UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number 811-22442
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First Trust High Income Long/Short Fund
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(Exact name of registrant as specified in charter)
120 East Liberty Drive, Suite 400
Wheaton, IL 60187
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(Address of principal executive offices) (Zip code)
W. Scott Jardine, Esq.
First Trust Portfolios L.P.
120 East Liberty Drive, Suite 400
Wheaton, IL 60187
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(Name and address of agent for service)
registrant's telephone number, including area code: 630-765-8000
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Date of fiscal year end: October 31
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Date of reporting period: October 31, 2012
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Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549. The OMB has reviewed this collection of information under
the clearance requirements of 44 U.S.C. ss. 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
FIRST TRUST
First Trust
High Income
Long/Short Fund
Annual Report
For the Year Ended
October 31, 2012
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TABLE OF CONTENTS
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First Trust High Income Long/Short Fund (FSD)
Annual Report
October 31, 2012
Shareholder Letter............................................................1
At A Glance...................................................................2
Portfolio Commentary .........................................................3
Portfolio of Investments .....................................................7
Schedule of Forward Foreign Currency Contracts...............................17
Statement of Assets and Liabilities .........................................18
Statement of Operations .....................................................19
Statements of Changes in Net Assets..........................................20
Statement of Cash Flows......................................................21
Financial Highlights.........................................................22
Notes to Financial Statements................................................23
Report of Independent Registered Public Accounting Firm......................31
Additional Information.......................................................32
Board of Trustees and Officers...............................................36
Privacy Policy...............................................................38
Caution Regarding Forward-Looking Statements
This report contains certain forward-looking statements within the meaning of
the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934,
as amended. Forward-looking statements include statements regarding the goals,
beliefs, plans or current expectations of First Trust Advisors L.P. ("First
Trust" or the "Advisor") and/or MacKay Shields LLC ("MacKay" or the
"Sub-Advisor") and their respective representatives, taking into account the
information currently available to them. Forward-looking statements include all
statements that do not relate solely to current or historical fact. For example,
forward-looking statements include the use of words such as "anticipate,"
"estimate," "intend," "expect," "believe," "plan," "may," "should," "would" or
other words that convey uncertainty of future events or outcomes.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause the actual results, performance or achievements of
First Trust High Income Long/Short Fund (the "Fund") to be materially different
from any future results, performance or achievements expressed or implied by the
forward-looking statements. When evaluating the information included in this
report, you are cautioned not to place undue reliance on these forward-looking
statements, which reflect the judgment of the Advisor and/or Sub-Advisor and
their respective representatives only as of the date hereof. We undertake no
obligation to publicly revise or update these forward-looking statements to
reflect events and circumstances that arise after the date hereof.
Performance and Risk Disclosure
There is no assurance that the Fund will achieve its investment objectives. The
Fund is subject to market risk, which is the possibility that the market values
of securities owned by the Fund will decline and that the value of the Fund's
shares may therefore be less than what you paid for them. Accordingly, you can
lose money by investing in the Fund. See "Risk Considerations" in the Notes to
Financial Statements for a discussion of certain other risks of investing in the
Fund.
Performance data quoted represents past performance, which is no guarantee of
future results, and current performance may be lower or higher than the figures
shown. For the most recent month-end performance figures, please visit
http://www.ftportfolios.com or speak with your financial advisor. Investment
returns, net asset value and common share price will fluctuate and Fund shares,
when sold, may be worth more or less than their original cost.
How to Read This Report
This report contains information that may help you evaluate your investment. It
includes details about the Fund and presents data and analysis that provide
insight into the Fund's performance and investment approach.
By reading the portfolio commentary by the portfolio management team of the
Fund, you may obtain an understanding of how the market environment affected the
Fund's performance. The statistical information that follows may help you
understand the Fund's performance compared to that of relevant market
benchmarks.
It is important to keep in mind that the opinions expressed by personnel of
MacKay are just that: informed opinions. They should not be considered to be
promises or advice. The opinions, like the statistics, cover the period through
the date on the cover of this report. The risks of investing in the Fund are
spelled out in the prospectus, the statement of additional information, this
report and other Fund regulatory filings.
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SHAREHOLDER LETTER
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First Trust High Income Long/Short Fund (FSD)
Annual Letter from the Chairman and CEO
October 31, 2012
Dear Shareholders:
I am pleased to present you with the annual report for your investment in First
Trust High Income Long/Sort Fund (the "Fund").
The report you hold contains detailed information about your investment; a
portfolio commentary from the Fund's management team that provides a recap of
the period; a performance analysis and a market and Fund outlook. Additionally,
you will find the Fund's financial statements for the period this report covers.
I encourage you to read this document and discuss it with your financial
advisor. A successful investor is also typically a knowledgeable one, as we have
found to be the case at First Trust.
First Trust remains committed to being a long-term investor and investment
manager and to bringing you quality financial solutions regardless of market ups
and downs. We have always believed, as I have written previously, that there are
two ways to attain success in reaching your financial goals: staying invested in
quality products and having a long-term investment horizon. We are committed to
this approach in the products we manage or supervise and offer to investors.
As you know, First Trust offers a variety of products that we believe could fit
many financial plans to help investors seeking long-term investment success. We
encourage you to talk to your advisor about the other investments First Trust
offers that might also fit your financial goals and to discuss those goals with
your advisor regularly so that he or she can help keep you on track.
First Trust will continue to make available up-to-date information about your
investments so you and your financial advisor are current on any First Trust
investments you own. We value our relationship with you, and thank you for the
opportunity to assist you in achieving your financial goals. I look forward to
the New Year and to the next edition of your Fund's report.
Sincerely,
/s/ James A. Bowen
James A. Bowen
Chairman of the Board of Trustees of First Trust High Income Long/Short Fund and
Chief Executive Officer of First Trust Advisors L.P.
Page 1
First Trust High Income Long/Short Fund
"AT A GLANCE"
October 31, 2012 (Unaudited)
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Fund Statistics
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Symbol on NYSE FSD
Common Share Price $18.78
Common Share Net Asset Value ("NAV") $19.05
Premium (Discount) to NAV (1.42)%
Net Assets Applicable to Common Shares $686,714,730
Current Monthly Distribution per Common Share (1) $0.1335
Current Annualized Distribution per Common Share $1.6020
Current Distribution Rate on Closing Common Share Price (2) 8.53%
Current Distribution Rate on NAV (2) 8.41%
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COMMON SHARE PRICE & NAV (WEEKLY CLOSING PRICE)
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Common Share Price NAV
10/11 $16.63 $17.82
16.24 17.56
15.93 17.35
15.79 17.12
11/11 15.38 16.69
15.48 16.87
15.66 17.04
15.30 16.89
15.38 17.10
12/11 15.27 17.02
15.70 17.29
16.06 17.39
16.43 17.65
1/12 16.85 17.96
17.06 18.04
17.24 18.11
17.55 18.18
2/12 17.78 18.34
17.82 18.39
18.01 18.34
18.09 18.50
3/12 17.94 18.46
18.13 18.46
18.05 18.27
17.92 18.14
17.94 18.21
4/12 18.16 18.36
17.92 18.34
17.98 18.30
17.17 17.86
5/12 17.36 17.83
17.20 17.55
17.20 17.70
17.32 17.72
6/12 17.72 17.91
17.65 18.00
17.97 17.96
18.01 18.04
17.98 18.18
7/12 18.11 18.19
18.25 18.25
18.21 18.36
18.32 18.43
8/12 18.38 18.50
18.36 18.51
18.26 18.64
18.82 18.98
18.79 19.02
9/12 18.74 18.81
18.61 18.86
18.73 18.95
18.75 19.13
18.56 19.05
10/12 18.78 19.05
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PERFORMANCE
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Average Annual Total Return
1 Year Ended Inception (9/27/2010)
10/31/2012 to 10/31/2012
FUND PERFORMANCE (3)
NAV 17.09% 8.42%
Market Value 23.69% 5.34%
INDEX PERFORMANCE
Bank of America Merrill Lynch U.S. High Yield Master II Constrained Index 13.15% 10.00%
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% of Long-Term
Industry Classification Investments
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Services 18.4%
Basic Industry 13.0
Energy 11.4
Banking 8.2
Insurance 8.2
Financial Services 6.6
Automotive 6.4
Capital Goods 6.2
Telecommunications 6.0
Technology & Electronics 4.2
Utility 2.8
Consumer Non-Cyclical 1.9
Healthcare 1.9
Media 1.9
Asset-Backed Securities 1.6
Mortgage-Backed Securities 0.8
Real Estate 0.5
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Total 100.0%
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% of Long-Term
Asset Classification Investments
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Corporate Bonds and Notes 71.3%
Foreign Corporate Bonds and Notes 21.2
Senior Floating-Rate Loan Interests 3.7
Asset-Backed Securities 1.6
Common Stocks 1.2
Collateralized Mortgage Obligations 0.8
Warrants 0.2
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Total 100.0%
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% of Long
Fixed-Income
Credit Quality (4) Investments
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BBB- and above 19.1%
BB 25.7
B 43.6
CCC and below 9.4
NR 2.2
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Total 100.0%
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% of Total
Country Exposure Investments
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United States 79.0%
United Kingdom 3.8
Netherlands 2.9
Luxembourg 2.4
Canada 2.0
Cayman Islands 1.7
Mexico 1.3
France 1.2
Germany 1.1
Australia 0.8
Liberia 0.7
Venezuela 0.6
Brazil 0.6
Ireland 0.5
Georgia 0.5
Finland 0.5
Bermuda 0.4
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Total 100.0%
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(1) Most recent distribution paid or declared through 10/31/2012. Subject to
change in the future. The distribution was decreased subsequent to
10/31/12. See Note 7 - Subsequent Events in the Notes to Financial
Statements.
(2) Distribution rates are calculated by annualizing the most recent
distribution paid or declared through the report date and then dividing by
Common Share price or NAV, as applicable, as of 10/31/2012. Subject to
change in the future.
(3) Total return is based on the combination of reinvested dividend, capital
gain and return of capital distributions, if any, at prices obtained by
the Dividend Reinvestment Plan and changes in NAV per share for net asset
value returns and changes in Common Share price for market value returns.
Total returns do not reflect sales load and are not annualized for periods
less than one year. Past performance is not indicative of future results.
(4) The credit quality and ratings information presented above reflects the
ratings assigned by one or more nationally recognized statistical rating
organizations (NRSROs), including Standard & Poor's Ratings Group, a
division of the McGraw Hill Companies, Inc., Moody's Investors Service,
Inc., Fitch Ratings or a comparably rated NRSRO. For situations in which a
security is rated by more than one NRSRO and the ratings are not
equivalent, the highest ratings are used. Sub-investment grade ratings are
those rated BB+/Ba1 or lower. Investment grade ratings are those rated
BBB-/Baa3 or higher.
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PORTFOLIO COMMENTARY
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First Trust High Income Long/Short Fund - FSD
October 31, 2012
Sub-Advisor
MacKay Shields LLC ("MacKay Shields" or the "Sub-Advisor") is a registered
investment adviser founded in 1938, and is Sub-Advisor to First Trust High
Income Long/Short Fund (the "Fund"). The Fund trades under the ticker symbol FSD
on the New York Stock Exchange. As of October 31, 2012, MacKay Shields had
approximately $76.4 billion in assets under management.
First Trust High Income Long/Short Fund
The Fund's primary investment objective is to provide current income. As a
secondary objective, the Fund seeks capital appreciation. The Fund is designed
to give investors a portfolio for varying market cycles and economic conditions.
In an expanding economy, the strategy of buying U.S. and foreign (including
emerging markets) high-yield corporate securities that are rated below
investment-grade is designed to generate monthly income and capital appreciation
(total return over the long term). However, if the market takes a downturn, the
"short" strategy of having sold borrowed securities that the Global Fixed Income
Team ("Investment Team") of MacKay Shields believes could decline in price, may
help lessen the impact of a significant net asset value decline.
Portfolio Management Team
Dan Roberts, PhD
Senior Managing Director, Head of Global Fixed Income Division and its Chief
Investment Officer
Mr. Roberts is Head of the Global Fixed Income Division and its Chief Investment
Officer. In October 2004, Mr. Roberts came to MacKay Shields when the firm
acquired the high-yield and global high-yield assets of Pareto Partners. He was
the Chief Investment Officer and an equity shareholder at Pareto Partners. Mr.
Roberts assembled the U.S. fixed-income team while serving 10 years at UBS Asset
Management, most recently as Managing Director and head of the fixed-income
group. Prior to its acquisition by UBS, he was a Financial Economist for Chase
Manhattan Bank, NA and later was head of Global Interest Rate and Currency Swaps
Trading. In 1997, Mr. Roberts' fixed-income group was lifted out of UBS by
Forstmann-Leff International and was subsequently purchased by Pareto Partners,
effective February 2000. His regulatory and government experience included a
two-year stint at the U.S. Securities and Exchange Commission, serving at The
White House with the President's Council of Economic Advisors and as an
Executive Director (Chief of Staff) of the U.S. Congress Joint Economic
Committee. Mr. Roberts holds a BBA and a PhD from the University of Iowa.
Louis N. Cohen, CFA
Managing Director, Global Fixed Income Division
Mr. Cohen is a Senior Portfolio Manager for the Global Fixed Income Division. He
joined MacKay Shields in October 2004 as a Director of Research and portfolio
manager for Core Plus Opportunities after MacKay Shields acquired the high-yield
and global high-yield assets of Pareto Partners, where he was an equity
shareholder. He joined Dan Roberts' fixed-income team at UBS in 1991 as a
Core/Core Plus Portfolio Manager and was Co-Chairman of the Credit Committee
while at UBS. Mr. Cohen's extensive credit experience began at Bankers Trust in
1978 where he was in the Commercial Banking Department. In 1981 he moved to
specialize in fixed-income as a Fixed Income Credit Analyst at Kidder Peabody.
He furthered his fixed-income credit experience as a fixed income credit manager
at several major Street firms, namely, Shearson, Drexel Burnham Lambert and
Paine Webber, prior to his move into portfolio management at UBS. With
experience in the fixed income markets since 1978, Mr. Cohen received his BA and
MBA from New York University and is a past President of the Capital Markets
Credit Analyst Society, and a member of the New York Society of Security
Analysts.
Michael Kimble, CFA
Managing Director, Global Fixed Income Division
Mr. Kimble is a Senior Portfolio Manager for the Global Fixed Income Division.
He joined MacKay Shields in October 2004 as Director and Co-Head of High-Yield
portfolio management when MacKay Shields acquired the high-yield and global
high-yield assets of Pareto Partners. Previously the Co-Head of Pareto Partners'
High-Yield Investments, Mr. Kimble began his investment career with positions at
Citicorp and E.F. Hutton as a fixed-income credit analyst. In 1988 he moved to
Home Insurance Company as a High-Yield Bond Analyst and Portfolio Manager.
Shortly thereafter Mr. Kimble was recruited by Dan Roberts to join the UBS team
in the same capacity. While at UBS, he was Co-Chairman of the Credit Committee.
He received a BA from Columbia University, an MBA from New York University and a
JD from Fordham School of Law. With fixed-income experience since 1984, Mr.
Kimble is a member of the Capital Markets Credit Analyst Society, the New York
Society of Security Analysts and the New York and Louisiana State Bar
Associations.
Taylor Wagenseil
Managing Director, Global Fixed Income Division
Mr. Wagenseil is a Senior Portfolio Manager for the Global Fixed Income
Division. He became Director and Co-Head of High-Yield portfolio management
after MacKay Shields acquired the high-yield and global high-yield assets of
Pareto Partners, where he was Co-Head of High-Yield Investments and an equity
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PORTFOLIO COMMENTARY - (CONTINUED)
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shareholder. He began his investment career with Citibank in 1979, specializing
in troubled loan workouts and recoveries. In 1986, Mr. Wagenseil moved to Drexel
Burnham Lambert as a Senior Vice President to head High-Yield Commercial Paper
Research. He remained at Drexel through the bankruptcy and then joined Bear
Stearns as a Managing Director in the Financial Restructuring Group. He was
recruited to join UBS in 1993 as a Senior Portfolio Manager for High-Yield and
High-Yield Arbitrage Portfolios. Mr. Wagenseil's public service and military
experience includes the U.S. Navy (Lieutenant) during the Vietnam War and five
years as the Commissioner, Department of Elderly Affairs for the City of Boston.
He received a BA from Dartmouth College and a MBA (Finance) from the Harvard
Business School and has experience in the high yield market since 1979.
Market Recap
This report covers the First Trust High Income Long/Short Fund (the "Fund") for
the twelve-month period ending October 31, 2012.
