|
First
Trust
Exchange-Traded
Fund III |
Prospectus
First Trust
Institutional Preferred Securities and Income ETF
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Ticker
Symbol: |
FPEI |
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Exchange: |
NYSE
Arca |
First
Trust Institutional Preferred Securities and Income ETF (the “Fund”) lists and
principally trades its shares on NYSE Arca, Inc. (“NYSE
Arca” 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 III (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)
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Maximum
Sales Charge (Load) Imposed on Purchases (as a percentage of offering
price) |
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(expenses that you pay each year as a percentage of the value of your investment)
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Management
Fees |
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Distribution
and Service (12b-1) Fees |
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Other
Expenses |
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Total
Annual Fund Operating Expenses |
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1
Year |
3
Years |
5
Years |
10
Years |
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$ |
$ |
$ |
$ |
3
4
5
6
7
8
9
10
Calendar Year Total Returns as of 12/31
11
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1
Year |
Since
Inception |
Inception
Date |
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Return Before
Taxes |
- |
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Return After
Taxes on Distributions |
- |
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Return After
Taxes on Distributions and Sale of Fund Shares |
- |
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Blended
Benchmark(1) (reflects no
deduction for fees, expenses or taxes) |
- |
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ICE BofA US
Investment Grade Institutional Capital Securities Index (reflects
no deduction
for fees, expenses or taxes) |
- |
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(1)
Management
Investment
Advisor
First
Trust Advisors L.P. (“First
Trust”
or the “Advisor”)
Investment
Sub-Advisor
Stonebridge
Advisors LLC (“Stonebridge” or the “Sub-Advisor”)
Portfolio
Managers
The
following persons serve as portfolio managers of the Fund.
•
Scott T. Fleming,
Chief Executive Officer and President, Stonebridge Advisors LLC
•
Robert Wolf, Chief
Investment Officer, Executive Vice President and Senior Portfolio Manager,
Stonebridge Advisors LLC
•
Eric Weaver,
Executive Vice President, Chief Strategist and Portfolio Manager, Stonebridge
Advisors LLC
•
Angelo Graci, CFA,
Executive Vice President, Head of Credit Research and Portfolio Manager,
Stonebridge Advisors LLC
The
portfolio managers are primarily and jointly responsible for the day-to-day
management of the Fund. Each portfolio manager has served as
part of the portfolio management team of the Fund since 2017, except for Eric
Weaver and Angelo Graci, who have served as members of the portfolio management
team since 2020 and 2022, respectively.
12
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 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.
13
Additional
Information on the Fund's Investment Objective and Strategies
The
Fund is a series of First Trust Exchange-Traded Fund III 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 objective is 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. 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 objective.
The
Fund has adopted a non-fundamental investment policy pursuant to Rule 35d-1
under the 1940 Act (the “Name
Policy”), whereby the Fund,
under normal market conditions, invests at least 80% of its net assets
(including investment borrowings) in institutional preferred securities and
incoming producing debt securities. The Name Policy may be changed by the Board
of Trustees without shareholder approval upon 60 days’ prior written
notice.
Fund
Investments
Principal
Investments
Preferred
Securities
Preferred
securities, which generally pay fixed or adjustable-rate dividends or interest
to investors and have preference over common stock in the
payment of dividends or interest and the liquidation of a company’s assets,
which means that a company typically must pay dividends or interest on its
preferred securities before paying any dividends on its common stock. Preferred
securities are generally junior to all forms of the company’s debt, including
both senior and subordinated debt.
While
some preferred securities are issued with a final maturity date, others are
perpetual in nature. In certain instances, a final maturity date
may be extended and/or the final payment of principal may be deferred at the
issuer’s option for a specified time without any adverse consequence to the
issuer. No redemption can typically take place unless all cumulative payment
obligations to preferred security investors have been met, although issuers may
be able to engage in open-market repurchases without regard to any cumulative
dividends or interest payable. A portion of the portfolio may include
investments in non-cumulative preferred securities, whereby the issuer does not
have an obligation to make up any arrearages to holders of such securities.
Should an issuer default on its obligations under such a security, the amount of
income earned by the Fund may be adversely affected.
Institutional
preferred securities are targeted to institutional, rather than retail,
investors, generally traded over the counter and may also be known
as “$1,000 par preferred securities.” They are typically issued in large,
institutional lot sizes by U.S. and non-U.S. financial services companies and
other companies. In recent years, the most common coupon structure for
institutional preferred securities has been the “fixed-to-floating-rate”
structure. Securities with this structure carry a fixed interest rate for a
specific period, usually until a first call date in 5-10 years, after which if
they are not called, they convert to a floating rate that adjusts periodically
at a predefined spread over a specific floating index for the remaining life of
the security.
Preferred
securities may be issued by trusts or other special purpose entities established
by operating companies, and therefore may not be direct
obligations of operating companies. At the time a trust or special purpose
entity sells its preferred securities to investors, the trust or special purpose
entity generally purchases debt of the operating company (with terms comparable
to those of the trust or special purpose entity securities). The trust or
special purpose entity, as the holder of the operating company’s debt, has
priority with respect to the operating company’s earnings and profits over the
operating company’s common shareholders, but is typically subordinated to other
classes of the operating company’s debt. Typically a preferred security has a
rating that is below that of its corresponding operating company’s senior debt
securities due to its subordinated nature.
Hybrid
Capital Securities
Hybrid
capital securities have the characteristics of both preferred securities and
debt securities. Hybrid capital securities may be issued by
corporations, generally in the form of interest-bearing notes with preferred
securities characteristics, or by an affiliated trust or partnership of the
corporation, generally in the form of preferred interests in subordinated
debentures
14
or
similarly structured securities. The hybrid capital securities market consists
of both fixed and floating coupon rate securities that are typically
issued with a final maturity date, although some are perpetual in nature. In
certain instances, a final maturity date may be extended and/or the final
payment of principal may be deferred at the issuer’s option for a specified time
without default. No redemption can typically take place unless all cumulative
payment obligations have been met, although issuers may be able to engage in
open-market repurchases without regard to whether all payments have been paid.
Examples of hybrid capital securities include, but are not limited to, trust
preferred securities, monthly income preferred securities, quarterly income bond
securities, quarterly income debt securities, quarterly income preferred
securities, corporate trust securities and public income notes.
