|
First
Trust
Exchange-Traded
Fund IV |
Prospectus
First Trust High
Income Strategic Focus ETF
(formerly First Trust Strategic Income ETF)
(formerly First Trust Strategic Income ETF)
|
Ticker
Symbol: |
HISF |
|
Exchange: |
Nasdaq |
First
Trust High Income Strategic Focus ETF (the “Fund”) lists and
principally trades its shares on The Nasdaq Stock Market LLC (“Nasdaq” or the “Exchange”). Market prices may
differ to some degree from the net asset value of the shares. Unlike mutual
funds, the Fund issues and redeems shares at net asset value, only in large
specified blocks of shares called "Creation
Units."
The
Fund is a series of First Trust Exchange-Traded Fund IV (the “Trust”) and an actively
managed exchange-traded fund organized as a separate series of a registered
management investment company.
Except
when aggregated in Creation Units, the shares are not redeemable securities of
the Fund.
The
Securities and Exchange Commission has not approved or disapproved of 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
March 1,
2023
Summary
Information
(fees paid directly from your investment)
|
Maximum
Sales Charge (Load) Imposed on Purchases (as a percentage of offering
price) |
|
(expenses that you pay each year as a percentage of the value of your investment)
|
Management
Fees |
|
|
Distribution
and Service (12b-1) Fees |
|
|
Other
Expenses |
|
|
Acquired
Fund Fees and Expenses |
|
|
Total Annual
Fund Operating Expenses |
|
|
Fee Waiver
and Expense Reimbursement(1) |
|
|
Net Annual
Fund Operating Expenses(2) |
|
(1)
(2)
|
1
Year |
3
Years |
5
Years |
10
Years |
|
$ |
$ |
$ |
$ |
3
4
5
6
7
8
9
10
11
12
Calendar Year Total Returns as of 12/31
|
|
|
|
|
|
|
|
|
|
13
|
|
1
Year |
5
Years |
Since
Inception |
Inception
Date |
|
Return Before
Taxes |
- |
|
|
|
|
Return After
Taxes on Distributions |
- |
- |
|
|
|
Return After
Taxes on Distributions and Sale of Shares |
- |
|
|
|
|
Blended
Index(1) (reflects no
deduction for fees, expenses or
taxes) |
- |
|
|
|
|
Bloomberg
U.S. Aggregate Bond Index (reflects no deduction for
fees,
expenses or taxes) |
- |
|
|
|
|
Russell
3000® Index
(reflects no deduction for fees, expenses or
taxes) |
- |
|
|
|
|
Prior Blended
Index(2) (reflects no
deduction for fees, expenses
or
taxes) |
- |
|
|
|
(1)
(2)
Management
Investment
Advisor
First
Trust Advisors L.P. (“First
Trust”
or the “Advisor”)
Portfolio
Managers
The
following persons serve as portfolio managers of the Fund.
•
Daniel J. Lindquist,
Chairman of the Investment Committee and Managing Director of First
Trust;
•
David G. McGarel,
Chief Investment Officer, Chief Operating Officer and Managing Director of First
Trust;
•
Chris A. Peterson,
CFA, Senior Vice President of First Trust;
•
William Housey, CFA,
Managing Director of Fixed Income of First Trust; and
•
Steve Collins, CFA,
Senior Vice President of First Trust.
The
portfolio managers are primarily and jointly responsible for the day-to-day
management of the Fund. Daniel J. Lindquist, David G. McGarel and
William Housey have served as part of the portfolio management team of the Fund
since 2014. Chris A. Peterson has served as part of the portfolio management
team of the Fund since 2016. Steve Collins has served as part of the portfolio
management team of the Fund since 2021.
Purchase
and Sale of Fund Shares
The
Fund issues and redeems shares on a continuous basis, at net asset value, only
in large blocks of shares called “Creation Units.” Individual
shares of the Fund may only be purchased and sold on the secondary market
through a broker-dealer. Since
14
shares
of the Fund trade on securities exchanges in the secondary market at their
market price rather than their net asset value, the Fund’s
shares may trade at a price greater than (premium) or less than (discount) the
Fund’s net asset value. An investor may incur costs attributable to the
difference between the highest price a buyer is willing to pay to purchase
shares of the Fund (bid) and the lowest price a seller is willing to accept for
shares of the Fund (ask) when buying or selling shares in the secondary market
(the “bid-ask
spread”). Recent
information, including the Fund’s net asset value, market price, premiums and
discounts, bid-ask spreads and the median bid-ask spread for the Fund’s most
recent fiscal year, is available online at
https://www.ftportfolios.com/Retail/etf/home.aspx.
Tax
Information
The
Fund’s distributions are taxable and will generally be taxed as ordinary income
or capital gains. Distributions on shares held in a
tax-deferred account, while not immediately taxable, will be subject to tax when
the shares are no longer held in a tax-deferred account.
Payments
to Broker-Dealers and Other Financial Intermediaries
If you purchase
shares of the Fund through a broker-dealer, registered investment adviser, bank
or other financial intermediary (collectively, “intermediaries”), First Trust and
First Trust Portfolios L.P., the Fund’s distributor, 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 Fund's Investment Objectives and Strategies
The
Fund is a series of First Trust Exchange-Traded Fund IV and is regulated as an
“investment company” under the 1940 Act. The Fund is actively
managed and does not seek to track the performance of an index. The Fund’s
investment objectives are fundamental and may not be changed without approval by
the holders of a majority of the outstanding voting securities of the Fund.
Unless an investment policy is identified as being fundamental, all investment
policies included in this prospectus and the Fund's Statement of Additional
Information (“SAI”) are non-fundamental
and may be changed by the Board of Trustees of the Trust (the “Board”) without shareholder
approval. The Fund's primary investment objective is to seek risk-adjusted
income. The Fund’s secondary investment objective is capital appreciation. If
there is a material change to the Fund’s principal investment strategies, you
should consider whether the Fund remains an appropriate investment for you.
There is no guarantee that the Fund will achieve its investment
objectives.
Additional
Information on the Fund’s Strategy
Under
normal market conditions, the Fund seeks to achieve its investment objectives by
investing in a portfolio of U.S.-listed exchange-traded funds
(“Underlying
ETFs”)
that is designed to follow the High Income Model (the “High
Income Model”) developed by the
Fund’s investment advisor, First Trust Advisors L.P. (“First
Trust”
or the “Advisor”). The Fund, through
its investments in the Underlying ETFs comprising the High Income Model, seeks
to provide investors with a diversified income stream by holding a blend of
fixed income assets that are actively managed to seek levels of high income and
total return. The High Income Model is principally composed of ETFs for which
First Trust serves as investment advisor. Therefore, a significant portion of
the ETFs in which the Fund invests are advised by First Trust. However, the Fund
may also invest in ETFs other than First Trust ETFs.
The
Advisor employs a dynamic approach in selecting the Underlying ETFs that are
included in the High Income Model. In constructing the High
Income Model, the Advisor uses a disciplined process for reviewing the
macroeconomic outlook, policy drivers and asset level analysis that inform
portfolio construction and ongoing risk management. The process begins with a
robust, top-down review of macroeconomic factors including monetary and fiscal
policies, growth forecasts, trade and tax policies, global market views and
current market valuations. The process combines these factors with disciplined
bottom-up asset level analysis including views on rates, duration, credit,
currency and current asset valuations. The Advisor utilizes this process to
evaluate the relative attractiveness of the various fixed-income asset classes
in an attempt to best position the Fund to take advantage of market trends and
investment opportunities. The High Income Model is also designed to allow the
Advisor to adjust portfolio risk for the Model on an ongoing basis, consistent
with the Fund’s investment objective to seek risk-adjusted income.
The Fund may invest
in Underlying ETFs that invest principally in the following asset
classes:
•
U.S. government
securities (securities issued or guaranteed by the U.S. government, its agencies
or instrumentalities);
•
Corporate bonds
issued by investment-grade U.S. issuers;
•
Corporate bonds
issued by non-investment-grade issuers (commonly referred to as “junk”
bonds);
•
Senior loans (which
are generally structured with floating rates of interest);
•
Securitized debt
securities (including asset-backed securities and residential- and
commercial-mortgaged backed securities including securities issued
non-governmental issuers, known as “non-agency securities”);
•
Bonds issued by
issuers located outside of the United States, including issuers located in
emerging market countries, including bonds issued by sovereign and
quasi-sovereign entities (such bonds may be denominated in currencies other than
U.S. dollars); and
•
Hybrid capital
securities (securities with unique characteristics such as preferred securities,
convertible securities and contingent convertible securities).
The
High Income Model, and therefore the Fund, is actively-managed and is designed
to be responsive to market conditions. Therefore the Fund
may engage in frequent trading. However, the High Income Model, and therefore
the Fund's portfolio, is constructed subject to certain exposure limits. Through
its investments in the Underlying ETFs, the Advisor will seek to position the
Fund's portfolio to have no more than 60% exposure to U.S. high-yield securities
(consisting of U.S. high-yield corporate bonds and U.S. high-yield senior
loans); no more than 30% exposure to debt securities issued by non-U.S. issuers
(including issuers located in emerging market countries); no more than 20%
exposure to debt securities issued by emerging market issuers; no more than 20%
exposure to preferred securities; and no more than 10% exposure to convertible
bonds. In determining whether a security is classified as non-investment-grade,
the Advisor considers the lowest rating provided by
16
the
"big three" credit rating agencies. The Underlying ETFs may also invest in
defaulted securities, restricted securities, when-issued
securities, to-be-announced securities and delayed delivery securities and may
utilize repurchase agreements.
The
Fund will not utilize derivatives but may invest in Underlying ETFs that utilize
derivatives for various purposes, such as hedging some of the
risks associated with its portfolio, as a substitute for a position in an
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 or
to preserve capital.
The
Fund invests significantly in shares of the First Trust TCW Opportunistic Fixed
Income ETF (“FIXD”). See below for a
summary of FIXD’s principal investment strategies.
FIXD
Under normal market
conditions, FIXD pursues its objective by investing at least 80% of its net
assets (including investment borrowings) in fixed income
securities. FIXD’s investments principally include securities issued or
guaranteed by the U.S. government or its agencies, instrumentalities or U.S.
government-sponsored entities; Treasury Inflation Protected Securities;
residential and commercial mortgage-backed securities; asset-backed securities;
U.S. corporate bonds; fixed income securities issued by non-U.S. corporations
and governments, including issuers with significant ties to emerging market
countries; bank loans, including first lien senior secured floating rate bank
loans and covenant-lite loans; municipal bonds; collateralized loan obligations;
Rule 144A securities; and other debt securities bearing fixed, floating or
variable interest rates of any maturity. FIXD may also invest in preferred stock
and common stock. FIXD may invest a significant portion of its assets in
securitized investment products, including up to 50% of its total assets in
non-agency, non-government-sponsored entity
securities and privately-issued mortgage-related and other asset-backed
securities: residential mortgage-backed securities, commercial mortgage-backed
securities, asset-backed securities and CLOs (collectively, “Private
MBS/ABS”); up to 25% of
its total assets in non-agency residential mortgage-backed securities; up to 25%
of its total assets in non-agency commercial mortgage-backed securities and
CLOs; and up to 25% of its total assets in non-agency asset-backed securities.
FIXD may also utilize listed and over-the-counter traded derivatives instruments
including, but not limited to, futures, options, swap agreements (including
credit default swaps) and forward contracts for duration/yield curve management
and/or hedging purposes. FIXD may invest up to 25% of its total assets in
derivatives instruments that are traded “over-the-counter” and not through an
exchange to reduce currency, interest rate or credit risk arising from FIXD’s
investments (that is, “hedge”). Additional information regarding FIXD, including
its prospectus and most recent annual report, is available without charge by
visiting
www.ftportfolios.com/Retail/Etf/EtfFundNews.aspx?Ticker=FIXD.
Fund
Investments
Principal
Investments
ETFs
The
Fund invests in ETFs, which are registered investment companies that trade on a
securities exchange. The shares of ETFs may, at times, trade
at a premium or discount to their net asset value. The Fund will incur brokerage
costs when purchasing and selling shares of ETFs. As a shareholder in an ETF,
the Fund will bear its ratable share of the ETF’s expenses, and would remain
subject to payment of the ETF’s advisory and administrative fees with respect to
assets so invested. Shareholders would therefore be subject to duplicative
expenses. Securities of ETFs may be leveraged, in which case the value and/or
yield of such securities will tend to be more volatile than securities of
unleveraged securities.
Generally,
investments in ETFs are subject to statutory limitations prescribed by the 1940
Act. These limitations include a prohibition on the
Fund acquiring more than 3% of the voting shares of any other investment
company, and a prohibition on the Fund investing more than 5% of its total
assets in the securities of any one investment company or more than 10% of its
total assets, in the aggregate, in investment company securities. However, the
Fund may rely on certain exemptions from the general statutory limitations to
invest in ETFs beyond those limitations, in accordance with Section 12 of the
1940 act and the rules thereunder.
Fixed
Income Securities
The
Fund will invest in ETFs that invest in fixed income securities. Fixed income
securities are generally issued by a government, corporation or other
entity to finance or expand operations. Fixed income securities generally
provide periodic payments and
17
the
eventual return of principal at maturity. Through its investments in the
Underlying ETFs, the Fund may have exposure to various types of
fixed income securities, including, but not limited to the
following:
Asset-Backed
Securities
Asset-backed
securities are securities backed by installment contracts, credit-card
receivables or other assets. Asset-backed securities represent
interests in “pools” of assets in which payments of both interest and principal
on the securities are made on a regular basis. The payments are, in effect,
“passed through” to the holder of the securities (net of any fees paid to the
issuer or guarantor of the securities). The average life of asset-backed
securities varies with the maturities of the underlying instruments and, as a
result of prepayments, can often be less than the original maturity of the
assets underlying the securities.
