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First
Trust
Exchange-Traded
Fund IV |
Prospectus
First Trust SSI
Strategic Convertible Securities ETF
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Ticker
Symbol: |
FCVT |
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Exchange: |
Nasdaq |
First
Trust SSI Strategic Convertible Securities ETF (the “Fund”) lists and
principally trades its shares on The Nasdaq Stock Market LLC (“Nasdaq” or the “Exchange”). Market prices may
differ to some degree from the net asset value of the shares. Unlike mutual
funds, the Fund issues and redeems shares at net asset value, only in large
specified blocks of shares called "Creation
Units."
The
Fund is a series of First Trust Exchange-Traded Fund IV (the “Trust”) and an actively
managed exchange-traded fund organized as a separate series of a registered
management investment company.
Except
when aggregated in Creation Units, the shares are not redeemable securities of
the Fund.
The
Securities and Exchange Commission has not approved or disapproved of these
securities or passed upon
the adequacy or accuracy of this prospectus. Any representation to the contrary
is a criminal offense.
NOT
FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE
March
1, 2022
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
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1
Year |
5
Years |
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 Shares |
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ICE BofA All
US Convertible Index (reflects no deduction for fees,
expenses or
taxes) |
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Management
Investment
Advisor
First
Trust Advisors L.P. (“First
Trust”
or the “Advisor”)
Investment
Sub-Advisor
SSI
Investment Management LLC (“SSI” or the “Sub-Advisor”)
Portfolio
Managers
The
following persons serve as portfolio managers of the Fund.
•
George M. Douglas,
CFA, Principal and Chief Investment Officer of SSI
11
•
Ravi Malik, CFA,
Principal and Portfolio Manager of SSI
•
Michael J. Opre, CFA,
Portfolio Manager of SSI
•
Florian Eitner, CFA,
Portfolio Manager of SSI
•
Stephen R. Wachtel,
CFA, Portfolio Manager of SSI
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 2015, except for Mr.
Wachtel, who has served as part of the Fund's portfolio management team since
2020.
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 or other financial
intermediary (such as a bank), 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.
12
Additional
Information on the Fund's Investment Objective and Strategies
The Fund is a series
of First Trust Exchange-Traded Fund IV and is regulated as an “investment
company” under the 1940 Act. The Fund is actively managed and does
not seek to track the performance of an index. The Fund’s investment 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 Convertible Securities. The Name
Policy may be changed by the Board without shareholder approval upon 60 days’
prior written notice. While it is not expected that the Fund will invest in the
securities of other investment companies, any such investments would be subject
to limitations imposed 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.
Fund
Investments
Principal
Investments
Convertible
Securities
Convertible
securities are generally bonds, debentures, notes, preferred securities or other
securities or investments that may be converted or
exchanged into equity securities (and/or the cash equivalent thereof), which may
be at a stated exchange ratio or predetermined price (the “conversion
price”).
A convertible security is designed to provide current income and also the
potential for capital appreciation through the conversion feature, which enables
the holder to benefit from increases (if any) in the market price of the
underlying equity security. Accordingly, these equity-linked instruments offer
the potential for equity market participation along with, in light of their
bond-like characteristics, potential mitigated downside risk (which is generally
the risk that a security may suffer a decline in value) in periods of equity
market declines.
A
convertible security generally entitles the holder to receive interest paid or
accrued until the convertible security matures or is redeemed,
converted or exchanged. Before conversion, convertible securities have
characteristics similar to non-convertible debt obligations and are designed to
provide for a stable stream of income with generally higher yields than common
stocks. However, there can be no assurance of current income because the issuers
of the convertible securities may default on their obligations.
Convertible
securities rank senior to common stock in a corporation’s capital structure and,
therefore, generally entail less risk than the
corporation’s common stock. Convertible debt securities may be subordinate in
rank to any senior debt obligations of the issuer and, therefore, such
subordinated convertible debt securities entail more risk than its senior debt
obligations.
A
convertible security may be called for redemption or conversion by the issuer
after a particular date and under certain circumstances
(including a specified price) established upon issue. 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.
Convertible
securities have valuation characteristics similar to both debt and equity
securities. Convertible securities generally offer lower interest
or dividend yields than non-convertible debt securities of similar credit
quality because of the potential for capital appreciation. The value of
convertible securities is influenced by both the yield of non-convertible
securities of comparable issuers and by the value of the underlying equity
security. The value of a convertible security viewed without regard to its
conversion feature (i.e., strictly on the
basis of its yield) is sometimes referred to as its “investment value.” The
investment value of the convertible security typically will fluctuate based on
the credit quality of the issuer and will fluctuate inversely with changes in
prevailing interest rates. However, at the same time, the value of a convertible
security will be influenced by its “conversion value,” which is the market value
of the underlying equity security that would be obtained if the convertible
security were converted. Conversion value fluctuates directly with the price of
the underlying equity security, and will therefore be subject to risks relating
to the activities of the issuer of the underlying equity security and general
market
13
and
economic conditions. Depending upon the relationship of the conversion price to
the market value of the underlying security, a
convertible security may trade more like an equity security than a debt
instrument.
If,
because of a low price of the underlying equity security, the conversion value
is substantially below the investment value of the convertible
security, the price of the convertible security is governed principally by its
investment value. Generally, if the conversion value of a convertible security
increases to a point that approximates or exceeds its investment value, the
value of the security will be principally influenced by its conversion value. A
convertible security will sell at a premium over its conversion value to the
extent investors place value on the right to acquire the underlying equity
security while holding an income-producing security.
Debt
and preferred securities with warrants attached to purchase equity securities
have many characteristics of convertible securities and their
prices may, to some degree, reflect the performance of the underlying equity
security. A warrant is a right to purchase an equity security at a specific
price (usually at a premium above the market value of the underlying equity
security at the time of issuance) during a specified period of
time.
Contingent
Convertible Securities. Contingent
convertible securities (which generally provide for conversion under certain
circumstances) are distinguished as a subset of convertible securities. Similar
to mandatory convertible securities (and unlike traditional convertible
securities), some contingent convertible securities provide for mandatory
conversion under certain circumstances. The mandatory conversion might be
automatically triggered, for instance, if a company fails to meet the minimum
amount of capital described in the security, the company’s regulator makes a
determination that the security should convert or the company receives specified
levels of extraordinary public support. Since the common stock of the issuer may
not pay a dividend, investors in these instruments could experience a reduced
income rate, potentially to zero, and conversion would deepen the subordination
of the investor, hence worsening standing in a bankruptcy. Further, some
contingent convertible securities have a set stock conversion rate that would
cause a reduction in value of the security if the price of the stock is below
the conversion price on the conversion date. In addition, various contingent
convertible securities may contain features that limit an investor’s ability to
convert the security unless certain conditions are met.
Exchangeable
Debt Securities. Exchangeable debt
securities are convertible debt securities in which the underlying equity
security is issued by an entity that is different from the issuer of the
convertible securities, often a subsidiary of the issuer. The valuation of an
exchangeable debt security is similar to that of a convertible debt security,
with the conversion value influenced by the issuer of the underlying equity
security.
Mandatory
Convertible Securities. Mandatory
convertible securities are distinguished as a subset of convertible securities
because the conversion is not optional and the conversion price at maturity (or
redemption) is based solely upon the market price of the underlying equity
security, which may be significantly less than par or the price (above or below
par) paid. Mandatory convertible securities automatically convert to equity
securities at maturity. For these reasons, the risks associated with investing
in mandatory convertible securities most closely resemble the risks inherent in
equity securities. Mandatory convertible securities customarily pay a higher
coupon yield to compensate for the potential risk of additional price volatility
and loss upon redemption. Since the correlation of common stock risk increases
as the security approaches its redemption date, there can be no assurance that
the higher coupon will compensate for the potential loss.