In general, the rally that began in last year's fourth quarter continued through
2012 with risk being rewarded. U.S. equities were the top performer, with the
S&P 500 up 15.21%. High yield, as measured by the Merrill Lynch High Yield
Master II Constrained Index, was close behind, returning 13.15%. The small-cap
Russell 2000 gained 12.08%, while U.S. investment-grade corporate bonds rose
10.21%, according to Barclays. The MSCI EAFE, burdened by concerns of the
European debt crisis during the period, only rose 5.15%. The 10-year Treasury
posted a 7.46% return as its yield declined 50 basis points (bps).
The events in Europe, which weighed heavily on the market at times, were the
primary driver of the rally during the previous twelve months. In November, the
period opened with a flight to quality trade, when Eurozone leaders failed to
meet expectations for a comprehensive solution to the sovereign debt crisis
after announcing that they finally understood the severity of the situation. In
December, concerns eased when a distinction was finally made between Europe,
which is most likely facing a recession, and the other global economies, most
notably the U.S., that are experiencing moderate growth. However, the major
turning point surrounding the events in Europe, and the single biggest factor
behind the rally at the beginning of the year, was the European Central Bank's
("ECB") Long Term Refinancing Operation ("LTRO"). On December 23rd, the ECB
extended (euro)489 billion in 3-year loans to 523 banks. Then, at the end of
February, another tranche of the LTRO provided more financial institutions (800
in total) an additional (euro)525.5 billion. When one combines this with the
sovereign bonds that were purchased through the Securities Market Program and
the fact that most banks are already in compliance with post stress test minimum
capital requirements, it is evident that there is substantial support for
European banks and the financial markets. Banks essentially are fully
provisioned for sovereign defaults, and their near-term funding needs are
satisfied. This leaves them not needing to sell any more of their sovereign debt
holdings, while also benefitting from the low-cost LTRO loans in lieu of
floating any more of their own public bonds.
In spite of these improved fundamentals, the weakness and uncertainty in Europe
resulted in tumultuous politics and markets during the first half of the year.
The debate surrounding how to resolve the economic woes in Europe centered on
how best to balance growth with austerity. In April, this crisis caused the
Dutch government to resign. In France, the demand for growth over austerity
drove the presidential campaign and the eventual victory of French Socialist
Francois Hollande. The balance between growth and austerity was also the focus
for the very tight election in Greece, which concluded with a modest majority
for the New Democracy party, a proponent of maintaining Greece's place in the
Euro and upholding the previously agreed upon austerity measures. While the
Greek election did not rule out that the country may exit the Euro at some
future point, it appears to have forestalled that event for the time being.
Thankfully, the sentiment surrounding the events in Europe turned around during
the summer months due to a persistent drumbeat of positive news, leading to a
rally in the third quarter. The rally was ignited by ECB President Mario
Draghi's statements in the last week of July that the Euro is "irreversible,"
and that speculation to the contrary is unacceptable. He further stated that the
ECB will do "whatever it takes" to preserve the Euro and "believe me, it will be
enough." As we have stated before, we believe the crux of the current crisis is
the separation between the ECB and the Eurozone treasuries. In other words, if a
country issues debt in its own currency and has the capacity to create this
currency, it can never be made to default. Therefore, the ECB statements cannot
be overemphasized. If the ECB is "all in", then we believe the current crisis is
over. This does not mean that recession in Europe won't occur or that long-term
inflation is not a threat. It does mean, however, that the threat of a Euro
collapse is clearly receding. As a natural and not unexpected follow-up at the
beginning of September, the ECB announced an unlimited bond-buying program to
stop further erosion in European debt markets. In September, Germany's highest
court rejected attempts to delay the ratification of key elements of the
Eurozone's debt management efforts. This cleared the path of the most
significant impediment to the ECB's plan, which in turn helped lift much of the
anxiety overhanging markets. Additionally, supporting the Eurozone, was that two
centrist, pro-European parties won general elections in the Netherlands.
It has also been constructive that central banks around the world continue to be
accommodative. In Asia, China recently lowered its lending rate to 6% and the
Bank of Japan announced that it would expand its asset purchase program by 10
trillion yen. In Europe, the ECB cut its rates to 0.75% and the Bank of England
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PORTFOLIO COMMENTARY - (CONTINUED)
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also recently announced an asset purchase plan. In the U.S., the Fed announced
further quantitative easing in August, additional mortgage purchases and
extended Operation Twist through the end of the year, citing concerns about the
employment situation. The Fed's focus is on the job market as many large
disparate employers announced layoffs. However, positive news that supports a
slow growth scenario for the U.S. economy included the ISM manufacturing survey
at the end of September, which was 51.5. Housing, auto sales and employment have
also showed improvements. Housing starts in the U.S. are up substantially year
to date, while inventories are at multi-year lows and home sales and
construction reached the highest level in two years. In fact, Jamie Dimon, the
CEO of JPMorgan Chase, stated that housing "has turned the corner." Further
bolstering the case for a U.S. acceleration were U.S. auto sales, which reached
a 4 1/2 year high in September. Non-farm payrolls beat expectations, rising
171,000 in October, while estimates for August and September were revised
higher.
Equities, on the other hand, were recently under pressure due to disappointing
earnings. Although U.S. corporate earnings continue to grow, the rate of growth
has slowed. With the corporate sector in such good health, however, even modest
earnings growth is more than enough to please credit markets, whereas equity
investors clearly had to adjust their estimate of fair value due to a lower
growth rate in the dividend discount model. However, as previously noted,
earnings growth is still positive. With 78% of the S&P 500 having reported for
the third quarter of 2012, the average growth in sales since last year is 3.6%,
while the average growth in earnings is 9.9%. This is still supportive of very
high levels of corporate credit quality. In addition, issuers have very high
levels of cash and have been lowering their interest expense through refinancing
and extending maturities on their debt.
The technicals of high yield remain strong. From the demand side, retail
high-yield bond funds saw net inflows of $35 billion year to date which is more
than double the amount for all of 2011. Anecdotally, we continue to see strong
interest from institutional investors in the asset class. On the supply side,
the new issue market was extremely active for most of the year. In this rally
over the year, all of the sectors of the high-yield market produced positive
returns; in fact, even the lagging sectors produced returns close to 8%. The
best-performing sectors were insurance, banking and real estate. The lagging
sectors were consumer basic industry, energy and utilities.
Performance Analysis
The Fund had a strong year, with significant outperformance versus its benchmark
for the twelve-month period ending October 31, 2012. The Fund returned a net
asset value ("NAV") total return(1) of 17.09% compared with the Bank of America
Merrill Lynch U.S. High Yield Master II Constrained Index, which gained 13.15%.
For the period, the Fund traded from a discount to NAV of 6.68% to a discount to
NAV of 1.42%, resulting in a market value total return(1) of 23.69%.
The Fund's beta(2) positioning was highly beneficial during the rally over the
previous year. Two sectors that we have successfully used in the past to help
lift the beta of the portfolio are financials (banks, financial services and
insurance) and housing related (home building and building materials). These
sectors helped the Fund's relative performance because they are overweight and
outperformed the broader market. As the concerns about Europe have eased and the
financial markets have rallied, the financial industry has directly benefitted.
Among the portfolio's top performers for the year from the financial sector were
insurance companies: AIG, Liberty Mutual and L-incoln National; banks: Ally and
Bank of America; as well as financial service companies: CIT and SLM Corp.
("Sallie Mae"). The positive trends in the housing market lifted the Fund's
housing-related companies, specifically: Pulte, Hovnanian, Beazer, USG and Texas
Industries. Sprint Nextel was also among the top performers in the Fund for the
year. The rally in Sprint bonds was due in part to an announcement that
Softbank, the Japanese technology company, would acquire a 70% stake in the
company.
On the negative side, the Fund's exposure to the coal, steel, utilities and
energy sectors was a drag on performance during the year. Coal producers, which
include holdings in Arch Coal and Alpha Natural Resources, were under pressure
as more utilities turn from coal to natural gas due to lower natural gas prices
and the Obama administration's new carbon-dioxide emissions regulations, which
have virtually eliminated the planned construction of new coal fired plants.
Additionally, our exposure to steel companies, US Steel and Aperam, were a drag
on the portfolio as steel prices declined. The warm winter in early 2012 caused
difficulties for utilities after the previous year's intense cold. As a result,
Texas Competitive Electricity (TXU) and Edison Mission were among the bottom
performers. Additionally, some energy and energy service companies weighed down
the Fund's performance, including OGX, Basic Energy Services, and Oil Insurance.
Geokinetics, the seismic data company, was also a laggard during the year. The
company had reported disappointing earnings earlier in the year as well as some
operating difficulties in this inherently cyclical industry, and it has been
reported that the company has hired an advisor to explore alternatives.
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1 Total return is based on the combination of reinvested dividends, capital
gain and return of capital distributions, if any, at prices obtained by
the Dividend Reinvestment Plan and changes in NAV per share for net asset
value returns and changes in Common Share price for market value returns.
Total returns do not reflect sales load and are not annualized for periods
less than one year. Past performance is not indicative of future results.
2 Beta is a measure of volatility of risk relative to the market as a whole.
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PORTFOLIO COMMENTARY - (CONTINUED)
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Additionally, the Fund's short position in Treasuries was somewhat of a drag on
performance during the year due to the decline in Treasury yields; however, this
position provided the Fund with leverage that was reinvested in the high-yield
market, magnifying the portfolio's absolute and relative gains.
Market and Fund Outlook
With the U.S. Presidential election behind us, the focus is now entirely on the
"fiscal cliff". As we have stated previously, we did not believe the outcome of
the election would have a material impact on the near-term trajectory of credit
spreads, nor do we think the U.S. economy will fall off the proverbial "fiscal
cliff" due to the potentially severe impact it could have on the real economy.
Virtually no one in Congress wants to be responsible for tipping the U.S. into
recession, and we believe a satisfactory compromise will be reached. However,
political theater, aided by 24-hour news coverage, should be expected through
the balance of the year.
Longer term, the markets remain flush with liquidity and investors continue to
be paid to hold high-yield bonds. Therefore, we still favor the high-yield
market for its yield advantage and capital appreciation potential relative to
other asset classes. We remain constructive on the fundamental underpinnings of
the issuer base and the positive market technicals helping to support bond
prices. We recognize earnings season is pointing to an environment of moderate
to slow growth, but we are not concerned about a meaningful pullback that would
negatively impact credit costs.
Page 6
First Trust High Income Long/Short Fund
Portfolio of Investments
October 31, 2012
Principal Stated Stated
Value Description Coupon Maturity Value
------------- ------------------------------------------------------------------- --------- ----------- --------------
CORPORATE BONDS AND NOTES - 87.5%
Automotive - 4.1%
$ 334,000 Chrysler Group LLC/Chrysler Group Co-Issuer, Inc. ................. 8.00% 06/15/19 $ 356,963
4,367,000 Chrysler Group LLC/Chrysler Group Co-Issuer, Inc. ................. 8.25% 06/15/21 4,689,066
2,376,000 Ford Motor Co. (a)................................................. 9.22% 09/15/21 3,053,160
553,000 Ford Motor Co. (a)................................................. 8.90% 01/15/32 736,181
3,000,000 Ford Motor Co. (a)................................................. 7.75% 06/15/43 3,476,250
2,480,000 Ford Motor Co. (a)................................................. 9.98% 02/15/47 3,456,500
21,000,000 General Motors Unsecured Claim Trust Units (Non-transferable) (b).. N/A N/A 2,100
21,432 General Motors Unsecured Claim Trust Units (Transferable) (b)...... N/A N/A 427,568
5,396,000 Goodyear Tire & Rubber (The) Co. (a)............................... 7.00% 05/15/22 5,686,035
4,872,000 Navistar International Corp. (a)................................... 8.25% 11/01/21 4,585,770
1,682,000 Tomkins Inc., LLC.................................................. 9.00% 10/01/18 1,892,250
-------------
28,361,843
-------------
Banking - 4.2%
740,000 Ally Financial, Inc. (a)........................................... 8.00% 11/01/31 883,672
2,285,000 Ally Financial, Inc. (a)........................................... 8.00% 11/01/31 2,730,575
5,610,000 Bank of America Corp............................................... 7.63% 06/01/19 7,123,657
6,500,000 Capital One Capital III (a)........................................ 7.69% 08/15/36 6,617,975
6,750,000 Deutsche Postbank Funding Trust IV (EUR) (c) (d)................... 5.98% 06/29/49 7,217,895
4,000,000 Fifth Third Capital Trust IV (a) (d)............................... 6.50% 04/15/37 4,025,000
-------------
28,598,774
-------------
Basic Industry - 10.2%
4,500,000 AK Steel Corp. (a)................................................. 8.38% 04/01/22 3,825,000
5,250,000 Aleris International, Inc.......................................... 7.63% 02/15/18 5,355,000
4,200,000 Alpha Natural Resources, Inc. (a).................................. 6.00% 06/01/19 3,706,500
596,000 Alpha Natural Resources, Inc....................................... 6.25% 06/01/21 521,500
1,255,000 Arch Coal, Inc..................................................... 7.00% 06/15/19 1,120,087
1,428,000 Arch Coal, Inc..................................................... 7.25% 10/01/20 1,270,920
1,125,000 Arch Coal, Inc..................................................... 7.25% 06/15/21 998,438
5,135,000 Associated Materials LLC........................................... 9.13% 11/01/17 5,109,325
2,279,000 Boise Cascade LLC.................................................. 7.13% 10/15/14 2,286,179
3,635,000 Boise Paper Holdings LLC/Boise Finance Co. (a) .................... 9.00% 11/01/17 4,016,675
1,357,000 Century Aluminum Co. (a)........................................... 8.00% 05/15/14 1,382,444
3,600,000 Cloud Peak Energy Resources Corp., LLC (a)......................... 8.25% 12/15/17 3,915,000
6,500,000 Hexion U.S. Finance Corp./Hexion Nova Scotia Finance ULC (a)....... 8.88% 02/01/18 6,597,500
8,655,000 Huntsman International LLC (a)..................................... 8.63% 03/15/21 9,888,337
1,300,000 Momentive Performance Materials, Inc. (e).......................... 10.00% 10/15/20 1,254,500
4,000,000 Momentive Performance Materials, Inc............................... 9.00% 01/15/21 2,780,000
4,000,000 Polypore International, Inc. (a)................................... 7.50% 11/15/17 4,340,000
5,150,000 Texas Industries, Inc. (a)......................................... 9.25% 08/15/20 5,523,375
4,000,000 USG Corp. (a)...................................................... 6.30% 11/15/16 4,090,000
1,878,000 USG Corp. (e)...................................................... 8.38% 10/15/18 2,056,410
228,000 Vertellus Specialties, Inc. (e).................................... 9.38% 10/01/15 183,540
-------------
70,220,730
-------------
Capital Goods - 7.0%
4,031,000 American Railcar Industries, Inc................................... 7.50% 03/01/14 4,091,465
3,265,000 Ducommun, Inc. (a)................................................. 9.75% 07/15/18 3,469,062
See Notes to Financial Statements Page 7
FIRST TRUST HIGH INCOME LONG/SHORT FUND
PORTFOLIO OF INVESTMENTS - (Continued)
OCTOBER 31, 2012
Principal Stated Stated
Value Description Coupon Maturity Value
------------- ------------------------------------------------------------------- --------- ----------- --------------
CORPORATE BONDS AND NOTES - (Continued)
Capital Goods - (Continued)
$ 5,000,000 Manitowoc (The), Inc., Co. (a)..................................... 8.50% 11/01/20 $ 5,637,500
3,625,000 Mcron Finance Sub LLC/ Mcron Finance Corp. (e) .................... 8.38% 05/15/19 3,742,812
3,760,000 Mueller Water Products, Inc. (a)................................... 7.38% 06/01/17 3,891,600
7,500,000 Reynolds Group Issuer, Inc., LLC................................... 8.50% 05/15/18 7,500,000
