funds of another
investment company. All purchases under the special sales charge waivers will be
subject to minimum purchase requirements as established by the Funds.
The reduced sales charge programs may be modified or discontinued by the
Funds at any time. For more information about the purchase of Class A shares or
the reduced sales charge program, or to obtain the required application forms,
call First Trust toll-free at (800) 621-1675.
CLASS C SHARES
You may purchase Class C shares at a public offering price equal to the
applicable net asset value per share without any up-front sales charge. Class C
shares are subject to an annual distribution fee of 0.75% to compensate FTP for
paying your financial advisor an ongoing sales commission. Class C shares are
also subject to an annual service fee of 0.25% to compensate financial
intermediaries for providing you with ongoing financial advice and other account
services. FTP compensates financial intermediaries for sales of Class C shares
at the time of the sale at a rate of 1% of the amount of Class C shares
purchased, which represents an advance of the first year's distribution fee of
0.75% plus an advance on the first year's annual service fee of 0.25%. See
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"Distribution and Service Plan." Class C share purchase orders equaling or
exceeding $500,000 will not be accepted. In addition, purchase orders for a
single purchaser that, when added to the value that day of all of such
purchaser's shares of any class of any First Trust non-ETF open-end fund, cause
the purchaser's cumulative total of shares in First Trust non-ETF open-end funds
to equal or exceed the aforementioned limit will not be accepted. Purchase
orders for a single purchaser equal to or exceeding the foregoing limit should
be placed only for Class A shares, unless such purchase has been reviewed and
approved as suitable for the client by the appropriate compliance personnel of
the financial intermediary, and the applicable Fund receives written
confirmation of such approval.
REDUCTION OR ELIMINATION OF CLASS A AND CLASS C CONTINGENT DEFERRED SALES CHARGE
Class A shares are normally redeemed at net asset value, without any CDSC.
However, in the case of Class A shares purchased at net asset value without a
sales charge because the purchase amount exceeded $1 million, where the
financial intermediary did not waive the sales commission, a CDSC of 1% is
imposed on any redemption within 12 months of purchase. Class C shares are
redeemed at net asset value, without any CDSC, except that a CDSC of 1% is
imposed upon redemption of Class C shares that are redeemed within 12 months of
purchase (except in cases where the shareholder's financial advisor agreed to
waive the right to receive an advance of the first year's distribution and
service fee).
In determining whether a CDSC is payable, the Funds will first redeem
shares not subject to any charge and then will redeem shares held for the
longest period, unless the shareholder specifies another order. No CDSC is
charged on shares purchased as a result of automatic reinvestment of dividends
or capital gains paid. In addition, no CDSC will be charged on exchanges of
shares into another First Trust non-ETF open-end fund. The holding period is
calculated on a monthly basis and begins on the date of purchase. The CDSC is
assessed on an amount equal to the lower of the then current market value or the
cost of the shares being redeemed. Accordingly, no sales charge is imposed on
increases of net asset value above the initial purchase price. FTP receives the
amount of any CDSC shareholders pay.
The CDSC may be waived or reduced under the following circumstances: (i)
in the event of total disability (as evidenced by a determination by the federal
Social Security Administration) of the shareholder (including a registered joint
owner) occurring after the purchase of the shares being redeemed; (ii) in the
event of the death of the shareholder (including a registered joint owner);
(iii) for redemptions made pursuant to a systematic withdrawal plan, up to 1%
monthly, 3% quarterly, 6% semiannually or 12% annually of an account's net asset
value depending on the frequency of the plan as designated by the shareholder;
(iv) involuntary redemptions caused by operation of law; (v) redemptions in
connection with a payment of account or plan fees; (vi) redemptions in
connection with the exercise of a reinstatement privilege whereby the proceeds
of a redemption of the Fund's shares subject to a sales charge are reinvested in
shares of certain funds within a specified number of days; (vii) redemptions in
connection with the exercise of the Funds' right to redeem all shares in an
account that does not maintain a certain minimum balance or that the Board of
Trustees has determined may have material adverse consequences to the applicable
Fund; (viii) in whole or in part for redemptions of shares by shareholders with
accounts in excess of specified breakpoints that correspond to the breakpoints
under which the up-front sales charge on Class A shares is reduced pursuant to
Rule 22d-1 under the Act; (ix) redemptions of shares purchased under
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circumstances or by a category of investors for which Class A shares could be
purchased at net asset value without a sales charge; (x) redemptions of Class A
or Class C shares if the proceeds are transferred to an account managed by an
affiliated advisor and the advisor refunds the advanced service and distribution
fees to FTP; and (xi) redemptions of Class C shares in cases where (a) you
purchase shares after committing to hold the shares for less than one year and
(b) your advisor consents up front to receiving the appropriate service and
distribution fee on the Class C shares on an ongoing basis instead of having the
first year's fees advanced by FTP. If a Fund waives or reduces the CDSC, such
waiver or reduction would be uniformly applied to all Fund shares in the
particular category. In waiving or reducing a CDSC, the Fund will comply with
the requirements of Rule 22d-1 under the 1940 Act.
In addition, the CDSC will be waived in connection with the following
redemptions of shares held by an employer-sponsored qualified defined
contribution retirement plan: (i) partial or complete redemptions in connection
with a distribution without penalty under Section 72(t) of the Code from a
retirement plan: (a) upon attaining age 59 1/2, (b) as part of a series of
substantially equal periodic payments, or (c) upon separation from service and
attaining age 55; (ii) partial or complete redemptions in connection with a
qualifying loan or hardship withdrawal; (iii) complete redemptions in connection
with termination of employment, plan termination or transfer to another
employer's plan or IRA; and (iv) redemptions resulting from the return of an
excess contribution. The CDSC will also be waived in connection with the
following redemptions of shares held in an IRA account: (i) for redemptions made
pursuant to an IRA systematic withdrawal based on the shareholder's life
expectancy including, but not limited to, substantially equal periodic payments
described in Code Section 72(t)(A)(iv) prior to age 59 1/2; and (ii) for
redemptions to satisfy required minimum distributions after age 70 1/2 from an
IRA account (with the maximum amount subject to this waiver being based only
upon the shareholder's First Trust IRA accounts).
CLASS F SHARES OF THE FIRST TRUST PREFERRED SECURITIES AND INCOME FUND
You may purchase Class F shares of the First Trust Preferred Securities
and Income Fund at a public offering price equal to the applicable net asset
value per share without any up-front sales charge. Class F shares are subject to
an annual service fee of 0.15% to compensate FTP for providing ongoing services.
See "Distribution and Service Plan." Class F shares are generally available to
investors participating in fee-based programs that have (or whose trading agents
have) an agreement with FTP and to certain investors that are clients of certain
registered investment advisors that have an agreement with FTP, if it so deems
appropriate.
CLASS I SHARES
Class I shares are available for purchases of $1 million or more directly
from each Fund and for purchases using dividends and capital gains distributions
on Class I shares. Class I shares also are available for the following
categories of investors:
o officers, trustees and former trustees of any First Trust non-ETF
open-end fund and their immediate family members and officers,
directors and former directors of any parent company of First
Trust or FTP, affiliates and subsidiaries thereof and their
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immediate family members ("immediate family members" are defined
as spouses, parents, children, grandparents, grandchildren,
parents-in-law, sons- and daughters-in-laws, siblings, a
sibling's spouse and a spouse's siblings);
o Certain employees, officers, directors and affiliates of the
Sub-Advisors;
o bona fide, full-time and retired employees of First Trust or FTP,
and subsidiaries thereof, or their immediate family members;
o any person who, for at least the last 90 days, has been an
officer, director or bona fide employee of any financial
intermediary, or their immediate family members;
(Any shares purchased by investors falling within any of the
first three categories listed above must be acquired for
investment purposes and on the condition that they will not be
transferred or resold except through redemption by the applicable
Fund.)
o bank or broker-affiliated trust departments investing funds over
which they exercise exclusive discretionary investment authority
and that are held in a fiduciary, agency, advisory, custodial or
similar capacity;
o investors purchasing through a periodic fee or asset-based fee
program which is sponsored by a registered broker-dealer or other
financial institution that has entered into an agreement with
FTP;
o fee paying clients of a registered investment advisor ("RIA") who
invest in First Trust non-ETF open-end funds through a fund
"supermarket" or other mutual fund trading platform sponsored by
a broker-dealer or trust company with which the RIA is not
affiliated and which has not entered into an agreement with FTP;
and
o employer-sponsored retirement plans, except SEPs, SAR-SEPs,
SIMPLE IRAs and KEOGH plans.
If you are eligible to purchase either Class A, Class F or Class I shares
without a sales charge at net asset value, you should be aware of the
differences between these three classes of shares. Class A and Class F shares
are subject to an annual service fee to compensate financial intermediaries for
providing you with ongoing account services. Class I shares are not subject to a
distribution or service fee and, consequently, holders of Class I shares may not
receive the same types or levels of services from financial intermediaries. In
choosing among Class A shares, Class F shares and Class I shares, you should
weigh the benefits of the services to be provided by financial intermediaries
against the annual service fee imposed upon the Class A and Class F shares.
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CLASS R3 SHARES
The Funds currently offers Class R3 shares. Class R3 shares are available
for purchase at the offering price, which is the net asset value per share
without any up-front sales charge. Class R3 shares are subject to annual
distribution and service fees of 0.50% of the applicable Fund's average daily
net assets, comprised of a 0.25% service (12b-1) fee and a 0.25% distribution
fee. The annual 0.25% service fee compensates your financial advisor and/or
associated financial intermediaries for providing ongoing service to you. The
annual 0.25% distribution fee compensates FTP for paying your financial advisor
and/or associated financial intermediaries an ongoing sales commission.
Class R3 shares are only available for purchase by certain retirement
plans that have an agreement with FTP to utilize R3 shares in certain investment
products or programs (collectively, "Retirement Plans"). Eligible retirement
plans include, but are not limited to, 401(k) plans, 457 plans,
employer-sponsored and individual 403(b) plans, profit sharing and money
purchase pension plans, defined benefit plans, non-qualified deferred
compensation plans and health care benefit funding plans. In addition, Class R3
shares are available to retirement plans where Class R3 shares are held on the
books of the applicable Fund through omnibus accounts (either at the retirement
plan level or at the level of the retirement plan's financial intermediary).
Class R3 shares are also available to traditional and Roth IRAs, Coverdell
Education Saving Accounts, SEPs, SAR-SEPs and simple IRAs.
The administrator of a retirement plan or employee benefits office can
provide plan participants with detailed information on how to participate in the
retirement plan and how to elect a Fund as an investment option. Retirement plan
participants may be permitted to elect different investment options, alter the
amounts contributed to the retirement plan, or change how contributions are
allocated among investment options in accordance with the retirement plan's
specific provisions. The retirement plan administrator or employee benefits
office should be consulted for details. For questions about their accounts,
participants should contact their employee benefits office, the retirement plan
administrator, or the organization that provides recordkeeping services for the
retirement plan.
Eligible retirement plans may open an account and purchase Class R3 shares
directly from a Fund or by contacting any financial intermediary authorized to
sell Class R3 shares of the Fund. Financial intermediaries may provide or
arrange for the provision of some or all of the shareholder servicing and
account maintenance services required by retirement plan accounts and their
retirement plan participants, including, without limitation, transfers of
registration and dividend payee changes. Financial intermediaries may also
perform other functions, including generating confirmation statements, and may
arrange with retirement plan administrators for other investment or
administrative services. Financial intermediaries may independently establish
and charge retirement plans and retirement plan participants transaction fees
and/or other additional amounts for such services, which may change over time.
Similarly, retirement plans may charge retirement plan participants for certain
expenses. These fees and additional amounts could reduce investment returns in
Class R3 shares of the Funds.
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Financial intermediaries and retirement plans may have omnibus accounts
and similar arrangements with a Fund and may be paid for providing shareholder
servicing and other services. A financial intermediary or retirement plan may be
paid for its services directly or indirectly by the Fund or FTP. FTP may pay a
financial intermediary an additional amount for sub-transfer agency or other
administrative services. Such sub-transfer agency or other administrative
services may include, but are not limited to, the following: processing and
mailing trade confirmations, monthly statements, prospectuses, annual reports,
semiannual reports and shareholder notices and other required communications;
capturing and processing tax data; issuing and mailing dividend checks to
shareholders who have selected cash distributions; preparing record date
shareholder lists for proxy solicitations; collecting and posting distributions
to shareholder accounts; and establishing and maintaining systematic
withdrawals, automated investment plans and shareholder account registrations.