Hybrid
capital securities are typically junior and fully subordinated liabilities of an
issuer or the beneficiary of a guarantee that is junior and fully
subordinated to the other liabilities of the guarantor. In addition, hybrid
capital securities typically permit an issuer to defer the payment of income for
18 months or more without triggering an event of default. Generally, the maximum
deferral period is five years. Because of their subordinated position in the
capital structure of an issuer, the ability to defer payments for extended
periods of time without default consequences to the issuer, and certain other
features (such as restrictions on common dividend payments by the issuer or
ultimate guarantor when full cumulative payments on the preferred securities
have not been made), these hybrid capital securities are often treated as close
substitutes for traditional preferred securities, both by issuers and investors.
Hybrid capital securities have many of the key characteristics of equity because
of their subordinated position in an issuer’s capital structure and because
their quality and value are heavily dependent on the profitability of the issuer
rather than on any legal claims to specific assets or cash flows.
Certain
hybrid capital securities are issued by trusts or other special purpose entities
established by operating companies, such as bank holding
companies in the case of trust preferred securities, and are not direct
obligations of the operating company. At the time the trust or special purpose
entity sells such preferred securities to investors, it purchases debt of the
operating company (with terms comparable to those of the trust or special
purpose entity securities), which enables the operating company to deduct for
tax purposes the interest paid on the debt held by the trust or special purpose
entity. An issuer of hybrid capital securities may be permitted to defer the
payment of income for a specified time, typically up to five years, without
triggering an event of default. In the case of many hybrid capital securities,
if the operating company fails to make its payments after this deferral period,
an event of default and acceleration occurs, giving holders of the hybrid
capital securities the right to take hold of the junior subordinated debt issued
by the operating company to the trust. At this time, the operating company’s
obligation to pay principal and interest on the underlying junior subordinated
debt accelerates and becomes immediately due and payable.
Within
the category of hybrid capital securities are senior debt instruments that trade
in the broader preferred securities market. These debt
instruments, which are sources of long-term capital for the issuers, have
structural features similar to preferred securities such as maturities ranging
from 30 years to perpetuity, call features, exchange listings and the inclusion
of accrued interest in the trading price. Similar to other hybrid capital
securities, these debt instruments usually do not offer equity capital
treatment.
Contingent
Convertible Securities
CoCos
are a common type of hybrid capital security. CoCos (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 CoCos 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 CoCos
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 CoCos may contain features that limit an
investor’s ability to convert the security unless certain conditions are
met.
Floating
Rate and Fixed-to-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
15
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.
Convertible
Securities
Convertible
securities combine the investment characteristics of both debt and equity
securities. Convertible securities typically consist of debt
securities or preferred securities that may be converted within a specified
period of time (typically for the entire life of the security) into a certain
amount of common stock or other equity security of the same or a different
issuer at a predetermined price. They also include debt securities with warrants
or common stock attached and derivatives combining the features of debt
securities and equity securities. Convertible securities entitle the holder to
receive interest paid or accrued on debt, or dividends paid or accrued on
preferred securities, until the securities mature or are redeemed, converted or
exchanged.
Restricted
Securities
The
Fund may invest in restricted securities, which are securities that may not be
sold to the public without an effective registration
statement under the Securities Act. The restriction on public sale may make it
more difficult to value such securities, limit the Fund’s ability to dispose of
them and lower the amount the Fund could realize upon their sale. Because they
are not registered, restricted securities may be sold only in a privately
negotiated transaction or pursuant to an exemption from registration. In
recognition of the increased size and liquidity of the institutional market for
unregistered securities and the importance of institutional investors in the
formation of capital, the Securities and Exchange Commission adopted Rule 144A
under the Securities Act. Rule 144A is designed to facilitate efficient trading
among institutional investors by permitting the sale of certain unregistered
securities to qualified institutional buyers. To the extent privately placed
securities held by the Fund qualify under Rule 144A and an institutional market
develops for those securities, the Fund likely will be able to dispose of the
securities without registering them under the Securities Act. To the extent that
institutional buyers become, for a time, uninterested in purchasing these
securities, investing in Rule 144A securities could increase the level of the
Fund’s illiquidity.
Corporate
Debt Securities
Corporate
debt securities are fixed-income securities issued by businesses to finance
their operations. Notes, bonds, debentures and commercial paper
are the most common types of corporate debt securities, with the primary
difference being their maturities and secured or unsecured status. Commercial
paper has the shortest term and is usually unsecured. Such debt instruments are
typically issued by corporations, generally in the form of interest-bearing
notes, or by an affiliated business trust of a corporation, generally in the
form of (i) beneficial interests in subordinated debentures or similarly
structured securities or (ii) more senior debt securities that pay income and
trade in a manner similar to preferred securities. The broad category of
corporate debt securities includes debt issued by U.S. and non-U.S. companies of
all kinds, including those with small-, mid- and large-capitalizations.
Corporate debt may be rated investment grade or below investment grade and may
carry fixed or floating rates of interest.
High
Yield Securities
Securities
that are rated below investment grade (or securities that are unrated and
determined by the Sub-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.
Non-U.S.
Investments
The Fund may invest
in securities issued by non-U.S. companies that are traded over-the-counter or
listed on an exchange.
Real
Estate Investment Trusts
The
Fund may invest in preferred shares of REITs. REITs are financial vehicles that
pool investors’ capital to purchase or finance real estate. REITs
are generally classified as equity REITs, mortgage REITs or a combination of
equity and mortgage REITs. Equity REITs invest the majority of their assets
directly in real property and derive income primarily from the collection of
rents. Equity REITs can also realize capital gains by selling properties that
have appreciated in value. Mortgage REITs invest the majority of their assets in
real estate mortgages and derive income from the collection of interest
payments. REITs are not taxed on income distributed to shareholders provided
they comply with the applicable tax requirements.
16
Non-Principal
Investments
Baby
Bonds
Baby
bonds are subordinated or senior debt that are designed to trade like preferred
securities. They trade in $25 par amounts, pay quarterly
interest, and are typically callable five years after issuance. Unlike the other
structures, the issuer generally cannot skip or defer payments on senior notes
without entering into default. These bonds rank higher in the capital structure
than hybrids, trust preferred securities and traditional preferred securities.