2,085,000 Reynolds Group Issuer, Inc., LLC................................... 9.88% 08/15/19 2,194,463
7,500,000 Terex Corp. (a).................................................... 8.00% 11/15/17 7,846,875
4,000,000 Transdigm, Inc. (a)................................................ 7.75% 12/15/18 4,430,000
4,650,000 Triumph Group, Inc. (a)............................................ 8.63% 07/15/18 5,242,875
-------------
48,046,652
-------------
Consumer Non-Cyclical - 0.4%
2,240,000 Smithfield Foods, Inc.............................................. 6.63% 08/15/22 2,352,000
-------------
Energy - 9.7%
4,725,000 Basic Energy Services, Inc. (e).................................... 7.75% 10/15/22 4,606,875
3,974,000 Berry Petroleum Co. (a)............................................ 6.75% 11/01/20 4,232,310
5,700,000 Chesapeake Energy Corp. (a)........................................ 9.50% 02/15/15 6,412,500
600,000 Chesapeake Energy Corp. (a)........................................ 7.25% 12/15/18 642,000
1,970,000 Chesapeake Energy Corp. (a)........................................ 6.63% 08/15/20 2,078,350
3,275,000 Everest Acquisition LLC/Everest Acquisition Finance, Inc. (e)...... 9.38% 05/01/20 3,635,250
3,000,000 Ferrellgas Finance Corp., L.P. (a)................................. 6.50% 05/01/21 2,910,000
800,000 Frontier Oil Corp. (a)............................................. 6.88% 11/15/18 856,000
1,411,000 Geokinetics Holdings USA, Inc...................................... 9.75% 12/15/14 631,423
4,000,000 Hornbeck Offshore Services, Inc. (a)............................... 8.00% 09/01/17 4,300,000
2,636,000 Linn Energy LLC/Linn Energy Finance Corp. (e)...................... 6.25% 11/01/19 2,649,180
5,240,000 Linn Energy LLC/Linn Energy Finance Corp........................... 8.63% 04/15/20 5,757,450
5,500,000 PHI, Inc. (a)...................................................... 8.63% 10/15/18 5,830,000
5,900,000 Plains Exploration & Production Co................................. 6.50% 11/15/20 5,907,375
3,499,000 Regency Energy Partners L.P./Regency Energy Finance Corp. (a)...... 9.38% 06/01/16 3,805,162
3,248,000 Samson Investment Co. (e).......................................... 9.75% 02/15/20 3,442,880
4,750,000 Swift Energy Co.................................................... 8.88% 01/15/20 5,153,750
3,425,000 Targa Resources Partners L.P./Targa Resources
Partners Finance Corp. (a)......................................... 7.88% 10/15/18 3,767,500
-------------
66,618,005
-------------
Financial Services - 7.0%
1,665,000 CIT Group, Inc..................................................... 5.00% 05/15/17 1,762,902
10,000,000 CIT Group, Inc..................................................... 4.25% 08/15/17 10,306,200
10,500,000 GE Capital Trust IV (EUR) (c) (d).................................. 4.63% 09/15/66 13,093,154
410,000 General Electric Capital Corp. (EUR) (c) (d)....................... 5.50% 09/15/67 528,495
7,500,000 Icahn Enterprises L.P./Icahn Enterprises Finance Corp. (a)......... 8.00% 01/15/18 8,100,000
8,000,000 SLM Corp. (a)...................................................... 8.00% 03/25/20 9,304,960
5,000,000 Springleaf Finance Corp. (a)....................................... 6.90% 12/15/17 4,425,000
700,000 Textron Financial Corp. (d) (e).................................... 6.00% 02/15/67 612,500
-------------
48,133,211
-------------
Healthcare - 2.3%
5,880,000 Alere, Inc......................................................... 9.00% 05/15/16 6,240,150
5,600,000 HCA Holdings, Inc.................................................. 7.75% 05/15/21 6,062,000
Page 8 See Notes to Financial Statements
First Trust High Income Long/Short Fund
Portfolio of Investments - (Continued)
October 31, 2012
Principal Stated Stated
Value Description Coupon Maturity Value
------------- ------------------------------------------------------------------- --------- ----------- --------------
CORPORATE BONDS AND NOTES - (Continued)
Healthcare - (Continued)
$ 3,150,000 Kinetic Concepts, Inc. (e)......................................... 10.50% 11/01/18 $ 3,370,500
-------------
15,672,650
-------------
Insurance - 8.1%
2,450,000 American International Group, Inc. (EUR) (c) (d)................... 8.00% 05/22/38 3,676,324
1,800,000 American International Group, Inc. (EUR) (c) (d)................... 4.88% 03/15/67 2,040,258
3,050,000 American International Group, Inc. (GBP) (c) (d)................... 8.63% 05/22/38 5,847,325
10,950,000 American International Group, Inc. (GBP) (c) (d)................... 5.75% 03/15/67 16,310,051
5,000,000 CHUBB Corp. (a) (d)................................................ 6.38% 03/29/67 5,450,000
11,000,000 Glen Meadow Pass Through Trust (d) (e)............................. 6.51% 02/12/67 10,120,000
6,500,000 Liberty Mutual Group, Inc. (d) (e)................................. 7.00% 03/15/37 6,483,750
3,500,000 Lincoln National Corp. (a) (d)..................................... 7.00% 05/17/66 3,605,000
1,800,000 Lincoln National Corp. (a) (d)..................................... 6.05% 04/20/67 1,809,000
-------------
55,341,708
-------------
Media - 2.3%
3,500,000 Cequel Communications Holdings I LLC/Cequel Capital Corp. (e)...... 8.63% 11/15/17 3,762,500
3,931,000 Clear Channel Communications, Inc. (a)............................. 5.50% 12/15/16 2,555,150
1,800,000 Clear Channel Communications, Inc. (a)............................. 9.00% 03/01/21 1,579,500
324,000 Clear Channel Worldwide Holdings, Inc.............................. 9.25% 12/15/17 348,300
4,008,000 Clear Channel Worldwide Holdings, Inc.............................. 9.25% 12/15/17 4,308,600
456,000 Clear Channel Worldwide Holdings, Inc.............................. 7.63% 03/15/20 432,060
3,193,000 Clear Channel Worldwide Holdings, Inc.............................. 7.63% 03/15/20 3,057,298
-------------
16,043,408
-------------
Services - 18.6%
4,716,098 American Airlines Pass Through Trust 2001-01....................... 6.98% 05/23/21 4,668,937
3,500,000 ARAMARK Corp. (a).................................................. 8.50% 02/01/15 3,561,285
1,095,000 Ashtead Capital, Inc. (e).......................................... 6.50% 07/15/22 1,160,700
5,500,000 Avis Budget Car Rental LLC/Avis Budget Finance, Inc. (a)........... 9.63% 03/15/18 6,153,125
1,426,000 Avis Budget Car Rental LLC/Avis Budget Finance, Inc. (a)........... 8.25% 01/15/19 1,563,252
6,500,000 Beazer Homes USA, Inc. (a)......................................... 8.13% 06/15/16 6,890,000
5,542,387 Continental Airlines 2003-ERJ1 Pass Through Trust ................. 7.88% 07/02/18 5,722,515
2,600,076 Continental Airlines 2005-ERJ1 Pass Through Trust ................. 9.80% 04/01/21 2,834,083
1,712,294 Delta Air Lines 2009-1 Series B Pass Through Trust ................ 9.75% 12/17/16 1,900,646
5,486,000 Energysolutions, Inc., LLC......................................... 10.75% 08/15/18 5,115,695
9,000,000 Harrah's Operating, Inc., Co....................................... 10.00% 12/15/18 5,490,000
8,000,000 Hertz (The) Corp................................................... 7.50% 10/15/18 8,720,000
5,250,000 Iron Mountain, Inc. (a)............................................ 8.38% 08/15/21 5,827,500
3,500,000 Isle of Capri Casinos, Inc. (a).................................... 7.75% 03/15/19 3,766,875
4,160,000 K Hovnanian Enterprises, Inc. (e).................................. 7.25% 10/15/20 4,409,600
8,000,000 MGM Resorts International.......................................... 11.13% 11/15/17 8,860,000
1,000,000 MGM Resorts International (e)...................................... 6.75% 10/01/20 995,000
3,500,000 Mohegan Tribal Gaming Authority (e)................................ 10.50% 12/15/16 3,333,750
3,236,793 Northwest Airlines 2001-1 Class B Pass Through Trust .............. 7.69% 04/01/17 3,366,265
1,780,000 Pulte Group, Inc. (a).............................................. 7.63% 10/15/17 2,095,950
4,570,000 Pulte Group, Inc. (a).............................................. 7.88% 06/15/32 4,912,750
3,319,000 Shea Homes L.P./Shea Homes Funding Corp............................ 8.63% 05/15/19 3,708,982
See Notes to Financial Statements Page 9
First Trust High Income Long/Short Fund
Portfolio of Investments - (Continued)
October 31, 2012
Principal Stated Stated
Value Description Coupon Maturity Value
------------- ------------------------------------------------------------------- --------- ----------- --------------
CORPORATE BONDS AND NOTES - (Continued)
Services - (Continued)
$ 5,500,000 Standard Pacific Corp. (a)....................................... 8.38% 05/15/18 $ 6,435,000
3,506,791 UAL 2009-2B Pass Through Trust (e)............................... 12.00% 01/15/16 3,839,936
7,000,000 United Air Lines, Inc. (e)....................................... 12.00% 11/01/13 7,210,000
7,062,000 United Rentals North America, Inc. (a)........................... 8.38% 09/15/20 7,768,200
375,000 UR Financing Escrow Corp. (e).................................... 7.38% 05/15/20 407,344
367,000 UR Financing Escrow Corp. (e).................................... 7.63% 04/15/22 403,241
6,971,154 US Airways 2000-3C Pass Through Trust ........................... 8.39% 03/01/22 6,692,308
-------------
127,812,939
-------------
Technology & Electronics - 5.2%
5,500,000 Alcatel-Lucent USA, Inc. (a)..................................... 6.45% 03/15/29 3,506,250
5,675,000 CommScope, Inc. (e).............................................. 8.25% 01/15/19 6,143,188
9,050,000 First Data Corp. (e)............................................. 8.88% 08/15/20 9,909,750
8,834,000 Freescale Semiconductor, Inc. (e)................................ 10.13% 03/15/18 9,584,890
6,460,000 Sungard Data Systems, Inc. (e)................................... 6.63% 11/01/19 6,548,825
-------------
35,692,903
-------------
Telecommunications - 5.6%
7,000,000 Frontier Communications Corp. (a)................................ 9.00% 08/15/31 7,507,500
2,411,000 Hughes Satellite Systems Corp. (a)............................... 7.63% 06/15/21 2,694,292
3,500,000 MetroPCS Wireless, Inc. (a)...................................... 7.88% 09/01/18 3,850,000
10,000,000 Sprint Capital Corp. (a)......................................... 8.75% 03/15/32 11,850,000
2,600,000 Sprint Nextel Corp............................................... 9.13% 03/01/17 3,068,000
6,000,000 Sprint Nextel Corp. (a).......................................... 9.25% 04/15/22 7,200,000
2,428,000 Viasat, Inc. (e)................................................. 6.88% 06/15/20 2,549,400
-------------
38,719,192
-------------
Utility - 2.8%
7,500,000 Calpine Corp. (e)................................................ 7.88% 07/31/20 8,250,000
3,350,000 Energy Future Intermediate Holding Co., LLC/Energy Future
Intermediate Holding Finance, Inc. (a)........................ 10.00% 12/01/20 3,676,625
5,000,000 NRG Energy, Inc. (a)............................................. 8.25% 09/01/20 5,537,500
2,150,000 Texas Competitive Electric Holdings Co. LLC/Texas Competitive
Electric Holdings Finance, Inc. (e)........................... 11.50% 10/01/20 1,548,000
-------------
19,012,125
-------------
Total Corporate Bonds and Notes.......................................................... 600,626,140
(Cost $577,532,950) -------------
Principal
Value
(Local Stated Stated Value
Currency) Description Coupon Maturity (US Dollars)
------------- ----------------------------------------------------------------- --------- ----------- --------------
FOREIGN CORPORATE BONDS AND NOTES - 25.9%
Banking - 5.5%
6,500,000 ABN AMRO Bank N.V. (EUR) (d)..................................... 4.31% 03/29/49 6,361,242
2,200,000 Barclays Bank PLC (GBP).......................................... 10.00% 05/21/21 4,463,344
Page 10 See Notes to Financial Statements
First Trust High Income Long/Short Fund
Portfolio of Investments - (Continued)
October 31, 2012
Principal
Value
(Local Stated Stated Value
Currency) Description Coupon Maturity (US Dollars)
------------- ----------------------------------------------------------------- --------- ----------- --------------
FOREIGN CORPORATE BONDS AND NOTES - (Continued)
Banking - (Continued)
8,264,000 Canada Square Operations PLC (GBP) (d)........................... 7.50% 05/29/49 $ 13,453,487
3,300,000 IKB Deutsche Industriebank AG (EUR) (f).......................... 1.20% 05/28/13 3,988,555
175,000 IKB Deutsche Industriebank AG (EUR).............................. 4.50% 07/09/13 220,020
2,700,000 Industrial Senior Trust (e)...................................... 5.50% 11/01/22 2,715,390
2,100,000 Mizuho Capital Investment, Ltd. (USD) (a) (d) (e)................ 14.95% 12/29/49 2,529,416
3,000,000 Royal Bank of Scotland N.V. (EUR) (f)............................ 4.70% 06/10/19 3,713,449
-------------
37,444,903
-------------
Basic Industry - 5.7%
4,500,000 Aperam (USD) (e)................................................. 7.38% 04/01/16 3,937,500
3,451,000 Boart Longyear Management Pty., Ltd. (USD) (e)................... 7.00% 04/01/21 3,511,393
4,065,000 Evraz Group S.A. (USD) (e)....................................... 7.40% 04/24/17 4,238,982
3,135,000 FMG Resources Pty, Ltd. (USD) (e)................................ 7.00% 11/01/15 3,182,025
1,000,000 INEOS Finance PLC (EUR).......................................... 9.25% 05/15/15 1,396,594
4,000,000 INEOS Group Holdings PLC (EUR)................................... 7.88% 02/15/16 4,970,707
6,300,000 Novelis, Inc. (USD) (a).......................................... 8.75% 12/15/20 6,977,250
4,200,000 Stora Enso Oyj (USD) (e)......................................... 7.25% 04/15/36 3,822,000
6,785,000 Vedanta Resources PLC (USD) (e).................................. 8.25% 06/07/21 7,039,437
-------------
39,075,888
-------------
Capital Goods - 0.6%
3,000,000 Ardagh Packaging Finance (EUR)................................... 9.25% 10/15/20 4,102,292
-------------
Consumer Non-Cyclical - 2.0%
6,000,000 JBS Finance II Ltd. (USD) (e).................................... 8.25% 01/29/18 6,315,000
3,770,000 Minerva Luxembourg S.A. (USD) (e)................................ 12.25% 02/10/22 4,505,150
3,000,000 Virgolino de Oliveira Finance Ltd. (USD) (e)..................... 11.75% 02/09/22 2,955,000
-------------
13,775,150
-------------
Energy - 3.4%
9,400,000 CHC Helicopter S.A. (USD) (a).................................... 9.25% 10/15/20 9,588,000
3,750,000 Georgian Oil and Gas Corp. (USD) (e)............................. 6.88% 05/16/17 3,890,625
5,600,000 OGX Petroleo e Gas Participacoes S.A. (USD) (e).................. 8.50% 06/01/18 4,914,000
5,000,000 Petroleos de Venezuela S.A. (USD)................................ 12.75% 02/17/22 5,150,000
-------------
23,542,625
-------------
Financial Services - 1.0%
7,450,000 Banque PSA Finance S.A. (e)...................................... 5.75% 04/04/21 7,179,900
-------------
Insurance - 2.1%
1,650,000 Aviva PLC (EUR) (d).............................................. 6.88% 05/22/38 2,165,368
3,500,000 CNP Assurances (EUR) (d)......................................... 5.25% 05/16/36 2,699,217
5,000,000 ING Groep N.V. (GBP) (d)......................................... 5.14% 03/29/49 6,196,846
3,500,000 Oil Insurance Ltd. (USD) (e) (f)................................. 3.34% 12/29/49 3,141,485
-------------
14,202,916
-------------
Services - 3.2%
4,600,000 Desarrolladora Homex Sab de CV (USD) (e)......................... 9.75% 03/25/20 4,669,000
1,800,000 Empresas ICA Sab de CV (USD) (e)................................. 8.38% 07/24/17 1,926,000
See Notes to Financial Statements Page 11
First Trust High Income Long/Short Fund
Portfolio of Investments - (Continued)
October 31, 2012
Principal
Value
(Local Stated Stated Value
Currency) Description Coupon Maturity (US Dollars)
------------- ----------------------------------------------------------------- --------- ----------- --------------
FOREIGN CORPORATE BONDS AND NOTES - (Continued)
Services - (Continued)
5,250,000 Hapag-Lloyd AG (USD) (e)......................................... 9.75% 10/15/17 $ 5,171,250
5,755,000 Royal Caribbean Cruises Ltd. (USD) (a)........................... 7.50% 10/15/27 6,201,012
4,500,000 Urbi Desarrollos Urbanos Sab de CV (USD) (e)..................... 9.75% 02/03/22 4,196,250
-------------
22,163,512
-------------
Telecommunications - 1.7%
2,857,000 En Germany Holdings B.V. (EUR)................................... 10.75% 11/15/15 3,638,276
4,900,000 Intelsat Luxembourg S.A. (USD) (a)............................... 11.25% 02/04/17 5,163,375
2,550,000 Intelsat Luxembourg S.A. (USD) (a)............................... 11.50% 02/04/17 2,693,437
-------------
11,495,088
-------------
Utility - 0.7%
5,000,000 Intergen N.V. (USD) (e).......................................... 9.00% 06/30/17 4,762,500
-------------
Total Foreign Corporate Bonds and Notes.................................................. 177,744,774
(Cost $175,781,662) -------------
Principal Stated
Value Description Rate (g) Maturity (h) Value
------------- ----------------------------------------------------------------- --------- ------------ -------------
SENIOR FLOATING-RATE LOAN INTERESTS - 4.5%
Automotive - 2.4%
$ 7,172,189 Allison Transmission, Inc........................................ 3.72% 08/07/17 7,182,947
7,149,871 Federal Mogul Corp Term Loan B................................... 2.15% 12/27/14 6,691,064
2,500,000 Navistar, Inc. Term Loan B....................................... 7.00% 08/17/17 2,506,250
-------------
16,380,261
-------------
Energy - 0.9%
5,940,000 Meg Energy Term Loan............................................. 4.00% 03/18/18 5,956,513
-------------
Real Estate - 0.5%
3,373,206 Realogy Initial Term Loan B...................................... 4.46% 10/10/16 3,364,165
474,960 Realogy Synthetic Letter of Credit............................... 4.31% 10/10/16 473,688
-------------
3,837,853
-------------
Services - 0.7%
4,861,111 US Airways Term Loan............................................. 2.71% 03/23/14 4,744,445
-------------
Total Senior Floating-Rate Loan Interests................................................ 30,919,072
(Cost $30,922,016) -------------
Principal Stated Stated
Value Description Coupon Maturity Value
------------- ----------------------------------------------------------------- --------- ----------- -------------
ASSET-BACKED SECURITIES - 2.0%
Ace Securities Corp.