Your retirement plan may establish various minimum investment requirements for
Class R3 shares of a Fund and may also establish certain privileges with respect
to purchases, redemptions and exchanges of Class R3 shares or the reinvestment
of dividends. Retirement plan participants should contact their retirement plan
administrator with respect to these issues. This SAI should be read in
conjunction with the retirement plan's and/or the financial intermediary's
materials regarding their fees and services.
SHAREHOLDER PROGRAMS
Exchange Privilege. You may exchange shares of a class of a Fund for
shares of the same class of any other First Trust non-ETF open-end fund with
reciprocal exchange privileges, at net asset value without a sales charge, by
either sending a written request to the applicable Fund, c/o First Trust
Portfolios L.P., 120 East Liberty Drive, Suite 400, Wheaton, Illinois 60187, or
by calling First Trust toll free (888) 373-5776. You may also, under certain
limited circumstances, exchange between certain classes of shares of the same
Fund if, after you purchased your shares, you became eligible to purchase a
different class of shares; however, the Advisor, the Distributor or any of their
affiliates may exchange between classes of shares of the same Fund at any time.
An exchange between classes of shares of the same Fund may not be considered a
taxable event; please consult your own tax advisor for further information. An
exchange between classes of shares of the same Fund may be done in writing to
the address stated above.
If you exchange shares between different First Trust non-ETF open-end
funds and your shares are subject to a CDSC, no CDSC will be charged at the time
of the exchange. However, if you subsequently redeem the shares acquired through
the exchange, the redemption may be subject to a CDSC, depending on when you
purchased your original shares and the CDSC schedule of the fund from which you
exchanged your shares. If you exchange between classes of shares of the same
Fund and your original shares are subject to a CDSC, the CDSC will be assessed
at the time of the exchange.
The shares to be purchased through an exchange must be offered in your
state of residence. The total value of exchanged shares must at least equal the
minimum investment requirement of the First Trust non-ETF open-end fund being
purchased. For federal income tax purposes, an exchange between different First
Trust non-ETF open-end funds constitutes a sale and purchase of shares and may
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result in capital gain or loss. Before making any exchange, you should obtain
the Prospectus for the First Trust non-ETF open-end fund you are purchasing and
read it carefully. If the registration of the account for the Fund you are
purchasing is not exactly the same as that of the fund account from which the
exchange is made, written instructions from all holders of the account from
which the exchange is being made must be received, with signatures guaranteed by
a member of an approved Medallion Guarantee Program or in such other manner as
may be acceptable to the Fund. The exchange privilege may be modified or
discontinued by the Fund at any time.
The exchange privilege is not intended to permit the Funds to be used as
vehicles for short-term trading. Excessive exchange activity may interfere with
portfolio management, raise expenses, and otherwise have an adverse effect on
all shareholders. In order to limit excessive exchange activity and in other
circumstances where Fund management believes doing so would be in the best
interest of the Funds, the Funds reserve the right to revise or terminate the
exchange privilege, or limit the amount or number of exchanges or reject any
exchange. Shareholders would be notified of any such action to the extent
required by law. See "Frequent Trading Policy" below.
Reinstatement Privilege. If you redeemed Class A or Class C shares of a
Fund or any other First Trust non-ETF open-end fund that were subject to a sales
charge or a CDSC, you have up to one year to reinvest all or part of the full
amount of the redemption in the same class of shares of the Funds at net asset
value. This reinstatement privilege can be exercised only once for any
redemption, and reinvestment will be made at the net asset value next calculated
after reinstatement of the appropriate class of Fund shares. If you reinstate
shares that were subject to a CDSC, your holding period as of the redemption
date also will be reinstated for purposes of calculating a CDSC and the CDSC
paid at redemption will be refunded. The federal income tax consequences of any
capital gain realized on a redemption will not be affected by reinstatement, but
a capital loss may be disallowed in whole or in part depending on the timing,
the amount of the reinvestment and the fund from which the redemption occurred.
Suspension of Right of Redemption. The Funds may suspend the right of
redemption of Fund shares or delay payment more than seven days (a) during any
period when the NYSE is closed (other than customary weekend and holiday
closings), (b) when trading in the markets the Fund normally utilizes is
restricted, or an emergency exists as determined by the SEC so that trading of
the Fund's investments or determination of its net asset value is not reasonably
practicable, or (c) for any other periods that the SEC by order may permit for
protection of Fund shareholders.
Redemption In-Kind. The Funds have reserved the right to redeem in-kind
(that is, to pay redemption requests in cash and portfolio securities, or wholly
in portfolio securities), although the Funds have no present intention to redeem
in-kind.
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FREQUENT TRADING POLICY
The Funds' Frequent Trading Policy is as follows:
The Funds are intended as long-term investments and not as short-term
trading vehicles. At the same time, the Funds recognize the need of investors to
periodically make purchases and redemptions of Fund shares when rebalancing
their portfolios and as their financial needs or circumstances change. The Trust
has adopted the following Frequent Trading Policy that seeks to balance these
needs against the potential for higher operating costs, portfolio management
disruption and other inefficiencies that can be caused by excessive trading of
Fund shares.
1. Definition of Round Trip. A Round Trip trade is the purchase and
subsequent redemption of Fund shares, including by exchange. Each side of a
Round Trip trade may be comprised of either a single transaction or a series of
closely-spaced transactions.
2. Round Trip Trade Limitations. The Trust limits the frequency of Round
Trip trades that may be placed in a Fund. Subject to certain exceptions noted
below, the Fund limits an investor to two Round Trips per trailing 90-day period
and may also restrict the trading privileges of an investor who makes a Round
Trip within a 30-day period where the purchase and redemption are of
substantially similar dollar amounts.
3. Enforcement. Trades placed in violation of the foregoing policies are
subject to rejection or cancellation by the Trust. The Trust may also bar an
investor (and/or an investor's financial advisor) who has violated these
policies from opening new accounts with the Fund and may restrict the investor's
existing account(s) to redemptions only. The Trust reserves the right, in its
sole discretion, to (a) interpret the terms and application of this Policy, (b)
waive unintentional or minor violations (including transactions below certain
minimum thresholds) if it determines that doing so does not harm the interests
of Fund Shareholders, and (c) exclude certain classes of redemptions from the
application of the trading restrictions set forth above.
The Trust reserves the right to impose restrictions on purchases or
exchanges that are more restrictive than those stated above if it determines,
in its sole discretion, that a proposed transaction or series of transactions
involve market timing or excessive trading that is likely to be detrimental to
the Funds. The Trust may modify or suspend the Frequent Trading Policy without
notice during periods of market stress or other unusual circumstances.
The ability of the Trust to implement the Frequent Trading Policy for
omnibus accounts at certain financial intermediaries may be dependent on
receiving from those intermediaries sufficient shareholder information to permit
monitoring of trade activity and enforcement of the Trust's Frequent Trading
Policy. In addition, the Trust may rely on a financial intermediary's policy to
restrict market timing and excessive trading if the Trust believes that the
policy is reasonably designed to prevent market timing that is detrimental to
a Fund. Such policy may be more or less restrictive than the Trust's Policy.
The Trust cannot ensure that these financial intermediaries will in all cases
apply the Trust's policy or their own policies, as the case may be, to accounts
under their control.
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The CCO is authorized to set and modify the above-described parameters
at any time as required to prevent adverse impact of frequent trading activity
on Fund shareholders.
Exclusions from the Frequent Trading Policy
As stated above, certain redemptions are eligible for exclusion from the
Frequent Trading Policy, including: (i) redemptions or exchanges by shareholders
investing through the fee-based platforms of certain financial intermediaries
(where the intermediary charges an asset-based or comprehensive "wrap" fee for
its services) that are effected by the financial intermediaries in connection
with systematic portfolio rebalancing; (ii) when there is a verified trade error
correction, which occurs when a dealer firm sends a trade to correct an earlier
trade made in error and then the firm sends an explanation to the Trust
confirming that the trade is actually an error correction; (iii) in the event of
total disability (as evidenced by a determination by the federal Social Security
Administration) of the shareholder (including a registered joint owner)
occurring after the purchase of the Fund shares being redeemed; (iv) in the
event of the death of the shareholder (including a registered joint owner); (v)
redemptions made pursuant to a systematic withdrawal plan, up to 1% monthly, 3%
quarterly, 6% semiannually or 12% annually of an account's net asset value
depending on the frequency of the plan as designated by the shareholder; (vi)
redemptions of Fund shares that were purchased through a systematic investment
program; (vii) involuntary redemptions caused by operation of law or Fund
Policy; (viii) redemptions in connection with a payment of account or plan fees;
(ix) redemptions or exchanges by any "fund of funds" advised by First Trust; and
(x) redemptions in connection with the exercise of a Fund's right to redeem all
shares in an account that does not maintain a certain minimum balance or that
the Board has determined may have material adverse consequences to the
shareholders of the Fund.
In addition, the following redemptions of shares by an employer-sponsored
qualified defined contribution retirement plan are excluded from the Frequent
Trading Policy: (i) partial or complete redemptions in connection with a
distribution without penalty under Section 72(t) of the Code from a retirement
plan: (a) upon attaining age 59 1/2; (b) as part of a series of substantially
equal periodic payments, or (c) upon separation from service and attaining age
55; (ii) partial or complete redemptions in connection with a qualifying loan or
hardship withdrawal; (iii) complete redemptions in connection with termination
of employment, plan termination, transfer to another employer's plan or IRA or
changes in a plan's recordkeeper; and (iv) redemptions resulting from the return
of an excess contribution. Also, the following redemptions of shares held in an
IRA account are excluded from the application of the Frequent Trading Policy:
(i) redemptions made pursuant to an IRA systematic withdrawal based on the
shareholder's life expectancy including, but not limited to, substantially equal
periodic payments described in Code Section 72(t)(A)(iv) prior to age 59 1/2;
and (ii) redemptions to satisfy required minimum distributions after age 70 1/2
from an IRA account.
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GENERAL MATTERS
The Funds may encourage registered representatives and their firms to help
apportion their assets among bonds, stocks and cash, and may seek to participate
in programs that recommend a portion of their assets be invested in equity
securities, equity and debt securities, or equity and municipal securities.
To help advisors and investors better understand and more efficiently use
the Funds to reach their investment goals, the Funds may advertise and create
specific investment programs and systems. For example, this may include
information on how to use the Funds to accumulate assets for future education
needs or periodic payments such as insurance premiums. The Funds may produce
software, electronic information sites, or additional sales literature to
promote the advantages of using the Funds to meet these and other specific
investor needs.
The Funds have authorized one or more brokers to accept on its behalf
purchase and redemption orders. Such brokers are authorized to designate other
intermediaries to accept purchase and redemption orders on the
Funds' behalf. A Fund will be deemed to have received a purchase or redemption
order when an authorized broker or, if applicable, a broker's authorized
designee accepts the order. Customer orders received by such broker (or their
designee) will be priced at a Fund's net asset value next computed after they
are accepted by an authorized broker (or their designee). Orders accepted by an
authorized broker (or their designee) before the close of regular trading on the
NYSE will receive that day's share price; orders accepted after the close of
trading will receive the next business day's share price.
In addition, you may exchange Class I shares of the Fund for Class A
shares of a Fund without a sales charge if the current net asset value of those
Class I shares is at least $5,000 or you already own Class A shares of such
Fund.
Shares will be registered in the name of the investor's financial advisor.
A change in registration or transfer of shares held in the name of a financial
advisor may only be made by an order in good form from the financial advisor
acting on the investor's behalf.
For more information on the procedure for purchasing shares of the Funds
and on the special purchase programs available thereunder, see "Investment in
Fund Shares" and "Account Services" in the Funds' Prospectus.
The Funds do not issue share certificates.
DISTRIBUTION AND SERVICE PLAN
The Funds have adopted a plan (the "Plan") pursuant to Rule 12b-1 under
the 1940 Act, which provides that Class C and Class R3 shares are subject to an
annual distribution fee, and that Class A, Class C, Class F (where applicable)
and Class R3 shares are subject to an annual service fee. Class I shares are not
subject to either distribution or service fees.
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The distribution fee applicable to Class C and Class R3 shares under the
Funds' Plan will be payable to compensate FTP for services and expenses incurred
in connection with the distribution of Class C and Class R3 shares,
respectively. These expenses include payments to financial intermediaries,
including FTP, who are brokers of record with respect to the Class C and Class
R3 shares, as well as, without limitation, expenses of printing and distributing
Prospectuses to persons other than current shareholders of the Funds, expenses
of preparing, printing and distributing advertising and sales literature and
reports to shareholders used in connection with the sale of Class C and Class R3
shares, certain other expenses associated with the distribution of Class C and
Class R3 shares, and any distribution-related expenses that may be authorized
from time to time by the Board of Trustees.