Convertible
Securities
Certain
Underlying ETFs may invest in convertible securities, which are generally bonds,
debentures, notes, preferred securities or other securities
or investments that may be converted or exchanged into equity securities (and/or
the cash equivalent thereof), which may be at a stated exchange ratio or
predetermined price (the “conversion
price”).
A convertible security is designed to provide current income and also the
potential for capital appreciation through the conversion feature, which enables
the holder to benefit from increases (if any) in the market price of the
underlying equity security. Accordingly, these equity-linked instruments offer
the potential for equity market participation along with, in light of their
bond-like characteristics, potential mitigated downside risk (which is generally
the risk that a security may suffer a decline in value) in periods of equity
market declines.
Contingent
Convertible Securities. Contingent
convertible securities (which generally provide for conversion under certain
circumstances) are distinguished as a subset of convertible securities. Similar
to mandatory convertible securities (and unlike traditional convertible
securities), some contingent convertible securities provide for mandatory
conversion under certain circumstances. The mandatory conversion might be
automatically triggered, for instance, if a company fails to meet the minimum
amount of capital described in the security, the company’s regulator makes a
determination that the security should convert or the company receives specified
levels of extraordinary public support. Since the common stock of the issuer may
not pay a dividend, investors in these instruments could experience a reduced
income rate, potentially to zero, and conversion would deepen the subordination
of the investor, hence worsening standing in a bankruptcy. Further, some
contingent convertible securities have a set stock conversion rate that would
cause a reduction in value of the security if the price of the stock is below
the conversion price on the conversion date. In addition, various contingent
convertible securities may contain features that limit an investor’s ability to
convert the security unless certain conditions are met.
Corporate
Debt Securities
The
Fund may invest in Underlying ETFs that hold corporate debt securities 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
differences 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 or floating
rates of interest.
Floating
Rate Securities
Certain
Underlying ETFs may invest in floating rate securities. Floating-rate and
fixed-to-floating rate securities may be traditional preferred
or hybrid capital securities. Floating-rate securities pay a rate of income that
resets periodically based on short and/or longer-term interest rate benchmarks.
If the associated interest rate benchmark rises, the coupon offered by the
floating-rate security may rise as well, making such securities less sensitive
to rising interest rates (or yields). Similarly, a fixed-to-floating rate
security may be less price sensitive to rising interest rates (or yields),
because it has a rate of payment that is fixed for a certain period (typically
five, ten or thirty years when first issued), after which period a floating-rate
of payment applies.
High
Yield Securities
Certain
underlying ETFs may invest in high yield securities. Securities that are rated
below investment grade (or securities that are unrated and
determined by the Advisor to be of comparable quality) are commonly referred to
as “high yield” or “junk” securities. High yield securities typically offer
higher yields than investment grade securities with similar maturities but
involve greater risks, including the possibility of default or bankruptcy, and
increased market price volatility.
18
Mortgage-Backed
Securities
Certain
Underlying ETFs may hold mortgage-backed securities, including commercial
mortgage-backed securities (“CMBS”) and residential
mortgage-backed securities (“RMBS”). Mortgage-backed
securities represent an interest in a pool of mortgage loans made by banks and
other financial institutions to finance purchases of homes, commercial buildings
and other real estate. The individual mortgage loans are packaged or “pooled”
together for sale to investors. As the underlying mortgage loans are paid off,
investors receive principal and interest payments. Mortgage-backed securities
may be fixed-rate or adjustable-rate mortgage-backed securities (“ARMS”). Certain
mortgage-backed securities (including RMBS and CMBS), where mortgage payments
are divided up between paying the loan’s principal and paying the loan’s
interest, are referred to as stripped mortgage-backed securities (“SMBS”). Further,
mortgage-backed securities can also be categorized as collateralized mortgage
obligations (“CMOs”) or real estate
mortgage investment conduits (“REMICs”) where they are
divided into multiple classes with each class being entitled to a different
share of the principal and/or interest payments received from the pool of
underlying assets.
Preferred
Securities
Certain
Underlying ETFs may invest in 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, 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.
Senior
Loans
Certain
Underlying ETFs may hold senior loans. Senior loans represent debt obligations
of sub-investment grade corporate borrowers, similar to
high yield bonds; however, senior loans are different from traditional high
yield bonds in that senior loans are typically senior to other obligations of
the borrower and generally secured by a lien on all or some portion of the
assets of the borrower. These loans are often arranged by a syndicate of banks
to refinance a borrower’s existing debt, to finance acquisitions, dividends,
leveraged buyouts, and for general corporate purposes. Senior loans may be
acquired by an underlying ETF in whole or through the purchase of a
participation. Senior loans rank at the top of a borrower’s capital structure in
terms of priority of payment, ahead of any subordinated debt or the borrower’s
preferred or common equity. These loans are often secured, as the holders of
these loans typically hold or share a first lien priority on most if not all of
the corporate borrower’s plant, property, equipment, receivables, cash balances,
licenses, trademarks, etc. Senior loans 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 loans are typically made to U.S.
and, to a lesser extent, non-U.S. corporations, partnerships and other business
entities which operate in various industries and geographical
regions.
The
senior loan market has seen a significant increase in loans with few or none of
the financial maintenance covenants (i.e., “covenant-lite
loans”) that have traditionally protected lenders including more aggressive
terms that favor borrowers with respect to restrictions regarding additional
debt, payment terms, income requirements and asset dispositions. A substantial
amount of the senior loans held by Underlying ETFs are expected to be
covenant-lite loans, meaning the ETFs may be unable to declare an event of
default if financial performance deteriorates, renegotiate the terms of the loan
based upon the elevated risk levels or take other actions to help mitigate
losses.
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 that 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.
Non-Principal
Investments
Cash
Equivalents and Short-Term Investments
Normally,
the Fund invests substantially all of its assets to meet its investment
objectives. The Fund may invest the remainder of its assets in
securities with maturities of less than one year or cash equivalents, or each
may hold cash. The percentage of the 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, the 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
19
achieve
its investment objectives. The Fund may adopt a defensive strategy when the
portfolio managers believe 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.
Illiquid
Investments
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 standard applicable to investment
companies, i.e., any investment that
the Fund reasonably expects cannot be sold or disposed of in current market
conditions in seven calendar days or less without the sale or disposition
significantly changing the market value of the investment). For this purpose,
illiquid investments may 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
Securities Act of 1933, as amended (the “Securities
Act”),
that are deemed to be illiquid, and certain repurchase agreements.
Disclosure
of Portfolio Holdings
The
Fund’s portfolio holdings are available on the Fund's website at
www.ftportfolios.com. A description of the policies and procedures with
respect to the disclosure of the Fund's portfolio securities is included in the
Fund's SAI, which is also available on the Fund's website.
Risks
of Investing in the Fund
Risk
is inherent in all investing. Investing in the Fund involves risk, including the
risk that you may lose all or part of your investment. There can
be no assurance that the Fund will meet its stated objectives. Before you
invest, you should consider the following disclosure pertaining to the Principal
Risks set forth above as well as additional Non-Principal Risks set forth below
in this prospectus. The order of the below risk factors does not indicate the
significance of any particular risk factor.
Principal
Risks
ASSET-BACKED
SECURITIES RISK. The Fund may invest
in Underlying ETFs that invest in asset-backed securities. Asset-backed
securities are debt securities typically created by buying and pooling loans or
other receivables other than mortgage loans and creating securities backed by
those similar type assets. They are typically issued by trusts and special
purpose co-purchasers that pass income from the underlying pool to investors. As
with other debt securities, asset-backed securities are subject to credit risk,
extension risk, interest rate risk, liquidity risk and valuation risk. Certain
asset-backed securities do not have the benefit of the same security interest in
the related collateral as do mortgage-backed securities, nor are they provided
government guarantees of repayment. Credit card receivables are generally
unsecured, and the debtors are entitled to the protection of a number of state
and federal consumer credit laws, many of which give such debtors the right to
set off certain amounts owed on the credit cards, thereby reducing the balance
due. In addition, some issuers of automobile receivables permit the servicers to
retain possession of the underlying obligations. If the servicer were to sell
these obligations to another party, there is a risk that the purchaser would
acquire an interest superior to that of the holders of the related automobile
receivables. The impairment of the value of collateral or other assets
underlying an asset-backed security, such as a result of non-payment of loans or
non-performance of underlying assets, may result in a reduction in the value of
such asset-backed securities and losses to an Underlying ETF.
ASSET
CONCENTRATION RISK. Since the Fund may
be comprised of a very small number of Underlying ETFs, the Fund’s performance
may be hurt disproportionately and significantly by the poor performance of
those Underlying ETFs to which it has significant exposure. Asset concentration
makes the Fund more susceptible to any single occurrence affecting the
Underlying ETFs and may subject the Fund to greater market risk than more
diversified funds.
AUTHORIZED
PARTICIPANT CONCENTRATION RISK. Only an authorized
participant may engage in creation or redemption transactions directly with the
Fund. A limited number of institutions act as authorized participants for the
Fund. However, participants are not obligated to make a market in the Fund’s
shares or submit purchase and redemption orders for creation units. To the
extent that these institutions exit the business, reduce their role or are
unable to proceed with creation and/or redemption orders and no other authorized
participant steps forward to create or redeem, the Fund’s shares may trade at a
premium or discount to the Fund’s net asset value and possibly face delisting
and the bid/ask spread on the Fund’s shares may widen.
BANK
LOANS RISK. The Fund may invest
in Underlying ETFs that hold bank loans. An Underlying ETF may invest in secured
and unsecured participations in bank loans and assignments of such loans. In
making investments in such loans, which are
20
made
by banks or other financial intermediaries to borrowers, an Underlying ETF will
depend primarily upon the creditworthiness of
the borrower for payment of principal and interest which will expose the
Underlying ETF to the credit risk of the underlying borrower. Participations by
an Underlying ETF in a lender's portion of a bank loan typically will result in
the Underlying ETF having a contractual relationship only with such lender, not
with the borrower. An Underlying ETF may have the right to receive payments of
principal, interest and any fees to which it is entitled only from the lender
selling a loan participation and only upon receipt by such lender of such
payments from the borrower, which exposes the Underlying ETF to the credit risk
of the lender. In connection with purchasing participations, an Underlying ETF
generally will have no right to enforce compliance by the borrower with the
terms of the loan agreement, nor any rights with respect to any funds acquired
by other lenders through set-off against the borrower, and an Underlying ETF may
not directly benefit from any collateral supporting the loan in which it has
purchased the participation. There is also the risk that the value of any
collateral securing a loan may decline and that the collateral may be
insufficient to cover the amount owed on the loan. The secondary market for bank
loans may not be highly liquid, and an Underlying ETF may have difficulty
selling bank loans (other than at a discount) and it may experience settlement
delays with respect to bank loan trades (in some cases longer than 7 days.
Further, loans held by an Underlying ETF may not be considered securities and,
therefore, purchasers, such as an Underlying ETF, may not be entitled to rely on
the anti-fraud protections of the federal securities laws and would be forced to
rely upon the contractual persons in the loan agreement and states law to
enforce its rights to repayment. Many of the loans in which an Underlying ETF
may invest or obtain exposure to may be “covenant-lite” loans. The amount of
public information available with respect to bank loans may be less extensive
than available for registered or exchange-traded securities. Covenant-lite loans
may contain fewer or no maintenance covenants compared to other loans and may
not include terms which allow the lender to monitor the performance of the
borrower and declare a default if certain criteria are breached. An Underlying
ETF may experience relatively greater realized or unrealized losses or delays in
enforcing its rights on its holdings of covenant-lite loans than its holdings of
loans with the usual covenants.
CALL
RISK.
The Fund invests in Underlying ETFs that hold debt securities. Some debt
securities may be redeemed at the option of the issuer, or “called,” before
their stated maturity date. In general, an issuer will call its debt securities
if they can be refinanced by issuing new debt securities which bear a lower
interest rate. An Underlying ETF is subject to the possibility that during
periods of falling interest rates an issuer will call its high yielding debt
securities. An Underlying ETF would then be forced to invest the unanticipated
proceeds at lower interest rates, likely resulting in a decline in the Fund’s
income. Such redemptions and subsequent reinvestments would also increase an
Underlying ETF’s portfolio turnover. If a called debt security was purchased by
an Underlying ETF at a premium, the value of the premium may be lost in the
event of a redemption.
CONTINGENT
CONVERTIBLE SECURITIES RISK. The Fund may invest
in Underlying ETFs that invest in contingent convertible securities. CoCos are
hybrid securities most commonly issued by banking institutions that present
risks similar to debt securities and convertible securities. CoCos are distinct
in that they are intended to either convert into equity or have their principal
written down upon the occurrence of certain “triggers.” When an issuer’s capital
ratio falls below a specified trigger level, or in a regulator’s discretion
depending on the regulator’s judgment about the issuer’s solvency prospects, a
CoCo may be written down, written off or converted into an equity security. Due
to the contingent write-down, write-off and conversion feature, CoCos may have
substantially greater risk than other securities in times of financial stress.