3,349,795 Series 2007-HE2, Class A2A (f)................................ 0.33% 12/25/36 1,870,631
Carrington Mortgage Loan Trust
2,609,167 Series 2006-NC4, Class A5 (f)................................. 0.27% 10/25/36 1,854,870
HSI Asset Securitization Corp. Trust
2,148,582 Series 2007-NC1, Class A1 (f)................................. 0.31% 04/25/37 1,822,878
Page 12 See Notes to Financial Statements
First Trust High Income Long/Short Fund
Portfolio of Investments - (Continued)
October 31, 2012
Principal Stated Stated
Value Description Coupon Maturity Value
------------- ----------------------------------------------------------------- --------- ----------- -------------
ASSET-BACKED SECURITIES - (Continued)
Keycorp Student Loan Trust
$ 2,886,462 Series 2000-A, Class A2 (f)................................... 0.75% 05/25/29 $ 2,647,060
Morgan Stanley ABS Capital I
1,104,074 Series 2006-HE6, Class A2B (f)................................ 0.31% 09/25/36 702,167
Securitized Asset Backed Receivables LLC Trust
10,060,027 Series 2006-FR4, Class A2A (f)................................ 0.29% 08/25/36 3,801,417
Soundview Home Equity Loan Trust
1,301,982 Series 2006-EQ2, Class A2 (f)................................. 0.32% 01/25/37 746,466
-------------
Total Asset-Backed Securities............................................................ 13,445,489
(Cost $16,733,290) -------------
MORTGAGE-BACKED SECURITIES - 1.0%
Collateralized Mortgage Obligations - 1.0%
Morgan Stanley Mortgage Loan Trust
1,789,892 Series 2007-6XS, Class 2A1S (f)............................... 0.32% 02/25/47 1,584,215
Specialty Underwriting & Residential Finance
2,399,673 Series 2006-BC4, Class A2B (f)................................ 0.32% 09/25/37 1,920,102
Wells Fargo Mortgage Backed Securities Trust
4,040,313 Series 2006-AR7, Class 2A4 (f)................................ 2.62% 05/25/36 3,521,136
-------------
Total Mortgage-Backed Securities......................................................... 7,025,453
(Cost $7,020,293) -------------
Shares Description Value
------------- ----------------------------------------------------------------------------------------- -------------
COMMON STOCKS - 1.5%
Automotive - 1.1%
448,000 Ford Motor Co............................................................................ 4,999,680
98,768 General Motors Co. (i)................................................................... 2,518,584
-------------
7,518,264
-------------
Banking - 0.4%
75,700 Citigroup, Inc........................................................................... 2,830,423
-------------
Total Common Stocks...................................................................... 10,348,687
(Cost $14,700,177) -------------
WARRANTS - 0.3%
Automotive - 0.3%
77,608 General Motors Co. (i)................................................................... 1,276,652
77,608 General Motors Co. (i)................................................................... 797,034
-------------
Total Warrants........................................................................... 2,073,686
(Cost $4,065,974) -------------
SHORT-TERM INVESTMENTS - 0.9%
6,254,513 Dreyfus Government Cash Management....................................................... 6,254,513
-------------
Total Short-Term Investments............................................................. 6,254,513
(Cost $6,254,513) -------------
Total Investments........................................................................ 848,437,814
(Cost $833,010,875) (j) -------------
See Notes to Financial Statements Page 13
First Trust High Income Long/Short Fund
Portfolio of Investments - (Continued)
October 31, 2012
Principal Stated Stated
Value Description Coupon Maturity Value
------------- ----------------------------------------------------------------- --------- ----------- -------------
U.S. GOVERNMENT BONDS SOLD SHORT - (24.7%)
$ (20,500,000) United States Treasury Note...................................... 0.25% 03/31/14 $ (20,504,018)
(119,200,000) United States Treasury Note...................................... 0.88% 02/28/17 (120,606,202)
(27,500,000) United States Treasury Note...................................... 2.00% 02/15/22 (28,481,833)
-------------
Total U.S. Government Bonds Sold Short........................... (169,592,053)
(Proceeds $167,794,344) -------------
Net Other Assets and Liabilities......................................................... 7,868,969
-------------
Net Assets - 100.0%...................................................................... $ 686,714,730
=============
-----------------
(a) This security or a portion of this security is segregated as collateral
for investments sold short.
(b) The non-transferable trust units were originally issued to facilitate
distribution of General Motors common stock and warrants pursuant to the
General Motors Bankruptcy Plan of Reorganization. On June 12, 2012, the
holders of these units received new transferable General Motors Unsecured
Claim (GUC) Trust Units, which were created to hold and administer the
common stock and warrants of General Motors Company to be contributed to
the GUC Trust under the General Motors Bankruptcy Plan of Reorganization.
As such, the non-transferable trust units currently exist only for the
purpose of receiving any residual cash, if any, from the General Motors
Bankruptcy. These units were received in exchange for the previously owned
General Motors 8.375% Corporate Notes that were scheduled to mature on
7/15/33.
(c) Security issued by a U.S. incorporated entity, that has its principal
value denominated in the listed foreign currency.
(d) Fixed-to-floating rate security. The interest rate shown reflects the
fixed rate in effect at October 31, 2012. At a predetermined date, the
fixed rate will change to a floating rate.
(e) This security, sold within the terms of a private placement memorandum, is
exempt from registration upon resale under Rule 144A of the Securities Act
of 1933, as amended (the "1933 Act"), and may be resold in transactions
exempt from registration, normally to qualified institutional buyers.
Pursuant to procedures adopted by the Fund's Board of Trustees, this
security has been determined to be liquid by MacKay Shields LLC, the
Fund's sub-advisor. Although market instability can result in periods of
increased overall market illiquidity, liquidity for each security is
determined based on security specific factors and assumptions, which
require subjective judgment. At October 31, 2012, securities noted as such
amounted to $196,816,624, or 28.66% of net assets.
(f) Floating rate security. The interest rate shown reflects the rate in
effect at October 31, 2012.
(g) Senior Loans in which the Fund invests generally pay interest at rates
which are periodically predetermined by reference to a base lending rate
plus a premium. These base lending rates are generally (i) the lending
rate offered by one or more major European banks, such as the London
Inter-Bank Offered Rate ("LIBOR"), (ii) the prime rate offered by one or
more United States banks or (iii) the certificate of deposit rate. Certain
Senior Loans are subject to a LIBOR floor that establishes a minimum LIBOR
rate. The interest rate shown reflects the rate in effect at October 31,
2012.
(h) Senior Loans generally are subject to mandatory and/or optional
prepayment. As a result, the actual remaining maturity of Senior Loans may
be substantially less than the stated maturities shown.
(i) Non-income producing security.
(j) Aggregate cost for federal income tax purposes is $833,010,875. As of
October 31, 2012, the aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost was
$39,953,322 and the aggregate gross unrealized depreciation for all
securities in which there was an excess of tax cost over value was
$24,526,383.
Currency Abbreviations:
EUR Euro
GBP British Pound Sterling
USD United States Dollar
Page 14 See Notes to Financial Statements
First Trust High Income Long/Short Fund
Portfolio of Investments - (Continued)
October 31, 2012
------------------------------------------------
Valuation Inputs
A summary of the inputs used to value the Fund's investments as of October 31,
2012 is as follows (see Note 2A - Portfolio Valuation in the Notes to Financial
Statements):
ASSETS TABLE
Level 2 Level 3
Total Level 1 Significant Significant
Value at Quoted Observable Unobservable
10/31/2012 Prices Inputs Inputs
-------------- ----------- --------------- ---------------
Corporate Bonds and Notes:
Automotive.............................. $ 28,361,843 $ -- $ 28,359,743 $ 2,100
Other Industry Categories*.............. 572,264,297 -- 572,264,297 --
------------- ------------- --------------- ------------
Total Corportate Bonds and Notes.... 600,626,140 -- 600,624,040 2,100
Foreign Corporate Bonds and Notes*.......... 177,744,774 -- 177,744,774 --
Senior Floating-Rate Loan Interests*........ 30,919,072 -- 30,919,072 --
Asset-Backed Securities..................... 13,445,489 -- 13,445,489 --
Mortgage-Backed Securities.................. 7,025,453 -- 7,025,453 --
Common Stocks*.............................. 10,348,687 10,348,687 -- --
Warrants*................................... 2,073,686 2,073,686 -- --
Short-Term Investments...................... 6,254,513 6,254,513 -- --
------------- ------------- --------------- ------------
Total Investments........................... 848,437,814 18,676,886 829,758,828 2,100
------------- ------------- --------------- ------------
Other Financial Instruments:
Forward Foreign Currency Contracts**........ 40,733 -- 40,733 --
------------- ------------- --------------- ------------
Total....................................... $ 848,478,547 $ 18,676,886 $ 829,799,561 $ 2,100
============= ============= =============== ============
LIABILITIES TABLE
Level 2 Level 3
Total Level 1 Significant Significant
Value at Quoted Observable Unobservable
10/31/2012 Prices Inputs Inputs
-------------- ------------- --------------- ---------------
U.S. Government Bonds Sold Short............ $(169,592,053) $ -- $ (169,592,053) $ --
Forward Foreign Currency Contracts**........ (612,612) -- (612,612) --
------------- ------------- --------------- ------------
Total....................................... $(170,204,665) $ -- $ (170,204,665) $ --
============= ============= =============== ============
* See the Portfolio of Investments for industry breakout.
** See the Schedule of Forward Foreign Currency Contracts for contract and
currency detail.
See Notes to Financial Statements Page 15
First Trust High Income Long/Short Fund
Portfolio of Investments - (Continued)
October 31, 2012
The following table presents the activity of the Fund's investments measured at
fair value on a recurring basis using significant unobservable inputs (Level 3)
for the period presented.
Beginning Balance at October 31, 2011
Corporate Bonds and Notes $ --
Net Realized Gain (Loss) --
Net Change in Unrealized Appreciation/Depreciation --
Purchases --
Sales --
Transfers In
Corporate Bonds and Notes 2,100
Transfers Out --
Ending Balance at October 31, 2012
Corporate Bonds and Notes 2,100
-----------
Total Level 3 holdings $ 2,100
===========
All transfers in and out of the Levels during the period are assumed to be
transferred on the last day of the period at their current value. The transfer
from Level 2 to Level 3 occurred due to the General Motors issuance of new
transferable unsecured claim trust units.
There was no net change in unrealized appreciation (depreciation) from Level 3
investments held as of October 31, 2012.
Page 16 See Notes to Financial Statements
First Trust High Income Long/Short Fund
Schedule of Forward Foreign Currency Contracts
October 31, 2012
Forward Foreign Currency Contracts
----------------------------------
Purchase Sale Unrealized
Settlement Amount Amount Value as of Value as of Appreciation/
Date Counterparty Purchased (a) Sold (a) October 31, 2012 October 31, 2012 (Depreciation)
---------- ------------ --------------- -------------- ---------------- ---------------- --------------
12/06/12 JPM EUR 660,000 USD 854,337 $ 855,754 $ 854,337 $ 1,417
12/06/12 JPM GBP 568,000 USD 914,224 916,499 914,224 2,275
12/06/12 JPM USD 60,654,284 EUR 46,751,000 60,654,284 60,617,243 37,041
12/06/12 JPM USD 46,696,791 GBP 29,320,000 46,696,791 47,309,403 (612,612)
--------------
Net Unrealized Appreciation (Depreciation)................................................................. $ (571,879)
==============
(a) Please see Portfolio of Investments for currency descriptions.