The following table sets forth the amount of 12b-1 fees paid by the Funds
pursuant to the Plan and the amount of such fees retained by the Distributor for
the specified periods.
TOTAL AMOUNT OF 12B-1 FEES PAID TO THE TOTAL AMOUNT OF 12B-1 FEES RETAINED BY
DISTRIBUTOR THE DISTRIBUTOR
FISCAL YEAR FISCAL JANUARY FISCAL FISCAL
JANUARY 11, YEAR YEAR 11, 2011 YEAR YEAR
2011 ENDED ENDED TO ENDED ENDED
TO OCTOBER OCTOBER OCTOBER OCTOBER OCTOBER OCTOBER
31, 2011 31, 2012 31, 2013 31, 2011 31, 2012 31, 2013
FUND
First Trust Preferred
Securities and Income Fund
Class A $ 4,427 $ 90,487 $263,690 $ 1,231 $ 4,798 $ 43,001
Class C $10,437 $143,433 $536,305 $10,437 $103,902 $493,458
Class F $ 1 $ 1,808 $ 8,544 $ 0 $ 284 $ 2,623
Class R3 $ 5 $ 1,337 $ 2,869 $ 5 $ 1,337 $ 2,636
First Trust/Confluence Small
Cap Value Fund
Class A $ 221 $ 1,295 $ 2,251 $ 39 $ 81 $ 791
Class C $ 36 $ 3,455 $ 14,655 $ 36 $ 3,455 $ 10,307
Class R3 $ 5 $ 5 $ 7 $ 5 $ 5 $ 6
First Trust Short Duration High
Income Fund
Class A N/A N/A $ 36,751 N/A N/A $ 8,912
Class C N/A N/A $ 58,461 N/A N/A $ 47,404
Class I N/A N/A N/A N/A N/A N/A
|
The service fee applicable to Class A, Class C, Class F and Class R3
shares under the Funds' Plan will be payable to financial intermediaries in
connection with the provision of ongoing account services to shareholders. These
services may include establishing and maintaining shareholder accounts,
answering shareholder inquiries and providing other personal services to
shareholders.
Each Fund may pay up to 0.25 of 1% per year of the average daily net
assets of Class A shares as a service fee under the Plan as applicable to Class
A shares. Each Fund may pay up to 0.25 of 1% per year of the average daily net
assets of Class C shares as a service fee and up to 0.75 of 1% per year of the
average daily net assets of Class C shares under the Plan as applicable to Class
C shares as a distribution fee. The First Trust Preferred Securities and Income
Fund may pay up to 0.15 of 1% per year of the average daily net assets of Class
F shares as a service fee under the Plan as applicable to Class F shares. Each
Fund may pay up to and 0.25 of 1% per year of the average daily net assets of
Class R3 shares as a service fee and up to 0.25 of 1% per year of the average
daily net assets of Class R3 shares under the Plan as applicable to Class R3
shares as a distribution fee. The distribution fees applicable to Class C shares
and Class R3 shares constitute asset-based sales charges whose purpose is the
same as an up-front sales charge.
Under the Funds' Plan, each Fund will report quarterly to the Board of
Trustees for its review all amounts expended per class of shares under the Plan.
The Plan may be terminated at any time with respect to any class of shares,
without the payment of any penalty, by a vote of a majority of the Independent
Trustees who have no direct or indirect financial interest in the Plan or by
vote of a majority of the outstanding voting securities of such class. The Plan
may be renewed from year to year if approved by a vote of the Board of Trustees
and a vote of the Independent Trustees who have no direct or indirect financial
interest in the Plan cast in person at a meeting called for the purpose of
voting on the Plan. The Plan may be continued only if the trustees who vote to
approve such continuance conclude, in the exercise of reasonable business
judgment and in light of their fiduciary duties under applicable law, that there
is a reasonable likelihood that the Plan will benefit the Funds and their
shareholders. The Plan may not be amended to increase materially the cost which
a class of shares may bear under the Plan without the approval of the
shareholders of the affected class, and any other material amendments of the
Plan must be approved by the Independent Trustees by a vote cast in person at a
meeting called for the purpose of considering such amendments. During the
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continuance of the Plan, the selection and nomination of the Independent
Trustees of the Trust will be committed to the discretion of the Independent
Trustees then in office.
FEDERAL TAX MATTERS
This section summarizes some of the main U.S. federal income tax
consequences of owning shares of a Fund. This section is current as of the date
of the Prospectus. Tax laws and interpretations change frequently, and these
summaries do not describe all of the tax consequences to all taxpayers. For
example, these summaries generally do not describe your situation if you are a
corporation, a non-U.S. person, a broker-dealer, or other investor with special
circumstances. In addition, this section does not describe your state, local or
foreign tax consequences.
This federal income tax summary is based in part on the advice of counsel
to the Funds. The Internal Revenue Service could disagree with any conclusions
set forth in this section. In addition, our counsel was not asked to review, and
has not reached a conclusion with respect to the federal income tax treatment of
the assets to be deposited in the Funds. This may not be sufficient for
prospective investors to use for the purpose of avoiding penalties under federal
tax law.
As with any investment, prospective investors should seek advice based on
their individual circumstances from their own tax advisor.
Each Fund intends to qualify annually and to elect to be treated as a
regulated investment company under the Internal Revenue Code of 1986, as amended
(the "Code").
To qualify for the favorable U.S. federal income tax treatment generally
accorded to regulated investment companies, each Fund must, among other things,
(a) derive in each taxable year at least 90% of its gross income from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of stock, securities or foreign currencies or other income
derived with respect to its business of investing in such stock, securities or
currencies, or net income derived from interests in certain publicly traded
partnerships; (b) diversify its holdings so that, at the end of each quarter of
the taxable year, (i) at least 50% of the market value of each Fund's assets is
represented by cash and cash items (including receivables), U.S. government
securities, the securities of other regulated investment companies and other
securities, with such other securities of any one issuer generally limited for
the purposes of this calculation to an amount not greater than 5% of the value
of each Fund's total assets and not greater than 10% of the outstanding voting
securities of such issuer, and (ii) not more than 25% of the value of its total
assets is invested in the securities (other than U.S. government securities or
the securities of other regulated investment companies) of any one issuer, or
two or more issuers which a Fund controls which are engaged in the same, similar
or related trades or businesses, or the securities of one or more of certain
publicly traded partnerships; and (c) distribute at least 90% of its investment
company taxable income (which includes, among other items, dividends, interest
and net short-term capital gains in excess of net long-term capital losses) and
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at least 90% of its net tax-exempt interest income each taxable year. There are
certain exceptions for failure to qualify if the failure is for reasonable cause
or is de minimis, and certain corrective action is taken and certain tax
payments are made by a Fund.
As regulated investment companies, the Funds generally will not be subject
to U.S. federal income tax on their investment company taxable income (as that
term is defined in the Code, but without regard to the deduction for dividends
paid) and net capital gain (the excess of net long-term capital gain over net
short-term capital loss), if any, that they distribute to shareholders. Each
Fund intends to distribute to its shareholders, at least annually, substantially
all of its investment company taxable income and net capital gain. If a Fund
retains any net capital gain or investment company taxable income, it will
generally be subject to federal income tax at regular corporate rates on the
amount retained. In addition, amounts not distributed on a timely basis in
accordance with a calendar year distribution requirement are subject to a
nondeductible 4% excise tax unless, generally, each Fund distributes during each
calendar year an amount equal to the sum of (1) at least 98% of its ordinary
income (not taking into account any capital gains or losses) for the calendar
year, (2) at least 98.2% of its capital gains in excess of its capital losses
(adjusted for certain ordinary losses) for the one-year period ending October 31
of the calendar year, and (3) any ordinary income and capital gains for previous
years that were not distributed during those years. In order to prevent
application of the excise tax, the Funds intend to make its distributions in
accordance with the calendar year distribution requirement. A distribution will
be treated as paid on December 31 of the current calendar year if it is declared
by a Fund in October, November or December with a record date in such a month
and paid by the Fund during January of the following calendar year. Such
distributions will be taxable to shareholders in the calendar year in which the
distributions are declared, rather than the calendar year in which the
distributions are received.
Subject to certain reasonable cause and de minimis exceptions, if a Fund
failed to qualify as a regulated investment company or failed to satisfy the 90%
distribution requirement in any taxable year, the Fund would be taxed as an
ordinary corporation on its taxable income (even if such income were distributed
to its shareholders) and all distributions out of earnings and profits would be
taxed to shareholders as ordinary income.
DISTRIBUTIONS
Dividends paid out of the Funds' investment company taxable income are
generally taxable to a shareholder as ordinary income to the extent of the
Fund's earnings and profits, whether paid in cash or reinvested in additional
shares. However, certain ordinary income distributions received from a Fund may
be taxed at capital gains tax rates. In particular, ordinary income dividends
received by an individual shareholder from regulated investment companies such
as the Funds are generally taxed at the same rates that apply to net capital
gain, provided that certain holding period requirements are satisfied and
provided the dividends are attributable to qualifying dividends received by each
Fund itself. Dividends received by the Funds from REITs and foreign corporations
are qualifying dividends eligible for this lower tax rate only in certain
circumstances. The Funds will provide notice to its shareholders of the amount
of any distributions that may be taken into account as a dividend which is
eligible for the capital gains tax rates. The Funds cannot make any guarantees
as to the amount of any distribution which will be regarded as a qualifying
dividend.
-74-
Under the "Health Care and Education Reconciliation Act of 2010," income
from a Fund may also be subject to a new 3.8% "Medicare tax" imposed for taxable
years beginning after 2012. This tax will generally apply to net investment
income if the taxpayer's adjusted gross income exceeds certain threshold
amounts, which are $250,000 in the case of married couples filing joint returns
and $200,000 in the case of single individuals.
A corporation that owns shares generally will not be entitled to the
dividends received deduction with respect to many dividends received from the
Funds because the dividends received deduction is generally not available for
distributions from regulated investment companies. However, certain ordinary
income dividends on shares that are attributable to qualifying dividends
received by the Funds from certain domestic corporations may be reported by the
Funds as being eligible for the dividends received deduction.
Distributions of net capital gain (the excess of net long-term capital
gain over net short-term capital loss), if any, properly reported as capital
gain dividends are taxable to a shareholder as long-term capital gains,
regardless of how long the shareholder has held Fund shares. Shareholders
receiving distributions in the form of additional shares, rather than cash,
generally will have a cost basis in each such share equal to the value of a
share of a Fund on the reinvestment date. A distribution of an amount in excess
of a Fund's current and accumulated earnings and profits will be treated by a
shareholder as a return of capital which is applied against and reduces the
shareholder's basis in his or her shares. To the extent that the amount of any
such distribution exceeds the shareholder's basis in his or her shares, the
excess will be treated by the shareholder as gain from a sale or exchange of the
shares.
Shareholders will be notified annually as to the U.S. federal income tax
status of distributions, and shareholders receiving distributions in the form of
additional shares will receive a report as to the value of those shares.
SALE OR EXCHANGE OF FUND SHARES
Upon the sale or other disposition of shares of the Funds, which a
shareholder holds as a capital asset, such a shareholder may realize a capital
gain or loss which will be long-term or short-term, depending upon the
shareholder's holding period for the shares. Generally, a shareholder's gain or
loss will be a long-term gain or loss if the shares have been held for more than
one year.
Any loss realized on a sale or exchange will be disallowed to the extent
that shares disposed of are replaced (including through reinvestment of
dividends) within a period of 61 days beginning 30 days before and ending 30
days after disposition of shares or to the extent that the shareholder, during
such period, acquires or enters into an option or contract to acquire,
substantially identical stock or securities. In such a case, the basis of the
shares acquired will be adjusted to reflect the disallowed loss. Any loss
realized by a shareholder on a disposition of Fund shares held by the
shareholder for six months or less will be treated as a long-term capital loss
to the extent of any distributions of long-term capital gain received by the
shareholder with respect to such shares.
-75-
NATURE OF FUND INVESTMENTS
Certain of the Funds' investment practices are 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 lower taxed long-term capital gain into higher taxed
short-term capital gain or ordinary income, (iii) convert an ordinary loss or a
deduction into a capital loss (the deductibility of which is more limited), (iv)
cause the Funds to recognize income or gain without a corresponding receipt of
cash, (v) adversely affect the time as to when a purchase or sale of stock or
securities is deemed to occur and (vi) adversely alter the characterization of
certain complex financial transactions.