Synthetic
Convertible Securities. Some synthetic
convertible securities consist of two or more distinct securities whose economic
characteristics, when taken together, resemble those of traditional convertible
securities (i.e., an income
producing component and the convertible component). For example, the income
producing component may be achieved by purchasing non-convertible securities
such as bonds, preferred securities or money market instruments and the
convertible component may be achieved through warrants or options to buy common
stock at a certain exercise price, or options on a stock index. Other synthetic
convertible securities include exchangeable or equity-linked securities issued
by a broker-dealer, investment bank or other financial institution with proceeds
going directly to the broker-dealer, investment bank or other financial
institution, as applicable, that have economic characteristics similar to those
of traditional convertible securities.
Synthetic
convertibles are typically offered by financial institutions in private
placement transactions and are typically sold back to the offering
institution. Upon conversion, the holder generally receives from the offering
institution shares and/or cash of the then-current value of the underlying
securities.
Synthetic
convertible securities may differ from traditional convertible securities in
several respects. The value of a synthetic convertible is the
sum of the values of its income producing component and its convertible
component. Thus, the values of a synthetic convertible and a traditional
convertible security will respond differently to market fluctuations. Purchasing
a synthetic convertible security may provide greater flexibility than purchasing
a traditional convertible security, including the
14
ability
to combine components representing distinct issuers or to combine a fixed income
security with a call option on a stock index. In addition,
synthetic convertible securities may alter the characteristics common to
traditional convertible securities such as by offering enhanced yields in
exchange for reduced capital appreciation or less downside protection. The
component parts of a synthetic convertible security may be purchased
simultaneously or separately.
The
holder of a synthetic convertible faces the risk that the price of the stock, or
the level of the market index underlying the convertible
component, will decline. In addition, in purchasing a synthetic convertible
security, a Fund may have counterparty risk with respect to the financial
institution that offers the instrument or with respect to the institution that
issued the income producing component of the convertible security when such an
institution is not the financial institution creating the synthetic convertible
security. Synthetic convertible securities are also subject to additional
liquidity risk and to the risks associated with derivatives.
Synthetic
convertible securities include convertible structured notes, which are income
producing debentures linked to equity and are typically
issued by investment banks. Convertible structured notes have the attributes of
a convertible security. However, the credit risk that the Fund assumes on
purchasing such a security pertains to the investment bank that issues the
convertible note, rather than the issuer of the underlying equity security into
which the note is convertible.
Debt
Securities
Debt
securities include obligations typically issued by corporations to borrow money
from investors, such as corporate bonds, debentures and notes.
These securities may be either secured or unsecured. Holders of debt securities,
as creditors, have a prior legal claim over common and preferred shareholders as
to both income and assets of the issuer for the principal and interest due them
and may have a prior claim over other creditors if liens or mortgages are
involved. Interest on debt securities is typically paid semi-annually and is
fully taxable to the holder of the securities. The investment return of debt
securities reflects interest on the security and changes in the market value of
the security. The market value of a fixed rate debt security generally may be
expected to rise and fall inversely with changes in interest rates and also may
be affected by the credit rating of the issuer, the issuer’s performance and
perceptions of the issuer in the marketplace. Debt securities issued by
corporations usually have a higher yield than government or agency bonds due to
the presence of credit risk. Certain of the debt securities in which the Fund
may invest may be rated below investment grade (commonly referred to as “junk”
or “high yield” securities).
Exchange-Traded
Notes.
ETNs are a type of senior, unsecured, unsubordinated debt security issued by
financial institutions that combines both aspects of bonds and ETFs. An ETN’s
returns are based on the performance of a market index minus fees and expenses.
Similar to ETFs, ETNs are listed on an exchange and traded in the secondary
market. However, unlike an ETF, an ETN can be held until the ETN’s maturity, at
which time the issuer is obligated to pay a return linked to the performance of
the market index to which the ETN is linked minus certain fees. Unlike regular
bonds, ETNs do not make periodic interest payments and principal is not
protected. When the Fund invests in ETNs, it will bear its proportionate share
of any fees and expenses borne by the ETN. The Fund’s decision to sell its ETN
holdings may be limited by the availability of a secondary market. In addition,
although an ETN may be listed on an exchange, the issuer may not be required to
maintain the listing and there can be no assurance that a secondary market will
exist for an ETN.
High
Yield Securities. The Fund may invest
in securities of any credit quality, including securities that are rated below
investment grade. Below investment grade securities are rated below “BBB-” by
Standard & Poor’s Ratings Group, a division of The McGraw-Hill Companies
(“S&P”), or Fitch Ratings,
Inc. (“Fitch”), below “Baa3” by
Moody’s Investors Service, Inc. (“Moody’s”) or comparably
rated by another nationally recognized statistical rating organization
(“NRSRO”) or, if unrated,
determined by the Sub-Advisor to be of comparable credit quality at the time of
purchase. Below investment grade securities are commonly referred to as “junk”
or “high yield” securities and are considered speculative with respect to the
issuer’s capacity to pay interest and repay principal.
Equity
Securities
The
Fund may hold equity securities in its portfolio through direct investments in
equity securities or upon conversion of a Convertible Security
into its corresponding underlying security. Equity securities include common and
preferred stocks, depositary receipts, and equity interests in BDCs. An
investment in the equity securities of a company represents a proportionate
ownership interest in that company. Therefore, the Fund participates in the
financial success or failure of any company in which it has an equity
interest.
Business
Development Companies. BDCs are a type of
closed-end fund regulated under the 1940 Act that typically invest in and lend
to small and medium-sized private and certain public companies that may not have
access to public equity markets for capital raising. BDCs invest in such diverse
industries as healthcare, chemical and manufacturing, technology and service
15
companies.
BDCs are unique in that at least 70% of their investments must be made in
private and certain public U.S. businesses, and BDCs are required
to make available significant managerial assistance to their portfolio
companies. Unlike corporations, BDCs are not taxed on income distributed to
their shareholders provided they comply with the applicable requirements of the
Internal Revenue Code of 1986, as amended. BDCs, which are required to
distribute substantially all of their income to investors in order to not be
subject to entity level taxation, often offer a yield advantage over other types
of securities. The Fund will indirectly bear its proportionate share of any
management and other expenses, and of any performance based or incentive fees,
charged by the BDCs in which it invests, in addition to the expenses paid by the
Fund. The Fund is permitted to invest in BDCs in excess of the limits imposed
under the 1940 Act pursuant to an exemptive order obtained by the Trust and the
Advisor.
Common
Stock.
Traditional convertible securities are typically converted into common stocks.
Common stocks represent residual ownership interest in issuers and holders of
common stocks are entitled to the income and increase in the value of the assets
and business of the issuers after all debt obligations and obligations to
preferred stockholders are satisfied. Common stocks generally have voting
rights. Common stocks fluctuate in price in response to many factors including
historical and prospective earnings of the issuer, the value of its assets,
general economic conditions, interest rates, investor perceptions and market
liquidity. The value of common stocks purchased by the Fund could decline if the
financial condition of the companies the Fund invests in declines or if overall
market and economic conditions deteriorate. Their value also may decline due to
factors that affect a particular industry or industries, such as labor shortages
or an increase in production costs and competitive conditions within an
industry. In addition, they may decline due to general market conditions that
are not specifically related to a company or industry, such as real or perceived
adverse economic conditions, changes in the general outlook for corporate
earnings, changes in interest or currency rates or generally adverse investor
sentiment.
Preferred
Securities. Preferred
securities represent an equity ownership interest in the issuer, but generally
entitle the holder to receive, in preference to the holders of other stocks such
as common stocks, dividends and a fixed share of the proceeds resulting from
liquidation of the company. Some preferred securities also entitle their holders
to receive additional liquidation proceeds on the same basis as holders of a
company’s common stock. Some preferred securities offer a fixed rate of return
with no maturity date. Because those preferred securities never mature, they act
like long-term bonds, can be more volatile than other types of preferred
securities and may have heightened sensitivity to changes in interest rates.