The payments on baby bonds are generally cumulative, in that the issuer must
make good on all missed payments before making any payout on a junior ranking
security such as a hybrid capital security, trust preferred security or
perpetual preferred security.
Cash
Equivalents and Short-Term Investments
Normally,
the Fund invests substantially all of its assets to meet its investment
objective. The Fund may invest the remainder of its assets in
securities with maturities of less than one year or cash equivalents, or it 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 achieve its investment objective. 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.
Derivative
Instruments
The Fund may invest
in exchange-traded and over-the-counter interest rate swaps, exchange-listed
options on Eurodollar futures contracts, exchange-listed
options on U.S. Treasury futures contracts, exchange-listed options on
exchange-traded funds, exchange-listed U.S. Treasury futures contracts,
exchange-listed Eurodollar futures contracts and exchange-traded and OTC
non-U.S. currency swaps. Derivatives are financial contracts whose value depends
upon, or is derived from, the value of an underlying asset, reference rate or
index, and may relate to, among other things, interest rates, currencies or
currency exchange rates. The Fund’s investments in derivative instruments will
be consistent with the Fund’s investment objective and the 1940 Act and will not
be used to seek to achieve a multiple or inverse multiple of an
index.
To the extent the Fund enters into derivatives transactions, it will do so pursuant to Rule 18f-4 under the 1940 Act. Rule 18f-4 requires the Fund to implement certain policies and procedures designed to manage its derivatives risks, dependent upon the Fund’s level of exposure to derivative instruments.
To the extent the Fund enters into derivatives transactions, it will do so pursuant to Rule 18f-4 under the 1940 Act. Rule 18f-4 requires the Fund to implement certain policies and procedures designed to manage its derivatives risks, dependent upon the Fund’s level of exposure to derivative instruments.
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.
Investment
Companies
The
Fund may invest in the securities of other investment companies, including ETFs
and closed-end funds. ETFs and closed-end funds trade on a
securities exchange and their shares may, at times, trade at a premium or
discount to their net asset value. As a stockholder in an investment company,
the Fund will bear its ratable share of that investment company’s expenses, and
would remain subject to payment of the Fund’s advisory and administrative fees
with respect to assets so invested.
The
Fund's ability to invest in other investment companies is limited by the 1940
Act and the related rules and interpretations. The Fund has adopted
a policy that it will not invest in other investment companies in excess of 1940
Act limits in reliance on Sections 12(d)(1)(F) or 12(d)(1)(G) of the 1940
Act.
Other
Debt Securities
Although
not a part of the Fund’s principal investment strategies, the Fund may invest in
senior loans, second lien loans, loan participations,
payment-in-kind securities, zero coupon bonds, bank certificates of deposit,
fixed-time deposits, bankers
17
acceptances,
U.S. government securities, fixed-income securities issued by non-U.S.
governments denominated in U.S. dollars or municipal
bonds.
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.
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 objective. 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
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.
BANKS
RISK.
The Fund invests significantly in banks. Banks are especially subject to the
adverse effects of economic recession, currency exchange rates, government
regulation, decreases in the availability of capital, volatile interest rates,
portfolio concentrations in geographic markets and in commercial and residential
real estate loans, and competition from new entrants in their fields of
business. In addition, banks are subject to extensive regulation at both the
federal and state level, which may affect permissible activities, profitability
and the amount of capital that they must maintain.
CALL
RISK.
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. The Fund is subject to the possibility that during periods
of falling interest rates an issuer will call its high yielding debt securities.
The Fund 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 the Fund’s
portfolio turnover. If a called debt security was purchased by the Fund at a
premium, the value of the premium may be lost in the event of a
redemption.
CASH
TRANSACTIONS RISK. The Fund will effect
some or all of its creations and redemptions for cash, rather than in-kind. 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 in-kind, will be passed on to those
18
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.
CONTINGENT
CONVERTIBLE SECURITIES RISK. 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 the Fund 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 the Fund)
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. 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 the Fund is called for redemption or conversion, the Fund 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 the
Fund’s ability to achieve its investment objective. The market 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, the Fund may be subject to additional exposure to
loss of income in situations where it would prefer to hold debt.
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. 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
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
19
dividends
or interest and repay principal. To the extent that the Fund 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. Credit spread risk
is the risk that credit spreads (i.e., the difference in
yield between debt securities that have differences in credit quality or other
factors) may increase, which may reduce the market values of the Fund’s debt
securities. While the Fund may employ strategies to mitigate credit spread risk,
these strategies may not be successful. Credit spreads often increase more for
lower rated and unrated securities than for investment grade securities. In
addition, when credit spreads increase, reductions in market value will
generally be greater for debt securities with longer maturities.
CURRENCY
RISK.
The Fund may invest in securities denominated in a non-U.S. currency. 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 the Fund 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 Fund's non-U.S. holdings 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. 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 the Fund 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 or unwillingness of issuers,
guarantors or liquidity providers to make scheduled principal or interest
payments or illiquidity in debt securities markets generally.
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DEPOSITARY
RECEIPTS RISK. The Fund
may invest in depositary receipts. Depositary receipts are securities issued by
a bank or trust company reflecting ownership of underlying securities issued by
a foreign company. An investment in depositary receipts involves further risks
due to certain unique features. Any distributions paid to the holders of
depositary receipts are usually subject to a fee charged by the depositary.
Holders of depositary receipts may have limited voting rights pursuant to a
deposit agreement between the underlying issuer and the depositary. In certain
cases, the depositary will vote the shares deposited with it as directed by the
underlying issuer’s board of directors. Furthermore, investment restrictions in
certain countries may adversely impact the value of depositary receipts because
such restrictions may limit the ability to convert shares into depositary
receipts and vice versa. Such restrictions may cause shares of the underlying
issuer to trade at a discount or premium to the market price of the depositary
receipt. Moreover, if depositary receipts are converted into shares, the laws in
certain countries may limit the ability of a non-resident to trade the shares
and to reconvert the shares to depositary receipts. Depositary receipts may be
“sponsored” or “unsponsored.” Sponsored depositary receipts are established
jointly by a depositary and the underlying issuer, whereas unsponsored
depositary receipts may be established by a depositary without participation by
the underlying issuer. Holders of unsponsored depositary receipts generally bear
all the costs associated with establishing the unsponsored depositary receipts.