If the trigger level is breached, the issuer's decision to write down, write off
or convert a CoCo may be outside its control, and an Underlying ETF may suffer a
complete loss on an investment in CoCos with no chance of recovery even if the
issuer remains in existence. CoCos are usually issued in the form of
subordinated debt instruments to provide the appropriate regulatory capital
treatment. If an issuer liquidates, dissolves or winds-up before a conversion to
equity has occurred, the rights and claims of the holders of the CoCos (such as
an Underlying ETF) against the issuer generally rank junior to the claims of
holders of unsubordinated obligations of the issuer. In addition, if the CoCos
are converted into the issuer's underlying equity securities after a conversion
event (i.e., a “trigger”), each
holder will be further subordinated. CoCos also may have no stated maturity and
have fully discretionary coupons. This means coupon payments can be canceled at
the issuer’s discretion or at the request of the relevant regulatory authority
in order to help the bank absorb losses, without causing a default. In general,
the value of CoCos is unpredictable and is influenced by many factors including,
without limitation: the creditworthiness of the issuer and/or fluctuations in
such issuer's applicable capital ratios; supply and demand for CoCos; general
market conditions and available liquidity; and economic, financial and political
events that affect the issuer, its particular market or the financial markets in
general.
CONVERTIBLE
SECURITIES RISK. The
Fund may invest in ETFs that hold convertible securities. Convertible securities
are bonds, debentures, notes, preferred stocks or other securities that may be
converted or exchanged (by the holder or by the issuer, depending on the terms
of the securities) into shares of the underlying common stock (or cash or
securities of equivalent value) at a stated exchange ratio. If a convertible
security held by an Underlying ETF is called for redemption or conversion, the
Underlying ETF could be required to tender it for redemption, convert it into
the underlying equity security or sell it to a third party, which may have an
adverse effect on an Underlying ETF’s ability to achieve its investment
objective. The market
21
values of
convertible securities tend to decline as interest rates increase. However, a
convertible security’s market value also tends to reflect the market price of
the equity security of the issuing company, particularly when the price of the
equity security 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 equity security). Convertible securities are also exposed to the risk
that an issuer will be unable to meet its obligation to make dividend or
principal payments when due as a result of changing financial or market
conditions. Convertible debt securities generally offer lower interest or
dividend yields than non-convertible debt securities of similar credit quality
because of their potential for capital appreciation. Moreover, there can be no
assurance that convertible securities will provide current income prior to
conversion because the issuers of the convertible securities may default on
their obligations. If the convertible security has a conversion or call feature
that allows the issuer to redeem the security before the conversion date, the
potential for capital appreciation may be diminished. In the event that
convertible securities are not optional but mandatory based upon the price of
the underlying common stock, an Underlying ETF may be subject to additional
exposure to loss of income in situations where it would prefer to hold
debt.
COUNTERPARTY
RISK.
The Fund may invest in Underlying ETFs that are subject to counterparty risk. If
an Underlying ETF enters into an investment or transaction that depends on the
performance of another party, the Underlying ETF becomes subject to the credit
risk of that counterparty. The ability of an Underlying ETF to profit from these
types of investments and transactions depends on the willingness and ability of
the counterparty to perform its obligations. If a counterparty fails to meet its
contractual obligations, an Underlying ETF may be unable to terminate or realize
any gain on the investment or transaction, resulting in a loss to the Underlying
ETF. An Underlying ETF may experience significant delays in obtaining any
recovery in an insolvency, bankruptcy, or other reorganization proceeding
involving a counterparty (including recovery of any collateral posted by it) and
may obtain only a limited recovery or may obtain no recovery in such
circumstances. If an Underlying ETF holds collateral posted by its counterparty,
it may be delayed or prevented from realizing on the collateral in the event of
a bankruptcy or insolvency proceeding relating to the counterparty. Under
applicable law or contractual provisions, including if an Underlying ETF enters
into an investment or transaction with a financial institution and such
financial institution (or an affiliate of the financial institution) experiences
financial difficulties, then the Underlying ETF may in certain situations be
prevented or delayed from exercising its rights to terminate the investment or
transaction, or to realize on any collateral and may result in the suspension of
payment and delivery obligations of the parties under such investment or
transactions or in another institution being substituted for that financial
institution without the consent of an Underlying ETF. Further, an Underlying ETF
may be subject to “bail-in” risk under applicable law whereby, if required by
the financial institution's authority, the financial institution's liabilities
could be written down, eliminated or converted into equity or an alternative
instrument of ownership. A bail-in of a financial institution may result in a
reduction in value of some or all of securities and, if an Underlying ETF holds
such securities or has entered into a transaction with such a financial security
when a bail-in occurs, the Underlying ETF may also be similarly
impacted.
COVENANT-LITE
LOANS RISK. The Fund may invest
in Underlying ETFs that hold covenant-lite loans. The loan agreement, which sets
forth the terms of a loan and the obligations of the borrower and lender,
contains certain covenants that mandate or prohibit certain borrower actions,
including financial covenants that dictate certain minimum and maximum financial
performance levels. Covenants that require the borrower to maintain certain
financial metrics during the life of the loan (such as maintaining certain
levels of cash flow and limiting leverage) are known as “maintenance covenants.”
These covenants are included to permit the lender to monitor the performance of
the borrower and declare an event of default if breached, allowing the lender to
renegotiate the terms of the loan based upon the elevated risk levels or take
other actions to help mitigate losses. Covenant-lite loans contain fewer or no
maintenance covenants making an investment in these types of loans inherently
riskier than an investment in loans containing provisions allowing the lender
reprice credit risk associated with the borrower or restructure a problematic
loan. An Underlying ETF's’s elevated exposure to such loans during a downturn in
the credit cycle could cause the Fund to experience outsized
losses.
CREDIT
RATING AGENCY RISK.
Credit ratings are determined by credit rating agencies such as S&P Global
Ratings, Moody’s Investors Services, Inc. and Fitch Inc., and are only the
opinions of such entities. Ratings assigned by a rating agency are not absolute
standards of credit quality and do not evaluate market risk or the liquidity of
securities. Any shortcomings or inefficiencies in credit rating agencies’
processes for determining credit ratings may adversely affect the credit ratings
of securities held by the Fund and, as a result, may adversely affect those
securities’ perceived or actual credit risk.
CREDIT
RISK.
The Fund invests in Underlying ETFs that hold debt securities. An issuer or
other obligated party of a debt security may be unable or unwilling to make
dividend, interest and/or principal payments when due. In addition, the value of
a debt security may decline because of concerns about the issuer’s ability or
unwillingness to make such payments. Debt securities are subject to varying
degrees of credit risk which are often reflected in credit ratings. The credit
rating of a debt security may be lowered if the issuer or other obligated party
suffers adverse changes to its financial condition. These adverse changes
22
may
lead to greater volatility in the price of the debt security and affect the
security’s liquidity. 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. To the extent that an Underlying ETF holds debt
securities that are secured or guaranteed by financial institutions, changes in
credit quality of such financial institutions could cause values of the debt
security to deviate.
CREDIT
SPREAD RISK. The Fund invests in
Underlying ETFs that hold debt securities. From time to time, spreads
(i.e., the difference in
yield between debt securities that have different credit qualities or other
differences) may increase, which may reduce the market value of some of the debt
securities held by an Underlying ETF. While such an Underlying ETF may employ
strategies to mitigate credit spread risk, these strategies may not be
successful.
CURRENCY
RISK.
The Fund may invest in Underlying ETFs that are subject to currency risk.
Changes in currency exchange rates affect the value of investments denominated
in a foreign currency, the value of dividends and interest earned from such
securities and gains and losses realized on the sale of such securities. The
Fund’s net asset value could decline if a currency to which an Underlying ETF
has exposure depreciates against the U.S. dollar or if there are delays or
limits on repatriation of such currency. Currency exchange rates can be very
volatile and can change quickly and unpredictably. 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 non-U.S. holdings of an
Underlying ETF whose value is tied to the affected non-U.S. currency.
Additionally, the prices of non-U.S. securities that are traded in U.S. dollars
are often indirectly influenced by currency fluctuations.
CYBER
SECURITY RISK. The Fund is
susceptible to operational risks through breaches in cyber security. A breach in
cyber security refers to both intentional and unintentional events that may
cause the Fund to lose proprietary information, suffer data corruption or lose
operational capacity. Such events could cause the Fund to incur regulatory
penalties, reputational damage, additional compliance costs associated with
corrective measures and/or financial loss. These risks typically are not covered
by insurance. In general, cyber incidents can result from deliberate attacks or
unintentional events. Cyber incidents include, but are not limited to, gaining
unauthorized access to digital systems (e.g., through “hacking”
or malicious software coding) for purposes of misappropriating assets or
sensitive information, corrupting data or causing operational disruption. Cyber
attacks may also be carried out in a manner that does not require gaining
unauthorized access, such as causing denial-of-service attacks on websites
(i.e., efforts to make
network services unavailable to intended users). Cyber security failures by or
breaches of the systems of the Advisor, distributor and other service providers
(including, but not limited to, sub-advisors, index providers, fund accountants,
custodians, transfer agents and administrators), market makers, authorized
participants or the issuers of securities in which the Fund invests, have the
ability to cause disruptions and impact business operations, potentially
resulting in: financial losses; interference with the Fund’s ability to
calculate its net asset value; disclosure of confidential trading information;
impediments to trading; submission of erroneous trades or erroneous creation or
redemption orders; the inability of the Fund or its service providers to
transact business; violations of applicable privacy and other laws; regulatory
fines penalties, reputational damage, reimbursement or other compensation costs;
or additional compliance costs. Substantial costs may be incurred by the Fund in
order to resolve or prevent cyber incidents in the future. While the Fund has
established business continuity plans in the event of, and risk management
systems to prevent, such cyber attacks, there are inherent limitations in such
plans and systems, including the possibility that certain risks have not been
identified and that prevention and remediation efforts will not be successful.
Furthermore, the Fund cannot control the cyber security plans and systems put in
place by service providers to the Fund, issuers in which the Fund invests,
market makers or authorized participants. However, there is no guarantee that
such efforts will succeed, and the Fund and its shareholders could be negatively
impacted as a result.
DEBT
SECURITIES RISK. The Fund invests in
Underlying ETFs that hold debt securities. Investments in debt securities
subject the holder to the credit risk of the issuer. Credit risk refers to the
possibility that the issuer or other obligor of a security will not be able or
willing to make payments of interest and principal when due. Generally, the
value of debt securities will change inversely with changes in interest rates.
To the extent that interest rates rise, certain underlying obligations may be
paid off substantially slower than originally anticipated and the value of those
securities may fall sharply. During periods of falling interest rates, the
income received by an Underlying ETF may decline. If the principal on a debt
security is prepaid before expected, the prepayments of principal may have to be
reinvested in obligations paying interest at lower rates. Debt securities
generally do not trade on a centralized securities exchange making them
generally less liquid and more difficult to value than common stock. The values
of debt securities may also increase or decrease as a result of market
fluctuations, actual or perceived inability
23
or
unwillingness of issuers, guarantors or liquidity providers to make scheduled
principal or interest payments or illiquidity in debt securities
markets generally.
DEFAULTED
SECURITIES RISK. The Fund may invest
in Underlying ETFs that hold defaulted securities. Defaulted securities pose a
greater risk that principal will not be repaid than non-defaulted securities.
The reorganization or liquidation of an issuer of a defaulted security may
result in an Underlying ETF losing its entire investment or being required to
accept cash or securities with a value less than its original investment. It may
also be difficult to obtain complete and accurate information regarding the true
financial condition of the issuer of a defaulted security. Defaulted securities
and any securities received in an exchange for such securities may be subject to
restrictions on resale.
DERIVATIVES
RISK.
The Fund may invest in Underlying ETFs that use derivatives. The use of
derivative instruments involves risks different from, or possibly greater than,
the risks associated with investing directly in securities and other traditional
investments. These risks include: (i) the risk that the counterparty to a
derivative transaction may not fulfill its contractual obligations; (ii) risk of
mispricing or improper valuation; and (iii) the risk that changes in the value
of the derivative may not correlate perfectly with the underlying asset.
Derivative prices are highly volatile and may fluctuate substantially during a
short period of time. Such prices are influenced by numerous factors that affect
the markets, including, but not limited to: changing supply and demand
relationships; government programs and policies; national and international
political and economic events, changes in interest rates, inflation and
deflation and changes in supply and demand relationships. Trading derivative
instruments involves risks different from, or possibly greater than, the risks
associated with investing directly in securities. Derivative contracts
ordinarily have leverage inherent in their terms. The low margin deposits
normally required in trading derivatives, including futures contracts, permit a
high degree of leverage. Accordingly, a relatively small price movement may
result in an immediate and substantial loss. The use of leverage may also cause
an Underlying ETF to liquidate portfolio positions when it would not be
advantageous to do so in order to satisfy its obligations or to meet collateral
segregation requirements. The use of leveraged derivatives can magnify potential
for gain or loss and, therefore, amplify the effects of market volatility on
share price.