Other preferred securities have a variable dividend, generally determined on a
quarterly or other periodic basis, either according to a formula based upon a
specified premium or discount to the yield on particular U.S. Treasury
securities or based on an auction process, involving bids submitted by holders
and prospective purchasers of such stocks. Because preferred securities
represent an equity ownership interest in a company, their value usually will
react more strongly than bonds and other debt instruments to actual or perceived
changes in the company’s financial condition or prospects or to fluctuations in
the equity markets. Holders of preferred securities generally have no voting
rights or their voting rights are limited to certain extraordinary transactions
or events.
Non-U.S.
Investments
Non-U.S.
investments include securities issued or guaranteed by companies organized under
the laws of countries other than the United States,
including companies domiciled in emerging markets. Non-U.S. investments may be
traded on foreign securities exchanges or in over-the-counter capital markets.
Many non-U.S. companies issue both foreign currency and U.S. dollar-denominated
securities. The Fund may also invest in ADRs and GDRs, or other securities
representing underlying securities of non-U.S. issuers.
ADRs
are typically issued by a financial institution (a depositary) and evidence
ownership interests in a security or a pool of securities issued by
a non-U.S. company and deposited with the depositary. Generally, ADRs in
registered form are dollar-denominated securities designed for use in the U.S.
securities markets. GDRs are receipts issued outside the United States,
typically by non-United States banks and trust companies, that evidence
ownership of either non-U.S. or domestic securities. Generally, GDRs are
designed for use outside the United States. ADRs and GDRs may be issued as
sponsored or unsponsored programs. In sponsored programs, an issuer has made
arrangements to have its securities trade in the form of ADRs or GDRs.
Unsponsored ADR and GDR programs are organized independently and without the
cooperation of the issuer of the underlying securities. The Fund will only
invest in sponsored ADRs and GDRs.
In
connection with its non-U.S. investments, to protect the value of its portfolio
against uncertainty in the level of future currency exchange rates, the
Fund may enter into foreign currency transactions on a spot (i.e., cash) basis or it
may enter into forward foreign currency exchange contracts (described
below).
16
Derivative
Instruments
The
Fund may invest in exchange-listed futures contracts on equity indexes,
exchange-listed and OTC index credit default swaps, and forward
foreign currency exchange contracts; however, the Fund will limit the aggregate
notional value of its positions in these instruments (calculated at the time of
investment) to 10% of the value of its net assets. The Fund will enter into the
foregoing transactions to seek to manage the risks of the Fund’s portfolio
securities or for investment or other purposes to the extent the Sub-Advisor
determines that their use would be consistent with the investment objective and
policies of the Fund, as well as applicable regulatory requirements. Generally,
derivatives are financial contracts whose values depend upon, or are derived
from, the value of an underlying asset, reference rate or index, and may relate
to, among others, individual debt instruments, interest rates, currencies or
currency exchange rates, commodities and related indexes. Certain of the Fund’s
derivative transactions may provide investment leverage to the Fund’s
portfolio.
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. The Fund will
only enter into transactions in OTC index credit default swaps and forward
foreign currency exchange contracts with counterparties that the Advisor and/or
the Sub-Advisor reasonably believes are capable of performing under the
applicable agreement.
Futures
Contracts. The Fund may invest
in exchange-listed futures contracts that provide long or short exposure to an
underlying equity index, either for hedging or investment purposes. A futures
contract may generally be described as an agreement between two parties to buy
and sell particular financial instruments for an agreed price during a
designated month or to deliver the final cash settlement price in the case of a
contract relating to an index or otherwise not calling for physical delivery at
the end of trading in the contract. The price at which the contract trades (the
“contract
price”)
is determined by relative buying and selling interest on a regulated exchange.
The Fund’s use of futures contracts will in all cases be consistent with
applicable regulatory requirements, including the rules and regulations of the
Commodity Futures Trading Commission.
Transaction
costs are incurred when a futures contract is bought or sold and margin deposits
must be maintained. Margin is the amount of funds
equal to a specified percentage of the current market value of the contract that
must be deposited by the Fund with its custodian in the name of the futures
commission merchant in order to initiate futures trading and to maintain the
Fund’s open positions in futures contracts. A margin deposit is intended to
ensure the Fund’s performance of the futures contract. The margin required for a
particular futures contract is set by the exchange on which the futures contract
is traded and may be significantly modified from time to time by the exchange
during the term of the futures contract.
Index
Credit Default Swap Agreements. The Fund may invest
in exchange-listed and OTC index credit default swap agreements. A swap is a
financial instrument that typically involves the exchange of cash flows between
two parties on specified dates, where the cash flows are based on agreed-upon
prices, rates, indexes, etc. The Fund may be either the buyer or seller in an
index credit default swap transaction. The buyer in a credit default contract is
obligated to pay the seller a periodic stream of payments over the term of the
contract, provided, that no event of default on an underlying reference
obligation has occurred. If an event of default occurs, the seller must pay the
buyer the full notional value, or “par value,” of the reference obligation.
Credit default swap transactions are either “physical delivery” settled or
“cash” settled. Physical delivery entails the actual delivery of the reference
asset to the seller in exchange for the payment of the full par value of the
reference asset. Cash settled entails a net cash payment from the seller to the
buyer based on the difference of the par value of the reference asset and the
current value of the reference asset that may have, through default, lost some,
most or all of its value. If no event of default occurs, the buyer will have
made a series of periodic payments and recover nothing of monetary value.
However, if an event of default occurs, the buyer will receive the full notional
value of the reference obligation either through a cash payment in exchange for
the asset or a cash payment in addition to owning the reference assets. The
seller receives a fixed rate of income throughout the term of the contract,
which typically is between six months and five years, provided, that there is no
event of default. If an event of default occurs, the seller must pay the buyer
the full notional value of the reference obligation.
An
index credit default swap is a swap on an index of credit default swaps. Index
credit default swaps allow an investor to manage credit risk or
to take a position on a basket of credit default swaps (or other instruments) in
a more efficient manner than transacting in single name credit default swaps. If
a credit event occurs in one of the underlying companies, the protection is paid
out via the delivery of the defaulted bond by the buyer of protection in return
for payment of the notional value of the defaulted bond by the seller of
protection or it may be settled through a cash settlement between the two
parties. The underlying company is then removed from the index.
Forward
Foreign Currency Exchange Contracts. To protect the
value of its portfolio against uncertainty in the level of future currency
exchange rates, as noted above, the Fund may enter into foreign currency
transactions on a spot (i.e., cash) basis or it
may enter into forward foreign currency exchange contracts. A forward foreign
currency exchange contract is an obligation
17
to
purchase or sell a specific currency at a future date, which may be any fixed
number of days agreed upon by the parties from the date of the
contract, at a price set on the date of the contract. The Fund expects to invest
in forward foreign currency exchange contracts for hedging or currency risk
management purposes and not in order to speculate on currency exchange rate
movements, and the amount the Fund may invest in such transactions is limited to
the extent of its non-U.S. investments. The Fund will only enter into forward
foreign currency exchange contracts with parties which it believes to be
creditworthy.
Restricted
Securities/Rule 144A Securities
Restricted
securities include, without limitation, securities eligible for purchase and
sale pursuant to Rule 144A and other securities issued in
private placements. A restriction on public sale of restricted securities may
make it more difficult to value the securities, limit the Fund’s ability to
dispose of them and lower the amount the Fund could realize upon their sale.