In addition, the issuers of the securities underlying unsponsored depositary
receipts are not obligated to disclose material information in the U.S. and,
therefore, there may be less information available regarding such issuers and
there may not be a correlation between such information and the market value of
the depositary receipts.
EMERGING
MARKETS RISK.
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 the Fund to value its portfolio securities and could cause the Fund 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.
EQUITY SECURITIES
RISK. The value of the
Fund’s shares will fluctuate with changes in the value of the equity securities
in which it invests.
Equity securities prices
fluctuate for several reasons, including changes in investors' perceptions of the financial condition
of
an issuer or
the
general condition of the
relevant equity market, such as market volatility, or when political
or
economic
events affecting the issuers occur. Common
stock prices may be particularly sensitive to rising interest rates, as the cost
of capital rises and borrowing costs increase. Equity securities may decline
significantly in price over short or extended periods of
time, and such declines may occur in the equity market as a whole, or they may occur in only
a
particular country,
company, industry or sector of the market. Additionally, holders of an issuer's
common stock may be subject to greater risks than holders of its preferred stock
and debt securities because common stockholders' claims are subordinated to those of
holders of preferred stocks and debt securities upon the bankruptcy of an
issuer.
21
EUROPE
RISK. The Fund may invest
significantly in the securities of European issuers. Therefore, in addition to
the risks associated with investments in non-U.S. securities generally, the Fund
is subject to certain risks associated specifically with investments in
securities of European issuers. Political or economic disruptions in European
countries, even in countries in which the Fund is not invested, may adversely
affect security values and thus the Fund’s holdings. A significant number of
countries in Europe are member states in the EU, and the member states no longer
control their own monetary policies by directing independent interest rates for
their currencies. In these member states, the authority to direct monetary
policies, including money supply and official interest rates for the Euro, is
exercised by the European Central Bank. In a 2016 referendum, the United Kingdom
elected to withdraw from the EU. After years of negotiations between the United
Kingdom and the EU, a withdrawal agreement was reached whereby the United
Kingdom formally left the EU. As the second largest economy among EU members,
the implications of the United Kingdom’s withdrawal are difficult to gauge and
cannot be fully known. Trade between the United Kingdom and the EU is highly
integrated through supply chains and trade in services, as well as through
multinational companies. The United Kingdom’s departure may negatively impact
the EU and Europe as a whole by causing volatility within the EU, triggering
prolonged economic downturns in certain European countries or sparking
additional member states to contemplate departing the EU (thereby perpetuating
political instability in the region).
EXTENSION
RISK.
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.
FINANCIAL
COMPANIES RISK. The Fund invests
significantly in financial companies. Financial companies are subject to
extensive governmental regulation and intervention, which may adversely affect
the scope of their activities, the prices they can charge, the amount and types
of capital they must maintain and, potentially, their size. Governmental
regulation may change frequently and may have significant adverse consequences
for financial companies, including effects not intended by such regulation. The
impact of more stringent capital requirements, or recent or future regulation in
various countries, on any individual financial company or on financial companies
as a whole cannot be predicted. Certain risks may impact the value of
investments in financial companies more severely than those of investments in
other issuers, including the risks associated with companies that operate with
substantial financial leverage. Financial companies may also be adversely
affected by volatility in interest rates, loan losses and other customer
defaults, decreases in the availability of money or asset valuations, credit
rating downgrades and adverse conditions in other related markets. Insurance
companies in particular may be subject to severe price competition and/or rate
regulation, which may have an adverse impact on their profitability. Financial
companies are also a target for cyber attacks and may experience technology
malfunctions and disruptions as a result.
FIXED-TO-FLOATING
RATE SECURITIES RISK. Fixed-to-floating
rate securities are securities that have a fixed dividend rate for an initial
term that converts to a floating dividend rate upon the expiration of the
initial term. Securities with a floating or variable interest rate component can
be less sensitive to interest rate changes than securities with fixed interest
rates but may decline in value if their interest rates do not rise as much, or
as quickly, as interest rates in general. While fixed-to-floating rate
securities can be less sensitive to interest rate risk than fixed-rate
securities they generally carry lower yields than similar fixed-rate securities.
The interest rate for a floating rate security resets or adjusts periodically by
reference to a benchmark interest rate. The impact of interest rate changes on
floating rate investments is typically mitigated by the periodic interest rate
reset of the investments. Fixed-to-floating rate securities generally are
subject to legal or contractual restrictions on resale, may trade infrequently
and their value may be impaired when the Fund needs to liquidate such
securities. There is no guarantee or assurance that the Fund will be able to
invest in a desired amount of fixed-to-floating rate securities, will be able to
buy such securities at a desirable price or that the fixed-to-floating rate
securities in which it invests or seeks to invest will be actively traded. Any
or all of the foregoing, should they occur, could negatively impact the
Fund.
FLOATING
RATE SECURITIES RISK. 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 the Fund 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,
22
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’s
investment in high yield securities, or “junk” bonds, may entail increased
credit risks and the risk that the value of the Fund’s assets will decline, and
may decline precipitously, with increases in interest rates. In recent years
there have been wide fluctuations in interest rates and 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 Fund’s portfolio managers 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. Hybrid capital
securities are securities which contain characteristics of both debt and equity
securities and are subject to many of the same 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 the Fund or otherwise
adversely affect the Fund.
INCOME
RISK.
The Fund’s income may decline when interest rates fall. This decline can occur
because the Fund may subsequently invest in lower-yielding securities as debt
securities in its portfolio mature, are near maturity or are called, or the Fund
otherwise needs to purchase additional debt securities. In addition, the Fund’s
income could decline when the Fund experiences defaults on the debt securities
it holds.
INDEX
OR MODEL CONSTITUENT RISK. The Fund may be a constituent of one
or more indices or ETF models. As a result, the Fund may be included in one or
more index-tracking ETFs or mutual funds. Being a component security of such a
vehicle could greatly affect the trading activity involving the Fund's shares,
the size of the Fund and the market volatility of the Fund’s shares. Inclusion
in an index could increase demand for the Fund and removal from an index could
result in outsized selling activity in a relatively short period of time. As a
result, the Fund’s net asset value could be negatively impacted and the Fund’s
market price may be below the Fund’s net asset value during certain periods. In
addition, index rebalances may potentially result in increased trading activity.