Counterparty Abbreviations:
JPM JPMorgan Chase
See Notes to Financial Statements Page 17
First Trust High Income Long/Short Fund
Statement of Assets and Liabilities
October 31, 2012
ASSETS:
Investments, at value
(Cost $833,010,875)........................................................................... $ 848,437,814
Cash............................................................................................... 368,157
Foreign currency (Cost $13,836).................................................................... 13,805
Unrealized appreciation on forward foreign currency contracts...................................... 40,733
Prepaid expenses................................................................................... 24,202
Receivables:
Interest...................................................................................... 16,776,807
Currency...................................................................................... 1,570,401
Dividends..................................................................................... 22,400
--------------
Total Assets............................................................................... 867,254,319
--------------
LIABILITIES:
Investments sold short, at value (proceeds $167,794,344)........................................... 169,592,053
Unrealized depreciation on forward foreign currency contracts...................................... 612,612
Payables:
Investment securities purchased............................................................... 9,205,275
Investment advisory fees...................................................................... 579,420
Interest on investments sold short............................................................ 299,717
Audit and tax fees............................................................................ 57,836
Printing fees................................................................................. 56,309
Administrative fees........................................................................... 46,011
Legal fees.................................................................................... 45,673
Custodian fees................................................................................ 25,202
Trustees' fees and expenses................................................................... 4,057
Transfer agent fees........................................................................... 3,821
Financial reporting fees...................................................................... 771
Other liabilities.................................................................................. 10,832
--------------
Total liabilities......................................................................... 180,539,589
--------------
NET ASSETS......................................................................................... $ 686,714,730
==============
NET ASSETS consist of:
Paid-in capital.................................................................................... $ 687,366,834
Par value.......................................................................................... 360,561
Accumulated net investment income (loss)........................................................... 3,630,512
Accumulated net realized gain (loss) on investments, forward foreign currency contracts,
foreign currency transactions, investments sold short, futures and swap contracts............... (17,746,452)
Net unrealized appreciation (depreciation) on investments, forward foreign currency contracts,
foreign currency translation and investment sold short.......................................... 13,103,275
--------------
NET ASSETS......................................................................................... $ 686,714,730
==============
NET ASSET VALUE, per Common Share (par value $0.01 per Common Share)............................... $ 19.05
==============
Number of Common Shares outstanding (unlimited number of Common Shares has been authorized)........ 36,056,159
==============
Page 18 See Notes to Financial Statements
First Trust High Income Long/Short Fund
Statement of Operations
For the Year Ended October 31, 2012
INVESTMENT INCOME:
Interest........................................................................................... $ 62,901,358
Dividends.......................................................................................... 92,628
Other.............................................................................................. 168,276
--------------
Total investment income....................................................................... 63,162,262
--------------
EXPENSES:
Investment advisory fees........................................................................... 6,504,844
Interest expense on investments sold short......................................................... 3,638,669
Short sale fees.................................................................................... 886,221
Administrative fees................................................................................ 517,863
Printing fees...................................................................................... 171,245
Legal fees......................................................................................... 126,410
Custodian fees..................................................................................... 101,985
Audit and tax fees................................................................................. 58,635
Trustees' fees and expenses........................................................................ 47,158
Transfer agent fees................................................................................ 31,391
Financial reporting fees........................................................................... 9,250
Other.............................................................................................. 153,361
--------------
Total expenses................................................................................ 12,247,032
--------------
NET INVESTMENT INCOME (LOSS)....................................................................... 50,915,230
--------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain (loss) on:
Investments................................................................................... (5,701,930)
Forward foreign currency contracts............................................................ (1,015,780)
Foreign currency transactions................................................................. (25,482)
Short sales................................................................................... (12,032,166)
Swap contracts................................................................................ 128,332
--------------
Net realized gain (loss)........................................................................... (18,647,026)
--------------
Net change in unrealized appreciation (depreciation) on:
Investments................................................................................... 58,121,319
Forward foreign currency contracts............................................................ 3,142,409
Foreign currency translation.................................................................. 45,547
Short positions............................................................................... 8,368,655
Swap contracts................................................................................ 116,273
--------------
Net change in unrealized appreciation (depreciation)............................................... 69,794,203
--------------
NET REALIZED AND UNREALIZED GAIN (LOSS)............................................................ 51,147,177
--------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS................................... $ 102,062,407
==============
See Notes to Financial Statements Page 19
First Trust High Income Long/Short Fund
Statements of Changes in Net Assets
Year Year
Ended Ended
10/31/2012 10/31/2011
--------------- --------------
OPERATIONS:
Net investment income (loss)..................................................... $ 50,915,230 $ 53,491,536
Net realized gain (loss)......................................................... (18,647,026) 9,062,128
Net change in unrealized appreciation (depreciation)............................. 69,794,203 (71,921,171)
--------------- --------------
Net increase (decrease) in net assets resulting from operations.................. 102,062,407 (9,367,507)
--------------- --------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income............................................................ (51,996,786) (52,948,469)
Net realized gain................................................................ (5,765,181) --
Return of capital................................................................ -- --
--------------- --------------
Total distributions to shareholders.............................................. (57,761,967) (52,948,469)
--------------- --------------
CAPITAL TRANSACTIONS:
Proceeds from Common Shares sold................................................. -- 42,037,630 (a)
Proceeds from Common Shares reinvested........................................... -- --
Offering costs................................................................... -- 88,650
--------------- --------------
Net increase (decrease) in net assets resulting from capital transactions........ -- 42,126,280
--------------- --------------
Total increase (decrease) in net assets.......................................... 44,300,440 (20,189,696)
NET ASSETS:
Beginning of period.............................................................. 642,414,290 662,603,986
--------------- --------------
End of period.................................................................... $ 686,714,730 $ 642,414,290
=============== ==============
Accumulated net investment income (loss) at end of period........................ $ 3,630,512 $ 5,577,910
=============== ==============
CAPITAL TRANSACTIONS were as follows
Common Shares at beginning of period............................................. 36,056,159 33,855,236
Common Shares sold............................................................... -- 2,200,923 (a)
Common Shares issued as reinvestment under the Dividend Reinvestment Plan........ -- --
--------------- --------------
Common Shares at end of period................................................... 36,056,159 36,056,159
=============== ==============
----------------------
(a) Represents shares sold from the over allotment option of the initial
public offering. The shares were sold on November 11, 2010, the trade
date, at the initial offering price of $19.10, which differed from the
closing common share price of $20.02 and the closing NAV per share of
$19.77 on that date.
Page 20 See Notes to Financial Statements
First Trust High Income Long/Short Fund
Statement of Cash Flows
For the Year Ended October 31, 2012
Cash flows from operating activities:
Net increase (decrease) in net assets resulting from operations............. $ 102,062,407
Adjustments to reconcile net increase (decrease) in net assets resulting
from operations to net cash provided by operating activities:
Purchases of investments................................................ (378,182,029)
Borrowed investments sold short......................................... 213,737,477
Sales, maturities and paydowns of investments........................... 403,664,754
Borrowed investments purchased.......................................... (232,429,812)
Receipt for swap contracts closed....................................... 1,130,234
Net amortization/accretion of premiums/discounts on investments......... 273,209
Net realized gain/loss on investments................................... 5,701,930
Net realized gain/loss on investments sold short........................ 12,032,166
Net change in unrealized appreciation/depreciation on forward
foreign currency contracts........................................... (3,142,409)
Net change in unrealized appreciation/depreciation on investments
sold short........................................................... (8,368,655)
Net change in unrealized appreciation/depreciation on investments....... (58,121,319)
Net change in unrealized appreciation/depreciation on swap contracts.... (116,273)
Changes in assets and liabilities:
Decrease in interest receivable......................................... 446,801
Decrease in swap contracts sold receivable.............................. 1,293,751
Increase in dividends receivable........................................ (22,400)
Increase in currency receivable......................................... (1,570,401)
Decrease in prepaid expenses............................................ 9,632
Decrease in interest payable on investments sold short.................. (400,480)
Increase in investment advisory fees payable............................ 64,821
Increase in audit and tax fees payable.................................. 3,651
Increase in legal fees payable.......................................... 33,344
Increase in printing fees payable....................................... 21,652
Increase in administrative fees payable................................. 4,852
Decrease in custodian fees payable...................................... (1,991)
Increase in transfer agent fees payable................................. 249
Increase in Trustees' fees and expenses payable......................... 765
Increase in other liabilities payable................................... 5,346
----------------
Cash provided by operating activities....................................... $ 58,131,272
----------------
Cash flows from financing activities:
Distributions to Common Shareholders from net realized gain............. (5,765,181)
Distributions to Common Shareholders from net investment income......... (51,996,786)
----------------
Cash used by financing activities........................................... (57,761,967)
----------------
Increase in cash (a)........................................................ 369,305
Cash at beginning of period................................................. 12,657
----------------
Cash at end of period....................................................... $ 381,962
================
Supplemental disclosure of cash flow information:
Cash paid during the period for interest and fees........................... $ 4,039,149
================
--------------------
(a) Includes net change in unrealized appreciation (depreciation) on foreign
currency of $45,547.
See Notes to Financial Statements Page 21
First Trust High Income Long/Short Fund
Financial Highlights
For a Common Share outstanding throughout the period
Year Year Period
Ended Ended Ended
10/31/2012 10/31/2011 10/31/2010 (a)
----------------- ----------------- ---------------
Net asset value, beginning of period ........... $ 17.82 $ 19.57 $ 19.10 (b)
----------------- ----------------- ---------------
Income from investment operations:
Net investment income (loss) ................... 1.41 1.48 0.08
Net realized and unrealized gain (loss) ........ 1.42 (1.72) 0.42
----------------- ----------------- ---------------
Total from investment operations ............... 2.83 (0.24) 0.50
----------------- ----------------- ---------------
Distributions paid to shareholders from:
Net investment income .......................... (1.44) (1.47) --
Net realized gain .............................. (0.16) -- --
Return of capital .............................. -- -- --
----------------- ----------------- ---------------
Total from distributions ....................... (1.60) (1.47) --
----------------- ----------------- ---------------
Common Shares offering costs charged to
paid-in capital ............................. -- -- (0.03)
----------------- ----------------- ---------------
Capital charge resulting from issuance of
Common Shares related to over allotment ..... -- (0.04) --
----------------- ----------------- ---------------
Net asset value, end of period ................. $ 19.05 $ 17.82 $ 19.57
================= ================= ===============
Market value, end of period .................... $ 18.78 $ 16.63 $ 20.01
================= ================= ===============
Total return based on net asset value (c)....... 17.09% (1.27)% 2.46%
================= ================= ===============
Total return based on market value (c).......... 23.69% (9.89)% 0.05%
================= ================= ===============
Ratios to average net assets/supplemental data:
Net assets, end of period (in 000's) ........... $ 686,715 $ 642,414 $ 662,604
Ratio of net expenses to average net assets .... 1.88% 2.09% 1.46% (d)
Ratio of net expenses to average net assets
excluding interest expense .................. 1.32% 1.29% 1.33% (d)
Ratio of net investment income (loss) to average
net assets .................................. 7.83% 7.78% 4.98% (d)
Portfolio turnover rate ........................ 24% 18% 0%
---------------------------
(a) Initial seed date was August 20, 2010. The Fund commenced operations on
September 27, 2010.
(b) Beginning NAV is net of sales load of $0.90 per share from the initial
offering.
(c) Total return is based on the combination of reinvested dividend, capital
gain and return of capital distributions, if any, at prices obtained by
the Dividend Reinvestment Plan, and changes in net asset value per share
for net asset value returns and changes in Common Share price for market
value returns. Total returns do not reflect sales load and are not
annualized for periods less than one year. Past performance is not
indicative of future results.
(d) Annualized.
Page 22 See Notes to Financial Statements
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
First Trust High Income Long/Short Fund (FSD)
October 31, 2012
1. Fund Description
First Trust High Income Long/Short Fund (the "Fund") is a diversified,
closed-end management investment company organized as a Massachusetts business
trust on June 18, 2010, and is registered with the Securities and Exchange
Commission ("SEC") under the Investment Company Act of 1940, as amended (the
"1940 Act"). The Fund trades under the ticker symbol FSD on the New York
Stock Exchange ("NYSE").
The Fund's primary investment objective is to provide current income. The Fund's
secondary objective is capital appreciation. The Fund seeks to achieve its
investment objectives by investing, under normal market conditions, a majority
of its assets in a diversified portfolio of U.S. and foreign (including emerging
markets) high-yield corporate fixed-income securities of varying maturities that
are rated below-investment grade at the time of purchase. For purposes of this
strategy, "corporate fixed-income securities" include corporate bonds,
debentures, notes, commercial paper and other similar types of corporate debt
instruments, including instruments issued by corporations with direct or
indirect government ownership, as well as asset backed securities, preferred
shares, senior floating-rate loan participations, commitments and assignments
("Senior Loans")1, payment-in-kind securities, zero-coupon bonds, bank
certificates of deposit, fixed time deposits, bankers' acceptances and
derivative instruments that provide the same or similar economic impact as a
physical investment in the above securities. Below-investment grade fixed-income
securities are commonly referred to as "high-yield" or "junk" bonds and are
considered speculative with respect to the issuer's capacity to pay interest and
repay principal. As part of its investment strategy, the Fund intends to
maintain both long and short positions in securities under normal market
conditions. The Fund will take long positions in securities that MacKay Shields
LLC ("MacKay" or the "Sub-Advisor") believes offer the potential for attractive
returns and that it considers in the aggregate to have the potential to
outperform the Fund's benchmark, the Bank of America Merrill Lynch U.S. High
Yield Master II Constrained Index (the "Index"). The Fund will take short
positions in securities that the Sub-Advisor believes in the aggregate will
underperform the Index. The Fund's long positions, either directly or through
derivatives, may total up to 130% of the Fund's Managed Assets. The Fund's short
positions, either directly or through derivatives, may total up to 30% of the
Fund's Managed Assets. "Managed Assets" means the average daily gross asset
value of the Fund (which includes the principal amount of any borrowings), minus
the sum of the Fund's liabilities. There can be no assurance that the Fund will
achieve its investment objectives. The Fund may not be appropriate for all
investors.
2. Significant Accounting Policies
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America ("U.S. GAAP") requires
management to make estimates and assumptions that affect the reported amounts
and disclosures in the financial statements. Actual results could differ from
those estimates.
A. Portfolio Valuation:
The net asset value ("NAV") of the Common Shares of the Fund is determined
daily, as of the close of regular trading on the NYSE, normally 4:00 p.m.
Eastern time, on each day the NYSE is open for trading. If the NYSE closes early
on a valuation day, the NAV is determined as of that time. Domestic debt
securities and foreign securities are priced using data reflecting the earlier
closing of the principal markets for those securities. The NAV per Common Share
is calculated by dividing the value of all assets of the Fund (including accrued
interest and dividends), less all liabilities (including accrued expenses,
dividends declared but unpaid and any borrowings of the Fund), by the total
number of Common Shares outstanding.
The Fund's investments are valued daily in accordance with valuation procedures
adopted by the Fund's Board of Trustees and in accordance with provisions of the
1940 Act. The Fund's securities will be valued as follows:
Corporate bonds, notes, U.S. Government Securities, Mortgage-backed Securities
("MBS"), Asset-backed Securities ("ABS") and other debt securities are valued on
the basis of valuations provided by dealers who make markets in such securities
or by an independent pricing service approved by the Fund's Board of Trustees,
which may use the following valuation inputs when available:
1) benchmark yields;
2) reported trades;
3) broker/dealer quotes;
4) issuer spreads;
5) benchmark securities;
6) bids and offers; and
7) reference data including market research publications.
A ready market does not exist for some of these investments. As such, these
values may differ from the values that would have been used had a ready market
for these investments existed, and the differences could be material.
---------------------
1 The terms "security" and "securities" used throughout the Notes to
Financial Statements include Senior Loans.
Page 23
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
--------------------------------------------------------------------------------
First Trust High Income Long/Short Fund (FSD)
October 31, 2012
Common stocks and other equity securities listed on any national or foreign
exchange (excluding the NASDAQ(R) Stock Market LLC ("NASDAQ") and the London
Stock Exchange Alternative Investment Market ("AIM")) are valued at the last
price on the exchange on which they are principally traded or, for NASDAQ and
AIM securities, the official closing price. Securities traded on more than one
securities exchange are valued at the last sale price or official closing price,
as applicable, at the close of the securities exchange representing the
principal market for such securities.
Securities traded in the over-the-counter market are valued at their closing bid
prices.
Credit default swaps, if any, are valued using a pricing service or, if the
pricing service does not provide a value, by quotes provided by the selling
dealer or financial institution.
The Senior Loans held in the Fund are not listed on any securities exchange or
board of trade. Senior Loans 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. This market, while having grown substantially since its
inception, generally has fewer trades and less liquidity than the secondary
market for other types of securities. Some Senior Loans have few or no trades,
or trade infrequently, and information regarding a specific Senior Loan may not
be widely available or may be incomplete. Accordingly, determinations of the
market value of Senior Loans 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 Senior Loans than for other types of
securities. Typically, Senior Loans are valued using information provided by a
third party pricing service. The third party pricing service primarily uses
over-the-counter pricing from dealer runs and broker quotes from indicative
sheets to value the Senior Loans.
Forward foreign currency contracts are 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 an
independent pricing service.
Debt securities having a remaining maturity of sixty days or less when purchased
are valued at cost adjusted for amortization of premiums and accretion of
discounts.
In the event the pricing service or dealer does not provide a valuation, or the
valuations received are deemed unreliable, the Fund's Board of Trustees has
designated First Trust Advisors L.P. ("First Trust") to use a fair value method
to value the Fund's securities. Additionally, if events occur after the close of
the principal markets for certain securities (e.g., domestic debt and foreign
securities) that could materially affect the Fund's NAV, First Trust may use a
fair value method to value the Fund's securities. The use of fair value pricing
is governed by valuation procedures adopted by the Fund's Board of Trustees, and
in accordance with the provisions of the 1940 Act. As a general principle, the
fair value of a security is the amount which the Fund might reasonably expect to
receive for the security upon its current sale. However, in light of the
judgment involved in fair valuations, there can be no assurance that a fair
value assigned to a particular security will be the amount which the Fund might
be able to receive upon its current sale. Fair valuation of a security is based
on the consideration of all available information, including, but not limited
to, the following:
1) the fundamental business data relating to the issuer;
2) an evaluation of the forces which influence the market in which
these securities are purchased and sold;
3) the type, size and cost of a security;
4) the financial statements of the issuer;
5) the credit quality and cash flow of the issuer, based on the
Sub-Advisor's or external analysis;
6) the information as to any transactions in or offers for the
security;
7) the price and extent of public trading in similar securities (or
equity securities) of the issuer/borrower, or comparable companies;
8) the coupon payments;
9) the quality, value and salability of collateral, if any, securing
the security;
10) the business prospects of the issuer, including any ability to
obtain money or resources from a parent or affiliate and an
assessment of the issuer's management;
11) the prospects for the issuer's industry, and multiples (of earnings
and/or cash flows) being paid for similar businesses in that
industry; and
12) other relevant factors.
The Fund is subject to fair value accounting standards that define fair value,
establish the framework for measuring fair value and provide a three-level
hierarchy for fair valuation based upon the inputs to the valuation as of the
measurement date. The three levels of the fair value hierarchy are as follows:
o Level 1 - Level 1 inputs are quoted prices in active markets for
identical investments. An active market is a market in which transactions
for the investment occur with sufficient frequency and volume to provide
pricing information on an ongoing basis.
o Level 2 - Level 2 inputs are observable inputs, either directly or
indirectly, and include the following:
o Quoted prices for similar investments in active markets.