Rule 144A provides a non-exclusive safe harbor exemption from the registration
requirements of the Securities Act for the resale of certain securities to
certain qualified institutional buyers, such as the Fund. Any resale of these
securities must generally be effected through a sale that is registered under
the Securities Act or otherwise exempted or excepted from such registration
requirements. 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. The restricted
securities held by the Fund that are also Convertible Securities will be treated
as such for purposes of the Fund’s policy to invest, under normal market
conditions, at least 80% of its net assets in Convertible Securities. In
addition, restricted securities determined by the Sub-Advisor to be illiquid are
subject to the limitation on
the
amount of illiquid securities in which the Fund may invest.
Non-Principal
Investments
Cash
Equivalents and Short-Term Investments
Under
normal market conditions, the Fund may invest up to 20% of its net assets in
short-term debt securities and other short-term debt
instruments (described below), as well as cash equivalents, or it may hold cash.
The percentage of the Fund’s net assets invested in such holdings will vary and
depend on several factors, including market conditions. For purposes of the
foregoing investment policy, short-term debt securities shall be securities from
issuers having a long-term debt rating of at least “A” from S&P, Moody’s or
Fitch and shall have a maturity of one year or less. The Fund may invest in the
following short-term debt instruments: (i) fixed rate and floating rate U.S.
government securities, including bills, notes and bonds differing as to maturity
and rates of interest, which are either issued or guaranteed by the U.S.
Treasury or by U.S. government agencies or instrumentalities; (ii) certificates
of deposit issued against funds deposited in a bank or savings and loan
association; (iii) bankers’ acceptances, which are short-term credit instruments
used to finance commercial transactions; (iv) repurchase agreements, which
involve purchases of debt securities and shall only be entered into with
financial institutions and dealers believed by the Advisor and/or the
Sub-Advisor to present minimal credit risks; (v) bank time deposits, which are
monies kept on deposit with banks or savings and loan associations for a stated
period of time at a fixed rate of interest; (vi) commercial paper, which are
short-term unsecured promissory notes and shall be rated “A-1” or higher by
S&P, “Prime-1” or higher by Moody’s or “F1” or higher by Fitch; and (vii)
corporate debt obligations.
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.
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.
18
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.
BDC
RISK. A BDC may invest
in the equity and fixed income securities of smaller and developing companies as
well as companies that are experiencing financial crises. Investments in these
types of companies present a greater risk of loss due to the companies’ youth
and limited track records. They are also generally more susceptible to
competition and economic and market changes due to limited products and market
shares. In addition, the securities of smaller and developing companies and
companies experiencing financial crises typically have limited liquidity. These
companies may also have limited capital resources, meaning that they present a
greater risk of default on fixed income securities issued and of non-payment of
dividends on any preferred and common stock issued. A BDC may use leverage
(e.g., borrowing and the issuance of fixed
income and preferred securities) to finance its own operations and may suffer
significant losses if market fluctuations cause the BDC’s net asset value to
decline or if related interest charges exceed investment income. The Fund has no
control over the investments made by BDCs, and BDCs are subject to additional
risks such as the fact that their shares may trade at a market price above or
below their net asset value and that an active market may not develop for their
shares.
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 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.
19
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
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 dividends or interest
and repay principal. To the extent that a 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.
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.
20
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.
DEPOSITARY
RECEIPTS RISK.
Depositary receipts may be less liquid than the underlying shares in their
primary trading market. Any distributions paid to the holders of depositary
receipts are usually subject to a fee charged by the depositary. Holders of
depositary receipts may have limited voting rights, and investment restrictions
in certain countries may adversely impact the value of depositary receipts
because such restrictions may limit the ability to convert the equity shares
into depositary receipts and vice versa. Such restrictions may cause the equity
shares of the underlying issuer to trade at a discount or premium to the market
price of the depositary receipts.
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.
21
Accordingly, a
relatively small price movement may result in an immediate and substantial loss.
The use of leverage may also cause a 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.
ETN
RISK. ETNs are unsecured
debt obligations. As such, ETNs are subject to the credit risk of the issuer,
and the value of an ETN may drop due to a downgrade in the issuer’s credit
rating, despite the ETN’s underlying market benchmark or assets remaining
unchanged. The value of an ETN may also be influenced by time to maturity, level
of supply and demand for the ETN, volatility and lack of liquidity in the
underlying market, changes in the applicable interest rates, and economic,
legal, political, or geographic events that affect the referenced underlying
market or assets. ETNs are also subject to the risk that the other party to the
contract will not fulfill its contractual obligations, which may cause losses or
additional costs to the Fund. When the Fund invests in ETNs it will bear its
proportionate share of any fees and expenses borne by the ETN. While ETNs are
exchange-traded, a trading market may not develop, limiting liquidity and
adversely affecting the market value of the ETN.
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.
FORWARD
CONTRACTS RISK. The Fund
may invest in forward contracts. A forward contract is an over-the-counter
derivative transaction between two parties to buy or sell a specified amount of
an underlying reference at a specified price (or rate) on a specified date in
the future. Forward contracts are negotiated on an individual basis and are not
standardized or traded on exchanges. The market for forward contracts is
substantially unregulated and can experience lengthy periods of illiquidity,
unusually high trading volume and other negative impacts, such as political
intervention, which may result in volatility or disruptions in such markets. A
relatively small price movement in a forward contract may result in substantial
losses to the Fund, exceeding the amount of the margin paid. Forward contracts
can increase the Fund’s risk exposure to underlying references and their
attendant risks, such as credit risk, currency risk, market risk, and interest
rate risk, while also exposing the Fund to counterparty risk, liquidity risk and
valuation risk, among others.
FUTURES
CONTRACTS RISK. The Fund
may invest in futures contracts. Futures contracts are typically exchange-traded
contracts that call for the future delivery of an asset by one party to another
at a certain price and date, or cash settlement of the terms of the contract.
The risk of a position in a futures contract may be very large compared to the
relatively low level of margin the Fund is required to deposit. In many cases, a
relatively small price movement in a futures contract may result in immediate
and substantial loss or gain to the investor relative to the size of a required
margin deposit. The ability to establish and close out positions in futures
contracts is be subject to the development and maintenance of a liquid secondary
market. There is no assurance that a liquid secondary market on an exchange will
exist for any particular futures contract at any particular time. If the Fund
uses futures contracts for hedging purposes, there is a risk of imperfect
correlation between movements in the prices of the derivatives and movements in
the securities or index underlying the derivatives or movements in the prices of
the Fund's investments that are the subject of such hedge. The prices of futures
contracts, for a number of reasons, may not correlate perfectly with movements
in the securities or index underlying them. For example, participants in the
futures markets are subject to margin deposit requirements less onerous than
margin requirements in the securities markets in general. As a result, futures
markets may attract more speculators than the securities markets. Increased
participation by speculators in those markets may cause temporary price
distortions. Due to the possibility of price distortion, even a correct forecast
of general market trends by the Fund’s portfolio managers still may not result
in a successful derivatives activity over a very short time period. The
Commodity Futures Trading Commission and the various exchanges have established
limits referred to as “speculative position limits” on the maximum net long or
net short positions that any person and certain affiliated entities may hold or
control in a particular futures contract. It is possible that, as a result of
such limits, the Fund will be precluded from taking positions in certain futures
contracts it might have otherwise taken to the disadvantage of
shareholders.
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.
22
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.
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, 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.
INFORMATION
TECHNOLOGY COMPANIES RISK. The Fund invests significantly in
information technology companies. Information technology companies produce and
provide hardware, software and information technology systems and services.
Information technology companies are generally subject to the following risks:
rapidly changing technologies and existing product obsolescence; short product
life cycles; fierce competition; aggressive pricing and reduced profit margins;
the loss of patent, copyright and trademark protections; cyclical market
patterns; evolving industry standards; and frequent new product introductions
and new market entrants. Information technology companies may be smaller and
less experienced companies, with limited product lines, markets or financial
resources and fewer experienced management or marketing personnel. Information
technology company stocks, particularly those involved with the internet, have
experienced extreme price and volume fluctuations that are often unrelated to
their operating performance. In addition, information technology companies are
particularly vulnerable to federal, state and local government regulation, and
competition and consolidation, both domestically and internationally, including
competition from foreign competitors with lower production costs. Information
technology companies also face competition for services of qualified personnel
and heavily rely on patents and intellectual property rights and the ability to
enforce such rights to maintain a competitive advantage.