FUTURES CONTRACTS AND OPTIONS
The Funds' transactions in Futures Contracts and options will be subject
to special provisions of the Code that, among other things, may affect the
character of gains and losses realized by the Funds (i.e., may affect whether
gains or losses are ordinary or capital, or short-term or long-term), may
accelerate recognition of income to the Funds and may defer Fund losses. These
rules could, therefore, affect the character, amount and timing of distributions
to shareholders. These provisions also (a) will require the Funds to
mark-to-market certain types of the positions in its portfolio (i.e., treat them
as if they were closed out), and (b) may cause the Funds to recognize income
without receiving cash with which to make distributions in amounts necessary to
satisfy the 90% distribution requirement for qualifying to be taxed as a
regulated investment company and the distribution requirements for avoiding
excise taxes.
INVESTMENTS IN CERTAIN FOREIGN CORPORATIONS
If a Fund holds an equity interest in any "passive foreign investment
companies" ("PFICs"), which are generally certain foreign corporations that
receive at least 75% of their annual gross income from passive sources (such as
interest, dividends, certain rents and royalties or capital gains) or that hold
at least 50% of their assets in investments producing such passive income, the
Fund could be subject to U.S. federal income tax and additional interest charges
on gains and certain distributions with respect to those equity interests, even
if all the income or gain is timely distributed to its shareholders. A Fund will
not be able to pass through to its shareholders any credit or deduction for such
taxes. A Fund may be able to make an election that could ameliorate these
adverse tax consequences. In this case, a Fund would recognize as ordinary
income any increase in the value of such PFIC shares, and as ordinary loss any
decrease in such value to the extent it did not exceed prior increases included
in income. Under this election, a Fund might be required to recognize in a year
income in excess of its distributions from PFICs and its proceeds from
dispositions of PFIC stock during that year, and such income would nevertheless
be subject to the distribution requirement and would be taken into account for
purposes of the 4% excise tax (described above). Dividends paid by PFICs are not
treated as qualified dividend income.
-76-
BACKUP WITHHOLDING
The Funds may be required to withhold U.S. federal income tax from all
taxable distributions and sale proceeds payable to shareholders who fail to
provide the Funds with their correct taxpayer identification number or to make
required certifications, or who have been notified by the Internal Revenue
Service that they are subject to backup withholding. Corporate shareholders and
certain other shareholders specified in the Code generally are exempt from such
backup withholding. This withholding is not an additional tax. Any amounts
withheld may be credited against the shareholder's U.S. federal income tax
liability.
NON-U.S. SHAREHOLDERS
U.S. taxation of a shareholder who, as to the United States, is a
nonresident alien individual, a foreign trust or estate, a foreign corporation
or foreign partnership ("non-U.S. shareholder") depends on whether the income of
a Fund is "effectively connected" with a U.S. trade or business carried on by
the shareholder.
In addition to the rules described in this section concerning the
potential imposition of withholding on distributions to non-U.S. persons,
distributions after June 30, 2014, to non-U.S. persons that are "financial
institutions" may be subject to a withholding tax of 30% unless an agreement is
in place between the financial institution and the U.S. Treasury to collect and
disclose information about accounts, equity investments, or debt interests in
the financial institution held by one or more U.S. persons or the institution is
a resident in a jurisdiction that has entered into such an agreement with the
U.S. Treasury. For these purposes, a "financial institution" means any entity
that (i) accepts deposits in the ordinary course of a banking or similar
business, (ii) holds financial assets for the account of others as a substantial
portion of its business, or (iii) is engaged (or holds itself out as being
engaged) primarily in the business of investing, reinvesting or trading in
securities, partnership interests, commodities or any interest (including a
futures contract or option) in such securities, partnership interests or
commodities. Dispositions of shares by such persons may be subject to such
withholding after December 31, 2016.
Distributions to non-financial non-U.S. entities (other than publicly
traded foreign entities, entities owned by residents of U.S. possessions,
-77-
foreign governments, international organizations, or foreign central banks)
after June 30, 2014, will also be subject to a withholding tax of 30% if the
entity does not certify that the entity does not have any substantial U.S.
owners or provide the name, address and TIN of each substantial U.S. owner.
Dispositions of shares by such persons may be subject to such withholding after
December 31, 2016.
Income Not Effectively Connected. If the income from a Fund is not
"effectively connected" with a U.S. trade or business carried on by the non-U.S.
shareholder, distributions of investment company taxable income will generally
be subject to a U.S. tax of 30% (or lower treaty rate), which tax is generally
withheld from such distributions.
Distributions of capital gain dividends and any amounts retained by a Fund
which are properly reported by the Fund as undistributed capital gains will not
be subject to U.S. tax at the rate of 30% (or lower treaty rate) unless the
non-U.S. shareholder is a nonresident alien individual and is physically present
in the United States for more than 182 days during the taxable year and meets
certain other requirements. However, this 30% tax on capital gains of
nonresident alien individuals who are physically present in the United States
for more than the 182 day period only applies in exceptional cases because any
individual present in the United States for more than 182 days during the
taxable year is generally treated as a resident for U.S. income tax purposes; in
that case, he or she would be subject to U.S. income tax on his or her worldwide
income at the graduated rates applicable to U.S. citizens, rather than the 30%
U.S. tax. In the case of a non-U.S. shareholder who is a nonresident alien
individual, the Funds may be required to withhold U.S. income tax from
distributions of net capital gain unless the non-U.S. shareholder certifies his
or her non-U.S. status under penalties of perjury or otherwise establishes an
exemption. If a non-U.S. shareholder is a nonresident alien individual, any gain
such shareholder realizes upon the sale or exchange of such shareholder's shares
of the Funds in the United States will ordinarily be exempt from U.S. tax unless
the gain is U.S. source income and such shareholder is physically present in the
United States for more than 182 days during the taxable year and meets certain
other requirements.
In the case of dividends with respect to taxable years of a Fund
beginning prior to 2014, distributions from the Fund that are properly reported
by the Fund as an interest-related dividend attributable to certain interest
income received by the Fund or as a short-term capital gain dividend
attributable to certain net short-term capital gain income received by the Fund
may not be subject to U.S. federal income taxes, including withholding taxes
when received by certain non-U.S. investors, provided that the Fund makes
certain elections and certain other conditions are met. In addition, capital
gains distributions attributable to gains from U.S. real property interests
(including certain U.S. real property holding corporations) will generally be
subject to United States withholding tax and will give rise to an obligation on
the part of the foreign shareholder to file a United States tax return.
Income Effectively Connected. If the income from a Fund is "effectively
connected" with a U.S. trade or business carried on by a non-U.S. shareholder,
then distributions of investment company taxable income and capital gain
dividends, any amounts retained by a Fund which are properly reported as
undistributed capital gains and any gains realized upon the sale or exchange of
shares of the Funds will be subject to U.S. income tax at the graduated rates
applicable to U.S. citizens, residents and domestic corporations. Non-U.S.
corporate shareholders may also be subject to the branch profits tax imposed by
the Code. The tax consequences to a non-U.S. shareholder entitled to claim the
benefits of an applicable tax treaty may differ from those described herein.
Non-U.S. shareholders are advised to consult their own tax advisors with respect
to the particular tax consequences to them of an investment in the Funds.
OTHER TAXATION
Fund shareholders may be subject to state, local and foreign taxes on
their Fund distributions. Shareholders are advised to consult their own tax
advisors with respect to the particular tax consequences to them of an
investment in the Funds.
-78-
DETERMINATION OF NET ASSET VALUE
The following information supplements and should be read in conjunction
with the section in the Prospectus entitled "Net Asset Value."
Each Fund's net asset value is determined for each class by dividing the
total value of the securities and other assets attributable to such class, less
liabilities attributable to such class, by the total number of shares
outstanding of each class. Under normal circumstances, daily calculation of the
net asset value will utilize the last closing price of each security held by a
Fund at the close of the market on which such security is principally listed.
Differences in net asset value of each class of the Fund's shares are generally
expected to be due to the daily expense accruals of the specified distribution
and service fees and transfer agency costs applicable to such class of shares
and the differential in the dividends that may be paid on each class of shares.
In determining net asset value, portfolio securities for a Fund for which
accurate market quotations are readily available will be valued by the Fund
accounting agent as follows:
(1) Common stocks and other equity securities listed on any
national or foreign exchange other than NASDAQ(R) and the London Stock
Exchange Alternative Investment Market ("AIM") are valued at the last sale
price on the exchange on which they are principally traded, or the
official closing price for NASDAQ(R) and AIM securities. Securities listed
on NASDAQ(R) or AIM are valued at the official closing price on the
business day as of which such value is being determined. Portfolio
securities traded on more than one securities exchange are valued at the
last sale price or official closing price, as applicable, 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.
(2) Securities traded in the OTC market are valued at the mean of
the bid and asked prices, if available, and otherwise at the closing bid
prices.
(3) Exchange-traded options and Futures Contracts will be valued at
the closing price in the market where such contracts are principally
traded.
(4) Forward foreign currency exchange contracts, which are traded
in the United States on regulated exchanges, are valued at the current
day's interpolated foreign exchange rate, as calculated using the current
day's spot rate, and the 30, 60, 90 and 180-day forward rates provided by
an independent pricing source or by certain independent dealers in such
contracts.
(5) Senior loan securities are generally valued by a pricing
service.
-79-
In addition, the following types of securities will be valued by the Fund
accounting agent as follows:
(1) Fixed-income securities are valued by the Fund accounting agent
using a pricing service.
(2) Fixed-income securities with remaining maturity of 60 days or
less when purchased are valued at cost adjusted for amortization of
premium and discretion of discounts.
(3) Repurchase agreements will be valued as follows. Overnight
repurchase agreements will be valued at cost. Term repurchase agreements
(i.e., those whose maturity exceeds seven days) will be valued by the
Pricing Committee at the average of the bid quotations obtained daily from
at least two recognized dealers.
The value of any portfolio security held by a Fund for which market
quotations are not readily available will be determined by First Trust in a
manner that most fairly reflects fair value of the security on the valuation
date, based on a consideration of all available information.
Certain securities may not be able to be priced by pre-established pricing
methods. Such securities may be valued by the Board of Trustees or its delegate
at fair value. These securities generally include but are not limited to,
restricted securities (securities which may not be publicly sold without
registration under the 1933 Act) for which a pricing service is unable to
provide a market price; securities whose trading has been formally suspended; a
security whose market price is not available from a pre-established pricing
source; a security with respect to which an event has occurred that is likely to
materially affect the value of the security after the market has closed but
before the calculation of Fund net asset value (as may be the case in foreign
markets on which the security is primarily traded) or make it difficult or
impossible to obtain a reliable market quotation; and a security whose price, as
provided by the pricing service, does not reflect the security's "fair value."
As a general principle, the current "fair value" of a security would appear to
be the amount which the owner might reasonably expect to receive for the
security upon their current sale. A variety of factors may be considered in
determining the fair value of such securities.
A Fund may suspend the right of redemption for the Fund only under the
following unusual circumstances: (a) when the NYSE is closed (other than
weekends and holidays) or trading is restricted; (b) when trading in the markets
normally utilized is restricted, or when an emergency exists as determined by
the SEC so that disposal of a Fund's investments or determination of its net
assets is not reasonably practicable; or (c) during any period when the SEC may
permit.
DIVIDENDS AND DISTRIBUTIONS
Dividend Reinvestment Service. The Funds automatically reinvest your
dividends, including capital gain dividends, in additional Fund shares unless
you request otherwise. You may request to have your dividends paid to you by
check, deposited directly into your bank account or invested in shares of
another First Trust Mutual Fund. For further information, contact your financial
advisor or call First Trust Funds at (800) 621-1675.
-80-
MISCELLANEOUS INFORMATION
Counsel. Chapman and Cutler LLP, 111 West Monroe Street, Chicago, Illinois
60603, is counsel to the Trust.
Independent Registered Public Accounting Firm. Deloitte & Touche LLP, 111
South Wacker Drive, Chicago, Illinois 60606, serves as the Funds' independent
registered public accounting firm. The firm audits each Fund's financial
statements and performs other related audit services.
FINANCIAL STATEMENTS
The audited financial statements and notes thereto for the Funds,
contained in the Annual Reports to Shareholders dated October 31, 2013, are
incorporated by reference into this SAI and have been audited by Deloitte &
Touche LLP, independent registered public accounting firm, whose report also
appears in each Annual Report and is also incorporated by reference herein. No
other parts of the Annual Reports are incorporated by reference herein. The
Annual Reports are available without charge by calling (800) 621-1675 or by
visiting the SEC's website at http://www.sec.gov.