EMERGING
MARKETS RISK. The Fund may invest
in Underlying ETFs that hold securities of issuers located in emerging market
countries. Investments in securities issued by governments and companies
operating in emerging market countries involve additional risks relating to
political, economic, or regulatory conditions not associated with investments in
securities and instruments issued by U.S. companies or by companies operating in
other developed market countries. This is due to, among other things, the
potential for greater market volatility, lower trading volume, a lack of
liquidity, potential for market manipulation, higher levels of inflation,
political and economic instability, greater risk of a market shutdown and more
governmental limitations on foreign investments in emerging market countries
than are typically found in more developed market countries. Moreover, emerging
market countries often have less uniformity in accounting and reporting
requirements, unsettled securities laws, less reliable securities valuations and
greater risks associated with custody of securities than developed markets. In
addition, the Public Company Accounting Oversight Board, which regulates
auditors of U.S. public companies, is unable to inspect audit work papers in
certain emerging market countries. Emerging market countries often have greater
risk of capital controls through such measures as taxes or interest rate control
than developed markets. Certain emerging market countries may also lack the
infrastructure necessary to attract large amounts of foreign trade and
investment. Local securities markets in emerging market countries may trade a
small number of securities and may be unable to respond effectively to increases
in trading volume, potentially making prompt liquidation of holdings difficult
or impossible. Settlement procedures in emerging market countries are frequently
less developed and reliable than those in the U.S. and other developed market
countries. In addition, significant delays may occur in registering the transfer
of securities. Settlement or registration problems may make it more difficult
for an Underlying ETF to value its portfolio securities and could cause the
Underlying ETF to miss attractive investment opportunities. Investing in
emerging market countries involves a higher risk of expropriation,
nationalization, confiscation of assets and property or the imposition of
restrictions on foreign investments and on repatriation of capital invested by
certain emerging market countries. Enforcing legal rights may be made difficult,
costly and slow in emerging markets as there may be additional problems
enforcing claims against non-U.S. governments. As such, the rights and remedies
associated with emerging market investment securities may be different than
those available for investments in more developed markets. For example, it may
be more difficult for shareholders to bring derivative litigation or for U.S.
regulators to bring enforcement actions against issuers in emerging
markets.
In
addition, due to the differences in regulatory, accounting, audit and financial
recordkeeping standards, including financial disclosures, less
information about emerging market companies is publicly available and
information that is available may be unreliable or outdated. This may affect the
Index Provider’s ability to compute and construct the Index and may further
impede the Advisor’s ability to accurately evaluate the index data provided.
This potential for error in index construction and index data could affect the
overall performance of the Fund.
24
ETF
RISK.
Most ETFs use a “passive” investment strategy and seek to replicate the
performance of a market index. Such ETFs do not take defensive positions in
volatile or declining markets their shares may trade below net asset value.
While some ETFs seek to achieve the same return as a particular market index,
the performance of the ETF may diverge from the performance of the index. Some
ETFs are actively managed ETFs and do not track a particular index which
indirectly subjects an investor to active management risk. An active secondary
market in ETF shares may not develop or be maintained and may be halted or
interrupted due to actions by its listing exchange, unusual market conditions or
other reasons. There can be no assurance that an ETF’s shares will continue to
be listed on an active exchange. In addition, shareholders bear both their
proportionate share of the Fund’s expenses and, indirectly, the ETF’s expenses,
incurred through the Fund’s ownership of the ETF. Because the expenses and costs
of an ETF are shared by its investors, redemptions by other investors in the ETF
could result in decreased economies of scale and increased operating expenses
for such ETF. These transactions might also result in higher brokerage, tax or
other costs for the ETF. This risk may be particularly important when one
investor owns a substantial portion of the ETF. There is a risk that ETFs in
which the Fund invests may terminate due to extraordinary events. For example,
any of the service providers to ETFs, such as the trustee or sponsor, may close
or otherwise fail to perform their obligations to the ETF, and the ETF may not
be able to find a substitute service provider. Also, certain ETFs may be
dependent upon licenses to use various indexes as a basis for determining their
compositions and/or otherwise to use certain trade names. If these licenses are
terminated, the ETFs may also terminate. In addition, an ETF may terminate if
its net assets fall below a certain amount.
EXTENSION
RISK.
The Fund invests in Underlying ETFs that hold debt securities. Extension risk is
the risk that, when interest rates rise, certain obligations will be paid off by
the issuer (or other obligated party) more slowly than anticipated, causing the
value of these debt securities to fall. Rising interest rates tend to extend the
duration of debt securities, making them more sensitive to changes in interest
rates. The value of longer-term debt securities generally changes more in
response to changes in interest rates than shorter-term debt securities. As a
result, in a period of rising interest rates, securities may exhibit additional
volatility and may lose value. Extension risk is particularly prevalent for a
callable debt security where an increase in interest rates could result in the
issuer of that security choosing not to redeem the debt security as anticipated
on the security’s call date. Such a decision by the issuer could have the effect
of lengthening the debt security’s expected maturity, making it more vulnerable
to interest rate risk and reducing its market value.
FLOATING
RATE SECURITIES RISK. Certain ETFs in which the Fund may
invest hold floating rate securities. Floating rate securities are structured so
that the security’s coupon rate fluctuates based upon the level of a reference
rate. Most commonly, the coupon rate of a floating rate security is set in the
loan agreement at the level of a widely followed interest rate, plus a fixed
spread. As a result, it is expected that when interest rates change, the value
of floating rate securities will fluctuate less than the value fixed rate debt
securities. The coupon on floating rate securities will generally decline in a
falling interest rate environment, causing an Underlying ETF to experience a
reduction in the income it receives from the security. A floating rate
security’s coupon rate resets periodically according to the terms of the
security. Consequently, in a rising interest rate environment, floating rate
securities with coupon rates that reset infrequently may lag behind the changes
in market interest rates and may effect the value of the security. Floating rate
securities may also contain terms that impose a maximum coupon rate the issuer
will pay, regardless of the level of the reference rate which would decrease the
value of the security. The secondary market value of a floating rate security is
based on the volatility of the reference rate, the time remaining to maturity,
the outstanding amount of such securities, market interest rates and the credit
quality or perceived financial status of the issuer. Floating rate securities
may be less liquid than other types of securities.
HIGH
YIELD SECURITIES RISK. The Fund will invest
in Underlying ETFs that hold high yield securities. An investment by an
Underlying ETF in high yield securities, or “junk” bonds, may entail increased
credit risks and the risk that the value of an Underlying ETF’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 therefore
in the value of debt securities generally. High yield securities 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 debt
securities. As interest rates rise, the value of high yield securities may
decline precipitously. Increased rates may also indicate a slowdown in the
economy which may adversely affect the credit of issuers of high yield
securities resulting in a higher incidence of defaults among such issuers. 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.
The portfolio managers of an Underlying ETF cannot predict future economic
policies or their consequences or, therefore, the course or extent of any
similar market fluctuations in the future. In addition, high yield securities
are generally less liquid than investment grade securities.
HYBRID
CAPITAL SECURITIES RISK. The Fund may invest
in Underlying ETFs that hold hybrid capital securities. Hybrid capital
securities are securities which contain characteristics of both debt and equity
securities and are subject to many of the same
25
risks
as equity and debt securities. The claims of holders of hybrid capital
securities of an issuer are generally subordinated to those of holders
of traditional debt securities in bankruptcy, and thus hybrid capital securities
may be more volatile and subject to greater risk than traditional debt
securities, and may in certain circumstances be even more volatile than
traditional equity securities. At the same time, hybrid capital securities may
not fully participate in gains of their issuer and thus potential returns of
such securities are generally more limited than traditional equity securities,
which would participate in such gains. Hybrid capital securities may also be
more limited in their rights to participate in management decisions of an issuer
(such as voting for the board of directors). The terms of hybrid capital
securities may vary substantially and the risks of a particular hybrid capital
security will depend upon the terms of the instrument. Certain hybrid capital
securities may be more thinly traded and less liquid than either publicly issued
equity or debt securities, especially hybrid capital securities that are
“customized” to meet the needs of particular investors, potentially making it
difficult for the Fund to sell such securities at a favorable price or at all.
Any of these features could cause a loss in market value of hybrid capital
securities held by an Underlying ETF or otherwise adversely affect the
Fund.
INCOME
RISK.
The Fund invests in Underlying ETFs that hold income-producing securities. The
income of an Underlying ETF may decline when interest rates fall. This decline
can occur because an Underlying ETF may subsequently invest in lower-yielding
securities as debt securities in its portfolio mature, are near maturity or are
called, or an Underlying ETF otherwise needs to purchase additional debt
securities. In addition, the Fund’s income could decline when an Underlying ETF
experiences defaults on the debt securities it holds.
INFLATION
RISK.
The Fund invests in Underlying ETFs that hold securities that are subject to
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 present value of an Underlying ETF's assets
and distributions may decline. This risk is more prevalent with respect to debt
securities held by an Underlying ETF. Inflation creates uncertainty over the
future real value (after inflation) of an investment. Inflation rates may change
frequently and drastically as a result of various factors, including unexpected
shifts in the domestic or global economy, and the investments applicable, may
not keep pace with inflation, which may result in losses to Fund
investors.
INTEREST
RATE RISK. The Fund invests in
Underlying ETFs that hold securities that are subject to inflation risk. The
value of debt securities held by an Underlying ETF will fluctuate in value with
changes in interest rates. In general, debt securities will increase in value
when interest rates fall and decrease in value when interest rates rise. An
Underlying ETF may be subject to a greater risk of rising interest rates than
would normally be the case due to the current period of historically low rates
and the effect of potential government fiscal policy initiatives and resulting
market reaction to those initiatives. 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 debt security’s
expected life on a present value basis, taking into account the debt security’s
yield, interest payments and final maturity. Duration is a reasonably accurate
measure of a debt security’s price sensitivity to changes in interest rates. The
longer the duration of a debt security, the greater the debt security’s price
sensitivity is to changes in interest rates. Rising interest rates also may
lengthen the duration of debt securities with call features, since exercise of
the call becomes less likely as interest rates rise, which in turn will make the
securities more sensitive to changes in interest rates and result in even
steeper price declines in the event of further interest rate increases. An
increase in interest rates could also cause principal payments on a debt
security to be repaid at a slower rate than expected. This risk is particularly
prevalent for a callable debt security where an increase in interest rates could
cause the issuer of that security to not redeem the security as anticipated on
the call date, effectively lengthening the security’s expected maturity, in turn
making that security more vulnerable to interest rate risk and reducing its
market value. When interest rates fall, an Underlying ETF may be required to
reinvest the proceeds from the sale, redemption or early prepayment of a debt
security at a lower interest rate.
LIBOR
TRANSITION RISK. The
United Kingdom’s Financial Conduct Authority (“FCA”), which regulates LIBOR, intends to
cease making LIBOR available as a reference rate over a phase-out period that
began on January 1, 2022. However, subsequent
announcements by the FCA, the LIBOR administrators, and other regulators
indicate that it is possible that the most widely used LIBOR rates may continue
until mid-2023. The unavailability or replacement of LIBOR may affect the value,
liquidity or return on certain fund investments and may result in costs incurred
in connection with closing out positions and entering into new trades. Any
potential effects of the transition away from LIBOR on the Fund or on certain
instruments in which the Fund invests can be difficult to ascertain, and they
may vary depending on a variety of factors. In the United States, it is
anticipated that in many instances SOFR, will replace LIBOR as the reference
rate for many of the floating rate instruments held by the funds. There is no
assurance that the composition or characteristics of SOFR, or any alternative
reference rate, will be similar to or produce the same value or economic
equivalence as LIBOR or that instruments using an alternative rate will have the
same volume or liquidity. As a result, the transition process might lead to
increased volatility and reduced liquidity in markets that currently rely on
LIBOR to determine interest rates; a reduction in the value of some LIBOR-based
investments; increased
26
difficulty
in borrowing or refinancing and diminished effectiveness of any applicable
hedging strategies against instruments whose terms currently
include LIBOR; and/or costs incurred in connection with temporary borrowings and
closing out positions and entering into new agreements. Any such effects (as
well as other unforeseen effects) of the transition away from LIBOR and the
adoption of alternative reference rates could result in losses to the
Fund.
LIQUIDITY
RISK.
The Fund may invest in Underlying ETFs that have investments that it may not be
able to dispose of or close out readily at a favorable time or price (or at
all), or at a price approximating the valuation of the investment made by an
Underlying ETF. For example, certain investments may be subject to restrictions
on resale, may trade over-the-counter or in limited volume, or may not have an
active trading market. Illiquid securities may trade at a discount from
comparable, more liquid investments and may be subject to wide fluctuations in
market value. It may be difficult for an Underlying ETF to value illiquid
securities accurately. The market for certain investments may become illiquid
under adverse market or economic conditions independent of any specific adverse
changes in the conditions of a particular issuer. If an Underlying ETF needed to
sell a large block of illiquid securities to meet shareholder redemption request
or to raise cash, these sales could further reduce the securities’ prices and
adversely affect performance of the Fund. Disposal of illiquid securities may
entail registration expenses and other transaction costs that are higher than
those for liquid securities.
MANAGEMENT
RISK.
The Fund is subject to management risk because it is an actively managed
portfolio. In managing the Fund’s investment portfolio, the portfolio managers
will apply investment techniques and risk analyses that may not produce the
desired result. There can be no guarantee that the Fund will meet its investment
objective(s), meet relevant benchmarks or perform as well as other funds with
similar objectives.
MARKET
MAKER RISK. The Fund faces
numerous market trading risks, including the potential lack of an active market
for Fund shares due to a limited number of market markers. Decisions by market
makers or authorized participants to reduce their role or step away from these
activities in times of market stress could inhibit the effectiveness of the
arbitrage process in maintaining the relationship between the underlying values
of the Fund’s portfolio securities and the Fund’s market price. The Fund 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 the Fund’s net asset value and the price at which the Fund’s
shares are trading on the Exchange, which could result in a decrease in value of
the Fund’s shares. This reduced effectiveness could result in Fund shares
trading at a discount to net asset value and also in greater than normal
intraday bid-ask spreads for Fund shares.
MARKET
RISK. Market risk is the
risk that a particular security, or shares of the Fund in general, may fall in
value. Securities 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. Shares of the Fund could
decline in value or underperform other investments due to short-term market
movements or any longer periods during more prolonged market downturns. In
addition, local, regional or global events such as war, acts of terrorism,
spread of infectious diseases or other public health issues, recessions, or
other events could have a significant negative impact on the Fund and its
investments. For example, the coronavirus disease 2019 (COVID-19) global
pandemic and the ensuing policies enacted by governments and central banks have caused and may continue to cause
significant volatility and uncertainty in global financial markets, negatively
impacting global growth prospects. While the
U.S. has resumed “reasonably” normal
business activity, many countries continue to impose lockdown measures.