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 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
23
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.
LIQUIDITY
RISK.
The Fund has 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. 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 aggressive responses taken by many governments, including
closing borders, restricting international and domestic travel, and the
imposition of prolonged quarantines or similar restrictions, had negative impacts, and in many
cases severe impacts, on markets worldwide. While the development of vaccines
has slowed the spread of the virus and allowed for the resumption of reasonably
normal business activity in the United States, many countries continue to impose
lockdown measures in an attempt to slow the spread. Additionally, there is no
guarantee that vaccines will be effective against emerging variants of the
disease. As this global pandemic
illustrated, such events may affect certain
geographic regions, countries, sectors and industries more significantly than
others. 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.
NON-U.S.
SECURITIES RISK. The
Fund may invest in non-U.S. securities. An investment in securities of non-U.S.
companies involves risks not associated with domestic issuers. Investment in
non-U.S. securities may involve higher costs than investment in U.S. securities,
including higher transaction and custody costs as well as the imposition of
additional taxes by non-U.S. governments. Non-U.S. investments may also involve
risks associated with the level of currency exchange rates, less complete
financial information about the issuers, less market liquidity, more market
volatility and political instability. Future political and economic
developments, the possible imposition of withholding taxes on dividend income,
the possible seizure or nationalization of non-U.S. holdings, the imposition of
sanctions by foreign governments, the possible establishment of capital
24
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.
OTC
DERIVATIVES RISK. The
Fund may utilize derivatives that are traded over-the-counter, or “OTC.” In
general, OTC derivatives are subject to the same risks as derivatives generally,
as described throughout. However, because OTC derivatives do not trade on an
exchange, the parties to an OTC derivative face heightened levels of
counterparty risk, liquidity risk and valuation risk. To the extent that the
Fund utilizes OTC derivatives, its counterparty risk will be higher if it only
trades with a single or small number of counterparties. The secondary market for
OTC derivatives may not be as deep as for other instruments and such instruments
may experience periods of illiquidity. In addition, some OTC derivatives may be
complex and difficult to value. Under certain market conditions it may not be
economically feasible to initiate a transaction or liquidate a position in time
to avoid a loss or take advantage of an opportunity. If a particular derivative
transaction is particularly large or if the relevant market is illiquid, it may
not be possible to initiate a transaction or liquidate a position at an
advantageous time or price, which may result in significant losses.
PORTFOLIO
TURNOVER RISK. The Fund has an
investment strategy that may frequently involve buying and selling portfolio
securities. High portfolio turnover may result in the Fund paying higher levels
of transaction costs, including brokerage commissions, dealer mark-ups and other
costs and may generate greater tax liabilities for shareholders. Portfolio
turnover risk may cause the Fund’s performance to be less than
expected.
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.
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.
25
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.
RESTRICTED
SECURITIES RISK. The Fund may invest
in restricted securities. Restricted securities are securities that cannot be
offered for public resale unless registered under the applicable securities laws
or that have a contractual restriction that prohibits or limits their resale.
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.
SMALLER
COMPANIES RISK. The Fund invests in
the securities of small and/or mid capitalization companies. 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.
SWAP
AGREEMENTS RISK. The
Fund may enter in swap agreements. Swap agreements are two-party contracts
entered into for a set period of time in which the parties agree to exchange
payments based on some underlying reference or asset (such as interest rates).
The use of swaps is a highly specialized activity that involves investment
techniques, risk analyses and tax planning different from those associated with
ordinary portfolio securities transactions. These transactions can result in
sizeable realized and unrealized capital gains and losses relative to the gains
and losses from the Fund’s direct investments in the reference assets.
Transactions in swaps can involve greater risks than if the Fund had invested
directly in the reference asset since, in addition to general market risks,
swaps may be leveraged and are also subject to credit risk, counterparty risk,
liquidity risk and valuation risk. Because they are two-party contracts and may
have terms of greater than seven days, certain swap transactions may be
considered to be illiquid. Moreover, the Fund bears the risk of loss of the
amount expected to be received under a swap agreement in the event of the
default or bankruptcy of a swap counterparty. Some swaps may be complex and
difficult to value. Swaps may also be subject to pricing or “basis” risk, which
exists when a particular swap becomes extraordinarily expensive relative to
historical prices or the price of corresponding cash market instruments. Under
certain market conditions it may not be economically feasible to initiate a
transaction or liquidate a position in time to avoid a loss or take advantage of
an opportunity. If a swap transaction is particularly large or if the relevant
market is illiquid, it may not be possible to initiate a transaction or
liquidate a position at an advantageous time or price, which may result in
significant losses. The prices of swaps can be very volatile, and a variance in
the degree of volatility or in the direction of the price of the reference asset
from the sub-adviser’s expectations may produce significant losses in the Fund’s
investments in swaps. In addition, a perfect correlation between a swap and an
investment position may be impossible to achieve. As a result, the Fund’s use of
swaps may not be effective in fulfilling the Fund’s investment strategies and
may contribute to losses that would not
26
have been incurred
otherwise. Certain swaps are not bilateral agreements but are centrally-cleared
and are exchange-traded. Central clearing tends to decrease
credit risk and improve liquidity but many regulations regarding
centrally-cleared swaps have not been fully implemented and the scope of the
risks remain unclear. As central clearing does not make the agreements risk-free
and there is no guarantee that the Fund would consider all centrally-cleared or
exchange-traded swaps to be liquid.
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.
Unlike publicly traded securities that trade on national securities exchanges,
there is no central place or exchange for trading most debt securities. Debt
securities generally trade on an “over-the-counter” market. Due to the lack of
centralized information and trading, and variations in lot sizes of certain debt
securities, the valuation of debt securities may carry more uncertainty and risk
than that of publicly traded securities. Debt securities are commonly valued by
third-party pricing services that utilize a range of market-based inputs and
assumptions, including readily available market quotations obtained from
broker-dealers making markets in such securities, cash flows and transactions
for comparable instruments. However, because the available information is less
reliable and more subjective, elements of judgment may play a greater role in
valuation of debt securities than for other types of securities. There is no
assurance that the Fund will be able to sell a portfolio security at the price
established by the pricing service, which could result in a loss to the
Fund.
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, 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.
CREDIT
RATING AGENCY RISK. Credit ratings are
determined by credit rating agencies such as Standard & Poor’s, Inc.,
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
27
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.
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.
EMERGING
MARKETS RISK. The Fund
may invest in securities issued by emerging market governments and companies
incorporated in emerging market countries. Investments in securities issued by
governments and companies operating in emerging market countries involve
additional risks relating to political, economic, or regulatory conditions not
associated with investments in securities and instruments issued by U.S.
companies or by companies operating in other developed market countries. This is
due to, among other things, the potential for greater market volatility, lower
trading volume, a lack of liquidity, potential for market manipulation, higher
levels of inflation, political and economic instability, greater risk of a
market shutdown and more governmental limitations on foreign investments in
emerging market countries than are typically found in more developed market
countries. Moreover, emerging market countries often have less uniformity in
accounting and reporting requirements, unsettled securities laws, less reliable
securities valuations and greater risks associated with custody of securities
than developed markets. In addition, the Public Company Accounting Oversight
Board, which regulates auditors of U.S. public companies, is unable to inspect
audit work papers in certain emerging market countries. Emerging market countries often have
greater risk of capital controls through such measures as taxes or interest rate
control than developed markets. Certain emerging market countries may also lack
the infrastructure necessary to attract large amounts of foreign trade and
investment. Local securities markets in emerging market countries may trade a
small number of securities and may be unable to respond effectively to increases
in trading volume, potentially making prompt liquidation of holdings difficult
or impossible. Settlement procedures in emerging market countries are frequently
less developed and reliable than those in the U.S. and other developed market
countries. In addition, significant delays may occur in registering the transfer
of securities. Settlement or registration problems may make it more difficult
for 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.