To the extent buying or selling activity increases, the Fund can be exposed to
increased brokerage costs and adverse tax consequences and the market price of
the Fund can be negatively affected.
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 the Fund’s assets and distributions
may decline. This risk is more prevalent with respect to debt securities held by
the Fund. 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 Fund’s investments may not keep pace with
inflation, which may result in losses to Fund investors.
INTEREST
RATE RISK. The value of debt
securities held by the Fund 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. The Fund may be subject to
a greater risk of rising interest rates than would normally be the case due to
the current period of historically
23
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, the
Fund may be required to reinvest the proceeds from the sale, redemption or early
prepayment of a debt security at a lower interest rate.
LARGE
CAPITALIZATION COMPANIES RISK. The Fund may invest in the
securities of large capitalization companies. Large capitalization companies may
grow at a slower rate and be less able to adapt
to changing market conditions than smaller capitalization companies. Thus, the
return on investment in securities of large capitalization companies may be less
than the return on investment in securities of small and/or mid capitalization
companies. The performance of large capitalization companies also tends to trail
the overall market during different market cycles.
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 Fund. 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 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 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 Fund’s valuation of the investment. 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 the Fund 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 the Fund 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.
24
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.
NON-U.S.
SECURITIES RISK. 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.
PREFERRED
SECURITIES RISK. Preferred securities
combine some of the characteristics of both common stocks and bonds. Preferred
securities are typically subordinated to bonds and other debt 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 the Fund.
Preferred securities may also be substantially less liquid than other
securities, including common stock.
25
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.
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 the Fund may be required to reinvest the
proceeds of any prepayment at lower interest rates, reducing its income. If the
Fund purchased the debt securities at a premium, prepayments on the securities
could cause the Fund 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.
REIT
RISK. REITs typically
own and operate income-producing real estate, such as residential or commercial
buildings, or real-estate related assets, including mortgages. As a result,
investments in REITs are subject to the risks associated with investing in real
estate, which may include, but are not limited to: fluctuations in the value of
underlying properties; defaults by borrowers or tenants; market saturation;
changes in general and local operating expenses; and other economic, political
or regulatory occurrences affecting companies in the real estate sector.
Additionally, investing in REITs involves certain other risks related to their
structure and focus, which include, but are not limited to, dependency upon
management skills, limited diversification, the risks of locating and managing
financing for projects, heavy cash flow dependency, possible default by
borrowers, the costs and potential losses of self-liquidation of one or more
holdings, the risk of a possible lack of mortgage funds and associated interest
rate risks, overbuilding, property vacancies, increases in property taxes and
operating expenses, changes in zoning laws, losses due to environmental damages,
changes in neighborhood values and appeal to purchasers, the possibility of
failing to maintain exemptions from registration under the 1940 Act, failure to
satisfy the requirements of the Internal Revenue Code of 1986 for maintaining
REIT status and, in many cases, relatively small market capitalization, which
may result in less market liquidity and greater price volatility for a REIT’s
shares. REITs are also subject to the risk that the real estate market may
experience an economic downturn generally, which may have a material effect on
the real estate in which the REITs invest and their underlying portfolio
securities.
RESTRICTED
SECURITIES RISK. 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. Restricted securities include
private placement securities that have not been registered under the applicable
securities laws, such as Rule 144A securities, and securities of U.S. and
non-U.S. issuers that are issued pursuant to Regulation S. Private placements
are generally subject to strict restrictions on resale. Restricted securities
may be illiquid as they generally are not listed on an exchange and may have no
active trading market. The Fund may be unable to sell a restricted security on
short notice or may be able to sell them only at a price below current value. It
may be more difficult to determine a market value for a restricted security.
Also, the Fund may get limited information about the issuer of a restricted
security, so it may be less able to predict a loss. In addition, if Fund
management receives material non-public information about the issuer, the Fund
may as a result be unable to sell the securities. Certain restricted securities
may involve a high degree of business and financial risk and may result in
substantial losses.
SIGNIFICANT
EXPOSURE RISK. To the extent that
the Fund 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 the Fund were more broadly diversified. A significant
exposure makes the Fund more susceptible to any single occurrence and may
subject the Fund to greater volatility and market risk than a fund that is more
broadly diversified.
26
SMALLER
COMPANIES RISK. The
stock price of small and/or mid capitalization companies may be more volatile
than those of larger companies and therefore the Fund’s share price may be more
volatile than those of funds that invest a larger percentage of their assets in
stocks issued by large capitalization companies. Stock prices of small and/or
mid capitalization companies are also generally more vulnerable than those of
large capitalization companies to adverse business and economic developments.
Securities of small and/or mid capitalization companies may be thinly traded,
making it difficult for the Fund to buy and sell them. In addition, small and/or
mid capitalization companies are typically less financially stable than larger,
more established companies and may reinvest a high proportion of their earnings
in their business and may not pay dividends. Small and/or mid capitalization
companies may also depend on a small number of essential personnel who may also
be less experienced than the management of larger companies, making these
companies more vulnerable to experiencing adverse effects due to the loss or
inexperience of personnel. Small and/or mid capitalization companies also
normally have less diverse product lines than those of large capitalization
companies and are more susceptible to adverse developments concerning their
products.
SUBORDINATED
DEBT RISK. Perpetual
subordinated debt is a type of hybrid instrument that has no maturity date for
the return of principal and does not need to be redeemed by the issuer. These
investments typically have lower credit ratings and lower priority than other
obligations of an issuer during bankruptcy, presenting a greater risk for
nonpayment. This risk increases as the priority of the obligation becomes lower.
Payments on these securities may be subordinated to all existing and future
liabilities and obligations of subsidiaries and associated companies of an
issuer. Additionally, some perpetual subordinated debt does not restrict the
ability of an issuer’s subsidiaries to incur further unsecured
indebtedness.
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.
VALUATION
RISK.