Additionally, there is no guarantee that vaccines will be effective against
emerging variants of the disease. Additionally, in February 2022, Russia invaded Ukraine
which has caused and could continue to
cause significant market disruptions and volatility within the markets in
Russia, Europe, and the United States. The hostilities and sanctions resulting from those
hostilities could have a significant impact on certain Fund investments as well
as Fund performance. These events also adversely affect the prices and liquidity
of the Fund’s portfolio securities or other instruments and could result in
disruptions in the trading markets. Any of such circumstances could have a
materially negative impact on the value of the Fund’s shares and result in
increased market volatility. During any such events, the Fund’s shares may trade
at increased premiums or discounts to their net asset value and the bid/ask
spread on the Fund’s shares may widen.
MORTGAGE-RELATED
SECURITIES RISK. The Fund may invest
in Underlying ETFs that hold mortgage-related securities. Mortgage-related
securities are subject to the same risks as investments in other types of debt
securities, including credit risk, interest rate risk, liquidity risk and
valuation risk. However, these investments make an Underlying ETF more
susceptible to adverse economic, political or regulatory events that affect the
value of real estate. Mortgage-related securities are also significantly
affected by the rate of prepayments and modifications of the mortgage loans
underlying those securities, as well as by other factors such as borrower
defaults, delinquencies, realized or liquidation losses and other shortfalls.
The incidence of borrower defaults or delinquencies may rise significantly
during financial downturns and could adversely affect the value of
mortgage-related securities held by an Underlying ETF. Events such as war, acts
of terrorism, spread of infectious diseases
27
or
other public health issues, recessions, or other events that result in broad and
simultaneous financial hardships for individuals and businesses could
have a significant negative impact on the value of mortgage-related securities.
Mortgage-related securities are particularly sensitive to prepayment risk, given
that the term to maturity for mortgage loans is generally substantially longer
than the expected lives of those securities. Nonetheless, the timing and amount
of prepayments cannot be accurately predicted. The timing of changes in the rate
of prepayments of the mortgage loans may significantly affect the actual yield
to maturity for an Underlying ETF on any mortgage-related securities, even if
the average rate of principal payments is consistent with the expectations of an
Underlying ETF. Along with prepayment risk, mortgage-related securities are
significantly affected by interest rate risk. In a low interest rate
environment, mortgage loan prepayments would generally be expected to increase
due to factors such as re-financings and loan modifications at lower interest
rates. In contrast, if prevailing interest rates rise, prepayments of mortgage
loans would generally be expected to decline and therefore extend the weighted
average lives of mortgage-related securities held or acquired by an Underlying
ETF. Investments in mortgage-backed securities issued by Ginnie Mae are backed
by the full faith and credit of the U.S. government. Fund investments in
mortgage-backed securities issued by Fannie Mae and Freddie Mac are not backed
by the full faith and credit of the U.S. government, and there can be no
assurance that the U.S. government would provide financial support to its
agencies or instrumentalities where it is not obligated to do so.
NON-AGENCY
SECURITIES RISK. The Fund may invest
in Underlying ETFs that hold non-agency securities. Investments in asset-backed
or mortgage-backed securities offered by non-governmental issuers, such as
commercial banks, savings and loans, private mortgage insurance companies,
mortgage bankers and other secondary market issuers are subject to additional
risks. There are no direct or indirect government or agency guarantees of
payments in loan pools created by non-government issuers. Securities issued by
private issuers are subject to the credit risks of the issuers. Timely payment
of interest and principal of non-governmental issuers is supported by various
forms of private insurance or guarantees, including individual loan, title, pool
and hazard insurance purchased by the issuer. There can be no assurance that the
private insurers can meet their obligations under the policies. Non-agency
securities are also not subject to the same underwriting requirements for the
underlying mortgages that are applicable to those mortgage-related securities
that have a government or government-sponsored entity guarantee. An unexpectedly
high rate of defaults on the loan pool may adversely affect the value of a
non-agency security and could result in losses to an Underlying ETF. The risk of
such defaults is generally higher in the case of loan pools that include
subprime loans. Subprime loans refer to loans made to borrowers with weakened
credit histories or with a lower capacity to make timely payments on their
loans. Non-agency securities are typically traded “over the counter” rather than
on a securities exchange and there may be a limited market for the securities,
especially when there is a perceived weakness in the mortgage and real estate
market sectors. Without an active trading market, the non-agency securities held
by an Underlying ETF may be particularly difficult to value because of the
complexities involved in assessing the value of the underlying
loans.
NON-U.S.
SECURITIES RISK. The Fund may invest
in Underlying ETFs that hold non-U.S. securities. An investment in securities of
non-U.S. companies involves risks not associated with domestic issuers.
Investment in non-U.S. securities may involve higher costs than investment in
U.S. securities, including higher transaction and custody costs as well as the
imposition of additional taxes by non-U.S. governments. Non-U.S. investments may
also involve risks associated with the level of currency exchange rates, less
complete financial information about the issuers, less market liquidity, more
market volatility and political instability. Future political and economic
developments, the possible imposition of withholding taxes on dividend income,
the possible seizure or nationalization of non-U.S. holdings, the imposition of
sanctions by foreign governments, the possible establishment of capital
controls, exchange controls or freezes on the convertibility of currency or the
adoption of other governmental restrictions might adversely affect an investment
in non-U.S. securities. Additionally, non-U.S. issuers may be subject to less
stringent regulation, and to different accounting, auditing and recordkeeping
requirements. The U.S. and non-U.S. markets often rise and fall at different
times or by different amounts due to economic or other regional developments
particular to a given country or region.
OPERATIONAL
RISK.
The Fund is subject to risks arising from various operational factors,
including, but not limited to, human error, processing and communication errors,
errors of the Fund’s service providers, counterparties or other third-parties,
failed or inadequate processes and technology or systems failures. The Fund
relies on third-parties for a range of services, including custody. Any delay or
failure relating to engaging or maintaining such service providers may affect
the Fund’s ability to meet its investment objective. Although the Fund and the
Fund’s investment advisor seek to reduce these operational risks through
controls and procedures, there is no way to completely protect against such
risks.
PORTFOLIO
TURNOVER RISK. High portfolio
turnover may result in the Fund and/or an Underlying ETF paying higher levels of
transaction costs, including brokerage commissions, dealer mark-ups and other
costs and may generate greater tax liabilities for shareholders. Portfolio
turnover risk may cause the Fund’s performance to be less than
expected.
28
PREFERRED
SECURITIES RISK. The Fund may invest
in Underlying ETFs that hold preferred securities. Preferred securities combine
some of the characteristics of both common stocks and bonds. Preferred
securities are typically subordinated to bonds and other debt securities in a
company’s capital structure in terms of priority to corporate income, subjecting
them to greater credit risk than those debt securities. Preferred securities
often 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. Generally,
holders of preferred securities 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 of director. Generally, once the
issuer pays all the arrearages, the preferred security holders no longer have
voting 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 or a change in regulatory trademark. As with
redemption provisions of debt securities, a special redemption by the issuer may
negatively impact the return of the preferred security held by an Underlying
ETF. Preferred securities may also be substantially less liquid than other
securities, including common stock.
PREMIUM/DISCOUNT
RISK. The market price
of the Fund’s shares will generally fluctuate in accordance with changes in the
Fund’s net asset value as well as the relative supply of and demand for shares
on the Exchange. First Trust cannot predict whether shares will trade below, at
or above their net asset value because the shares trade on the Exchange at
market prices and not at net asset value. Price differences may be due, in large
part, to the fact that supply and demand forces at work in the secondary trading
market for shares will be closely related, but not identical, to the same forces
influencing the prices of the holdings of the Fund trading individually or in
the aggregate at any point in time. However, given that shares can only be
purchased and redeemed in Creation Units, and only to and from broker-dealers
and large institutional investors that have entered into participation
agreements (unlike shares of closed-end funds, which frequently trade at
appreciable discounts from, and sometimes at premiums to, their net asset
value), First Trust believes that large discounts or premiums to the net asset
value of shares should not be sustained absent disruptions to the creation and
redemption mechanism, extreme market volatility or potential lack of authorized
participants. During stressed market conditions, the market for the Fund’s
shares may become less liquid in response to deteriorating liquidity in the
market for the Fund’s underlying portfolio holdings, which could in turn lead to
differences between the market price of the Fund’s shares and their net asset
value and the bid/ask spread on the Fund’s shares may widen.
PREPAYMENT
RISK.
The Fund invests in Underlying ETFs that hold debt securities. Prepayment risk
is the risk that the issuer of a debt security will repay principal (in part or
in whole) prior to the scheduled maturity date. Debt securities allowing
prepayment may offer less potential for gains during a period of declining
interest rates, as an Underlying ETF may be required to reinvest the proceeds of
any prepayment at lower interest rates, reducing its income. If an Underlying
ETF purchased the debt securities at a premium, prepayments on the securities
could cause the Underlying ETF to lose a portion of its principal investment.
These factors may cause the value of an investment in the Fund to change. The
impact of prepayments on the price of a debt security may be difficult to
predict and may increase the security’s volatility.
REPURCHASE
AGREEMENT RISK. The Fund may invest
in Underlying ETFs that utilize repurchase agreements. Repurchase agreements are
subject to the risk of failure. If an Underlying ETF’s counterparty defaults on
its obligations and the Underlying ETF is delayed or prevented from recovering
the collateral, or the value of the collateral is insufficient, the Underlying
ETF may realize a loss.
RESTRICTED
SECURITIES RISK. The Fund may invest
in Underlying ETFs that hold restricted securities. Restricted securities are
securities that cannot be offered for public resale unless registered under the
applicable securities laws or that have a contractual restriction that prohibits
or limits their resale. An Underlying ETF may be unable to sell a restricted
security on short notice or may be able to sell it only at a price below current
value.
SENIOR
LOAN RISK. The Fund may invest
in Underlying ETFs that hold senior loans. Senior loans represent debt
obligations of sub-investment grade corporate borrowers, similar to high yield
bonds; however, senior loans are different from traditional high yield bonds in
that senior loans are typically senior to other obligations of the borrower and
generally secured by the assets of the borrower. The senior loan market has seen
a significant increase in loans with limited financial maintenance covenants or,
in some cases, no financial maintenance covenants (i.e., “covenant-lite
loans”) that would typically be included in a traditional loan credit agreement
and general weakening of other restrictive covenants applicable to the borrower
such as limitations on incurrence of additional debt, restrictions on payments
of junior debt or restrictions on dividends and distributions, all of which may
impact recovery values and/or trading levels of senior loans in the future. The
absence of financial maintenance covenants in a loan agreement generally means
that the lender may be unable to declare a default if financial
29
performance
deteriorates. This may hinder the ability of an Underlying ETF to reprice credit
risk associated with the borrower and reduce the
ability of an Underlying ETF to restructure a problematic loan and mitigate
potential loss. As a result, the Fund’s exposure to losses on investments in
senior loans may be increased, especially during a downturn in the credit cycle
or changes in market or economic conditions.
Senior
loans are also subject to the same risks as investments in other types of debt
securities, including credit risk, interest rate risk, liquidity
risk and valuation risk that may be heightened because of the limited public
information available regarding senior loans and because loan borrowers may be
more highly leveraged and tend to be more adversely affected by changes in
market or economic conditions. If an Underlying ETF holds a senior loan through
another financial institution or relies on a financial institution to administer
the loan, its receipt of principal and interest on the loan may be subject to
the credit risk of that financial institution. Although senior loans are
generally secured by specific collateral, there can be no assurance that
liquidation of such collateral would satisfy the borrower’s obligation in the
event of non-payment of scheduled interest or principal or that such collateral
could be readily liquidated. To the extent that a senior loan is collateralized
by equity interests in the borrower or its subsidiaries, such equity interest
may lose all of its value in the event of the bankruptcy of the borrower.
Uncollateralized senior loans involve a greater risk of loss. Senior loans made
in connection with highly leveraged transactions are subject to greater risks
than other senior loans. For example, the risks of default or bankruptcy of the
borrower or the risks that other creditors of the borrower may seek to nullify
or subordinate the claims of an Underlying ETF on any collateral securing the
loan are greater in highly leveraged transactions.
Additionally,
there is no central clearinghouse for loan trades and the loan market has not
established enforceable settlement standards or remedies
for failure to settle. As such, the secondary market for senior loans may be
subject to irregular trading activity, wide bid/ask spreads and extended trade
settlement periods, which may cause an Underlying ETF to be unable to realize
the full value of its investment. Lastly, senior loans may not be considered
“securities,” and an Underlying ETF may not be entitled to rely on the
anti-fraud protections of the federal securities laws and could be forced to
rely on the contractual provisions in the loan agreement and state law to
enforce its right to repayment.
SIGNIFICANT
EXPOSURE RISK. To the extent that
an Underlying ETF invests a significant percentage of its assets in a single
asset class or the securities of issuers within the same country, state, region,
industry or sector, an adverse economic, business or political development that
affected a particular asset class, region or industry may affect the value of
the Fund’s investments more than if it were more broadly diversified. A
significant exposure makes an Underlying ETF more susceptible to any single
occurrence and may subject the Underlying ETF to greater volatility and market
risk than a fund that is more broadly diversified.