EUROPE
RISK. The Fund may invest
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).
28
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.
FAILURE
TO QUALIFY AS A REGULATED INVESTMENT COMPANY RISK. If, in any year, the Fund fails to
qualify as a regulated investment company under the applicable tax laws, the
Fund would be taxed as an ordinary corporation. In such circumstances, the Fund
could be required to recognize unrealized gains, pay substantial taxes and
interest and make substantial distributions before requalifying as a regulated
investment company that is accorded special tax treatment.
INTERNATIONAL
CLOSED MARKET TRADING RISK. Because securities
held by the Fund will trade on non-U.S. exchanges that are closed when the
Fund's primary listing exchange is open, there are likely to be deviations
between the current price of an underlying security and the last quoted price
for the underlying security (i.e., the Fund’s quote
from the closed foreign market), resulting in premiums or discounts to the
Fund's net asset value that may be greater than those experienced by other ETFs.
However, because shares can be created and redeemed in Creation Units at the
Fund’s net asset value, it is not expected that large discounts or premiums to
the net asset value of the Fund will be sustained over the long term (unlike
shares of many closed-end funds, which frequently trade at appreciable discounts
from, and sometimes at premiums to, their net asset values).
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 the securities of 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 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 that may have a
negative impact on certain securities in which the Fund invests. In addition,
litigation regarding any of the securities owned by the Fund may negatively
impact the value of a Fund’s shares. 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.
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,
29
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.
WARRANTS
RISK.
The Fund may invest in warrants. The prices of warrants, which entitle the
holder to purchase equity securities at specific prices for a certain period of
time, do not necessarily move parallel to the prices of the underlying
securities and likely fluctuate more than the prices of the underlying
securities. Warrants have no voting rights, receive no dividends, and have no
rights with respect to the assets of the issuer.
Fund
Organization
The Fund is a series
of the Trust, an investment company registered under the 1940 Act. The Fund is
treated as a separate fund with its own investment
objectives and policies. The Trust is organized as a Massachusetts business
trust. The Board is responsible for the overall management and direction of the
Trust. The Board elects the Trust’s officers and approves all significant
agreements, including those with the Advisor, Sub-Advisor, 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 Board.
First Trust serves
as advisor or sub-advisor for 8 mutual fund portfolios, 10 exchange-traded funds
consisting of 193 series
and 16 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 SSI Investment Management LLC, 9440
Santa Monica Blvd, 8th
Floor, Beverly Hills, California 90210, to serve as investment sub-advisor
pursuant to a sub-advisory agreement (the "Sub-Advisory
Agreement"). In this
capacity, SSI is responsible for the selection and ongoing monitoring of the
securities in the Fund’s investment portfolio. SSI is an investment management
firm specializing in alternative investment solutions utilizing convertible
assets, equity securities and hedging strategies. SSI was formed in 1973 and
serves as investment advisor to investment portfolios with approximately $2.7
billion in assets which it managed as of December 31, 2021. SSI provides
investment advisory services to pension and profit sharing plans, corporations,
foundations and endowments, Taft-Hartley plans, family offices, insurance
companies, public funds, high-net worth individuals, private investment
vehicles, religious organizations and mutual funds.
George
M. Douglas, CFA, Ravi Malik, CFA, Michael J. Opre, CFA, Florian Eitner, CFA and
Stephen R. Wachtel, CFA are the Fund’s portfolio managers
and are jointly and primarily responsible for the day-to-day management of the
Fund’s investment portfolio.
•
Mr. Douglas, CFA, has been a
Principal and the Chief Investment Officer and Managing Principal of SSI
Investment Management LLC since 1994 and oversees SSI’s qualitative and
quantitative research processes. In 2019 Mr. Douglas became the Managing
Principal of SSI Investment Management LLC. Mr. Douglas has 45 years of
experience in quantitative equity research and portfolio management. Prior to
joining SSI, Mr. Douglas was Director of Quantitative Equity Investments and
Portfolio Manager for CS First Boston Asset Management from 1992 to 1994. From
1990 to 1992, Mr. Douglas was Chief Investment Officer for Structured Asset
30
Management,
which was part of Templeton International, and from 1980 to 1990, Mr. Douglas
was Senior Vice President and
Director of Research for Drexel Burnham Lambert. Mr. Douglas received an MBA in
Finance in 1978, an MS in Statistics in 1977 and a BS in Mathematics in 1976
from the University of Wisconsin-Madison.
•
Mr. Malik, CFA, is a Principal and
Portfolio Manager overseeing the daily management of the Convertible Investment
portfolios as well as providing equity and credit research in the Technology and
Emerging Markets Sectors. Mr. Malik has 27 years of experience as a Portfolio
Manager and 4 years as an Analyst on SSI’s Convertible Investment Team and the
Froley Revy Convertible Team (acquired by SSI in 2009). Mr. Malik collaborates
with SSI’s CIO in analyzing Global and Macro environments and formulates
strategy according to client mandates. Prior to joining SSI, Mr. Malik spent 10
years in the Indian Administrative Service (IAS), India’s highest level “Think
Tank”. He also served as Finance Commissioner to the Andaman Islands. Mr. Malik
received an MBA in Finance from the Anderson Graduate School of Management,
University of California, Los Angeles as well as a B.A. in Mathematics and
Economics from Punjab University.
•
Mr. Opre, CFA, is a Portfolio Manager
overseeing the daily management of the Convertible Investment portfolios as well
as providing equity and credit research in the Finance, Energy and Materials
Sectors. Mr. Opre has 34 years of industry experience, including 20 years as a
Portfolio Manager of the SSI Convertible Investment Team and the Froley Revy
Convertible Team (acquired by SSI in 2009).Mr. Opre’s prior experience includes
serving as a Senior Investment Manager at Wells Fargo and as a Research Analyst
with Pacific Strategic Fund Group, Inc. specializing in fundamental analysis and
risk arbitrage. He holds an MBA in Finance from the Anderson Graduate School of
Management, University of California, Los Angeles as well as a BA from the
University of California, Los Angeles.
•
Mr. Eitner, CFA, is a Portfolio
Manager overseeing the daily management of the Convertible Investment portfolios
as well as providing equity and credit research in the Healthcare, Telecom,
Industrials and Transportation Sectors. Mr. Eitner has 25 years of industry
experience, including 20 years as an Analyst and Portfolio Manager of SSI’s
Convertible Investment Team and the Froley Revy Convertible Team (acquired by
SSI in 2009). Prior to joining SSI, Mr. Eitner was an Associate in the Leveraged
Finance Group at Lehman Brothers Europe. Previously, he was a member of CTC, LLC
options trading group at the Chicago Mercantile Exchange. Mr. Eitner has an MBA
in Finance from the Anderson Graduate School of Management, University of
California, Los Angeles, where he was a Student Investment Fund Fellow. He also
holds a BA in Economics from Northwestern University,
Chicago.
•
Mr. Wachtel, CFA, is a Portfolio
Manager overseeing the daily management of the Convertible Investment portfolios
as well as providing equity and credit research in the Technology, Financials,
and Consumer Discretionary, Consumer Staples Sectors. He is also a Portfolio
Manager for Equity Strategy portfolios. Mr. Wachtel has 22 years of industry
experience, including 18 years in multiple roles for SSI and Froley Revy
(acquired by SSI in 2009). Prior to joining SSI, Mr. Wachtel was a Manager at
Telekurs Financial focusing on market research. Mr. Wachtel has an MBA in
Finance from the Anderson School of Management, University of California, Los
Angeles, where he was a Student Investment Fund Fellow. He also holds a BS in
Finance from Lehigh University.