The Fund may hold securities or other assets that may be valued on the basis of
factors other than market quotations. This may occur because the asset or
security does not trade on a centralized exchange, or in times of market turmoil
or reduced liquidity. There are multiple methods that can be used to value a
portfolio holding when market quotations are not readily available. The value
established for any portfolio holding at a point in time might differ from what
would be produced using a different methodology or if it had been priced using
market quotations. Portfolio holdings that are valued using techniques other
than market quotations, including “fair valued” assets or securities, may be
subject to greater fluctuation in their valuations from one day to the next than
if market quotations were used. In addition, there is no assurance that the Fund
could sell or close out a portfolio position for the value established for it at
any time, and it is possible that the Fund would incur a loss because a
portfolio position is sold or closed out at a discount to the valuation
established by the Fund at that time. The Fund’s ability to value investments
may be impacted by technological issues or errors by pricing services or other
third-party service providers.
Non-Principal
Risks
ASIA
RISK.
The Fund may invest in the securities of Asian issuers. Such investments subject
the Fund to certain risks associated specifically with investments in securities
of Asian issuers, including distinct legal, regulatory, political and economic
risks. Many Asian economies have experienced rapid growth and industrialization,
and there is no assurance that this growth rate will be maintained. Some Asian
economies are highly dependent on trade, and economic conditions in other
countries within and outside Asia can impact these economies. Certain of these
economies may be adversely affected by trade or policy disputes with its major
trade partners. There is also a high concentration of market capitalization and
trading volume in a small number of issuers representing a limited number of
industries, as well as a high concentration of investors and financial
intermediaries. Certain Asian countries have experienced and may in the future
experience expropriation and nationalization of assets, confiscatory taxation,
currency manipulation, political instability, armed conflict and social
instability as a result of religious, ethnic, socio-economic and/or political
unrest. In particular, escalated tensions involving North Korea and any outbreak
of hostilities involving North Korea could have a severe adverse effect on Asian
economies. Governments of certain Asian countries have exercised, and continue
to exercise, substantial influence over many aspects of the private sector. In
certain cases, the government owns or controls many companies, including the
largest in the country. Accordingly, government actions could have a significant
effect on the issuers of the Fund’s securities or on economic conditions
generally. Issuers in Asia may not be subject to the same accounting, auditing
and financial reporting standards as U.S. companies and if their securities are
not listed on a U.S. exchange, they may not be subject to the same corporate
governance standards as U.S. issuers. In addition,
27
satisfactory
custodial services for investment securities may not be available in some Asia
countries, which may result in the Fund incurring
additional costs and delays in providing transportation and custody services for
such securities outside such countries. Recent developments in relations between
the U.S. and China have heightened concerns of increased tariffs and
restrictions on trade between the two countries. An increase in tariffs or trade
restrictions, or even the threat of such developments, could lead to a
significant reduction in international trade, which could have a negative impact
on the economy of Asian countries and a commensurately negative impact on the
Fund.
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.
DEPENDENCE
ON KEY PERSONNEL RISK. The Sub-Advisor is
dependent upon the experience and expertise of the Fund’s portfolio managers in
providing advisory services with respect to the Fund’s investments. If the
Sub-Advisor were to lose the services of any of these portfolio managers, its
ability to service the Fund could be adversely affected. There can be no
assurance that a suitable replacement could be found for any of the portfolio
managers in the event of their death, resignation, retirement or inability to
act on behalf of the Sub-Advisor.
DERIVATIVES
RISK. 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 the Fund 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.
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.
INVESTMENT
COMPANIES RISK. The Fund
may invest in securities of other investment companies. As a shareholder in
another investment company, the Fund will bear its ratable share of that
investment company’s expenses, and would remain subject to payment of the Fund’s
advisory and administrative fees with respect to assets so invested.
Shareholders would therefore be subject to duplicative expenses to the extent
the Fund invests in other investment companies. In addition, the Fund will incur
brokerage costs when purchasing and selling shares of exchange-traded investment
companies.
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.
LATIN
AMERICA RISK. The Fund may invest
in Latin American issuers. The economies of Latin American countries have in the
past experienced considerable difficulties, including high inflation rates, high
interest rates, high unemployment, government overspending and political
instability. International economic conditions, particularly those in the United
States, Europe and Asia, as well as world prices for oil and other commodities
may also influence the development of Latin American economies. Many Latin
American countries are highly reliant on the exportation of commodities and
their economies may be significantly impacted by fluctuations in commodity
prices and the global demand for certain commodities. In the past, certain Latin
American economies have been influenced by changing supply and demand for a
particular currency, monetary policies of governments (including exchange
control programs, restrictions on local exchanges or markets and limitations on
foreign investment in a country or on investment by residents of a country in
other countries), and currency devaluations and
28
revaluations.
Other Latin American investment risks may include inadequate investor
protection, less developed regulatory, accounting, auditing
and financial standards, unfavorable changes in laws or regulations, natural
disasters, corruption and military activity. The governments of many Latin
American countries may also exercise substantial influence over many aspects of
the private sector, and any such exercise could have a significant effect on
companies in which the Fund invests. Securities of companies in Latin America
may also be subject to significant price volatility.
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 companies in
which the Fund invests. In addition, litigation regarding any of the issuers 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 Sub-Advisor determines to sell such a holding.
U.S.
GOVERNMENT SECURITIES RISK. The Fund may invest
in 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 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. No
assurance can be given that the U.S. government will provide financial support
to its government sponsored entities or any other agency if not obligated by law
to do so.
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
objective 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, Sub-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 overseeing the Sub-Advisor in the investment of the Fund's
assets, managing the Fund's business affairs and providing certain clerical,
bookkeeping and other administrative services.
First Trust is a
limited partnership with one limited partner, Grace Partners of DuPage L.P., and
one general partner, The Charger Corporation. Grace Partners of DuPage
L.P. is a limited partnership with one general partner, The Charger Corporation,
and a number of limited partners. The Charger Corporation is an Illinois
corporation controlled by James A. Bowen, the Chief Executive Officer of First
Trust. First Trust discharges its responsibilities subject to the policies of
the Fund.
First Trust serves
as advisor or sub-advisor for 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.
The Trust, on behalf
of the Fund, and First Trust have retained Stonebridge, an affiliate of First
Trust, to serve as investment sub-advisor pursuant to a
sub-advisory agreement (the “Sub-Advisory
Agreement”). In this
capacity, Stonebridge is responsible for the selection and ongoing monitoring of
the securities in the Fund’s investment portfolio. Stonebridge is a niche asset
management firm that manages portfolios of preferred securities for investors.