SOVEREIGN
AND QUASI-SOVEREIGN DEBT SECURITIES RISK. The Fund may invest
in sovereign and quasi-sovereign debt securities. Sovereign debt securities are
issued or guaranteed by foreign governmental entities. Investments in such
securities are subject to the risk that the relevant sovereign government or
governmental entity may delay or refuse to pay interest or repay principal on
its debt. Such delays or refusals may be due to cash flow problems, insufficient
foreign currency reserves, political considerations, the size of its debt
relative to the economy or the failure to put in place economic reforms required
by the International Monetary Fund or other multilateral agencies. A
governmental entity may default on its obligations or may require renegotiation
as to maturity or interest rate units of debt payments. Any restructuring of a
sovereign debt obligation held by an Underlying ETF will likely have a
significant adverse effect on the value of the obligation. A restricting or
default of sovereign debt security may cause additional impacts on financial
markets such as downgrades to credit ratings, disruptions in trading markets,
reduced liquidity and increase volatility. Additionally, an Underlying ETF may
be unable to pursue legal action against the sovereign issuer or to realize on
collateral securing the debt. The sovereign debt of many non-U.S. governments,
including their sub-divisions and instrumentalities, is rated below
investment-grade.
TRADING
ISSUES RISK. Trading in Fund
shares on the Exchange may be halted due to market conditions or for reasons
that, in the view of the Exchange, make trading in shares inadvisable. In
addition, trading in Fund shares on the Exchange is subject to trading halts
caused by extraordinary market volatility pursuant to the Exchange’s “circuit
breaker” rules. There can be no assurance that the requirements of the Exchange
necessary to maintain the listing of the Fund will continue to be met or will
remain unchanged. The Fund may have difficulty maintaining its listing on the
Exchange in the event the Fund’s assets are small, the Fund does not have enough
shareholders, or if the Fund is unable to proceed with creation and/or
redemption orders.
U.S.
GOVERNMENT SECURITIES RISK. The Fund invests in
Underlying ETFs that hold U.S. government securities. U.S. government securities
are subject to interest rate risk but generally do not involve the credit risks
associated with investments in other types of debt securities. As a result, the
yields available from U.S. government securities are generally lower than the
yields available from other debt securities. U.S. government securities are
guaranteed only as to the timely payment of interest and the payment of
principal when held to maturity. While securities issued or guaranteed by U.S.
federal government agencies (such as Ginnie Mae) are backed by the full faith
and credit of the U.S. Department of the Treasury, securities issued by
30
government
sponsored entities (such as Fannie Mae and Freddie Mac) are solely the
obligation of the issuer and generally do not carry any
guarantee from the U.S. government.
VALUATION
RISK. The Fund will invest in Underlying
ETFs that hold debt securities. The sale price the Underlying ETF could receive
for a security may differ from the Underlying ETF’s valuation of the security,
particularly for securities that trade in low volume or volatile markets or that
are valued using a fair value methodology. Unlike publicly traded securities
that trade on national securities exchanges, there is no central place or
exchange for trading most debt securities. Debt securities generally trade on an
“over-the-counter” market. Due to the lack of centralized information and
trading, and variations in lot sizes of certain debt securities, the valuation
of debt securities may carry more uncertainty and risk than that of publicly
traded securities. Debt securities are commonly valued by third-party pricing
services that utilize a range of market-based inputs and assumptions, including
readily available market quotations obtained from broker-dealers making markets
in such securities, cash flows and transactions for comparable instruments.
However, because the available information is less reliable and more subjective,
elements of judgment may play a greater role in valuation of debt securities
than for other types of securities. Different pricing services may incorporate
different assumptions and inputs into their valuation methodologies, potentially
resulting in different values for the same securities. As a result, if the
Advisor were to change its valuation policies, or if the Underlying ETF were to
change pricing services, or if a pricing service were to change its valuation
methodology, there could be a material impact, either positive or negative, on
the Underlying ETF’s net asset value. Additionally, pricing services generally
price debt securities assuming orderly transactions of an institutional “round
lot” size, but some trades may occur in smaller, “odd lot” sizes, often at lower
prices than institutional round lot trades. There is no assurance that the
Underlying ETF will be able to sell a portfolio security at the price
established by the pricing service, which could result in a loss to the
Underlying ETF and, in turn, the Fund. In addition, the value of the debt
securities in the Underlying ETF’s portfolio may change on days or during time
periods when shareholders will not be able to purchase or sell the Underlying
ETF’s shares. Net asset value calculation may also be impacted by operational
risks arising from factors such as failures in systems and
technology.
WHEN-ISSUED,
TBA AND DELAYED DELIVERY TRANSACTIONS RISK. The Fund may invest
in Underlying ETFs that purchase securities on a when-issued, TBA, delayed
delivery or forward commitment basis. In such a transaction, the purchase price
of the securities is typically fixed at the time of the commitment, but delivery
and payment can take place a month or more after the date of the commitment. At
the time of delivery of the securities, the value may be more or less than the
purchase or sale price. Purchasing securities on a when-issued, TBA, delayed
delivery or forward commitment basis may give rise to investment leverage and
may increase the Underlying ETF’s volatility. Default by, or bankruptcy of, a
counterparty to a when-issued, TBA or delayed delivery transaction would expose
the Underlying ETF to possible losses because of an adverse market action,
expenses or delays in connection with the purchase or sale of the pools
specified in such transaction. The Financial Industry Regulatory Authority
recently imposed mandatory margin requirements for certain types of when-issued,
TBA, delayed delivery or forward commitment transactions. Such transactions
require mandatory collateralization which could increase the cost of such
transactions and impose added operational complexity.
Non-Principal
Risks
BORROWING
AND LEVERAGE RISK. If the Fund borrows
money, it must pay interest and other fees, which may reduce the Fund’s returns.
Any such borrowings are intended to be temporary. However, under certain market
conditions, including periods of decreased liquidity, such borrowings might be
outstanding for longer periods of time. As prescribed by the 1940 Act, the Fund
will be required to maintain specified asset coverage of at least 300% with
respect to any bank borrowing immediately following such borrowing and at all
times thereafter. 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.
CASH
TRANSACTIONS RISK. The Fund may, under
certain circumstances, effect a portion of creations and redemptions for cash,
rather than in-kind securities. As a result, an investment in the Fund may be
less tax-efficient than an investment in an ETF that effects its creations and
redemptions only in-kind. ETFs are able to make in-kind redemptions and avoid
being taxed on gains on the distributed portfolio securities at the fund level.
A Fund that effects redemptions for cash may be required to sell portfolio
securities in order to obtain the cash needed to distribute redemption proceeds.
Any recognized gain on these sales by the Fund will generally cause the Fund to
recognize a gain it might not otherwise have recognized, or to recognize such
gain sooner than would otherwise be required if it were to distribute portfolio
securities only in-kind. The Fund intends to distribute these gains to
shareholders to avoid being taxed on this gain at the fund level and otherwise
comply with the special tax rules that apply to it. This strategy may cause
shareholders to be subject to tax on gains they would not otherwise be subject
to, or at an earlier date than if they had made an investment in a different
ETF. Moreover, cash transactions may have to be carried out over several days if
the securities market is relatively illiquid and may involve considerable
brokerage fees and taxes. These brokerage fees and taxes, which will be higher
than if the Fund sold and redeemed its shares entirely
31
in-kind,
will be passed on to those purchasing and redeeming Creation Units in the form
of creation and redemption transaction fees. In addition,
these factors may result in wider spreads between the bid and the offered prices
of the Fund’s shares than for ETFs that distribute portfolio securities
in-kind.
DEPENDENCE
ON KEY PERSONNEL RISK. The Advisor is
dependent upon the experience and expertise of the portfolio managers in
providing advisory services with respect to the Fund’s investments. If the
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 the portfolio
managers in the event of their death, resignation, retirement or inability to
act on behalf of the Advisor.
FAILURE
TO QUALIFY AS A REGULATED INVESTMENT COMPANY RISK. If, in any year, the
Fund fails to qualify as a regulated investment company under the applicable tax
laws, the Fund would be taxed as an ordinary corporation. In such circumstances,
the Fund could be required to recognize unrealized gains, pay substantial taxes
and interest and make substantial distributions before requalifying as a
regulated investment company that is accorded special tax
treatment.
INTERNATIONAL
CLOSED MARKET TRADING RISK. Because securities held by the Fund
trade on non-U.S. exchanges that are closed when the Fund’s primary listing
exchange is open, there are likely to be deviations between the current price of
an underlying security and the last quoted price for the underlying security
(i.e., the Fund’s quote from the closed
foreign market) used for purposes of calculating the
Fund net asset value, resulting in premiums or discounts to the Fund’s net asset
value that may be greater than those experienced by other exchange-traded funds.
In addition, shareholders may not be able to purchase and sell shares of the
Fund on days when the net asset value of the Fund could
be significantly affected by events in the relevant foreign markets.
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.
LEGISLATION/LITIGATION
RISK.
From time to time, various legislative initiatives are proposed in the United
States and abroad which may have a negative impact on certain securities in
which the Fund invests. In addition, litigation regarding any of the securities
owned by the Fund, or industries represented by these issuers, may negatively
impact the value of the securities. Such legislation or litigation may cause the
Fund to lose value or may result in higher portfolio turnover if the Advisor
determines to sell such a holding.
Fund
Organization
The Fund is a series
of the Trust, an investment company registered under the 1940 Act. The Fund is
treated as a separate fund with its own investment
objectives and policies. The Trust is organized as a Massachusetts business
trust. The 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 the Advisor, distributor, custodian and fund
administrative and accounting agent.
Management
of the Fund
First
Trust Advisors L.P., 120 East Liberty Drive, Wheaton, Illinois 60187, is the
investment advisor to the Fund. In this capacity, First Trust is
responsible for the selection and ongoing monitoring of the securities in the
Fund’s portfolio and certain other services necessary for the management of the
portfolio.
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. First Trust discharges its responsibilities subject to the policies of
the Fund.
First Trust serves
as advisor or sub-advisor to 9 mutual fund portfolios, 10
exchange-traded funds consisting of 201 series and 14 closed-end funds. It 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
Fund.
Daniel
J. Lindquist, David G. McGarel, Chris A. Petersen, William Housey and Steve
Collins are the Fund’s portfolio managers and are jointly and
primarily responsible for the day-to-day management of the Fund’s investment
portfolio.
32
•
Mr. Lindquist is
Chairman of the Investment Committee and presides over Investment Committee
meetings. Mr. Lindquist is responsible for overseeing the implementation of the
Fund’s investment strategy. Mr. Lindquist was a Senior Vice President of First
Trust and FTP from September 2005 to July 2012 and is now a Managing Director of
First Trust and FTP.
•
Mr. McGarel is the
Chief Investment Officer, Chief Operating Officer and a Managing Director of
First Trust and FTP. As First Trust’s Chief Investment Officer, Mr. McGarel
consults with the other members of the Investment Committee on market conditions
and First Trust’s general investment philosophy. Mr. McGarel was a Senior Vice
President of First Trust and FTP from January 2004 to July 2012.
•
Mr. Peterson, CFA, is
a Senior Vice President and head of First Trust’s strategy research group. He
joined First Trust in January of 2000. Mr. Peterson is responsible for
developing and implementing quantitative equity investment strategies. Mr.
Peterson received his B.S. in Finance from Bradley University in 1997 and his
M.B.A. from the University of Chicago Booth School of Business in 2005. He has
over 20 years of financial services industry experience and is a recipient of
the Chartered Financial Analyst designation.
•
William Housey, CFA,
joined First Trust in June 2010 as the Senior Portfolio Manager for the
Leveraged Finance Investment Team and has 21 years of investment experience. Mr.
Housey is the Managing Director of Fixed Income of First Trust. 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.
•
Steve Collins is a
Senior Vice President of First Trust. Mr. Collins joined First Trust Advisors in
August 2007 and is a Senior Vice President and fixed income research analyst.
Mr. Collins is responsible for selecting and monitoring fixed income and equity
unit investment trusts and has 11 years of investment experience. He is a member
of a counterparty credit committee providing credit analysis for the banking
sector.
For
additional information concerning First Trust, including a description of the
services provided to the Fund, see the Fund’s SAI. Additional
information about the portfolio managers’ compensation, other accounts managed
by the portfolio managers and the portfolio managers’ ownership of securities in
the Fund is provided in the SAI.
Management
Fee
Pursuant
to an investment management agreement between First Trust and the Trust, on
behalf of the Fund (the "Investment
Management Agreement"), First Trust
manages the investment of the Fund's assets. First Trust is paid an annual
unitary management fee by the Fund equal to 0.20% of the Fund's average daily
net assets and is responsible for the Fund’s expenses, including the cost of
transfer agency, custody, fund administration, legal, audit and other services,
but excluding fee payments under the Investment Management Agreement, interest,
taxes, acquired fund fees and expenses, if any, brokerage commissions and other
expenses connected with the execution of portfolio transactions, distribution
and service fees pursuant to a Rule 12b-1 plan, if any, and extraordinary
expenses.
From
the Fund's inception on August 13, 2014 to January 25, 2022, First Trust was
paid an annual unitary management fee equal to 0.85% of the
Fund's average daily net assets. Pursuant to certain changes in the Fund's
principal investment strategies that were approved by shareholders at a meeting
taking place on January 24, 2022, First Trust's management fee was reduced from
0.85% to 0.20% of the Fund's average daily net assets.