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First Trust High Income Long/Short Fund (FSD)
October 31, 2012
o Quoted prices for identical or similar investments in markets
that are non-active. A non-active market is a market where there
are few transactions for the investment, the prices are not
current, or price quotations vary substantially either over time
or among market makers, or in which little information is
released publicly.
o Inputs other than quoted prices that are observable for the
investment (for example, interest rates and yield curves
observable at commonly quoted intervals, volatilities,
prepayment speeds, loss severities, credit risks, and default
rates).
o Inputs that are derived principally from or corroborated by
observable market data by correlation or other means.
o Level 3 - Level 3 inputs are unobservable inputs. Unobservable inputs may
reflect the reporting entity's own assumptions about the assumptions that
market participants would use in pricing the investments.
The inputs or methodology used for valuing investments are not necessarily an
indication of the risk associated with investing in those investments. A summary
of the inputs used to value the Fund's investments as of October 31, 2012, is
included with the Fund's Portfolio of Investments.
B. SECURITIES TRANSACTIONS AND INVESTMENT INCOME:
Securities transactions are recorded as of the trade date. Realized gains and
losses from securities transactions are recorded on the identified cost basis.
Interest income is recorded daily on the accrual basis. Amortization of premiums
and accretion of discounts are recorded using the effective interest method.
Securities purchased on a when-issued, delayed-delivery or forward purchase
commitment basis may have extended settlement periods. The value of the security
so purchased is subject to market fluctuations during this period. The Fund
maintains liquid assets with a current value at least equal to the amount of its
when-issued, delayed-delivery or forward purchase commitments until payment is
made. At October 31, 2012, the Fund had no when-issued, delayed-delivery or
forward purchase commitments.
C. UNFUNDED LOAN COMMITMENTS:
The Fund may enter into certain credit agreements, all or a portion of which may
be unfunded. The Fund is obligated to fund these loan commitments at the
borrower's discretion. The Fund did not have unfunded delayed draw loan
commitments as of October 31, 2012.
D. FORWARD FOREIGN CURRENCY CONTRACTS:
The Fund is subject to foreign currency risk in the normal course of pursuing
its investment objectives. Forward foreign currency contracts are agreements to
exchange one currency for another at a future date and at a specified price. The
Fund uses forward foreign currency contracts to facilitate transactions in
foreign securities and to manage the Fund's foreign currency exposure. These
contracts are valued daily, and the Fund's net equity therein, representing
unrealized gain or loss on the contracts as measured by the difference between
the forward foreign exchange rates at the dates of entry into the contracts and
the forward rates at the reporting date, is included in "Unrealized
appreciation/(depreciation) on forward foreign currency contracts" on the
Statement of Assets and Liabilities. When the forward contract is closed, the
Fund records a realized gain or loss equal to the difference between the
proceeds from (or the cost of) the closing transaction and the Fund's basis in
the contract. This realized gain or loss is included in "Net realized gain
(loss) on forward foreign currency contracts" on the Statement of Operations.
Risks arise from the possible inability of counterparties to meet the terms of
their contracts and from movement in currency and securities values and interest
rates. Due to the risks, the Fund could incur losses in excess of the net
unrealized value shown on the Schedule of Forward Foreign Currency Contracts.
During the year ended October 31, 2012, the open and close notional values of
forward foreign currency contracts were $1,650,694,375 and $(1,628,560,858),
respectively.
E. FOREIGN CURRENCY:
The books and records of the Fund are maintained in U.S. dollars. Foreign
currencies, investments and other assets and liabilities are translated into
U.S. dollars at the exchange rates prevailing at the end of the period.
Purchases and sales of investments and items of income and expense are
translated on the respective dates of such transactions. Unrealized gains and
losses on assets and liabilities, other than investments in securities, which
result from changes in foreign currency exchange rates have been included in
"Net change in unrealized appreciation (depreciation) on foreign currency
translation" on the Statement of Operations. Unrealized gains and losses on
investments in securities which result from changes in foreign exchange rates
are included with fluctuations arising from changes in market price and are
shown in "Net change in unrealized appreciation (depreciation) on investments"
on the Statement of Operations. Net realized foreign currency gains and losses
include the effect of changes in exchange rates between trade date and
settlement date on investment security transactions, foreign currency
transactions and interest and dividends received. The portion of foreign
currency gains and losses related to fluctuation in exchange rates between the
initial purchase trade date and subsequent sale trade date is included in "Net
realized gain (loss) on foreign currency transactions" on the Statement of
Operations.
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First Trust High Income Long/Short Fund (FSD)
October 31, 2012
F. SHORT SALES:
Short sales are utilized for investment and risk management purposes and are
transactions in which securities or other instruments (such as options,
forwards, futures or other derivative contracts) are sold that are not currently
owned in the Fund's portfolio. When a short sale is engaged in, the security
sold short must be borrowed and delivered to the counterparty. Short selling
allows the Fund to profit from a decline in a market price to the extent such
decline exceeds the transaction costs and the costs of borrowing the securities.
The Fund will pay a fee or premium to borrow the securities and is obligated to
repay the lenders of the securities. Any dividends or interest that accrues on
the securities during the period of the loan are due to the lenders. A gain,
limited to the price at which the security was sold short, or a loss, unlimited
in size, will be recognized upon the termination of the short sale. Any such
gain or loss may be offset, completely or in part, by the change in the value of
the long portion of the Fund's portfolio. The Fund is subject to the risk it may
be unable to reacquire a security to terminate a short position except at a
price substantially in excess of the last quoted price. Also, there is the risk
that the counterparty to a short sale may fail to honor its contractual terms,
causing a loss to the Fund.
G. Credit Default Swaps:
The Fund may enter into credit default swap contracts ("CDS") for investment
purposes or to manage credit risk. A CDS is an agreement between two parties
("Counterparties") to exchange the credit risk of an issuer. A buyer of a CDS is
said to buy protection by paying a fixed payment over the life of the agreement
and in some situations an upfront payment to the seller of the CDS. If a defined
credit event occurs (such as payment default or bankruptcy), the Fund as a
protection buyer would cease paying its fixed payment, the Fund would deliver
eligible bonds issued by the reference entity to the seller, and the seller
would pay the full notional value, or the "par value", of the referenced
obligation to the Fund. A seller of a CDS is said to sell protection and thus
would receive a fixed payment over the life of the agreement and an upfront
payment, if applicable. If a credit event occurs, the Fund as a protection
seller would cease to receive the fixed payment stream, the Fund would pay the
buyer "par value" or the full notional value of the referenced obligation, and
the Fund would receive the eligible bonds issued by the reference entity. In
turn, these bonds may be sold in order to realize a recovery value.
Alternatively, the seller of the CDS and its counterparty may agree to net the
notional amount and the market value of the bonds and make a cash payment equal
to the difference to the buyer of protection. If no credit event occurs, the
Fund receives the fixed payment over the life of the agreement. As the seller,
the Fund would effectively add leverage to its portfolio because, in addition to
its total net assets, the Fund would be subject to investment exposure on the
notional amount of the CDS. In connection with these agreements, cash and
securities may be identified as collateral in accordance with the terms of the
respective swap agreements to provide assets of value and recourse in the event
of default under the swap agreement or bankruptcy/insolvency of a party to the
swap agreement. In the event of a default by the Counterparty, the Fund will
seek withdrawal of this collateral and may incur certain costs exercising its
right with respect to the collateral. If a Counterparty becomes bankrupt or
otherwise fails to perform its obligations due to financial difficulties, the
Fund may experience significant delays in obtaining any recovery in a bankruptcy
or other reorganization proceeding. The Fund may obtain only limited recovery or
may obtain no recovery in such circumstances.
Credit default swap contracts are marked to market daily based upon quotations
from brokers, market makers or an independent pricing service and the change in
value, if any, is recorded as unrealized appreciation (depreciation). For a
credit default swap contract sold by the Fund, payment of the agreed upon amount
made by the Fund in the event of default of the referenced debt obligation is
recorded as the cost of the reference debt obligation purchased/received.
During the year ended October 31, 2012, the open and close notional values of
credit default swap contracts were $0 and $(14,500,000), respectively. At
October 31, 2012, the Fund had no credit default swap contracts.
H. Dividends and Distributions to Shareholders:
Level dividend distributions are declared and paid monthly to Common
Shareholders after the payment of interest and/or dividends in connection with
leverage. The level dividend rate may be modified by the Board of Trustees from
time to time. If, for any monthly distribution, net investment company taxable
income, if any (which term includes net short-term capital gain), is less than
the amount of the distribution, the difference will generally be a tax-free
return of capital distributed from the Fund's assets. Distributions of any net
long-term capital gains earned by the Fund are distributed at least annually.
Distributions will automatically be reinvested into additional Common Shares
pursuant to the Fund's Dividend Reinvestment Plan unless cash distributions are
elected by the shareholder.
Distributions from income and capital gains are determined in accordance with
income tax regulations, which may differ from U.S. GAAP. Certain capital
accounts in the financial statements are periodically adjusted for permanent
differences in order to reflect their tax character. These permanent differences
are primarily due to the varying treatment of income and gain/loss on portfolio
securities held by the Fund and have no impact on net assets or NAV per share.
Temporary difference, which arise from recognizing certain items of income,
expense and gain/loss in different periods for financial statement and tax
purposes, will reverse at some point in the future. Permanent differences
incurred during the fiscal year ended October 31, 2012, resulting in book and
tax accounting differences, have been reclassified at year end to reflect a
decrease in accumulated net investment income (loss) by $865,842, an increase in
accumulated net realized gain (loss) on investments by $900,574 and a decrease
to paid-in capital of $34,732. Net assets were not affected by this
reclassification.
Page 26
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First Trust High Income Long/Short Fund (FSD)
October 31, 2012
The tax character of distributions paid during the fiscal years ended October
31, 2012 and October 31, 2011 was as follows:
Distributions paid from: 2012 2011
Ordinary income......................... $ 57,752,609 $ 52,948,469
Capital gain............................ 9,358 --
Return of capital....................... -- --
As of October 31, 2012, the distributable earnings and net assets on a tax basis
were as follows:
Undistributed ordinary income......................... $ 3,058,633
Undistributed capital gains........................... --
------------
Total undistributed earnings.......................... 3,058,633
Accumulated capital and other losses.................. (17,746,452)
Net unrealized appreciation (depreciation)............ 13,675,154
------------
Total accumulated earnings (losses)................... (1,012,665)
Other................................................. --
Paid-in capital....................................... 687,727,395
------------
Net assets............................................ $686,714,730
============
I. Income and Other Taxes:
The Fund intends to continue to qualify as a regulated investment company by
complying with the requirements under Subchapter M of the Internal Revenue Code
of 1986, as amended, which includes distributing substantially all of its net
investment income and net realized gains to shareholders. Accordingly, no
provision has been made for federal or state income taxes. However, due to the
timing and amount of distributions, the Fund may be subject to an excise tax of
4% of the amount by which approximately 98% of the Fund's taxable income exceeds
the distributions from such taxable income for the calendar year.
Under the Regulated Investment Company Modernization Act of 2010 (the "Act"),
net capital losses recognized after December 31, 2010, may be carried forward
indefinitely, and their character is retained as short-term and/or long-term
losses. Previously, net capital losses were carried forward eight years and
treated as short-term losses. As a transition rule, the Act requires that
post-enactment net capital losses be used before pre-enactment net capital
losses. At October 31, 2012, the Fund had no pre-enactment net capital losses
for federal income tax purposes. At October 31, 2012 the Fund had post-enactment
net capital losses for federal income tax purposes of $17,746,452 to be carried
forward indefinitely.
The Fund is subject to certain limitations under the U.S. tax rules on the use
of capital loss carryforwards and net unrealized built-in losses. These
limitations apply when there has been a 50% change in ownership.
The Fund is subject to accounting standards that establish a minimum threshold
for recognizing, and a system for measuring, the benefits of a tax position
taken or expected to be taken in a tax return. Taxable years ending 2010, 2011
and 2012 remain open to federal and state audit. As of October 31, 2012,
management has evaluated the application of these standards to the Fund and has
determined that no provision for income tax is required in the Fund's financial
statements for uncertain tax positions.
J. Expenses:
The Fund will pay all expenses directly related to its operations.
K. Organization and Offering Costs:
Organization costs consisted of costs incurred to establish the Fund and enable
it to legally conduct business. These costs included filing fees, listing fees,
fees for legal services pertaining to the organization of the business and audit
fees relating to auditing the initial statement of assets and liabilities, among
other fees. Offering costs consisted of legal fees pertaining to the Fund's
shares offered for sale, registration fees, underwriting fees, and printing of
the initial prospectus, among other fees. First Trust paid all organization
expenses. The Fund's Common Share offering costs of $967,500 were recorded as a
reduction of the proceeds from the sale of Common Shares during the period ended
October 31, 2010. During the fiscal year ended October 31, 2012, it was
determined that the actual offering costs were less then the estimated offering
costs by $88,650. Therefore, paid-in capital was increased by that amount in the
current year, as reflected on the Statements of Changes in Net Assets.
L. Accounting Pronouncements:
In May 2011, the Financial Accounting Standards Board ("FASB") issued ASU
2011-04 "Amendments to Achieve Common Fair Value Measurement and Disclosure
Requirements in U.S. GAAP and IFRSs," modifying Topic 820, "Fair Value
Measurements and Disclosures." At the same time, the International Accounting
Standards Board ("IASB") issued International Financial Reporting Standard
("IFRS") 13, "Fair Value Measurement." The objective of the FASB and IASB is
convergence of their guidance on fair value measurements and disclosures.
Specifically, the ASU requires reporting entities to disclose (i) the amounts of
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NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
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First Trust High Income Long/Short Fund (FSD)
October 31, 2012
any transfers between Level 1 and Level 2, and the reasons for the transfers,
(ii) for Level 3 fair value measurements, quantitative information about
significant unobservable inputs used, (iii) a description of the valuation
processes used by the reporting entity, and (iv) a narrative description of the
sensitivity of the fair value measurement to changes in unobservable inputs if a
change in those inputs might result in a significantly higher or lower fair
value measurement. The effective date of the ASU is for interim and annual
periods beginning after December 15, 2011, and it is therefore not effective for
the current fiscal year. Management is in the process of assessing the impact of
the updated standards on the Fund's financial statements, if any.
3. Investment Advisory Fee, Affiliated Transactions and Other Fee Arrangements
First Trust, the investment advisor to the Fund, is a limited partnership with
one limited partner, Grace Partners of DuPage L.P., and one general partner, The
Charger Corporation. The Charger Corporation is an Illinois corporation
controlled by James A. Bowen, Chief Executive Officer of First Trust. First
Trust is responsible for the ongoing monitoring of the Fund's investment
portfolio, managing the Fund's business affairs and providing certain
administrative services necessary for the management of the Fund. For these
investment management services, First Trust is entitled to a monthly fee
calculated at an annual rate of 1.00% of the Fund's Managed Assets. First Trust
also provides fund reporting services to the Fund for a flat annual fee in the
amount of $9,250.
MacKay serves as the Fund's sub-advisor and manages the Fund's portfolio subject
to First Trust's supervision. The Sub-Advisor receives a portfolio management
fee at an annual rate of 0.50% of Managed Assets that is paid by First Trust
from its investment advisory fee.
BNY Mellon Investment Servicing (US) Inc. serves as the Fund's Administrator,
Fund Accountant and Transfer Agent in accordance with certain fee arrangements.
The Bank of New York Mellon serves as the Fund's Custodian in accordance with
certain fee arrangements.
Effective January 23, 2012, James A. Bowen resigned from his position as the
President and Chief Executive Officer of the Fund. He continues as a Trustee,
the Chairman of the Board of Trustees and a member of the Executive Committee.
The Board elected Mark R. Bradley to serve as the President and Chief Executive
Officer of the Fund and James M. Dykas to serve as the Treasurer, Chief
Financial Officer and Chief Accounting Officer of the Fund.
Effective January 1, 2012, each Trustee who is not an officer or employee of
First Trust, any sub-advisor or any of their affiliates ("Independent Trustees")
is paid a fixed annual retainer of $125,000 per year and an annual per fund fee
of $4,000 for each closed-end fund or other actively managed fund and $1,000 for
each index fund in the First Trust Fund Complex. The fixed annual retainer is
allocated pro rata among each fund in the First Trust Fund Complex based on net
assets. Prior to January 1, 2012, each Independent Trustee received an annual
retainer of $10,000 per trust for the first 14 trusts of the First Trust Fund
Complex and an annual retainer of $7,500 per trust for each additional trust in
the First Trust Complex. The annual retainer was allocated equally among each of
the trusts.