In managing the
Fund’s investment portfolio, the portfolio managers work together with Lily Yu,
a convertible securities trader.
•
Mrs. Yu is the Head Convertible
Investment Trader responsible for trading all Convertible Investment portfolios.
She maintains and develops new outright institutional trading relationships.
Mrs. Yu has 32 years of experience in the finance industry and 27 years of
experience in convertible trading with SSI and the Froley Revy Investment Team
(acquired by SSI in 2009). Mrs. Yu holds a BA from the University of California,
Los Angeles.
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 SSI’s management of the Fund’s assets and pays SSI for its services as
Sub-Advisor. First Trust is paid an annual unitary management fee by the Fund
equal to 0.95% of the Fund's average daily net assets and is responsible for the
Fund’s expenses, including the cost of transfer agency, custody, fund
administration, legal, audit and other services, but excluding fee payments
under the Investment Management Agreement, interest, taxes, acquired
31
fund
fees and expenses, if any, brokerage commissions and other expenses connected
with the execution of portfolio transactions,
distribution and service fees pursuant to a 12b-1 plan, if any, and
extraordinary expenses.
A discussion
regarding the Board’s approval of the continuation of the Investment Management
Agreement and Sub-Advisory Agreement is available in the Fund’s
Annual Report to shareholders for the fiscal year ended October 31,
2021.
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 (“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
32
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 purchase and redemption orders from APs that the Advisor
has determined may be disruptive to the management of the Fund, or otherwise not
in the Fund's best interests.
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 could disagree with any conclusions set
forth in this section. In addition, counsel to the Fund may not have been asked
to review, and may not have reached a conclusion with respect to, the federal
income tax treatment of the assets to be included in the Fund. 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” under
the federal tax laws. If the Fund qualifies as a regulated
investment company and distributes its income as required by the tax law, the
Fund generally will not pay federal income taxes.
Distributions
The
Fund’s distributions are generally taxable. After the end of each year, you will
receive a tax statement that separates the distributions of the
Fund into two categories: ordinary income distributions and capital gain
dividends. Ordinary income distributions are generally taxed at your ordinary
tax rate, however, as further discussed below, certain ordinary income
distributions received from the Fund may be taxed at the capital gains tax
rates. Generally, you will treat all capital gain dividends as long-term capital
gains regardless of how long you have owned your shares.
To
determine your actual tax liability for your capital gain dividends, you must
calculate your total net capital gain or loss for the tax year after
considering all of your other taxable transactions, as described below. In
addition, the Fund may make distributions that represent a return of capital for
tax purposes and thus will generally not be taxable to you; however, such
distributions may reduce your tax basis in your shares, which could result in
you having to pay higher taxes in the future when shares are sold, even if you
sell the shares at a loss from your original investment. A "return of capital"
is a return, in whole or in part, of the funds that you previously invested in
the Fund. A return of capital distribution should not be considered part of a
Fund’s dividend yield or total return of an investment in Fund shares. The tax
status of your distributions from the Fund is not affected by whether you
reinvest your distributions in additional shares or receive them in cash. The
income from the Fund that you must take into account for federal income tax
purposes is not reduced by amounts used to pay a deferred sales
33
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 regulated investment companies. 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 income below certain thresholds). Some capital gains, including some
portion of your capital gain dividends may be taxed at a higher maximum stated
tax rate. Capital gains may also be subject to the Medicare tax described
above.
Net
capital gain equals net long-term capital gain minus net short-term capital loss
for the taxable year. Capital gain or loss is long-term if the
holding period for the asset is more than one year and is short-term if the
holding period for the asset is one year or less. You must exclude the date you
purchase your shares to determine your holding period. However, if you receive a
capital gain dividend from the Fund and sell your share at a loss after holding
it for six months or less, the loss will be recharacterized as long-term capital
loss to the extent of the capital gain dividend received. The tax rates for
capital gains realized from assets held for one year or less are generally the
same as for ordinary income. The Internal Revenue Code of 1986, as amended,
treats certain capital gains as ordinary income in special
situations.
An
election may be available to you to defer recognition of the gain attributable
to a capital gain dividend if you make certain qualifying
investments within a limited time. You should talk to your tax advisor about the
availability of this deferral election and its requirements.
Ordinary
income dividends received by an individual shareholder from a regulated
investment company such as the Fund are generally taxed at
the same rates that apply to net capital gain (as discussed above), provided
certain holding period requirements are satisfied and provided the dividends are
attributable to qualifying dividends received by the Fund itself. The Fund will
provide notice to its shareholders of the amount of any distribution which may
be taken into account as a dividend which is eligible for the capital gains tax
rates.
Sale
of Shares
If
you sell or redeem your shares, you will generally recognize a taxable gain or
loss. To determine the amount of this gain or loss, you must
subtract your tax basis in your shares from the amount you receive in the
transaction. Your tax basis in your shares is generally equal to the cost of
your shares, generally including sales charges. In some cases, however, you may
have to adjust your tax basis after you purchase your shares. An election may be
available to you to defer recognition of capital gain if you make certain
qualifying investments within a limited time. You should talk to your tax
advisor about the availability of this deferral election and its
requirements.
Taxes
on Purchase and Redemption of Creation Units
If
you exchange securities for Creation Units you will generally recognize a gain
or a loss. The gain or loss will be equal to the difference between
the market value of the Creation Units at the time and your aggregate basis in
the securities surrendered and the cash component paid. If you exchange Creation
Units for securities, you will generally recognize a gain or loss equal to the
difference between your basis in the Creation Units and the aggregate market
value of the securities received and the cash redemption amount. The Internal
Revenue Service, 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.
34
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.
Distributions
may be subject to a U.S. withholding tax of 30% in the case of distributions to
(i) certain non-U.S. financial institutions that
have not entered into an agreement with the U.S. Treasury to collect and
disclose certain information and are not resident in a jurisdiction that has
entered into such an agreement with the U.S. Treasury and (ii) certain other
non-U.S. entities that do not provide certain certifications and information
about the entity’s U.S. owners. This withholding tax is also currently scheduled
to apply to the gross proceeds from the disposition of securities that produce
U.S. source interest or dividends. However, proposed regulations may eliminate
the requirement to withhold on payments of gross proceeds from
dispositions.
Investments
in Certain Non-U.S. Corporations
If
the Fund holds an equity interest in any passive foreign investment companies
(“PFICs”), which are
generally certain non-U.S. corporations that receive at least 75% of their
annual gross income from passive sources (such as interest, dividends, certain
rents and royalties or capital gains) or that hold at least 50% of their assets
in investments producing such passive income, the Fund could be subject to U.S.
federal income tax and additional interest charges on gains and certain
distributions with respect to those equity interests, even if all the income or
gain is timely distributed to its shareholders. The Fund will not be able to
pass through to its shareholders any credit or deduction for such taxes. The
Fund may be able to make an election that could ameliorate these adverse tax
consequences. In this case, the Fund would recognize as ordinary income any
increase in the value of such PFIC shares, and as ordinary loss any decrease in
such value to the extent it did not exceed prior increases included in income.
Under this election, the Fund might be required to recognize in a year income in
excess of its distributions from PFICs and its proceeds from dispositions of
PFIC stock during that year, and such income would nevertheless be subject to
the distribution requirement and would be taken into account for purposes of the
4% excise tax. Dividends paid by PFICs are not treated as qualified dividend
income.
Distribution
Plan
FTP
serves as the distributor of Creation Units for the Fund on an agency basis. FTP
does not maintain a secondary market in shares.