Pursuant to a
contractual agreement between the Trust, on behalf of the Fund, and First Trust,
First Trust has agreed to waive fees and/or reimburse Fund expenses
to the extent that the operating expenses of the Fund (excluding interest
expense, brokerage commissions and other trading expenses, taxes and
extraordinary expenses) exceed 0.87% of its average daily net assets (the
“Expense Cap”) at least through March 1, 2024. The agreement may be terminated
by the Trust, on behalf of the Fund, at any time and by First Trust only after
March 1, 2024 upon 60 days’ written notice.
As approved by the
Trust’s Board of Trustees, the management fee paid to First Trust will be
reduced at certain levels of Fund net assets (“breakpoints”). See the Fund's Statement of
Additional Information for more information on the breakpoints.
33
A discussion
regarding the Board’s approval of the continuation of the Investment Management
Agreement is available in the Fund’s Annual Report to Shareholders
for the fiscal year ended October 31, 2022.
How
to Buy and Sell Shares
Most
investors buy and sell shares of the Fund in secondary market transactions
through brokers. Shares of the Fund are listed for trading on the
secondary market on one or more national securities exchanges. Shares can be
bought and sold throughout the trading day like other publicly traded shares.
There is no minimum investment when buying shares on the Exchange. Although
shares are generally purchased and sold in “round lots” of 100 shares, brokerage
firms typically permit investors to purchase or sell shares in smaller “odd
lots,” at no per-share price differential. When buying or selling shares through
a broker, investors should expect to pay brokerage commissions, investors may
receive less than the net asset value of the shares because shares are bought
and sold at market prices rather than at net asset value, and investors may pay
some or all of the bid-ask spread for each transaction (purchase or sale) of
Fund shares. Share prices are reported in dollars and cents per
share.
Under
normal circumstances, the Fund will pay out redemption proceeds to a redeeming
authorized participant within two days after the
authorized participant’s redemption request is received, in accordance with the
process set forth in the Fund’s SAI and in the agreement between the authorized
participant and the Fund’s distributor. However, the Fund reserves the right,
including under stressed market conditions, to take up to seven days after the
receipt of a redemption request to pay an authorized participant, all as
permitted by the 1940 Act. If the Fund has foreign investments in a country
where a local market holiday, or series of consecutive holidays, or the extended
delivery cycles for transferring foreign investments to redeeming authorized
participants prevents the Fund from delivering such foreign investments to an
authorized participant in response to a redemption request, the Fund may take up
to 15 days after the receipt of the redemption request to deliver such
investments to the authorized participant.
For purposes of the
1940 Act, the Fund is treated as a registered investment company,
and
the acquisition of
shares by other registered investment companies relying on Sections 3(c)(1) or
3(c)(7) of the 1940 Act is subject to the restrictions of Section 12(d)(1) of
the 1940 Act and the related rules and interpretations.
Book
Entry
Shares
are held in book-entry form, which means that no share certificates are issued.
The Depository Trust Company (“DTC”) or its nominee is
the record owner of all outstanding shares of the Fund and is recognized as the
owner of all shares for all purposes.
Investors
owning shares are beneficial owners as shown on the records of DTC or its
participants. DTC serves as the securities depository for all
shares. Participants in DTC include securities brokers and dealers, banks, trust
companies, clearing corporations and other institutions that directly or
indirectly maintain a custodial relationship with DTC. As a beneficial owner of
shares, you are not entitled to receive physical delivery of share certificates
or to have shares registered in your name, and you are not considered a
registered owner of shares. Therefore, to exercise any right as an owner of
shares, you must rely upon the procedures of DTC and its participants. These
procedures are the same as those that apply to any other stocks that you hold in
book-entry or “street name” form.
Share
Trading Prices
The
trading price of shares of the Fund on the secondary market is based on market
price and may differ from the Fund’s daily net asset value and
can be affected by market forces of supply and demand, economic conditions and
other factors.
Frequent
Purchases and Redemptions of the Fund's Shares
The
Fund imposes no restrictions on the frequency of purchases and redemptions
(“market
timing”). In determining not
to approve a written, established policy, the Board evaluated the risks of
market timing activities by the Fund's shareholders. The Board considered that
the Fund's shares can only be purchased and redeemed directly from the Fund in
Creation Units by broker-dealers and large institutional investors that have
entered into participation agreements (i.e., authorized
participants (“APs”)) and that the vast
majority of trading in the Fund's shares occurs on the secondary market. Because
the secondary market trades do not involve the Fund directly, it is unlikely
those trades would cause many of the harmful effects of market timing, including
dilution, disruption of portfolio management, increases in the Fund's trading
costs and the realization of capital gains. As may effect the purchase or
redemption of Creation Units in exchange wholly or partially for cash, the Board
noted that such trades could result in dilution to the Fund and increased
transaction costs, which could negatively impact the Fund's ability to achieve
its investment objectives. However, the Board noted that direct trading by APs
is critical to ensuring
34
that the shares
trade at or close to net asset value. In addition, the Fund imposes fixed and
variable transaction fees on purchases and redemptions of Creation Units to
cover the custodial and other costs incurred by the Fund in effecting trades.
Finally, the Advisor monitors purchase and redemption orders from APs for
patterns of abusive trading and the Fund reserves the right to not accept orders
from APs that the Advisor has determined may be disruptive to the management of
the Fund.
Dividends,
Distributions and Taxes
Dividends
from net investment income, if any, are declared and paid monthly by the Fund.
The Fund distributes its net realized capital gains, if
any, to shareholders at least annually.
Distributions
in cash may be reinvested automatically in additional whole shares only if the
broker through whom you purchased shares makes such
option available. Such shares will generally be reinvested by the broker based
upon the market price of those shares and investors may be subject to customary
brokerage commissions charged by the broker.
Federal
Tax Matters
This
section summarizes some of the main U.S. federal income tax consequences of
owning shares of the Fund. 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 Fund. The Internal
Revenue Service ("IRS") could disagree with any conclusions
set forth in this section. The following disclosure 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
The Fund intends to
continue to qualify as a “regulated investment company” (a “RIC”) under the federal tax laws. If the
Fund qualifies as a RIC and distributes its income as required by the tax law,
the Fund generally will not pay federal income taxes.
Distributions
The
Fund’s distributions are generally taxable. After the end of each year, you will
receive a tax statement that separates the distributions of the
Fund into two categories, ordinary income distributions and capital gain
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 gain dividends as long-term capital
gains regardless of how long you have owned your shares.
To
determine your actual tax liability for your capital gain 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 Fund 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 your tax basis in your shares, 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. A “return of capital”
is a return, in whole or in part, of the funds that you previously invested in
the Fund. A return of capital distribution should not be considered part of a
Fund’s dividend yield or total return of an investment in Fund shares. The tax
status of your distributions from the Fund is not affected by whether you
reinvest your distributions in additional shares or receive them in cash. The
income from the 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.
Income
from the Fund may also be subject to a 3.8% “Medicare tax.” This tax generally
applies 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.
35
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
RICs. However, certain ordinary income dividends on shares that are attributable
to qualifying dividends received by the Fund from certain corporations may be
reported by the Fund as being eligible for the dividends received
deduction.
Capital
Gains and Losses and Certain Ordinary Income Dividends
If
you are an individual, the maximum marginal stated federal tax rate for net
capital gain is generally 20% (15% or 0% for taxpayers with
taxable incomes below certain thresholds). Some capital gains, including some
portion of your capital gain dividends may be taxed at a higher maximum stated
tax rate. 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 the Fund and sell your share 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 Internal Revenue Code of 1986, as amended,
treats certain capital gains as ordinary income in special
situations.
An
election may be available to you to defer recognition of the gain attributable
to a capital gain dividend if you make certain qualifying
investments within a limited time. You should talk to your tax advisor about the
availability of this deferral election and its requirements.
Ordinary income
dividends received by an individual shareholder from a RIC such as the Fund 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 Fund itself.
The Fund will provide notice to its 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 brokerage fees, if any. In some cases, however, you may have to adjust
your tax basis after you purchase your shares. An election may be available to
you to defer recognition of capital gain if you make certain qualifying
investments within a limited time. You should talk to your tax advisor about the
availability of this deferral election and its requirements.
Taxes
on Purchase and Redemption of Creation Units
If you exchange
securities for Creation Units, you will generally recognize a gain or a loss.
The gain or loss will be equal to the difference between the market value
of the Creation Units at the time and your aggregate basis in the securities
surrendered and the cash component paid. If you exchange Creation Units for
securities, you will generally recognize a gain or loss equal to the difference
between your basis in the Creation Units and the aggregate market value of the
securities received and the cash redemption amount. The IRS, however, may assert
that a loss realized upon an exchange of securities for Creation Units or
Creation Units for securities cannot be deducted currently under the rules
governing “wash sales,” or on the basis that there has been no significant
change in economic position.
Treatment
of Fund Expenses
Expenses incurred and
deducted by the Fund will generally not be treated as income taxable to
you.
Non-U.S.
Tax Credit
Because
the Fund invests in non-U.S. securities, the tax statement that you receive may
include an item showing non-U.S. taxes the Fund paid
to other countries. In this case, dividends taxed to you will include your share
of the taxes the Fund paid to other countries. You may be able to deduct or
receive a tax credit for your share of these taxes.
36
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 the Fund will be characterized as dividends for federal
income tax purposes (other than dividends which the 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 the Fund that are
properly reported by the Fund as capital gain dividends may not be subject to
U.S. federal income taxes, including withholding taxes, provided that the Fund
makes certain elections and certain other conditions are met. 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. For tax years
after December 31, 2022, amounts paid to or recognized by a non-U.S. affiliate
that are excluded from tax under the portfolio interest, capital gain dividends,
short-term capital gains or tax-exempt interest dividend exceptions or
applicable treaties, may be taken into consideration in determining whether a
corporation is an “applicable corporation” subject to a 15% minimum tax on
adjusted financial statement income.
Distributions
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. This withholding tax is also currently scheduled
to apply to the gross proceeds from the disposition of securities that produce
U.S. source interest or dividends. However, proposed regulations may eliminate
the requirement to withhold on payments of gross proceeds from
dispositions.
Investments
in Certain Non-U.S. Corporations
If
the Fund holds an equity interest in any “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 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. The Fund will not be able to
pass through to its shareholders any credit or deduction for such taxes. The
Fund may be able to make an election that could ameliorate these adverse tax
consequences. In this case, the 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, the 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
Plan
FTP
serves as the distributor of Creation Units for the Fund on an agency basis. FTP
does not maintain a secondary market in shares.
The
Board has adopted a Distribution and Service Plan pursuant to Rule 12b-1 under
the 1940 Act. In accordance with the Rule 12b-1 plan, the
Fund is authorized to pay an amount up to 0.25% of its average daily net assets
each year to reimburse FTP for amounts expended to finance activities primarily
intended to result in the sale of Creation Units or the provision of investor
services. FTP may also use this amount to compensate securities dealers or other
persons that are APs for providing distribution assistance, including
broker-dealer and shareholder support and educational and promotional
services.
The Fund does not
currently pay 12b-1 fees, and pursuant to a contractual arrangement, the Fund
will not pay 12b-1 fees any time before March 31, 2024.
However, in the event 12b-1 fees are charged in the future, because these fees
are paid out of the Fund's assets, over time these fees will increase the cost
of your investment and may cost you more than certain other types of sales
charges.
37
Net
Asset Value
The
Fund's net asset value is determined as of the close of trading (normally 4:00
p.m., Eastern Time) on each day the New York Stock Exchange
is open for business. Net asset value is calculated for the Fund by taking the
market price of the Fund’s total assets, including interest or dividends accrued
but not yet collected, less all liabilities, and dividing such amount by the
total number of shares outstanding. The result, rounded to the nearest cent, is
the net asset value per share. All valuations are subject to review by the Board
or its delegate.
The Fund’s
investments are valued daily in accordance with valuation procedures
approved by the Board,
and in accordance with provisions of the 1940 Act and the rules thereunder. Rule
2a-5 under the 1940 Act requires the fair valuation of all portfolio investments
for which market quotations are not readily available. Pursuant to Rule 2a-5
under the 1940 Act, the Board has appointed the Advisor as its valuation
designee for all portfolio investments. Certain securities in which the Fund may
invest are not listed on any securities exchange or board of trade. Such
securities are typically bought and sold by institutional investors in
individually negotiated private transactions that function in many respects like
an over the counter secondary market, although typically no formal market makers
exist. Certain securities, particularly debt securities, have few or no trades,
or trade infrequently, and information regarding a specific security may not be
widely available or may be incomplete. Accordingly, determinations of the fair
value of debt securities may be based on infrequent and dated information.
Because there is less reliable, objective data available, elements of judgment
may play a greater role in valuation of debt securities than for other types of
securities. Typically, debt securities are valued using information provided by
a third-party pricing service. The third-party pricing service primarily uses
broker quotes to value the securities.
The Fund's
investments are valued daily at market value or, in the absence of market value
with respect to any portfolio securities, at fair value, in
accordance with valuation procedures approved by the Board and in accordance
with the 1940 Act and the rules thereunder. Portfolio securities listed on any
exchange other than Nasdaq and the London Stock Exchange Alternative Investment
Market (“AIM”) are valued at the last sale price
on the business day as of which such value is being determined. Securities
listed on Nasdaq or the 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 primary exchange for such securities. Portfolio securities traded in the
over-the-counter market, but excluding securities trading on Nasdaq or the AIM,
are valued at the mean of the most recent bid and asked price, if available, and
otherwise at the last trade price. Short-term investments that
mature in less than 60 days when purchased are fair valued at cost adjusted for
amortization of premiums and accretion of discount, provided the Advisor has
determined that the use of amortized cost is an appropriate reflection of fair
value given market and issuer-specific conditions existing at the time of
determination. Net asset value may change on days when investors may not sell or
redeem Fund shares.