Additionally, the Lead Independent Trustee is paid $15,000 annually, the
Chairman of the Audit Committee is paid $10,000 annually, and each of the
Chairmen of the Nominating and Governance Committee and the Valuation Committee
is paid $5,000 annually to serve in such capacities, with such compensation
allocated pro rata among each fund in the First Trust Fund Complex based on net
assets. Prior to January 1, 2012, the annual amounts paid were $10,000, $5,000
and $2,500, respectively. Trustees are reimbursed for travel and out-of-pocket
expenses in connection with all meetings. The Lead Independent Trustee and each
Committee chairman will serve two-year terms until December 31, 2013 before
rotating to serve as chairman of another committee or as Lead Independent
Trustee. After December 31, 2013, the Lead Independend Trustee and Committee
Chairman will rotate every three years. The officers and "Interested" Trustee
receive no compensation from the funds for acting in such capacities.
4. Purchases and Sales of Securities
Cost of purchases and proceeds from sales of investments, excluding short-term
investments, for the year ended October 31, 2012, were $189,184,504 and
$211,630,193, respectively.
5. Indemnification
The Fund has a variety of indemnification obligations under contracts with its
service providers. The Fund's maximum exposure under these arrangements is
unknown. However, the Fund has not had prior claims or losses pursuant to these
contracts and expects the risk of loss to be remote.
6. Risk Considerations
Risks are inherent in all investing. The following summarizes some, but not all,
of the risks that should be considered for the Fund. For additional information
about the risks associated with investing in the Fund, please see the Fund's
prospectus and statement of additional information, as well as other Fund
regulatory filings.
Investment and Market Risk: An investment in the Fund's Common Shares is subject
to investment risk, including the possible loss of the entire principal
invested. An investment in Common Shares represents an indirect investment in
the securities owned by the Fund. The value of these securities, like other
market investments, may move up or down, sometimes rapidly and unpredictably.
Common Shares at any point in time may be worth less than the original
investment, even after taking into account the reinvestment of Fund dividends
and distributions. Security prices can fluctuate for several reasons including
the general condition of the securities markets, or when political or economic
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First Trust High Income Long/Short Fund (FSD)
October 31, 2012
events affecting the issuers occur. When the Advisor or Sub-Advisor determines
that it is temporarily unable to follow the Fund's investment strategy or that
it is impractical to do so (such as when a market disruption event has occurred
and trading in the securities is extremely limited or absent), the Fund may take
temporary defensive positions.
Below-Investment Grade Securities Risk: The Fund invests in below-investment
grade securities. The market values for high-yield securities tend to be very
volatile, and these securities are less liquid than investment grade debt
securities. For these reasons, an investment in the Fund is subject to the
following specific risks: (a) increased price sensitivity to changing interest
rates and to a deteriorating economic environment; (b) greater risk of loss due
to default or declining credit quality; (c) adverse issuer specific events are
more likely to render the issuer unable to make interest and/or principal
payments; and (d) a negative perception of the high-yield market may depress the
price and liquidity of high-yield securities ..
Distressed Securities Risk: The Fund may invest in securities issued by
companies in a bankruptcy reorganization proceeding, subject to some other form
of a public or private debt restructuring or otherwise in default or in
significant risk of default in the payment of interest or repayment of principal
or trading at prices substantially below other below-investment grade debt
securities of companies in similar industries. Distressed securities frequently
do not produce income while they are outstanding. The Fund may be required to
incur certain extraordinary expenses in order to protect and recover its
investment. Therefore, to the extent the Sub-Advisor seeks capital appreciation
through investment in distressed securities, the ability to achieve current
income may be diminished.
Economic Conditions Risk: Adverse changes in economic conditions are more likely
to lead to a weakened capacity of a high-yield issuer to make principal payments
and interest payments than an investment grade issuer. An economic downturn
could severely affect the ability of highly leveraged issuers to service their
debt obligations or to repay their obligations upon maturity. Under adverse
market or economic conditions, the secondary market for high-yield securities
could contract further, independent of any specific adverse changes in the
condition of a particular issuer and these securities may become illiquid. As a
result, the Sub-Advisor could find it more difficult to sell these securities or
may be able to sell the securities only at prices lower than if such securities
were widely traded.
Fixed-Income Securities Risk: Debt securities, including high-yield securities,
are subject to certain risks, including: (i) issuer risk, which is the risk that
the value of fixed-income securities may decline for a number of reasons which
directly relate to the issuer, such as management performance, financial
leverage and reduced demand for the issuer's goods and services or, in the case
of asset-backed issuers, a decline in the value and/or cash flows of the
underlying assets; (ii) reinvestment risk, which is the risk that income from
the Fund's portfolio will decline if the proceeds from matured, traded or called
bonds are reinvested at market interest rates that are below the portfolio's
current earnings rate; (iii) prepayment risk, which is the risk that during
periods of declining interest rates, the issuer of a security may exercise its
option to prepay principal earlier than scheduled, forcing the reinvestment in
lower yielding securities; and (iv) credit risk, which is the risk that a
security in the Fund's portfolio will decline in price or the issuer fails to
make interest payments when due because the issuer of the security experiences a
decline in its financial status.
Interest Rate Risk: The Fund's portfolio is also subject to interest rate risk.
Interest rate risk is the risk that fixed-income securities will decline in
value because of changes in market interest rates. Investments in debt
securities with long-term maturities may experience significant price declines
if long-term interest rates increase.
Short Selling Risk: Short selling allows the Fund to profit from a decline in
market price to the extent such decline exceeds the transaction costs and the
costs of borrowing the securities. If a security sold short increases in price,
the Fund may have to cover its short position at a higher price than the short
sale price, resulting in a loss. The Fund may have substantial short positions
and must borrow those securities to make delivery to the buyer. The Fund may not
be able to borrow a security that it needs to deliver or it may not be able to
close out a short position at an acceptable price and may have to sell related
long positions before it had intended to do so. Thus, the Fund may not be able
to successfully implement its short sale strategy due to limited availability of
desired securities or for other reasons. Also, there is the risk that the
counterparty to a short sale may fail to honor its contractual terms, causing a
loss to the Fund. Because losses on short sales arise from increases in the
value of the security sold short, such losses are theoretically unlimited. The
use of short sales in combination with long positions in the Fund's portfolio in
an attempt to improve performance or reduce overall portfolio risk may not be
successful and may result in greater losses or lower positive returns than if
the Fund held only long positions. It is possible that the Fund's long
securities positions will decline in value at the same time that the value of
its short securities positions increase, thereby increasing potential losses to
the Fund.
By investing the proceeds received from selling securities short, the Fund could
be deemed to be employing a form of leverage, which creates special risks. The
use of leverage may increase the Fund's exposure to long securities positions
and make any change in the Fund's NAV greater than it would be without the use
of leverage. This could result in increased volatility of returns. There is no
guarantee that any leveraging strategy the Fund employs will be successful
during any period in which it is employed.
Currency Risk: The value of securities denominated or quoted in foreign
currencies may be adversely affected by fluctuations in the relative currency
exchange rates and by exchange control regulations. The Fund's investment
performance may be negatively affected by a devaluation of a currency in which
the Fund's investments are denominated or quoted. Further, the Fund's investment
performance may be significantly affected, either positively or negatively, by
currency exchange rates because the U.S. dollar value of securities denominated
or quoted in another currency will increase or decrease in response to changes
in the value of such currency in relation to the U.S. dollar. While certain of
the Fund's non-U.S. dollar-denominated securities may be hedged into U.S.
dollars, hedging may not alleviate all currency risks.
Page 29
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NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
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First Trust High Income Long/Short Fund (FSD)
October 31, 2012
7. Subsequent Events
Management has evaluated the impact of all subsequent events to the Fund through
the date the financial statements were issued, and has determined that there
were the following subsequent events:
On November 20, 2012, the Fund declared a dividend of $0.1155 per share to
Common Shareholders of record on December 5, 2012, payable December 10, 2012.
This was a decrease from the prior month's distribution paid on November 15,
2012 of $0.1335 per share.
On December 20, 2012, the Fund declared a dividend of $0.1155 per share to
Common Shareholders of record on December 31, 2012, payable January 15, 2013.
Page 30
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
--------------------------------------------------------------------------------
To the Board of Trustees and Shareholders of First Trust High Income Long/Short
Fund:
We have audited the accompanying statement of assets and liabilities of First
Trust High Income Long/Short Fund ("the Fund"), including the portfolio of
investments, as of October 31, 2012, and the related statements of operations
and cash flows for the year then ended, the statements of changes in net assets
for each of the two years in the period then ended, and the financial highlights
for each of the periods presented. These financial statements and financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and financial highlights
based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements and financial highlights are free of material misstatement.
The Fund is not required to have, nor were we engaged to perform, an audit of
its internal control over financial reporting. Our audits included consideration
of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of October 31, 2012 by correspondence with the Fund's
custodian, agent banks, and brokers; where replies were not received, we
performed other auditing procedures. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of the
First Trust High Income Long/Short Fund as of October 31, 2012, the results of
its operations and its cash flows for the year then ended, the changes in its
net assets for each of the two years in the period then ended, and the financial
highlights for each of the periods presented, in conformity with accounting
principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
Chicago, Illinois
December 24, 2012
Page 31
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ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
First Trust High Income Long/Short Fund (FSD)
October 31, 2012 (Unaudited)
DIVIDEND REINVESTMENT PLAN
If your Common Shares are registered directly with the Fund or if you hold your
Common Shares with a brokerage firm that participates in the Fund's Dividend
Reinvestment Plan (the "Plan"), unless you elect, by written notice to the Fund,
to receive cash distributions, all dividends, including any capital gain
distributions, on your Common Shares will be automatically reinvested by BNY
Mellon Investment Servicing (US) Inc. (the "Plan Agent"), in additional Common
Shares under the Plan. If you elect to receive cash distributions, you will
receive all distributions in cash paid by check mailed directly to you by the
Plan Agent, as the dividend paying agent.
If you decide to participate in the Plan, the number of Common Shares you will
receive will be determined as follows:
(1) If Common Shares are trading at or above net asset value ("NAV") at
the time of valuation, the Fund will issue new shares at a price
equal to the greater of (i) NAV per Common Share on that date or
(ii) 95% of the market price on that date.
(2) If Common Shares are trading below NAV at the time of valuation, the
Plan Agent will receive the dividend or distribution in cash and
will purchase Common Shares in the open market, on the NYSE or
elsewhere, for the participants' accounts. It is possible that the
market price for the Common Shares may increase before the Plan
Agent has completed its purchases. Therefore, the average purchase
price per share paid by the Plan Agent may exceed the market price
at the time of valuation, resulting in the purchase of fewer shares
than if the dividend or distribution had been paid in Common Shares
issued by the Fund. The Plan Agent will use all dividends and
distributions received in cash to purchase Common Shares in the open
market within 30 days of the valuation date except where temporary
curtailment or suspension of purchases is necessary to comply with
federal securities laws. Interest will not be paid on any uninvested
cash payments.
You may elect to opt-out of or withdraw from the Plan at any time by giving
written notice to the Plan Agent, or by telephone at (866) 340-1104, in
accordance with such reasonable requirements as the Plan Agent and the Fund may
agree upon. If you withdraw or the Plan is terminated, you will receive a
certificate for each whole share in your account under the Plan, and you will
receive a cash payment for any fraction of a share in your account. If you wish,
the Plan Agent will sell your shares and send you the proceeds, minus brokerage
commissions.
The Plan Agent maintains all Common Shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. Common Shares in your account will be held by the
Plan Agent in non-certificated form. The Plan Agent will forward to each
participant any proxy solicitation material and will vote any shares so held
only in accordance with proxies returned to the Fund. Any proxy you receive will
include all Common Shares you have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or distributions
in Common Shares. However, all participants will pay a pro rata share of
brokerage commissions incurred by the Plan Agent when it makes open market
purchases.
Automatically reinvesting dividends and distributions does not mean that you do
not have to pay income taxes due upon receiving dividends and distributions.
Capital gains and income are realized although cash is not received by you.
Consult your financial advisor for more information.
If you hold your Common Shares with a brokerage firm that does not participate
in the Plan, you will not be able to participate in the Plan and any dividend
reinvestment may be effected on different terms than those described above.
The Fund reserves the right to amend or terminate the Plan if in the judgment of
the Board of Trustees the change is warranted. There is no direct service charge
to participants in the Plan; however, the Fund reserves the right to amend the
Plan to include a service charge payable by the participants. Additional
information about the Plan may be obtained by writing BNY Mellon Investment
Servicing (US) Inc., 301 Bellevue Parkway, Wilmington, Delaware 19809.
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that the Fund uses to determine how
to vote proxies and information on how the Fund voted proxies relating to
portfolio investments during the most recent 12-month period ended June 30 is
available (1) without charge, upon request, by calling (800) 988-5891; (2) on
the Fund's website located at http://www.ftportfolios.com; and (3) on the
Securities and Exchange Commission's ("SEC") website located at
http://www.sec.gov.
Page 32
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ADDITIONAL INFORMATION - (CONTINUED)
--------------------------------------------------------------------------------
First Trust High Income Long/Short Fund (FSD)
October 31, 2012 (Unaudited)
PORTFOLIO HOLDINGS
The Fund files its complete schedule of portfolio holdings with the SEC for the
first and third quarters of each fiscal year on Form N-Q. The Fund's Forms N-Q
are available (1) by calling (800) 988-5891; (2) on the Fund's website located
at http://www.ftportfolios.com; (3) on the SEC's website at http://www.sec.gov;
and (4) for review and copying at the SEC's Public Reference Room ("PRR") in
Washington, DC. Information regarding the operation of the PRR may be obtained
by calling (800) SEC-0330.
TAX INFORMATION
Of the ordinary income (including short-term capital gain) distributions made by
the Fund during the year ended October 31, 2012, none qualify for the corporate
dividends received deduction available to corporate shareholders or as qualified
dividend income.
For the year ended October 31, 2012, the amount of long-term capital gain
distributions designated by the Fund was $9,358 which is taxable at the maximum
rate of 15% for federal income tax purposes.
NYSE CERTIFICATION INFORMATION
In accordance with Section 303A-12 of the New York Stock Exchange ("NYSE")
Listed Company Manual, the Fund's President has certified to the NYSE that, as
of May 8, 2012, he was not aware of any violation by the Fund of NYSE corporate
governance listing standards. In addition, the Fund's reports to the SEC on
Forms N-CSR, N-CSRS and N-Q contain certifications by the Fund's principal
executive officer and principal financial officer that relate to the Fund's
public disclosure in such reports and are required by Rule 30a-2 under the 1940
Act.
SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
The Joint Annual Meeting of Shareholders of the Common Shares of First Trust
Energy Income and Growth Fund, First Trust Enhanced Equity Income Fund, First
Trust/Aberdeen Global Opportunity Income Fund, First Trust Mortgage Income Fund,
First Trust Strategic High Income Fund II, First Trust/Aberdeen Emerging
Opportunity Fund, First Trust Specialty Finance and Financial Opportunities
Fund, First Trust Active Dividend Income Fund and First Trust High Income
Long/Short Fund was held on April 18, 2012 (the "Annual Meeting"). At the Annual
Meeting, Richard E. Erickson and Thomas R. Kadlec were elected by the Common
Shareholders of the First Trust High Income Long/Short Fund as Class II Trustees
for a three-year term expiring at the Fund's annual meeting of shareholders in
2015. The number of votes cast in favor of Mr. Erickson was 32,666,816, and the
number of votes against was 754,614 and the number of abstentations was
2,634,729. The number of votes cast in favor of Mr. Kadlec was 32,669,966, and
the number of votes against was 751,464 and the number of abstentations was
2,634,729. James A. Bowen, Niel B. Nielson and Robert F. Keith are the other
current and continuing Trustees.
ADVISORY AND SUB-ADVISORY AGREEMENTS
BOARD CONSIDERATIONS REGARDING APPROVAL OF CONTINUATION OF INVESTMENT MANAGEMENT
AGREEMENT AND SUB-ADVISORY AGREEMENT
The Board of Trustees of First Trust High Income Long/Short Fund (the "Fund"),
including the Independent Trustees, approved the Investment Management Agreement
(the "Advisory Agreement") between the Fund and First Trust Advisors L.P. (the
"Advisor") and the Investment Sub-Advisory Agreement (the "Sub-Advisory
Agreement" and together with the Advisory Agreement, the "Agreements") among the
Fund, the Advisor and MacKay Shields LLC (the "Sub-Advisor"), at a meeting held
on June 10-11, 2012. The Board determined that the continuation of the
Agreements is in the best interests of the Fund in light of the extent and
quality of the services provided and such other matters as the Board considered
to be relevant in the exercise of its reasonable business judgment.