-81-
APPENDIX A
First Trust Preferred Securities and Income Fund
------------------------------------------------
NAME OF BENEFICIAL OWNER SHARES OWNED % OF OUTSTANDING
SHARES OWNED
CLASS A
LPL FINANCIAL CORPORATION 287,887 7.75%
P.O. Box 509046, San Diego, CA 92150
UBS FINANCIAL SERVICES INC. 1,992,542 53.66%
100 Harbor Blvd., 5th Floor, Weehawken, NJ 07086
CLASS C
MORGAN STANLEY SMITH BARNEY 668,607 26.98%
2000 Westchester Avenue, Purchase, NY 10577
UBS FINANCIAL SERVICES INC. 779,315 31.45%
100 Harbor Blvd., 5th Floor, Weehawken, NJ 07086
CLASS F
NATIONAL FINANCIAL SERVICES LLC 68,597 40.33%
499 Washington Blvd., Jersey City, NJ 07310
RAYMOND JAMES & ASSOCIATES INC* 8,853 5.21%
880 Carillion Parkway, St. Petersburg, FL 33716
CLASS I
FIRST CLEARING LLC 193,052 8.18%
501 N. Broadway Street, St. Louis, MO 68102
MORGAN STANLEY SMITH BARNEY 1,234,731 52.33%
2000 Westchester Avenue, Purchase, NY 10577
NATIONAL FINANCIAL SERVICES LLC 523,275 22.18%
499 Washington Blvd., Jersey City, NJ 07310
CLASS R
FIRST TRUST PORTFOLIOS L.P. 12,725 53.91%
120 East Liberty Drive, Suite 400, Wheaton, Illinois 60187
JJB HILLIARD WL LYONS LLC * 2,808 11.90%
500 W. Jefferson Street, Suite 700, Louisville, KY 40202
JJB HILLIARD WL LYONS LLC * 1,872 7.93%
500 W. Jefferson Street, Suite 700, Louisville, KY 40202
JJB HILLIARD WL LYONS LLC * 2,808 11.90%
500 W. Jefferson Street, Suite 700, Louisville, KY 40202
JJB HILLIARD WL LYONS LLC * 1,451 6.15%
500 W. Jefferson Street, Suite 700, Louisville, KY 40202
First Trust/Confluence Small Cap Value Fund
-------------------------------------------
NAME OF BENEFICIAL OWNER SHARES OWNED % OF OUTSTANDING
SHARES OWNED
CLASS A
RBC CAPITAL MARKETS LLC 4,999 9.60%
RBC Plaza, P21, 60 South Sixth Street, Minneapolis, MN
55402
CLASS C
NONE TO REPORT
CLASS I
STIFEL NICOLAUS & COMPANY INC * 539 5.05%
501 N. Broadway Street, St. Louis, MO 68102
STIFEL NICOLAUS & COMPANY INC * 757 7.09%
501 N. Broadway Street, St. Louis, MO 68102
A-1
|
FIRST TRUST PORTFOLIOS L.P. 1,269 11.88%
120 East Liberty Drive, Suite 400, Wheaton, Illinois 60187
NATIONAL FINANCIAL SERVICES LLC 7,297 68.34%
499 Washington Blvd., Jersey City, NJ 07310
CLASS R
FIRST TRUST PORTFOLIOS L.P. 50 100%
120 East Liberty Drive, Suite 400, Wheaton, Illinois 60187
First Trust Short Duration High Income Fund
-------------------------------------------
NAME OF BENEFICIAL OWNER SHARES OWNED % OF OUTSTANDING
SHARES OWNED
CLASS A
LPL FINANCIAL CORPORATION 292,218 11.18%
P.O. Box 509046, San Diego, CA 92150
MORGAN STANLEY SMITH BARNEY 172,491 6.60%
2000 Westchester Avenue, Purchase, NY 10577
UBS FINANCIAL SERVICES INC. 1,440,414 55.11%
100 Harbor Blvd., 5th Floor, Weehawken, NJ 07086
CLASS C
MORGAN STANLEY SMITH BARNEY 253,114 31.09%
2000 Westchester Avenue, Purchase, NY 10577
UBS FINANCIAL SERVICES INC. 108,160 13.29%
100 Harbor Blvd., 5th Floor, Weehawken, NJ 07086
CLASS I
MORGAN STANLEY SMITH BARNEY 1,360,251 53.60%
2000 Westchester Avenue, Purchase, NY 10577
NATIONAL FINANCIAL SERVICES LLC 738,710 29.11%
499 Washington Blvd., Jersey City, NJ 07310
RELIANCE TRUST COMPANY 170,396 6.71%
1100 Abernathy Road, Suite 400, Atlanta GA 30328
* Record holder that does not beneficially hold the shares
|
A-2
APPENDIX B - PROXY VOTING GUIDELINES
ISS
An MSCI Brand
Transparency. Inclusiveness. Global Expertise.
2014 U.S. Proxy Voting Concise Guidelines
December 19, 2013
Institutional Shareholder Services Inc.
Copyright (C) 2013 by ISS
-B-1-
ISS' 2014 U.S. Proxy Voting Concise Guidelines
The policies contained herein are a sampling of select, key proxy voting
guidelines and are not exhaustive. A full listing of ISS' 2014
proxy voting guidelines can be found at:
http://www.issgovernance.com/policy/2014/policy_information
ROUTINE/MISCELLANEOUS
Auditor Ratification
Vote for proposals to ratify auditors unless any of the following apply:
o An auditor has a financial interest in or association with the
company, and is therefore not independent;
o There is reason to believe that the independent auditor has rendered
an opinion that is neither accurate nor indicative of the company's
financial position;
o Poor accounting practices are identified that rise to a serious level
of concern, such as: fraud; misapplication of GAAP, or material
weaknesses identified in Section 404 disclosures; or
o Fees for non-audit services ("Other" fees) are excessive.
Non-audit fees are excessive if:
o Non-audit ("other") fees > audit fees + audit-related fees + tax
compliance/preparation fees
o o o o o
BOARD OF DIRECTORS:
Voting on Director Nominees in Uncontested Elections
Four fundamental principles apply when determining votes on director nominees:
1. Accountability
2. Responsiveness
3. Composition
4. Independence
Generally vote for director nominees, except under the following circumstances:
1. Accountability
B-2
Vote against(1) or withhold from the entire board of directors (except new
nominees(2), who should be considered case-by-case) for the following:
Problematic Takeover Defenses
Classified Board Structure:
1.1. The board is classified, and a continuing director responsible for a
problematic governance issue at the board/committee level that would
warrant a withhold/against vote recommendation is not up for
election. All appropriate nominees (except new) may be held
accountable.
Director Performance Evaluation:
1.2. The board lacks accountability and oversight, coupled with sustained
poor performance relative to peers. Sustained poor performance is
measured by one- and three-year total shareholder returns in the
bottom half of a company's four-digit GICS industry group (Russell
3000 companies only). Take into consideration the company's
five-year total shareholder return and operational metrics.
Problematic provisions include but are not limited to:
o A classified board structure;
o A supermajority vote requirement;
o Either a plurality vote standard in uncontested director
elections or a majority vote standard with no plurality
carve-out for contested elections;
o The inability of shareholders to call special meetings;
o The inability of shareholders to act by written consent;
o A dual-class capital structure; and/or
o A non-shareholder-approved poison pill.
Poison Pills:
1.3. The company's poison pill has a "dead-hand" or "modified dead-hand"
feature. Vote against or withhold from nominees every year until
this feature is removed;
1.4. The board adopts a poison pill with a term of more than 12 months
("long-term pill"), or renews any existing pill, including any
"short-term" pill (12 months or less), without shareholder approval.
A commitment or policy that puts a newly adopted pill to a binding
shareholder vote may potentially offset an adverse vote
1 In general, companies with a plurality vote standard use "Withhold" as the
contrary vote option in director elections; companies with a majority vote
standard use "Against". However, it will vary by company and the proxy must
be checked to determine the valid contrary vote option for the particular
company.
2 A "new nominee" is any current nominee who has not already been elected by
shareholders and who joined the board after the problematic action in
question transpired. If ISS cannot determine whether the nominee joined the
board before or after the problematic action transpired, the nominee will be
considered a "new nominee" if he or she joined the board within the 12
months prior to the upcoming shareholder meeting.
B-3
recommendation. Review such companies with classified boards every
year, and such companies with annually elected boards at least once
every three years, and vote against or withhold votes from all
nominees if the company still maintains a non-shareholder-approved
poison pill; or
1.5. The board makes a material adverse change to an existing poison pill
without shareholder approval.
Vote case-by-case on all nominees if:
1.6. The board adopts a poison pill with a term of 12 months or less
("short-term pill") without shareholder approval, taking into
account the following factors:
o The date of the pill's adoption relative to the date of the
next meeting of shareholders--i.e., whether the company had
time to put the pill on ballot for shareholder ratification
given the circumstances;
o The issuer's rationale;
o The issuer's governance structure and practices; and
o The issuer's track record of accountability to shareholders.
Problematic Audit-Related Practices
Generally vote against or withhold from the members of the Audit Committee if:
1.7. The non-audit fees paid to the auditor are excessive (see discussion
under "Auditor Ratification");
1.8. The company receives an adverse opinion on the company's financial
statements from its auditor; or
1.9. There is persuasive evidence that the Audit Committee entered into
an inappropriate indemnification agreement with its auditor that
limits the ability of the company, or its shareholders, to pursue
legitimate legal recourse against the audit firm.
Vote case-by-case on members of the Audit Committee, and potentially the full
board, if:
1.10. Poor accounting practices are identified that rise to a level of
serious concern, such as: fraud, misapplication of GAA; and material
weaknesses identified in Section 404 disclosures. Examine the
severity, breadth, chronological sequence, and duration, as well as
the company's efforts at remediation or corrective actions, in
determining whether withhold/against votes are warranted.
Problematic Compensation Practices/Pay for Performance Misalignment
B-4
In the absence of an Advisory Vote on Executive Compensation ballot item or in
egregious situations, vote against or withhold from the members of the
Compensation Committee, and potentially the full board, if:
1.11. There is a significant misalignment between CEO pay and company
performance (pay for performance);
1.12. The company maintains significant problematic pay practices;
1.13. The board exhibits a significant level of poor communication and
responsiveness to shareholders;
1.14. The company fails to submit one-time transfers of stock options to a
shareholder vote; or
1.15. The company fails to fulfill the terms of a burn rate commitment
made to shareholders.
Vote case-by-case on Compensation Committee members (or, in exceptional cases,
the full board) and the Management Say-on-Pay proposal if:
1.16. The company's previous say-on-pay proposal received the support of
less than 70 percent of votes cast, taking into account:
o The company's response, including:
- Disclosure of engagement efforts with major institutional
investors regarding the issues that contributed to the low
level of support;
- Specific actions taken to address the issues that
contributed to the low level of support;
- Other recent compensation actions taken by the company;
o Whether the issues raised are recurring or isolated;
o The company's ownership structure; and
o Whether the support level was less than 50 percent, which
would warrant the highest degree of responsiveness.
Governance Failures
Under extraordinary circumstances, vote against or withhold from directors
individually, committee members, or the entire board, due to:
1.17. Material failures of governance, stewardship, risk oversight(3), or
fiduciary responsibilities at the company;
1.18. Failure to replace management as appropriate; or
1.19. Egregious actions related to a director's service on other boards
that raise substantial doubt about his or her ability to effectively
oversee management and serve the best interests of shareholders at
any company.
2. Responsiveness
3 Examples of failure of risk oversight include, but are not limited to:
bribery; large or serial fines or sanctions from regulatory bodies;
significant adverse legal judgments or settlements; hedging of company
stock; or significant pledging of company stock.
B-5
Vote case-by-case on individual directors, committee members, or the entire
board of directors, as appropriate, if:
2.1. The board failed to act on a shareholder proposal that received the
support of a majority of the shares cast in the previous year.
Factors that will be considered are:
o Disclosed outreach efforts by the board to shareholders in the
wake of the vote;
o Rationale provided in the proxy statement for the level of
implementation;
o The subject matter of the proposal;
o The level of support for and opposition to the resolution in
past meetings;
o Actions taken by the board in response to the majority vote
and its engagement with shareholders;
o The continuation of the underlying issue as a voting item on
the ballot (as either shareholder or management proposals);
and
o Other factors as appropriate.
2.2. The board failed to act on takeover offers where the majority of
shares are tendered;
2.3. At the previous board election, any director received more than 50
percent withhold/against votes of the shares cast and the company
has failed to address the issue(s) that caused the high
withhold/against vote;
2.4. The board implements an advisory vote on executive compensation on a
less frequent basis than the frequency that received the majority of
votes cast at the most recent shareholder meeting at which
shareholders voted on the say-on-pay frequency; or
2.5. The board implements an advisory vote on executive compensation on a
less frequent basis than the frequency that received a plurality,
but not a majority, of the votes cast at the most recent shareholder
meeting at which shareholders voted on the say-on-pay frequency,
taking into account:
o The board's rationale for selecting a frequency that is
different from the frequency that received a plurality;
o The company's ownership structure and vote results;
o ISS' analysis of whether there are compensation concerns or a
history of problematic compensation practices; and
o The previous year's support level on the company's say-on-pay
proposal.