Stonebridge, formed in December 2004, serves as investment advisor to investment
portfolios with approximately $14.408 billion in assets which it managed as of
December 31, 2022.
Scott
T. Fleming, Robert Wolf, Eric Weaver and Angelo Graci are the Fund’s portfolio
managers and share responsibilities for the day-to-day
management of the Fund’s investment portfolio.
•
Scott Fleming serves
as Chief Executive Officer and President of Stonebridge setting the strategic
direction of Stonebridge including operations, business and product development,
and marketing strategies. Mr. Fleming
29
leads
the Investment Committee and oversees investment policies and strategies for all
of the company’s portfolio management
activities. Additionally, Mr. Fleming directs the daily management of preferred
stock portfolios. Prior to founding Stonebridge in 2004, Mr. Fleming co-founded
Spectrum Asset Management, Inc., an investment advisor that specializes in
preferred securities asset management for institutional clients and mutual
funds. During his 13-year tenure there, he served as Chairman of the Board of
Directors, Chief Financial Officer and Chief Investment Officer. Under his
leadership, Spectrum grew to be the largest preferred securities manager in the
country. Mr. Fleming previously served as Vice President, Portfolio Manager for
DBL Preferred Management, Inc. in New York City. Mr. Fleming received a B.S. in
Accounting from Bentley College in Waltham, MA and his MBA in Finance from
Babson College in Wellesley, MA.
•
Robert Wolf serves as
Chief Investment Officer, Executive Vice President and Senior Portfolio Manager
at Stonebridge. Mr. Wolf is a senior member of Stonebridge Advisors’ Investment
Committee and oversees investment strategies and portfolio management activities
across fund products and separately managed accounts. Mr. Wolf directs the daily
management of preferred securities portfolios and performs both credit research
and trading functions. Mr. Wolf has over twenty-two years of fixed-income
experience in both portfolio management and credit research. Prior to joining
Stonebridge in 2006, Mr. Wolf was a high-yield fixed-income research analyst at
Lehman Brothers. In this role, his responsibilities included detailed credit
analysis across multiple sectors, relative value analysis, and developing trade
recommendations. Mr. Wolf previously worked for Lehman Brothers’ commercial
mortgage-backed securities (CMBS) trading desk as a
credit analyst. Mr. Wolf received his B.S. degree in Chemistry from Villanova
University and his MBA in Finance from the New York University Stern School of
Business.
•
Eric Weaver serves as
Executive Vice President, Chief Strategist and Portfolio Manager at Stonebridge.
Mr. Weaver is a senior member of Stonebridge Advisors’ Investment Committee and
oversees the investment strategy across all fund products and separately managed
accounts. In addition, Mr. Weaver leads the development of proprietary portfolio
management, security selection, trading, and operational tools. Mr. Weaver has
fourteen years of investment management experience in portfolio management,
trading, risks analysis, and research. Prior to joining Stonebridge in 2013, Mr.
Weaver worked at a private proprietary trading firm as a senior derivatives
trader, with OTC and electronic trading experience on the NASDAQ OMX PHLX and
CBOE options exchanges. In this role, Mr. Weaver focused on trading, portfolio
and risk management, and pricing complex derivatives in a large and diverse
portfolio of equities, options, and futures. Mr. Weaver received a B.A. degree
in Economics and Mathematics and a MS degree in Economics from Lehigh University
in Bethlehem, PA.
•
Angelo Graci is Executive Vice
President, Head of Credit Research, and Portfolio Manager of
Stonebridge Advisors. Mr. Graci is a senior
member of the Investment Committee and manages a team of analysts that oversees
all of Stonebridge’s portfolio investments. His extensive knowledge of global
banking, insurance, non-bank finance and REITs brings an impressive level of
analytical depth to the Stonebridge research team. Mr. Graci has 27 years of
credit and equity research experience with a focus on
financials. Prior to joining Stonebridge in 2018, Mr. Graci was a global
financials credit strategist at Stifel Financial, with a particular focus on
hybrid/preferred strategy. Before Stifel, he was a senior analyst at Caxton
Associates, responsible for financial sector credit and equity analysis and
portfolio management. Prior roles included global financials and hybrid strategy
at Citadel Securities and credit analysis and trading at Merrill Lynch. Mr.
Graci received a BS in Finance from SUNY Albany and an MBA in Finance from the
New York University Stern School of Business. He holds the CFA® designation awarded by CFA
Institute.
For
additional information concerning First Trust and the Sub-Advisor, 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 shares 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
oversees Stonebridge's management of the Fund's assets and pays Stonebridge for
its services as Sub-Advisor. First Trust is paid an annual unitary management
fee by the Fund equal to 0.85% of the Fund's average daily net assets and is
responsible for the Fund's expenses, including the cost of transfer agency,
sub-advisory, custody, fund administration, legal, audit and other services, but
excluding fee payments under the Investment Management Agreement,
30
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 payable pursuant to a Rule
12b-1 plan, if any, and extraordinary expenses.
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.
A discussion
regarding the Board’s approval of the continuation of the Investment Management
Agreement and the Sub-Advisory 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 and 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
31
(“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. With respect to trades directly with
the Fund, to the extent effected in-kind (i.e., for securities), those trades do
not cause any of the harmful effects that may result from frequent cash trades.
To the extent that the Fund 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 objective.
However, the Board noted that direct trading by APs is critical to ensuring 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. Some portion of the ordinary income distributions that are attributable
to dividends received by the Fund from shares in certain real estate investment
trusts may be designated by the Fund as eligible for a deduction for qualified
business income, provided certain holding period requirements are satisfied.
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
32
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.
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 gain received from assets held for more than one year that is
considered “unrecaptured section 1250 gain” (which may be the case, for example,
with some capital gains attributable to equity interests in real estate
investment trusts that constitute interests in entities treated as real estate
investment trusts for federal income tax purposes) is taxed at a maximum
marginal stated federal tax rate of 25%. In the case of capital gain dividends,
the determination of which portion of the capital gain dividend, if any, is
subject to the 25% tax rate, will be made based on rules prescribed by the
United States Treasury. 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.