Certain securities
may not be able to be priced by pre-established pricing methods. Such securities
may be valued by the Advisor at fair value. The use of fair value
pricing by the Fund is governed by valuation procedures approved by the Board
and in accordance with the provisions of the 1940 Act and the rules thereunder.
These securities generally include, but are not limited to, certain 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 or fair value 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 Fund's net asset value 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, in the opinion of the Advisor,
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 portfolio investment upon the measurement
date under current market conditions. When fair value prices are used, generally
they will differ from the current market valuations. See the Fund's SAI for
details.
Fund
Service Providers
The
Bank of New York Mellon, 240 Greenwich Street, New York, New York 10286, acts as
the administrator, custodian and fund accounting and
transfer agent for the Fund. Chapman and Cutler LLP, 320 S. Canal St., Chicago,
Illinois 60606, serves as legal counsel to the Fund.
38
Premium/Discount
Information
Information
showing the number of days the market price of the Fund's shares was greater (at
a premium) and less (at a discount) than the Fund's net
asset value for the most recently completed year, and the most recently
completed calendar quarters since that year (or life of the Fund, if shorter),
is available at https://www.ftportfolios.com/Retail/etf/home.aspx.
Total
Return Information
The table below
compares the total return of the Fund to two broad-based security market indices
and to the Fund's benchmark index and prior blended benchmark.
The information presented for the Fund is for the period indicated.
“Average annual
total returns” represent the average annual change in the value of an investment
over the period indicated. “Cumulative total returns” represent
the total change in value of an investment over the period indicated. The return
information shown under “Annual Total Return” in the Fund’s summary prospectus
represents the average annual total returns of the Fund as of the calendar year
end, while the information presented below is as of the Fund’s fiscal year end.
The net asset value per share of the Fund is the value of one share of the Fund
and is computed by dividing the value of all assets of the Fund (including
accrued interest and dividends), less liabilities (including accrued expenses
and dividends declared but unpaid), by the total number of outstanding shares.
The net asset value return is based on the net asset value per share of the Fund
and the market return is based on the market price per share of the Fund. The
price used to calculate market return (“Market
Price”) is determined by
using the midpoint of the national best bid and offer price (“NBBO”) as of the time that the Fund’s net
asset value is calculated. Under SEC rules, the NBBO consists of the highest
displayed buy and lowest sell prices among the various exchanges trading the
Fund at the time the Fund's net asset value is calculated. Prior to January 1,
2019, the price used was the midpoint between the highest bid and the lowest
offer on the stock exchange on which shares of the Fund were listed for trading
as of the time that the Fund's net asset value was calculated. Since the shares
of the Fund typically do not trade in the secondary market until several days
after the Fund's inception, for the period from inception to the first day of
secondary market trading in shares of the Fund, the net asset value of the Fund
is used as a proxy for the secondary market trading price to calculate market
returns. Market and net asset value returns assume that all distributions have
been reinvested in the Fund at Market Price and net asset value, respectively.
An index is a statistical composite that tracks a specified financial market or
sector. Unlike the Fund, an index does not actually hold a portfolio of
securities and therefore does not incur the expenses incurred by the Fund. These
expenses negatively impact the performance of the Fund. Also, market returns do
not include brokerage commissions that may be payable on secondary market
transactions. If brokerage commissions were included, market returns would be
lower. The total returns reflect the reinvestment of dividends on securities in
the indices. The returns shown in the table below do not reflect the deduction
of taxes that a shareholder would pay on Fund distributions or the redemption or
sale of shares of the Fund. The investment return and principal value of shares
of the Fund will vary with changes in market conditions. Shares of the Fund may
be worth more or less than their original cost when they are redeemed or sold in
the market. The Fund's past performance is no guarantee of future results. On
February 28, 2022, the Fund changed its principal investment strategies.
Therefore, the Fund’s performance and historical returns shown below are not
necessarily indicative of the performance that the Fund, under its current
strategy, would have generated.
39
First
Trust High Income Strategic Focus ETF (HISF)
Total Returns as of October 31, 2022
Total Returns as of October 31, 2022
|
|
|
Average
Annual |
Cumulative | ||
|
|
1
Year |
5
Years |
Inception
(8/13/2014) |
5
Years |
Inception
(8/13/2014) |
|
Fund
Performance |
|
|
|
|
|
|
Net Asset
Value |
-10.38% |
1.12% |
2.34% |
5.73% |
20.96% |
|
Market
Price |
-10.49% |
1.11% |
2.34% |
5.67% |
20.97% |
|
Index
Performance |
|
|
|
|
|
|
Blended
Index(1) |
-14.37% |
0.25% |
1.45% |
1.27% |
12.53% |
|
Bloomberg
U.S. Aggregate Bond Index |
-15.68% |
-0.54% |
0.63% |
-2.68% |
5.34% |
|
Russell
3000®
Index |
-16.52% |
9.87% |
10.33% |
60.08% |
124.20% |
|
Prior
Blended Benchmark(2)
|
-5.81% |
3.36% |
3.29% |
17.96% |
30.44% |
(1)
The Blended
Index is comprised of the Bloomberg US Aggregate Bond Index (the “Agg”) (70%)
and the ICE BofA U.S. High Yield Constrained Index (30%).
(2)
The Prior
Blended Index is equally weighted to include these six indices: the Alerian MLP
Index, Dow Jones U.S. Select Dividend Index, ICE BofA Fixed Rate Preferred
Securities Index, ICE BofA U.S. High Yield Index, Bloomberg EM USD Aggregate
Index and Bloomberg U.S. MBS Index. An index does not charge management fees or
brokerage expenses, and no such fees or expenses were deducted from the index
performance shown. Indices are unmanaged and an investor cannot invest directly
in an index. The Prior Blended Index returns are calculated by using the monthly
return of the six indices during each period shown above. At the beginning of
each month the six indices are rebalanced to a 16.66 percentage weighting for
each to account for divergence from that percentage weighting that occurred
during the course of each month. The monthly returns are then compounded for
each period shown above, giving the performance of the Prior Blended Index for
each period shown above.
40
Financial
Highlights
The financial
highlights table is intended to help you understand the Fund's financial
performance for the periods shown. Certain information reflects financial
results for a single share of the Fund. The total returns represent the rate
that an investor would have earned (or lost) on an investment in the Fund
(assuming reinvestment of all dividends and distributions). The information for
the periods indicated has been derived from financial statements audited by
Deloitte & Touche LLP, whose report, along with the Fund's financial
statements, is included in the Fund's Annual Report to Shareholders dated
October 31, 2022 and is incorporated by reference in the Fund's SAI, which is
available upon request.
First
Trust Exchange-Traded Fund IV
Financial
Highlights
For a share outstanding throughout each period
For a share outstanding throughout each period
First
Trust High Income Strategic Focus ETF (HISF)
|
|
Year
Ended October 31, | |||||
|
|
2022 |
2021 |
2020 |
2019 |
2018 |
|
|
Net
asset value, beginning of period |
$50.34 |
$44.98 |
$50.62 |
$47.72 |
$50.68 |
|
|
Income
from investment operations: |
|
|
|
|
|
|
|
Net
investment income (loss) |
0.99 |
1.47 |
1.46 |
1.63 |
1.69 |
|
|
Net
realized and unrealized gain (loss) |
(6.12) |
5.80(a) |
(5.07) |
3.34 |
(2.26) |
|
|
Total
from investment operations |
(5.13) |
7.27 |
(3.61) |
4.97 |
(0.57) |
|
|
Distributions
paid to shareholders from: |
|
|
|
|
|
|
|
Net
investment income |
(1.70) |
(1.91) |
(1.97) |
(2.07) |
(2.10) |
|
|
Return of
capital |
— |
— |
(0.06) |
— |
(0.29) |
|
|
Total
distributions |
(1.70) |
(1.91) |
(2.03) |
(2.07) |
(2.39) |
|
|
Net
asset value, end of period |
$43.51 |
$50.34 |
$44.98 |
$50.62 |
$47.72 |
|
|
Total
Return (b) |
(10.38)% |
16.33%
(a) |
(7.19)% |
10.60% |
(1.21)% |
|
|
Ratios/supplemental
data: |
|
|
|
|
|
|
|
Net
assets, end of period (in 000’s) |
$39,162 |
$70,477 |
$60,719 |
$91,120 |
$83,504 |
|
|
Ratios
to average net assets: |
|
|
|
|
|
|
|
Ratio of
total expenses to average net assets (c) |
0.46% |
0.85% |
0.85% |
0.85% |
0.86%
(d) |
|
|
Ratio of
net expenses to average net assets (c) |
0.30% |
0.42% |
0.46% |
0.50% |
0.50%
(d) |
|
|
Ratio of
net investment income (loss) to average net assets |
2.83% |
2.94% |
3.08% |
3.21% |
3.40% |
|
|
Portfolio
turnover rate (e) |
149% |
101% |
118% |
91% |
113% |
|
(a)
The Fund
received a reimbursement from the Advisor in the amount of $1,758 in connection
with a trade error, which represents less than $0.01 per share. Since the
Advisor reimbursed the Fund, there was no effect on the Fund’s total
return.
(b)
Total return is
calculated assuming an initial investment made at the net asset value at the
beginning of the period, reinvestment of all distributions at net asset value
during the period, and redemption at net asset value on the last day of the
period. The returns presented do not reflect the deduction of taxes that a
shareholder would pay on Fund distributions or the redemption or sale of Fund
shares. Total return is calculated for the time period presented and is not
annualized for periods of less than a year. The total returns would have been
lower if certain fees had not been waived by the Advisor.
(c)
The Fund
indirectly bears its proportionate share of fees and expenses incurred by the
underlying funds in which the Fund invests. This ratio does not include these
indirect fees and expenses.
(d)
Includes excise
tax. If this excise tax expense was not included, the total and net expense
ratios would have been 0.85% and 0.49%, respectively.
(e)
Portfolio
turnover is calculated for the time period presented and is not annualized for
periods of less than a year and does not include securities received or
delivered from processing creations or redemptions and in-kind
transactions.
41
Other
Information
Continuous
Offering
The
Fund issues, on a continuous offering basis, its shares in one or more groups of
a fixed number of Fund shares (each such group of such
specified number of individual Fund shares, a “Creation
Unit Aggregation”). The method by
which Creation Unit Aggregations of Fund shares are created and traded may raise
certain issues under applicable securities laws. Because new Creation Unit
Aggregations of shares are issued and sold by the Fund on an ongoing basis, a
“distribution,” as such term is used in the Securities Act, may occur at any
point. Broker-dealers and other persons are cautioned that some activities on
their part may, depending on the circumstances, result in their being deemed
participants in a distribution in a manner which could render them statutory
underwriters and subject them to the prospectus delivery requirement and
liability provisions of the Securities Act.
For
example, a broker-dealer firm or its client may be deemed a statutory
underwriter if it takes Creation Unit Aggregations after placing an
order with FTP, breaks them down into constituent shares and sells such shares
directly to customers, or if it chooses to couple the creation of a supply of
new shares with an active selling effort involving solicitation of secondary
market demand for shares. A determination of whether one is an underwriter for
purposes of the Securities Act must take into account all the facts and
circumstances pertaining to the activities of the broker-dealer or its client in
the particular case, and the examples mentioned above should not be considered a
complete description of all the activities that could lead to a characterization
as an underwriter.
Broker-dealer
firms should also note that dealers who are not “underwriters” but are effecting
transactions in shares, whether or not participating
in the distribution of shares, are generally required to deliver a prospectus.
This is because the prospectus delivery exemption in Section 4(a)(3) of the
Securities Act is not available in respect of such transactions as a result of
Section 24(d) of the 1940 Act. As a result, broker-dealer firms should note that
dealers who are not underwriters but are participating in a distribution (as
contrasted with ordinary secondary market transactions) and thus dealing with
the shares that are part of an overallotment within the meaning of Section
4(a)(3)(C) of the Securities Act would be unable to take advantage of the
prospectus delivery exemption provided by Section 4(a)(3) of the Securities Act.
Firms that incur a prospectus delivery obligation with respect to shares are
reminded that, under the Securities Act Rule 153, a prospectus delivery
obligation under Section 5(b)(2) of the Securities Act owed to a broker-dealer
in connection with a sale on the Exchange is satisfied by the fact that the
prospectus is available from the Exchange upon request. The prospectus delivery
mechanism provided in Rule 153 is available with respect to transactions on a
national securities exchange, a trading facility or an alternative trading
system.
42
|
First
Trust
Exchange-Traded
Fund IV |
First
Trust High Income Strategic Focus ETF
(formerly
First Trust Strategic Income ETF)
For
More Information
For
more detailed information on the Fund, several additional sources of information
are available to you. The SAI, incorporated by
reference into this prospectus, contains detailed information on the Fund's
policies and operation. Additional information about the Fund's investments is
available in the annual and semi-annual reports to shareholders. In the Fund's
annual report, you will find a discussion of the market conditions and
investment strategies that significantly impacted the Fund's performance during
the last fiscal year. The Fund's most recent SAI, annual and semi-annual reports
and certain other information are available free of charge by calling the Fund
at (800) 621-1675, on the Fund's 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 Fund, including the SAI and
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
www.sec.gov. You may also request information regarding the Fund by sending a
request (along with a duplication fee) to the SEC by sending an electronic
request to [email protected].
First Trust
Advisors L.P.
120 East Liberty Drive, Suite 400
Wheaton, Illinois 60187
(800) 621-1675
120 East Liberty Drive, Suite 400
Wheaton, Illinois 60187
(800) 621-1675
www.ftportfolios.com
SEC
File #: 333-174332
811-22559
811-22559