The
Board has adopted a Distribution and Service Plan pursuant to Rule 12b-1 under
the 1940 Act. In accordance with the Rule 12b-1 plan, the
Fund is authorized to pay an amount up to 0.25% of its average daily net assets
each year to reimburse FTP for amounts expended to finance activities primarily
intended to result in the sale of Creation Units or the provision of investor
services. FTP may also use this amount to compensate securities dealers or other
persons that are APs for providing distribution assistance, including
broker-dealer and shareholder support and educational and promotional
services.
The Fund does not
currently pay 12b-1 fees, and pursuant to a contractual arrangement, the Fund
will not pay 12b-1 fees any time before March 31, 2023.
However, in the event 12b-1 fees are charged in the future, because these fees
are paid
35
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 the New York Stock Exchange (the "NYSE") on each day the NYSE is open for
trading. If the NYSE closes early on a valuation day, the Fund’s net asset value
will be determined as of that time. Net asset value per share 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.
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,
Convertible Securities, short-term debt instruments and OTC index credit default
swaps are fair valued using information provided by a Pricing Service or
obtained from broker-dealer quotations. Short-term debt instruments having a
remaining maturity of 60 days or less when purchased are typically valued at
cost adjusted for amortization of premiums and accretion of discounts, provided
that the Pricing Committee 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 the determination.
The Fund's
investments are valued daily at market or, in the absence of market value with
respect to any investments, at fair value. Market value prices represent
last sale or official closing prices from a national or foreign exchange
(i.e., a regulated market) and are
primarily obtained from third party pricing services (“Pricing
Services”). Fair value
prices represent any prices not considered market value prices and are either
obtained from a Pricing Service or determined by the Advisor’s pricing committee
(the “Pricing
Committee”), in
accordance with valuation procedures (which may be revised from time to time)
adopted by the Board, and in accordance with provisions of the 1940 Act. As a
general principle, the current “fair value” of a security would appear to be the
amount which the owner might reasonably expect to receive for the security upon
its current sale. Valuing the Fund’s assets using fair value pricing can result
in using prices for those assets (particularly assets that trade in foreign
markets) that may differ from current market valuations.
Equity
securities and ETNs listed on any exchange other than Nasdaq and the London
Stock Exchange Alternative Investment Market (“AIM”) are typically
valued at the last sale price on the exchange on which they are principally
traded. Such securities listed on Nasdaq or the AIM are typically valued at the
official closing price on the business day as of which such value is being
determined. If there has been no sale on such day, or no official closing price
in the case of securities traded on Nasdaq
or the
AIM, such securities are typically valued using fair value pricing. Such
securities traded on more than one securities exchange are valued at the last
sale price or official closing price, as applicable, on the business day as of
which such value is being determined at the close of the exchange representing
the principal market for such securities.
Exchange-listed
Convertible Securities (if any), exchange-listed equity index futures contracts
and exchange-listed index credit default swaps are
typically valued at the closing price in the market where such instruments are
principally traded. If no official closing price is available, such instruments
are fair valued at the mean of their most recent bid and asked price on the
exchange on which they are principally traded, if available, and otherwise at
their closing bid price.
Forward
foreign currency exchange contracts are typically fair valued at the current
day’s interpolated foreign exchange rate, as calculated using
the current day’s spot rate, and the thirty, sixty, ninety and
one-hundred-eighty day forward rates provided by a Pricing Service or by certain
independent dealers in such contracts.
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. Assets denominated in foreign
currencies are translated into U.S. dollars at the exchange rate of such
currencies against the U.S. dollar as provided by a Pricing Service. The value
of assets denominated in foreign currencies is converted into U.S. dollars at
the exchange rates in effect at the time of valuation.
36
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 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 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 SSI Strategic Convertible Securities ETF (FCVT)
Total Returns as of October 31, 2021
Total Returns as of October 31, 2021
|
|
|
Average
Annual |
Cumulative | ||
|
|
1
Year |
5
Years |
Inception
(11/3/2015) |
5
Years |
Inception
(11/3/2015) |
|
Fund
Performance |
|
|
|
|
|
|
Net Asset
Value |
32.74% |
17.90% |
15.24% |
127.83% |
133.93% |
|
Market
Price |
31.30% |
17.73% |
15.17% |
126.17% |
133.14% |
|
Index
Performance |
|
|
|
|
|
|
ICE BofA
All US Convertible Index |
32.95% |
18.59% |
15.74% |
134.57% |
140.12% |
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, 2021 and is incorporated by reference in the Fund's SAI, which is
available upon request.
First
Trust Exchange-Traded Fund IV
Financial
Highlights
For a share outstanding throughout each period
For a share outstanding throughout each period
First
Trust SSI Strategic Convertible Securities ETF (FCVT)
|
|
Year
Ended October 31, | ||||
|
|
2021 |
2020 |
2019 |
2018 |
2017 |
|
Net
asset value, beginning of period |
$40.14 |
$31.57 |
$28.72 |
$29.01 |
$25.21 |
|
Income
from investment operations: |
|
|
|
|
|
|
Net
investment income (loss) |
(1.33) |
(0.55) |
(0.24) |
(0.09) |
(0.14) |
|
Net
realized and unrealized gain (loss) |
14.42 |
9.65 |
3.58 |
0.52 |
4.45 |
|
Total
from investment operations |
13.09 |
9.10 |
3.34 |
0.43 |
4.31 |
|
Distributions
paid to shareholders from: |
|
|
|
|
|
|
Net
investment income |
(0.62) |
(0.53) |
(0.49) |
(0.67) |
(0.51) |
|
Net
realized gain |
(0.39) |
— |
— |
(0.05) |
— |
|
Total
distributions |
(1.01) |
(0.53) |
(0.49) |
(0.72) |
(0.51) |
|
Net
asset value, end of period |
$52.22 |
$40.14 |
$31.57 |
$28.72 |
$29.01 |
|
Total
Return (a) |
32.74% |
29.10% |
11.72% |
1.46% |
17.29% |
|
Ratios/supplemental
data: |
|
|
|
|
|
|
Net
assets, end of period (in 000’s) |
$305,460 |
$236,802 |
$194,158 |
$202,467 |
$58,016 |
|
Ratios
to average net assets: |
|
|
|
|
|
|
Ratio of
total expenses to average net assets |
0.95% |
0.95% |
0.95% |
0.95% |
0.95% |
|
Ratio of
net investment income (loss) to average net assets |
(2.60)% |
(1.36)% |
(0.63)% |
(2.16)% |
(1.86)% |
|
Portfolio
turnover rate (b)
|
135% |
119% |
64% |
71% |
56% |
(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 IV |
First Trust SSI Strategic Convertible Securities ETF
For
More Information
For
more detailed information on the Fund, several additional sources of information
are available to you. The SAI, incorporated by
reference into this prospectus, contains detailed information on the Fund's
policies and operation. Additional information about the Fund's investments is
available in the annual and semi-annual reports to shareholders. In the Fund's
annual report, you will find a discussion of the market conditions and
investment strategies that significantly impacted the Fund's performance during
the last fiscal year. The Fund's most recent SAI, annual and semi-annual reports
and certain other information are available free of charge by calling the Fund
at (800) 621-1675, on the Fund's website at www.ftportfolios.com or through your
financial advisor. Shareholders may call the toll-free number above with any
inquiries.
You may obtain
this and other information regarding the Fund, including the SAI and the Codes
of Ethics adopted by
First Trust, FTP and the Trust, directly from the Securities and Exchange
Commission (the "SEC"). Information on the SEC’s website
is free of charge. Visit the SEC’s online EDGAR database at
www.sec.gov. You may also request information
regarding the Fund by sending a request (along with a duplication fee) to the
SEC by sending an electronic request to
[email protected].
First Trust
Advisors L.P.
120 East Liberty Drive, Suite 400
Wheaton, Illinois 60187
(800) 621-1675
120 East Liberty Drive, Suite 400
Wheaton, Illinois 60187
(800) 621-1675
www.ftportfolios.com
SEC
File #: 333-174332
811-22559
811-22559