B-6
3. Composition
Attendance at Board and Committee Meetings:
3.1. Generally vote against or withhold from directors (except new
nominees, who should be considered case-by-case(4)) who attend less
than 75 percent of the aggregate of their board and committee
meetings for the period for which they served, unless an acceptable
reason for absences is disclosed in the proxy or another SEC filing.
Acceptable reasons for director absences are generally limited to
the following:
o Medical issues/illness;
o Family emergencies; and
o Missing only one meeting (when the total of all meetings is
three or fewer).
3.2. If the proxy disclosure is unclear and insufficient to determine
whether a director attended at least 75 percent of the aggregate of
his/her board and committee meetings during his/her period of
service, vote against or withhold from the director(s) in question.
Overboarded Directors:
Vote against or withhold from individual directors who:
3.3. Sit on more than six public company boards; or
3.4. Are CEOs of public companies who sit on the boards of more than two
public companies besides their own--withhold only at their outside
boards(5).
4. Independence
Vote against or withhold from Inside Directors and Affiliated Outside Directors
when:
4.1. The inside or affiliated outside director serves on any of the three
key committees: audit, compensation, or nominating;
4.2. The company lacks an audit, compensation, or nominating committee so
that the full board functions as that committee;
4.3. The company lacks a formal nominating committee, even if the board
attests that the independent directors fulfill the functions of such
a committee; or
4.4. Independent directors make up less than a majority of the directors.
4 For new nominees only, schedule conflicts due to commitments made prior to
their appointment to the board are considered if disclosed in the proxy or
another SEC filing.
5 Although all of a CEO's subsidiary boards will be counted as separate
boards, ISS will not recommend a withhold vote from the CEO of a parent
company board or any of the controlled (>50 percent ownership) subsidiaries
of that parent, but will do so at subsidiaries that are less than 50 percent
controlled and boards outside the parent/subsidiary relationships.
B-7
o o o o o
Proxy Access
ISS supports proxy access as an important shareholder right, one that is
complementary to other best-practice corporate governance features. However, in
the absence of a uniform standard, proposals to enact proxy access may vary
widely; as such, ISS is not setting forth specific parameters at this time and
will take a case-by-case approach in evaluating these proposals.
Vote case-by-case on proposals to enact proxy access, taking into account, among
other factors:
o Company-specific factors; and
o Proposal-specific factors, including:
- The ownership thresholds proposed in the resolution (i.e.,
percentage and duration);
- The maximum proportion of directors that shareholders may
nominate each year; and
- The method of determining which nominations should appear
on the ballot if multiple shareholders submit nominations.
o o o o o
Proxy Contests--Voting for Director Nominees in Contested Elections
Vote case-by-case on the election of directors in contested elections,
considering the following factors:
o Long-term financial performance of the target company relative to its
industry;
o Management's track record;
o Background to the proxy contest;
o Qualifications of director nominees (both slates);
o Strategic plan of dissident slate and quality of critique against
management;
o Likelihood that the proposed goals and objectives can be achieved
(both slates);
o Stock ownership positions.
When the addition of shareholder nominees to the management card ("proxy access
nominees") results in a number of nominees on the management card which exceeds
the number of seats available for election, vote case-by-case considering the
same factors listed above.
o o o o o
SHAREHOLDER RIGHTS & DEFENSES
B-8
Poison Pills- Management Proposals to Ratify Poison Pill
Vote case-by-case on management proposals on poison pill ratification, focusing
on the features of the shareholder rights plan. Rights plans should contain the
following attributes:
o No lower than a 20% trigger, flip-in or flip-over;
o A term of no more than three years;
o No dead-hand, slow-hand, no-hand or similar feature that limits the
ability of a future board to redeem the pill;
o Shareholder redemption feature (qualifying offer clause); if the board
refuses to redeem the pill 90 days after a qualifying offer is
announced, 10 percent of the shares may call a special meeting or seek
a written consent to vote on rescinding the pill.
In addition, the rationale for adopting the pill should be thoroughly explained
by the company. In examining the request for the pill, take into consideration
the company's existing governance structure, including: board independence,
existing takeover defenses, and any problematic governance concerns.
o o o o o
Poison Pills- Management Proposals to Ratify a Pill to Preserve Net Operating
Losses (NOLs)
Vote against proposals to adopt a poison pill for the stated purpose of
protecting a company's net operating losses (NOL) if the term of the pill would
exceed the shorter of three years and the exhaustion of the NOL.
Vote case-by-case on management proposals for poison pill ratification,
considering the following factors, if the term of the pill would be the shorter
of three years (or less) and the exhaustion of the NOL:
o The ownership threshold to transfer (NOL pills generally have a
trigger slightly below 5 percent);
o The value of the NOLs;
o Shareholder protection mechanisms (sunset provision, or commitment to
cause expiration of the pill upon exhaustion or expiration of NOLs);
o The company's existing governance structure including: board
independence, existing takeover defenses, track record of
responsiveness to shareholders, and any other problematic governance
concerns; and
o Any other factors that may be applicable.
o o o o o
B-9
Shareholder Ability to Act by Written Consent
Generally vote against management and shareholder proposals to restrict or
prohibit shareholders' ability to act by written consent.
Generally vote for management and shareholder proposals that provide
shareholders with the ability to act by written consent, taking into account the
following factors:
o Shareholders' current right to act by written consent;
o The consent threshold;
o The inclusion of exclusionary or prohibitive language;
o Investor ownership structure; and
o Shareholder support of, and management's response to, previous
shareholder proposals.
Vote case-by-case on shareholder proposals if, in addition to the considerations
above, the company has the following governance and antitakeover provisions:
o An unfettered(6) right for shareholders to call special meetings at a
10 percent threshold;
o A majority vote standard in uncontested director elections;
o No non-shareholder-approved pill; and
o An annually elected board.
o o o o o
CAPITAL/RESTRUCTURING
Common Stock Authorization
Vote for proposals to increase the number of authorized common shares where the
primary purpose of the increase is to issue shares in connection with a
transaction on the same ballot that warrants support.
Vote against proposals at companies with more than one class of common stock to
increase the number of authorized shares of the class of common stock that has
superior voting rights.
Vote against proposals to increase the number of authorized common shares if a
vote for a reverse stock split on the same ballot is warranted despite the fact
that the authorized shares would not be reduced proportionally.
6 "Unfettered" means no restrictions on agenda items, no restrictions on the
number of shareholders who can group together to reach the 10 percent
threshold, and only reasonable limits on when a meeting can be called: no
greater than 30 days after the last annual meeting and no greater than 90
prior to the next annual meeting.
B-10
Vote case-by-case on all other proposals to increase the number of shares of
common stock authorized for issuance. Take into account company-specific factors
that include, at a minimum, the following:
o Past Board Performance:
- The company's use of authorized shares during the last three years
o The Current Request:
- Disclosure in the proxy statement of the specific purposes of the
proposed increase;
- Disclosure in the proxy statement of specific and severe risks to
shareholders of not approving the request; and
- The dilutive impact of the request as determined by an allowable
increase calculated by ISS (typically 100 percent of existing
authorized shares) that reflects the company's need for shares and
total shareholder returns.
o o o o o
Dual Class Structure
Generally vote against proposals to create a new class of common stock, unless:
o The company discloses a compelling rationale for the dual-class
capital structure, such as:
o The company's auditor has concluded that there is substantial doubt
about the company's ability to continue as a going concern; or
o The new class of shares will be transitory;
o The new class is intended for financing purposes with minimal or no
dilution to current shareholders in both the short term and long term;
and
o The new class is not designed to preserve or increase the voting power
of an insider or significant shareholder.
o o o o o
Preferred Stock Authorization
Vote for proposals to increase the number of authorized preferred shares where
the primary purpose of the increase is to issue shares in connection with a
transaction on the same ballot that warrants support.
Vote against proposals at companies with more than one class or series of
preferred stock to increase the number of authorized shares of the class or
series of preferred stock that has superior voting rights.
Vote case-by-case on all other proposals to increase the number of shares of
preferred stock authorized for issuance. Take into account company-specific
factors that include, at a minimum, the following:
B-11
o Past Board Performance:
- The company's use of authorized preferred shares during the last
three years;
o The Current Request:
- Disclosure in the proxy statement of the specific purposes for the
proposed increase;
- Disclosure in the proxy statement of specific and severe risks to
shareholders of not approving the request;
- In cases where the company has existing authorized preferred
stock, the dilutive impact of the request as determined by an
allowable increase calculated by ISS (typically 100 percent of
existing authorized shares) that reflects the company's need for
shares and total shareholder returns; and
- Whether the shares requested are blank check preferred shares that
can be used for antitakeover purposes.
o o o o o
Mergers and Acquisitions
Vote case-by-case on mergers and acquisitions. Review and evaluate the merits
and drawbacks of the proposed transaction, balancing various and sometimes
countervailing factors including:
o Valuation - Is the value to be received by the target shareholders (or
paid by the acquirer) reasonable? While the fairness opinion may
provide an initial starting point for assessing valuation
reasonableness, emphasis is placed on the offer premium, market
reaction and strategic rationale.
o Market reaction - How has the market responded to the proposed deal? A
negative market reaction should cause closer scrutiny of a deal.
o Strategic rationale - Does the deal make sense strategically? From
where is the value derived? Cost and revenue synergies should not be
overly aggressive or optimistic, but reasonably achievable. Management
should also have a favorable track record of successful integration of
historical acquisitions.
o Negotiations and process - Were the terms of the transaction
negotiated at arm's-length? Was the process fair and equitable? A fair
process helps to ensure the best price for shareholders. Significant
negotiation "wins" can also signify the deal makers' competency. The
comprehensiveness of the sales process (e.g., full auction, partial
auction, no auction) can also affect shareholder value.
o Conflicts of interest - Are insiders benefiting from the transaction
disproportionately and inappropriately as compared to non-insider
shareholders? As the result of potential conflicts, the directors and
officers of the company may be more likely to vote to approve a merger
than if they did not hold these interests. Consider whether these
interests may have influenced these directors and officers to support
or recommend the merger. The CIC figure presented in the "ISS
Transaction Summary" section of this report is an aggregate figure
that can in certain cases be a misleading indicator of the true value
transfer from shareholders to insiders. Where such figure appears to
be excessive, analyze the underlying assumptions to determine whether
a potential conflict exists.
o Governance - Will the combined company have a better or worse
governance profile than the current governance profiles of the
B-12
respective parties to the transaction? If the governance profile is to
change for the worse, the burden is on the company to prove that other
issues (such as valuation) outweigh any deterioration in governance.
o o o o o
COMPENSATION
Executive Pay Evaluation
Underlying all evaluations are five global principles that most investors expect
corporations to adhere to in designing and administering executive and director
compensation programs:
1. Maintain appropriate pay-for-performance alignment, with emphasis on
long-term shareholder value: This principle encompasses overall
executive pay practices, which must be designed to attract, retain,
and appropriately motivate the key employees who drive shareholder
value creation over the long term. It will take into consideration,
among other factors, the link between pay and performance; the mix
between fixed and variable pay; performance goals; and equity-based
plan costs;
2. Avoid arrangements that risk "pay for failure": This principle
addresses the appropriateness of long or indefinite contracts,
excessive severance packages, and guaranteed compensation;
3. Maintain an independent and effective compensation committee: This
principle promotes oversight of executive pay programs by directors
with appropriate skills, knowledge, experience, and a sound process
for compensation decision-making (e.g., including access to
independent expertise and advice when needed);
4. Provide shareholders with clear, comprehensive compensation
disclosures: This principle underscores the importance of informative
and timely disclosures that enable shareholders to evaluate executive
pay practices fully and fairly;
5. Avoid inappropriate pay to non-executive directors: This principle
recognizes the interests of shareholders in ensuring that compensation
to outside directors does not compromise their independence and
ability to make appropriate judgments in overseeing managers' pay and
performance. At the market level, it may incorporate a variety of
generally accepted best practices.
Advisory Votes on Executive Compensation--Management Proposals (Management
Say-on-Pay)
Vote case-by-case on ballot items related to executive pay and practices, as
well as certain aspects of outside director compensation.
B-13
Vote against Advisory Votes on Executive Compensation (Management
Say-on-Pay--MSOP) if:
o There is a significant misalignment between CEO pay and company
performance (pay for performance);
o The company maintains significant problematic pay practices;
o The board exhibits a significant level of poor communication and
responsiveness to shareholders.