Distributions with respect to shares in REITs and foreign corporations are
qualifying dividends only in limited circumstances. 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
33
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.
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.
34
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 February 28, 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.
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 The Nasdaq Stock Market LLC ("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. For portfolio securities traded on an exchange
that provides both an official closing price and a last sale price, the Advisor,
at its discretion, shall determine to use either the last sale price or the
official closing price, depending on which price reflects the appropriate market
value. 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
35
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 quotations or official closing prices
on the applicable exchange. A variety of factors may be considered in
determining the fair value of such securities. See the Fund's SAI for
details.
Because
foreign securities exchanges may be open on different days than the days during
which an investor may purchase or sell shares of the
Fund, the value of the Fund's securities may change on days when investors are
not able to purchase or sell shares of the Fund. The value of securities
denominated in foreign currencies is converted into U.S. dollars at the exchange
rates in effect at the time of valuation.
Preferred,
hybrid and fixed income securities will be valued by the fund accounting agent
using a pricing service. Fixed income securities with a
remaining maturity of 60 days or less when purchased will be valued at cost
adjusted for amortization of premiums and accretion of discounts. When price
quotes are not available, fair market value is based on prices of comparable
securities.
Repurchase
agreements will be valued as follows: Overnight repurchase agreements will be
valued at cost. Term
repurchase agreements (i.e., those whose maturity exceeds seven
days) will be valued by the Advisor at the average of the bid quotations
obtained daily from at least two recognized dealers.
Currency-linked
notes, credit-linked notes, interest rate swaps, credit default swaps, and other
similar instruments will be valued by the Fund by
using a pricing service or, if the pricing service does not provide a value, by
quotes provided by the selling dealer or financial institution. When price
quotes are not available, fair market value is based on prices of comparable
securities. Absent a material difference between the exit price for these
instruments and the market rates for similar instruments, currency-linked notes,
credit-linked notes, etc. will be valued at the exit price.
Fund
Service Providers
Brown
Brothers Harriman & Co., 50 Post Office Square, Boston, Massachusetts 02110,
acts as the administrator, accounting agent, custodian and
transfer agent for the Fund. Chapman and Cutler LLP, 320 S. Canal St., Chicago,
Illinois 60606, serves as legal counsel to the Fund. First Trust serves as the
fund reporting agent for the Fund.
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 a blended benchmark and a
market index. 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
36
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 index. 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.
First
Trust Institutional Preferred Securities and Income ETF (FPEI)
Total Returns as of October 31, 2022
Total Returns as of October 31, 2022
|
|
|
Average
Annual |
Cumulative | ||
|
|
1
Year |
5
Years |
Inception
(8/22/2017) |
5
Years |
Inception
(8/22/2017) |
|
Fund
Performance |
|
|
|
|
|
|
Net Asset
Value |
-11.68% |
1.88% |
2.20% |
9.77% |
11.97% |
|
Market
Price |
-11.70% |
1.91% |
2.24% |
9.91% |
12.17% |
|
Index
Performance |
|
|
|
|
|
|
Blended
Benchmark(1) |
-14.90% |
1.50% |
1.85% |
7.75% |
9.96% |
|
ICE BofA
US Investment Grade Institutional Capital
Securities
Index |
-13.64% |
1.61% |
1.80% |
8.33% |
9.69% |
(1)
The Blended
Benchmark consists of a 45/40/15 blend of the ICE BofA US Investment Grade
Institutional Capital Securities Index, the ICE USD Contingent Capital Index and
the ICE BofA US High Yield Institutional Capital Securities Index. The Blended
Benchmark is intended to reflect the proportional market cap of each segment
within the institutional market. The Blended Benchmark returns are calculated by
using the monthly returns of the three indices during each period shown above.
At the beginning of each month the three indices are rebalanced to a 45/40/15
ratio to account for divergence from that ratio that occurred during the course
of each month. The monthly returns are then compounded for each period shown
above, giving the performance for the Blended Benchmark for each period shown
above.
37
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 III
Financial
Highlights
For a share outstanding throughout each period
For a share outstanding throughout each period
First
Trust Institutional Preferred Securities and Income ETF (FPEI)
|
|
Year
ended October 31, | ||||
|
|
2022 |
2021 |
2020 |
2019 |
2018 |
|
Net
asset value, beginning of period |
$20.52 |
$19.36 |
$19.85 |
$18.75 |
$20.26 |
|
Income
from investment operations: |
|
|
|
|
|
|
Net
investment income (loss) |
0.88 |
0.90 |
1.01 |
1.01 |
0.99 |
|
Net
realized and unrealized gain (loss) |
(3.22) |
1.19 |
(0.50) |
1.12 |
(1.47) |
|
Total
from investment operations |
(2.34) |
2.09 |
0.51 |
2.13 |
(0.48) |
|
Distributions
paid to shareholders from: |
|
|
|
|
|
|
Net
investment income |
(0.87) |
(0.88) |
(0.97) |
(1.00) |
(1.03) |
|
Return of
capital |
(0.05) |
(0.05) |
(0.03) |
(0.03) |
— |
|
Total
distributions |
(0.92) |
(0.93) |
(1.00) |
(1.03) |
(1.03) |
|
Net
asset value, end of period |
$17.26 |
$20.52 |
$19.36 |
$19.85 |
$18.75 |
|
Total
Return (a) |
(11.68)% |
10.91% |
2.76% |
11.75% |
(2.42)% |
|
Ratios/supplemental
data: |
|
|
|
|
|
|
Net
assets, end of period (in 000’s) |
$649,036 |
$492,418 |
$284,519 |
$235,178 |
$93,757 |
|
Ratios
to average net assets: |
|
|
|
|
|
|
Ratio of
total expenses to average net assets |
0.85% |
0.85% |
0.85% |
0.85% |
0.85% |
|
Ratio of
net investment income (loss) to average net assets |
4.89% |
4.60% |
5.22% |
5.39% |
5.36% |
|
Portfolio
turnover rate (b) |
31% |
22% |
48% |
28% |
25% |
(a)
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.
(b)
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.
38
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.
39
|
First
Trust
Exchange-Traded
Fund III |
First
Trust Institutional Preferred Securities and 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 #: 333-176976
811-22245
811-22245