Vote against or withhold from the members of the Compensation Committee and
potentially the full board if:
o There is no MSOP on the ballot, and an against vote on an MSOP is
warranted due to a pay for performance misalignment, problematic pay
practices, or the lack of adequate responsiveness on compensation
issues raised previously, or a combination thereof;
o The board fails to respond adequately to a previous MSOP proposal that
received less than 70 percent support of votes cast;
o The company has recently practiced or approved problematic pay
practices, including option repricing or option backdating; or
o The situation is egregious.
Vote against an equity plan on the ballot if:
o A pay for performance misalignment is found, and a significant portion
of the CEO's misaligned pay is attributed to non-performance-based
equity awards, taking into consideration:
- Magnitude of pay misalignment;
- Contribution of non-performance-based equity grants to overall
pay; and
- the proportion of equity awards granted in the last three fiscal
years concentrated at the named executive officer (NEO) level.
Primary Evaluation Factors for Executive Pay
Pay-for-Performance Evaluation
ISS annually conducts a pay-for-performance analysis to identify strong or
satisfactory alignment between pay and performance over a sustained period. With
respect to companies in the Russell 3000 index, this analysis considers the
following:
B-14
1. Peer Group(7) Alignment:
o The degree of alignment between the company's annualized TSR
rank and the CEO's annualized total pay rank within a peer
group, each measured over a three-year period.
o The multiple of the CEO's total pay relative to the peer group
median.
2. Absolute Alignment - the absolute alignment between the trend in CEO
pay and company TSR over the prior five fiscal years - i.e., the
difference between the trend in annual pay changes and the trend in
annualized TSR during the period.
If the above analysis demonstrates significant unsatisfactory long-term
pay-for-performance alignment or, in the case of non-Russell 3000 index
companies, misaligned pay and performance are otherwise suggested, our analysis
may include any of the following qualitative factors, if they are relevant to
the analysis to determine how various pay elements may work to encourage or to
undermine long-term value creation and alignment with shareholder interests:
o The ratio of performance- to time-based equity awards;
o The overall ratio of performance-based compensation;
o The completeness of disclosure and rigor of performance goals;
o The company's peer group benchmarking practices;
o Actual results of financial/operational metrics, such as growth in
revenue, profit, cash flow, etc., both absolute and relative to peers;
o Special circumstances related to, for example, a new CEO in the prior
FY or anomalous equity grant practices (e.g., bi-annual awards);
o Realizable pay(8) compared to grant pay; and
o Any other factors deemed relevant.
Problematic Pay Practices
The focus is on executive compensation practices that contravene the global pay
principles, including:
o Problematic practices related to non-performance-based compensation
elements;
o Incentives that may motivate excessive risk-taking; and
o Options Backdating.
7 The revised peer group is generally comprised of 14-24 companies that are
selected using market cap, revenue (or assets for certain financial firms),
GICS industry group and company's selected peers' GICS industry group with
size constraints, via a process designed to select peers that are closest to
the subject company in terms of revenue/assets and industry and also within
a market cap bucket that is reflective of the company's.
8 ISS research reports will include realizable pay for S&P1500 companies.
B-15
Problematic Pay Practices related to Non-Performance-Based Compensation Elements
Pay elements that are not directly based on performance are generally evaluated
case-by-case considering the context of a company's overall pay program and
demonstrated pay-for-performance philosophy. Please refer to ISS' Compensation
FAQ document for detail on specific pay practices that have been identified as
potentially problematic and may lead to negative recommendations if they are
deemed to be inappropriate or unjustified relative to executive pay best
practices. The list below highlights the problematic practices that carry
significant weight in this overall consideration and may result in adverse vote
recommendations:
o Repricing or replacing of underwater stock options/SARS without prior
shareholder approval (including cash buyouts and voluntary surrender
of underwater options);
o Excessive perquisites or tax gross-ups, including any gross-up related
to a secular trust or restricted stock vesting;
o New or extended agreements that provide for:
- CIC payments exceeding 3 times base salary and average/target/most
recent bonus;
- CIC severance payments without involuntary job loss or substantial
diminution of duties ("single" or "modified single" triggers);
- CIC payments with excise tax gross-ups (including "modified"
gross-ups).
Incentives that may Motivate Excessive Risk-Taking
o Multi-year guaranteed bonuses;
o A single or common performance metric used for short- and long-term
plans;
o Lucrative severance packages;
o High pay opportunities relative to industry peers;
o Disproportionate supplemental pensions; or
o Mega annual equity grants that provide unlimited upside with no
downside risk.
Factors that potentially mitigate the impact of risky incentives include
rigorous claw-back provisions and robust stock ownership/holding guidelines.
Options Backdating
The following factors should be examined case-by-case to allow for distinctions
to be made between "sloppy" plan administration versus deliberate action or
fraud:
o Reason and motive for the options backdating issue, such as
inadvertent vs. deliberate grant date changes;
o Duration of options backdating;
o Size of restatement due to options backdating;
o Corrective actions taken by the board or compensation committee, such
as canceling or re-pricing backdated options, the recouping of option
gains on backdated grants; and
B-16
o Adoption of a grant policy that prohibits backdating, and creates a
fixed grant schedule or window period for equity grants in the future.
Board Communications and Responsiveness
Consider the following factors case-by-case when evaluating ballot items related
to executive pay on the board's responsiveness to investor input and engagement
on compensation issues:
o Failure to respond to majority-supported shareholder proposals on
executive pay topics; or
o Failure to adequately respond to the company's previous say-on-pay
proposal that received the support of less than 70 percent of votes
cast, taking into account:
- The company's response, including:
o Disclosure of engagement efforts with major institutional
investors regarding the issues that contributed to the low
level of support;
o Specific actions taken to address the issues that contributed
to the low level of support;
o Other recent compensation actions taken by the company;
- Whether the issues raised are recurring or isolated;
- The company's ownership structure; and
- Whether the support level was less than 50 percent, which would
warrant the highest degree of responsiveness.
o o o o o
Frequency of Advisory Vote on Executive Compensation ("Say When on Pay")
Vote for annual advisory votes on compensation, which provide the most
consistent and clear communication channel for shareholder concerns about
companies' executive pay programs.
o o o o o
Voting on Golden Parachutes in an Acquisition, Merger, Consolidation, or
Proposed Sale
Vote case-by-case on say on Golden Parachute proposals, including consideration
of existing change-in-control arrangements maintained with named executive
officers rather than focusing primarily on new or extended arrangements.
Features that may result in an against recommendation include one or more of the
following, depending on the number, magnitude, and/or timing of issue(s):
o Single- or modified-single-trigger cash severance;
o Single-trigger acceleration of unvested equity awards;
o Excessive cash severance (>3x base salary and bonus);
o Excise tax gross-ups triggered and payable (as opposed to a provision
to provide excise tax gross-ups);
o Excessive golden parachute payments (on an absolute basis or as a
percentage of transaction equity value); or
B-17
o Recent amendments that incorporate any problematic features (such as
those above) or recent actions (such as extraordinary equity grants)
that may make packages so attractive as to influence merger agreements
that may not be in the best interests of shareholders; or
o The company's assertion that a proposed transaction is conditioned on
shareholder approval of the golden parachute advisory vote.
Recent amendment(s) that incorporate problematic features will tend to carry
more weight on the overall analysis. However, the presence of multiple legacy
problematic features will also be closely scrutinized.
In cases where the golden parachute vote is incorporated into a company's
advisory vote on compensation (management say-on-pay), ISS will evaluate the
say-on-pay proposal in accordance with these guidelines, which may give higher
weight to that component of the overall evaluation.
o o o o o
Equity-Based and Other Incentive Plans
Vote case-by-case on equity-based compensation plans. Vote against the equity
plan if any of the following factors apply:
o The total cost of the company's equity plans is unreasonable;
o The plan expressly permits repricing;
o A pay-for-performance misalignment is found;
o The company's three year burn rate exceeds the burn rate cap of its
industry group;
o The plan has a liberal change-of-control definition; or
o The plan is a vehicle for problematic pay practices.
SOCIAL/ENVIRONMENTAL ISSUES
Global Approach
Issues covered under the policy include a wide range of topics, including
consumer and product safety, environment and energy, labor standards and human
rights, workplace and board diversity, and corporate political issues. While a
variety of factors goes into each analysis, the overall principle guiding all
vote recommendations focuses on how the proposal may enhance or protect
shareholder value in either the short or long term.
Generally vote case-by-case, taking into consideration whether implementation of
the proposal is likely to enhance or protect shareholder value, and, in
addition, the following will also be considered:
o If the issues presented in the proposal are more appropriately or
effectively dealt with through legislation or government regulation;
B-18
o If the company has already responded in an appropriate and sufficient
manner to the issue(s) raised in the proposal;
o Whether the proposal's request is unduly burdensome (scope or
timeframe) or overly prescriptive;
o The company's approach compared with any industry standard practices
for addressing the issue(s) raised by the proposal;
o If the proposal requests increased disclosure or greater transparency,
whether or not reasonable and sufficient information is currently
available to shareholders from the company or from other publicly
available sources; and
o If the proposal requests increased disclosure or greater transparency,
whether or not implementation would reveal proprietary or confidential
information that could place the company at a competitive
disadvantage.
o o o o o
Political Activities
Lobbying
Vote case-by-case on proposals requesting information on a company's lobbying
(including direct, indirect, and grassroots lobbying) activities, policies, or
procedures, considering:
o The company's current disclosure of relevant lobbying policies, and
management and board oversight;
o The company's disclosure regarding trade associations or other groups
that it supports, or is a member of, that engage in lobbying
activities; and
o Recent significant controversies, fines, or litigation regarding the
company's lobbying-related activities.
o o o o o
Political Contributions
Generally vote for proposals requesting greater disclosure of a company's
political contributions and trade association spending policies and activities,
considering:
o The company's current disclosure of policies and oversight mechanisms
related to its direct political contributions and payments to trade
associations or other groups that may be used for political purposes,
including information on the types of organizations supported and the
business rationale for supporting these organizations; and
o Recent significant controversies, fines, or litigation related to the
company's political contributions or political activities.
B-19
Vote against proposals barring a company from making political contributions.
Businesses are affected by legislation at the federal, state, and local level;
barring political contributions can put the company at a competitive
disadvantage.
Vote against proposals to publish in newspapers and other media a company's
political contributions. Such publications could present significant cost to the
company without providing commensurate value to shareholders.
o o o o o
Political Ties
Generally vote against proposals asking a company to affirm political
nonpartisanship in the workplace, so long as:
o There are no recent, significant controversies, fines, or litigation
regarding the company's political contributions or trade association
spending; and
o The company has procedures in place to ensure that employee
contributions to company-sponsored political action committees (PACs)
are strictly voluntary and prohibit coercion.
Vote against proposals asking for a list of company executives, directors,
consultants, legal counsels, lobbyists, or investment bankers that have prior
government service and whether such service had a bearing on the business of the
company. Such a list would be burdensome to prepare without providing any
meaningful information to shareholders.
o o o o o
8. Foreign Private Issuers Listed on U.S. Exchanges
Vote against (or withhold from) non-independent director nominees at companies
which fail to meet the following criteria: a majority-independent board, and the
presence of an audit, a compensation, and a nomination committee, each of which
is entirely composed of independent directors.
Where the design and disclosure levels of equity compensation plans are
comparable to those seen at U.S. companies, U.S. compensation policy will be
used to evaluate the compensation plan proposals. Otherwise, they, and all other
voting items, will be evaluated using the relevant ISS regional or market proxy
voting guidelines.
o o o o o
DISCLOSURE/DISCLAIMER
This document and all of the information contained in it, including without
limitation all text, data, graphs, and charts (collectively, the "Information")
is the property of Institutional Shareholder Services Inc. (ISS), its
subsidiaries, or, in some cases third party suppliers.
B-20
The Information has not been submitted to, nor received approval from, the
United States Securities and Exchange Commission or any other regulatory body.
None of the Information constitutes an offer to sell (or a solicitation of an
offer to buy), or a promotion or recommendation of, any security, financial
product or other investment vehicle or any trading strategy, and ISS does not
endorse, approve, or otherwise express any opinion regarding any issuer,
securities, financial products or instruments or trading strategies.
The user of the Information assumes the entire risk of any use it may make or
permit to be made of the Information.
ISS MAKES NO EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS WITH RESPECT TO
THE INFORMATION AND EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING,
WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS,
NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY, AND FITNESS for A PARTICULAR
PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION.
Without limiting any of the foregoing and to the maximum extent permitted by
law, in no event shall ISS have any liability regarding any of the Information
for any direct, indirect, special, punitive, consequential (including lost
profits), or any other damages even if notified of the possibility of such
damages. The foregoing shall not exclude or limit any liability that may not by
applicable law be excluded or limited.
o o o o o
B-21
APPENDIX C
CONFLUENCE INVESTMENT MANAGEMENT LLC PROXY VOTING POLICIES AND PROCEDURES
1. INTRODUCTION
As a registered investment adviser, Confluence Investment Management LLC
("Confluence" or the "Adviser") has a fiduciary duty to act solely in the best
interests of its clients. If the client is a registered investment company under
the Investment Company Act of 1940 or the client requests Confluence to do so in
writing, the Adviser will vote proxy materials for its clients.
In cases where the client has delegated proxy voting responsibility and
authority to the Adviser, the Adviser has adopted and implemented the following
policies and procedures, which it believes are reasonably designed to ensure
that proxies are voted in the best interests of its clients. In pursuing this
policy, proxies should be voted in a manner that is intended to maximize value
to the client. In situations where Adviser accepts such delegation and agrees to
vote proxies, Adviser will do so in accordance with these Policies and
Procedures. The Adviser may delegate its responsibilities under these Policies
and Procedures to a third party, provided that no such delegation shall relieve
the Adviser of its responsibilities hereunder and the Adviser shall retain final
authority and fiduciary responsibility for such proxy voting.
2. GENERAL
a. In the event requests for proxies are received with respect to the voting
of equity securities on routine matters, such as election of directors or
approval of auditors, the proxies usually will be voted with management
unless the Adviser determines it has a conflict or the Adviser determines
there are other reasons not to vote with management. On non-routine
matters, such as amendments to governing instruments, proposals relating
to compensation and stock option and equity compensation plans, corporate
governance proposals and shareholder proposals, the Adviser will vote, or
abstain from voting if deemed appropriate, on a case by case basis in a
manner it believes to be in the best interest of the Company's
shareholders. In the event requests for proxies are received with respect
to debt securities, the Adviser will vote on a case by case basis in a
manner it believes to be in the best economic interest of the Company's
shareholders.
b. The Chief Compliance Officer or his/her designate is responsible for
monitoring Adviser's proxy voting actions and ensuring that (i) proxies
are received and forwarded to the appropriate decision makers; and (ii)
proxies are voted in a timely manner upon receipt of voting instructions.
The Adviser is not responsible for voting proxies it does not receive, but
will make reasonable efforts to obtain missing proxies.
c. The Chief Compliance Officer or his/her designate shall implement
procedures to identify and monitor potential conflicts of interest that
could affect the proxy voting process, including (i) significant client
relationships; (ii) other potential material business relationships; and
(iii) material personal and family relationships.
d. All decisions regarding proxy voting shall be determined by the Investment
Committee of the Adviser and shall be executed by the Chief Compliance
Officer or his/her designate. Every effort shall be made to consult with
the portfolio manager and/or analyst covering the security.
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e. The Adviser may determine not to vote a particular proxy, if the costs and
burdens exceed the benefits of voting (e.g., when securities are subject
to loan or to share blocking restrictions).
3. REGISTERED INVESTMENT COMPANIES
In cases in which the client is a registered investment company under the
Investment Company Act of 1940, delegates proxy voting (e.g., where Confluence
acts as a sub-adviser of a closed-end fund) and required by law, Confluence will
vote such proxies in the same proportion as the vote of all other shareholders
of the fund (i.e. "echo vote" or 'mirror vote"), unless otherwise required by
law. When required by law, Confluence will also echo vote proxies of securities
in unaffiliated investment vehicles. For example, section 12(d)(1)(F) of the
Investment Company Act of 1940 requires echo voting of registered investment
companies that sub-advise or manage securities of other registered investment
companies.
4. CONFLICTS OF INTEREST
In the event an employee determines that the Adviser has a conflict of interest
due to, for example, a relationship with a company or an affiliate of a company,
or for any other reason which could influence the advice given, the employee
will advise the Chief Compliance Officer who will advise the Investment
Committee, and the Investment Committee will decide whether the Adviser should
either (1) disclose to the client the conflict to enable the client to evaluate
the advice in light of the conflict or (2) disclose to the client the conflict
and decline to provide the advice.
The Adviser shall use commercially reasonable efforts to determine whether a
potential conflict may exist, and a potential conflict shall be deemed to exist
only if one or more of the managers of the Adviser actually knew or should have
known of the conflict. The Adviser is sensitive to conflicts of interest that
may arise in the proxy decision-making process and has identified the following
potential conflicts of interest:
o A principal of the Adviser or any person involved in the proxy
decision-making process currently serves on the Board of the portfolio
company.
o An immediate family member of a principal of the Adviser or any person
involved in the proxy decision-making process currently serves as a
director or executive officer of the portfolio company.
o The Adviser, any fund managed by the Adviser, or any affiliate holds a
significant ownership interest in the portfolio company.
This list is not intended to be exclusive. All employees are obligated to
disclose any potential conflict to the Adviser's Chief Compliance Officer.
If a material conflict is identified, Adviser management may (i) disclose the
potential conflict to the client and obtain consent; or (ii) establish an
ethical wall or other informational barriers between the person(s) that are
involved in the conflict and the persons making the voting decisions.
5. RECORDKEEPING The Chief Compliance Officer or his/her designate is
responsible for maintaining the following records:
o proxy voting policies and procedures;
o proxy statements (provided, however, that the Adviser may rely
on the Securities and Exchange Commission's EDGAR system if the issuer
filed its proxy statements via EDGAR or may rely on a third party as
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long as the third party has provided the Adviser with a copy of the
proxy statement promptly upon request);
o records of votes cast and abstentions; and
o any records prepared by the Adviser that were material to a
proxy voting decision or that memorialized a decision.
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APPENDIX D
STONEBRIDGE ADVISORS LLC
PROXY VOTING POLICIES
GENERAL POLICY.
The preferred securities in which we generally invest do not normally carry
proxy voting rights, and we do not anticipate acquiring equity securities that
have such rights. But in the event that a proxy vote is solicited on a security
held in client portfolios, Stonebridge will strive to cast its vote in the best
economic interests of the client, following the Proxy Voting Guidelines detailed
below.
Clients may obtain a copy of Stonebridge's Proxy Voting Policy as well as
information relating to how proxies were voted.
PROXY VOTING GUIDELINES.
We will normally vote proxies in accordance with the following guidelines unless
we determine that it is in the best economic interests of our clients do
otherwise:
o We will consider the proposal's expected impact on shareholder value and will
not consider any benefit to us, our employees or affiliates.
o We consider the reputation, experience and competence of a company's
management when we evaluate the merits of investing in a particular company, and
we invest in companies in which we believe management goals and shareholder
goals are aligned. Therefore, on most issues, we cast our votes in accordance
with management's recommendations. However, when we believe management's
position on a particular issue is not in the best interests our clients, we will
vote contrary to management's recommendation.
o With respect to a company's board of directors, we believe there should
be a majority of independent directors on company boards, and that audit,
compensation and nominating committees should consist solely of independent
directors. Therefore, we will normally vote in favor of proposals that insure
such independence.
o With respect to auditors, we believe that the relationship between a public
company and its auditors should be limited primarily to the audit engagement,
and we will normally vote in favor of proposals to prohibit or limit fees paid
to auditors for any services other than auditing or closely-related activities
that do not raise any appearance of impaired independence.
o With respect to equity-based compensation plans, we believe that appropriately
designed plans approved by a company's shareholders can be an effective way to
align the interests of long-term shareholders and the interests of management,
employees and directors. However, we will normally vote against plans that
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substantially dilute our ownership interest in the company or provide
participants with excessive awards. We will also normally vote in favor of
proposals to require the expensing of options.
o With respect to shareholder rights, we believe that all shareholders of a
company should have an equal voice and that barriers that limit the ability of
shareholders to effect corporate change and to realize the full value of their
investment are not desirable. Therefore, we will normally vote against proposals
for supermajority voting rights, against the adoption of poison pill plans, and
against proposals for different classes of stock with different voting rights.
o With respect to "social responsibility" issues, we believe that matters
related to a company's day-to-day business operations are primarily the
responsibility of management. We are focused on maximizing long-term shareholder
value and will normally vote against shareholder proposals requesting that a
company disclose or change certain business practices, unless we believe the
proposal would have a substantial, positive economic impact on the company.
o Sometimes a client will fund a new account with in-kind securities. When this
happens, we review the in-kind portfolio, retain those securities that fit
Stonebridge's strategies, and quickly sell the rest in order to produce cash
which can then be invested in the strategies. It may occur that a proxy vote
solicitation is received on a security that was received in-kind and slated for
immediate sale. It is our policy to vote "Abstain" on such securities, as we
claim no knowledge or expertise concerning securities that are outside of our
strategies, and have only transitory possession of them.
o In other circumstances, we may also decide to refrain from voting a particular
proxy. In these instances, we will document the reasons for our decision.
RESPONSIBILITY.
The CCO or his designee is responsible for the administration of the proxy
voting policy.
The Chief Investment Officer or his designee is responsible for voting and
submitting proxies and monitoring corporate actions of portfolio securities.
IMPLEMENTATION.
Implementation procedures are as follows:
o A description of the Proxy Voting Policy is disclosed in Form ADV Part 2A,
along with contact information for clients interested in requesting a copy of
the policy.
o An offer is made to all existing clients on an annual basis to allow them to
request, at no charge, a copy of the Proxy Voting Policy.
o When a proxy vote is required, the Chief Investment Officer or his designee
will maintain documentation of all proxies/corporate action information that was
received, records of how and when the proxies were voted.
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o Client requests for information regarding proxy votes or policies and
procedures will be forwarded to the CCO for a written response.
o The CCO periodically reviews documentation maintained by the Chief Investment
Officer to provide reasonable assurance that procedures are followed and proxies
are being voted in the best interest of the clients.
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APPENDIX E
STANDARD & POOR'S CREDIT RATING DEFINITIONS*
As published by Standard & Poor's
A Standard & Poor's issue credit rating is a forward-looking opinion about
the creditworthiness of an obligor with respect to a specific financial
obligation, a specific class of financial obligations, or a specific financial
program (including ratings on medium-term note programs and commercial paper
programs). It takes into consideration the creditworthiness of guarantors,
insurers, or other forms of credit enhancement on the obligation and takes into
account the currency in which the obligation is denominated. The opinion
reflects Standard & Poor's view of the obligor's capacity and willingness to
meet its financial commitments as they come due, and may assess terms, such as
collateral security and subordination, which could affect ultimate payment in
the event of default.
LONG-TERM ISSUE CREDIT RATINGS
Issue credit ratings are based, in varying degrees, on the following
considerations:
1. 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;
2. Nature of and provisions of the obligation;
3. Protection afforded by, and relative position of, the obligation in the
event of bankruptcy, reorganization, or other arrangement under the
laws of bankruptcy and other laws affecting creditors' rights.
The issue rating definitions are an assessment of default risk, but
may incorporate an assessment of relative seniority or ultimate recovery
in the event of default. Junior obligations are typically rated lower than
senior obligations, to reflect the lower priority in bankruptcy, as noted
above. (Such differentiation may apply when an entity has both senior and
subordinated obligations, secured and unsecured obligations, or operating
company and holding company obligations.)
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.
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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.
Obligations rated "BB," "B," "CCC," "CC" and "C" are regarded as
having significant speculative characteristics. "BB" indicates the least
degree of speculation and "C" the highest. While such obligations will
likely have some quality and protective characteristics, these may be
outweighed by large uncertainties or major exposures to adverse
conditions.
BB. An obligation rated "BB" is less vulnerable to nonpayment than
other speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which
could lead to the obligor's inadequate capacity to meet its financial
commitment on the obligation.
B. An obligation rated "B" is more vulnerable to nonpayment than
obligations rated "BB," but the obligor currently has the capacity to meet
its financial commitment on the obligation. Adverse business, financial,
or economic conditions will likely impair the obligor's capacity or
willingness to meet its financial commitment on the obligation.
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. A "C" rating is assigned to obligations that are currently highly
vulnerable to nonpayment, obligations that have payment arrearages allowed
by the terms of the documents, or obligations of an issuer that is the
subject of a bankruptcy petition or similar action which have not
experienced a payment default. Among others, the "C" rating may be
assigned to subordinated debt, preferred securities or other obligations
on which cash payments have been suspended in accordance with the
instrument's terms or when preferred securities is the subject of a
distressed exchange offer, whereby some or all of the issue is either
repurchased for an amount of cash or replaced by other instruments having
a total value that is less than par.
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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 grade 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. An obligation's rating is lowered to "D" upon completion of a
distressed exchange offer, whereby some or all of the issue is either
repurchased for an amount of cash or replaced by other instruments having
a total value that is less than par.
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.
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