To reach this determination, the Board considered its duties under the
Investment Company Act of 1940, as amended (the "1940 Act"), as well as under
the general principles of state law in reviewing and approving advisory
contracts; the requirements of the 1940 Act in such matters; the fiduciary duty
of investment advisors with respect to advisory agreements and compensation; the
standards used by courts in determining whether investment company boards have
fulfilled their duties; and the factors to be considered by the Board in voting
on such agreements. To assist the Board in its evaluation of the Agreements, the
Independent Trustees received a separate report from each of the Advisor and the
Sub-Advisor in advance of the Board meeting responding to a request for
information from counsel to the Independent Trustees. The reports, among other
things, outlined the services provided by the Advisor and the Sub-Advisor
(including the relevant personnel responsible for these services and their
experience); the advisory and sub-advisory fees for the Fund as compared to fees
charged to other clients of the Advisor and the Sub-Advisor and as compared to
fees charged by investment advisors and sub-advisors to comparable funds;
expenses of the Fund as compared to expense ratios of comparable funds; the
nature of expenses incurred in providing services to the Fund and the potential
for economies of scale, if any; financial data on the Advisor and the
Sub-Advisor; any fall-out benefits to the Advisor and the Sub-Advisor; and
information on the Advisor's and the Sub-Advisor's compliance programs.
Page 33
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ADDITIONAL INFORMATION - (CONTINUED)
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First Trust High Income Long/Short Fund (FSD)
October 31, 2012 (Unaudited)
Following receipt of this information, counsel to the Independent Trustees posed
follow-up questions, and the Independent Trustees and their counsel then met
separately to discuss the information provided by the Advisor and the
Sub-Advisor, including the supplemental responses. The Board applied its
business judgment to determine whether the arrangements between the Fund and the
Advisor and among the Fund, the Advisor and the Sub-Advisor are reasonable
business arrangements from the Fund's perspective as well as from the
perspective of shareholders. The Board considered that shareholders chose to
invest or remain invested in the Fund knowing that the Advisor and the
Sub-Advisor manage the Fund.
In reviewing the Agreements, the Board considered the nature, extent and quality
of services provided by the Advisor and the Sub-Advisor under the Agreements.
The Board considered the Advisor's statements regarding the incremental benefits
associated with the Fund's advisor/sub-advisor management structure. With
respect to the Advisory Agreement, the Board considered that the Advisor is
responsible for the overall management and administration of the Fund and
reviewed the services provided by the Advisor to the Fund, including the
oversight of the Sub-Advisor. The Board noted the compliance program that had
been developed by the Advisor and considered that it includes a robust program
for monitoring the Sub-Advisor's compliance with the 1940 Act and the Fund's
investment objectives and policies. With respect to the Sub-Advisory Agreement,
the Board received a presentation from representatives of the Sub-Advisor
discussing the services that the Sub-Advisor provides to the Fund and how the
Sub-Advisor manages the Fund's investments. In light of the information
presented and the considerations made, the Board concluded that the nature,
extent and quality of services provided to the Fund by the Advisor and the
Sub-Advisor under the Agreements have been and are expected to remain
satisfactory and that the Sub-Advisor, under the oversight of the Advisor, has
managed the Fund consistent with its investment objectives and policies.
The Board considered the advisory and sub-advisory fees paid under the
Agreements. The Board considered the advisory fees charged by the Advisor to
similar funds and other non-fund clients, noting that the Advisor does not
provide advisory services to other funds with investment objectives and policies
similar to the Fund's, but does provide services to certain separately managed
accounts with investment objectives and policies similar to the Fund's. The
Board noted that the Advisor charges a lower advisory fee rate to the separately
managed accounts, as well as the Advisor's statement that the nature of the
services provided to the separately managed accounts is not comparable to those
provided to the Fund. The Board considered the sub-advisory fee and how it
relates to the Fund's overall advisory fee structure and noted that the
sub-advisory fee is paid by the Advisor from its advisory fee. The Board also
considered the terms of the relationship agreement between the Advisor and
Sub-Advisor, which expires in September 2014 (the "Expiration Date"). The Board
noted that under the terms of the relationship agreement, the Advisor will
reimburse the Sub-Advisor for a percentage of the Fund's underwriting and
offering costs paid by the Sub-Advisor in the event the Sub-Advisor is
terminated prior to the Expiration Date (except for certain defined events that
constitute "termination for cause"). The Board noted the potential conflict of
interest for the Advisor created by the relationship agreement. The Board also
considered information provided by the Sub-Advisor as to the fees it charges to
other similar clients, noting that the sub-advisory fee rate is generally lower
than the fee rate charged by the Sub-Advisor to other similar clients. In
addition, the Board received data prepared by Lipper Inc. ("Lipper"), an
independent source, showing the advisory fees and expense ratios of the Fund as
compared to the advisory fees and expense ratios of a peer group selected by
Lipper and similar data for a separate peer group selected by the Advisor. The
Board also received advisory fee and expense ratio data for a peer group of
funds compiled by Morningstar Associates, LLC ("Morningstar"), an independent
source. The Board noted that the Lipper, Advisor and Morningstar peer groups did
not include any overlapping peer funds. The Board discussed with representatives
of the Advisor the limitations in creating a relevant peer group for the Fund,
including that (i) the Fund is unique in its composition, which makes assembling
peers with similar strategies and asset mix difficult; (ii) peer funds may use
different types of leverage which have different costs associated with them or
may use no leverage, noting that the Fund uses non-traditional leverage by
shorting bonds and reinvesting the proceeds; and (iii) most peer funds do not
employ an advisor/sub-advisor management structure. The Board took these
limitations into account in considering the peer data. In reviewing the peer
data, the Board noted that the Fund's contractual advisory fee was above the
median of the Lipper, Advisor and Morningstar peer groups.
The Board also considered performance information for the Fund, noting that the
performance information included the Fund's quarterly performance report, which
is part of the process that the Board has established for monitoring the Fund's
performance and portfolio risk on an ongoing basis. The Board determined that
this process continues to be effective for reviewing the Fund's performance. In
addition to the Board's ongoing review of performance, the Board also received
data prepared by Lipper comparing the Fund's performance to the Lipper peer
group, as well as to a larger peer universe and to a benchmark. In reviewing the
Fund's performance as compared to the performance of the Lipper peer group and
Lipper peer universe, the Board took into account the limitations described
above with respect to creating a relevant peer group for the Fund. The Board
also noted that, because the Fund launched in September 2010, it only had one
full calendar year of performance. The Board considered the Fund's dividend
yield as of March 30, 2012 and an analysis prepared by the Advisor on the
continued benefits provided by the Fund's leverage. In addition, the Board
compared the Fund's premium/discount over the past five quarters to the average
and median premium/discount of the Advisor peer group over the same period,
noting that the Fund's premium/discount was generally indicative of the asset
class and market events.
Page 34
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ADDITIONAL INFORMATION - (CONTINUED)
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First Trust High Income Long/Short Fund (FSD)
October 31, 2012 (Unaudited)
On the basis of all the information provided on the fees, expenses and
performance of the Fund, the Board concluded that the advisory and sub-advisory
fees were reasonable and appropriate in light of the nature, extent and quality
of services provided by the Advisor and Sub-Advisor under the Agreements.
The Board noted that the Advisor has continued to invest in personnel and
infrastructure and considered whether fee levels reflect any economies of scale
for the benefit of shareholders. The Board noted the Advisor's statement that
economies of scale in providing services to the Fund are not available at
current asset levels. The Board determined that due to the Fund's closed-end
structure, the potential for realization of economies of scale as Fund assets
grow was not a material factor to be considered. The Board also considered the
costs of the services provided and profits realized by the Advisor from serving
as investment advisor to the Fund for the twelve months ended December 31, 2011,
as set forth in the materials provided to the Board. The Board noted the
inherent limitations in the profitability analysis, and concluded that the
Advisor's estimated profitability appeared to be not excessive in light of the
services provided to the Fund. In addition, the Board considered fall-out
benefits described by the Advisor that may be realized from its relationship
with the Fund, including the Advisor's compensation for fund reporting services
pursuant to a separate Fund Reporting Services Agreement.
The Board noted the Sub-Advisor's statement that it will not experience
significant economies of scale based on the current level of assets of the Fund.
The Board considered that the sub-advisory fee rate was negotiated at arm's
length between the Advisor and the Sub-Advisor, an unaffiliated third party. The
Board also considered data provided by the Sub-Advisor as to the profitability
of the Sub-Advisory Agreement to the Sub-Advisor. The board noted the inherent
limitations in the profitability analysis and concluded that the profitability
analysis for the Advisor was more relevant. The Board considered fall-out
benefits realized by the Sub-Advisor from its relationship with the Fund, noting
that the Sub-Advisor did not identify any material fall-out benefits.
Based on all of the information considered and the conclusions reached, the
Board, including the Independent Trustees, unanimously determined that the terms
of the Agreements continue to be fair and reasonable and that the continuation
of the Agreements is in the best interests of the Fund. No single factor was
determinative in the Board's analysis.
Page 35
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BOARD OF TRUSTEES AND OFFICERS
--------------------------------------------------------------------------------
First Trust High Income Long/Short Fund (FSD)
October 31, 2012 (Unaudited)
Number of
Portfolios in
the First Trust Other
Name, Address, Term of Office Fund Complex Trusteeships or
Date of Birth and and Length of Principal Occupations Overseen by Directorships
Position with the Fund Service (2) During Past 5 Years Trustee Held by Trustee
INDEPENDENT TRUSTEES
Richard E. Erickson, Trustee o Three Year Term Physician; President, Wheaton Orthopedics; 96 None
c/o First Trust Advisors L.P. Co-Owner and Co-Director (January 1996
120 East Liberty Drive, o Since Fund to May 2007), Sports Med Center for
Suite 400 Inception Fitness; Limited Partner, Gundersen Real
Wheaton, IL 60187 Estate Limited Partnership; Member,
D.O.B.: 04/51 Sportsmed LLC
Thomas R. Kadlec, Trustee o Three Year Term President (March 2010 to Present), Senior 96 Director of ADM
c/o First Trust Advisors L.P. Vice President and Chief Financial Officer Investor Services,
120 East Liberty Drive, o Since Fund (May 2007 to March 2010), Vice President Inc. and ADM
Suite 400 Inception and Chief Financial Officer (1990 to May Investor Services,
Wheaton, IL 60187 2007), ADM Investor Services, Inc. (Futures International
D.O.B.: 11/57 Commission Merchant)
Robert F. Keith, Trustee o Three Year Term President (2003 to Present), Hibs 96 Director of
c/o First Trust Advisors L.P. Enterprises (Financial and Management Illinois Trust
120 East Liberty Drive, o Since Fund Consulting) Company
Suite 400 Inception
Wheaton, IL 60187
D.O.B.: 11/56
Niel B. Nielson, Trustee o Three Year Term President and Chief Executive Officer(June 96 Director of
c/o First Trust Advisors L.P. 2012 to Present), Dew Learning LLC Covenant
120 East Liberty Drive, o Since Fund (Educational Products and Services); President Transport Inc.
Suite 400 Inception (June 2002 to June 2012), Covenant College
Wheaton, IL 60187
D.O.B.: 03/54
INTERESTED TRUSTEE
James A. Bowen(1), Trustee and o Three Year Term Chief Executive Officer (December 2010 96 None
Chairman of the Board to Present), President (until December
120 East Liberty Drive, o Since Fund 2010), First Trust Advisors L.P. and First
Suite 400 Inception Trust Portfolios L.P.; Chairman of the
Wheaton, IL 60187 Board of Directors, BondWave LLC
D.O.B.: 09/55 (Software Development Company/
Investment Advisor) and Stonebridge
Advisors LLC (Investment Advisor)
----------------------
(1) Mr. Bowen is deemed an "interested person" of the Fund due to his position
as CEO of First Trust Advisors L.P., investment advisor of the Fund.
(2) Currently, Robert F. Keith, as a Class I Trustee, is serving as a trustee
until the Fund's 2014 annual meeting of shareholders. Richard E. Erickson
and Thomas R. Kadlec, as Class II Trustees, are serving as trustees until
the Fund's 2015 annual meeting of shareholders. James A. Bowen and Niel B.
Nielson, as Class III Trustees, are serving as trustees until the Fund's
2013 annual meeting of shareholders.
Page 36
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BOARD OF TRUSTEES AND OFFICERS - (CONTINUED)
--------------------------------------------------------------------------------
First Trust High Income Long/Short Fund (FSD)
October 31, 2012 (Unaudited)
Name, Address Position and Offices Term of Office and Principal Occupations
and Date of Birth with Fund Length of Service During Past 5 Years
OFFICERS(3)
Mark R. Bradley President and Chief o Indefinite Term Chief Operating Officer (December 2010 to Present)
120 East Liberty Drive, Executive Officer and Chief Financial Officer, First Trust Advisors
Suite 400 o Since January 2012 L.P. and First Trust Portfolios L.P.; Chief
Wheaton, IL 60187 Financial Officer, BondWave LLC (Software
D.O.B.: 11/57 Development Company/Investment Advisor) and
Stonebridge Advisors LLC (Investment Advisor)
James M. Dykas Treasurer, Chief Financial o Indefinite Term Controller (January 2011 to Present), Senior Vice
120 East Liberty Drive, Officer and Chief President (April 2007 to January 2011), Vice
Suite 400 Accounting Officer o Since January 2012 President (January 2005 to April 2007), First
Wheaton, IL 60187 Trust Advisors L.P. and First Trust Portfolios
D.O.B.: 01/66 L.P.
W. Scott Jardine Secretary and Chief o Indefinite Term General Counsel, First Trust Advisors L.P., First
120 East Liberty Drive, Legal Officer Trust Portfolios L.P. and BondWave LLC
Suite 400 o Since Fund Inception (Software Development Company/Investment
Wheaton, IL 60187 Advisor): Secretary of Stonebridge Advisors LLC
D.O.B.: 05/60 (Investment Advisor)
Daniel J. Lindquist Vice President o Indefinite Term Senior Vice President (September 2005 to
120 East Liberty Drive, Present), First Trust Advisors L.P. and
Suite 400 o Since Fund Inception First Trust Portfolios L.P.
Wheaton, IL 60187
D.O.B.: 02/70
Kristi A. Maher Assistant Secretary and o Indefinite Term Deputy General Counsel (May 2007 to Present)
120 East Liberty Drive, Chief Compliance Officer o Assistant Secretary
Suite 400 Since Fund Inception
Wheaton, IL 60187 o Chief Compliance
D.O.B.: 12/66 Officer
Since January 2011
--------------
(3) Officers of the Fund have an indefinite term. The term "officer" means the
president, vice president, secretary, treasurer, controller or any other
officer who performs a policy making function.
Page 37
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PRIVACY POLICY
--------------------------------------------------------------------------------
First Trust High Income Long/Short Fund (FSD)
October 31, 2012 (Unaudited)
Privacy Policy
First Trust values our relationship with you and consider your privacy an
important priority in maintaining that relationship. We are committed to
protecting the security and confidentiality of your personal information.
Sources of Information
We collect nonpublic personal information about you from the following sources:
o Information we receive from you and your broker-dealer, investment
advisor or financial representative through interviews, applications,
agreements or other forms;
o Information about your transactions with us, our affiliates or others;
o Information we receive from your inquiries by mail, e-mail or telephone;
and
o Information we collect on our website through the use of "cookies". For
example, we may identify the pages on our website that your browser
requests or visits.
Information Collected
The type of data we collect may include your name, address, social security
number, age, financial status, assets, income, tax information, retirement and
estate plan information, transaction history, account balance, payment history,
investment objectives, marital status, family relationships and other personal
information.
Disclosure of Information
We do not disclose any nonpublic personal information about our customers or
former customers to anyone, except as permitted by law. In addition to using
this information to verify your identity (as required under law), the permitted
uses may also include the disclosure of such information to unaffiliated
companies for the following reasons:
o In order to provide you with products and services and to effect
transactions that you request or authorize, we may disclose your personal
information as described above to unaffiliated financial service
providers and other companies that perform administrative or other
services on our behalf, such as transfer agents, custodians and trustees,
or that assist us in the distribution of investor materials such as
trustees, banks, financial representatives, proxy services, solicitors
and printers.
o We may release information we have about you if you direct us to do so,
if we are compelled by law to do so, or in other legally limited
circumstances (for example to protect your account from fraud).
In addition, in order to alert you to our other financial products and services,
we may share your personal information within First Trust.
Privacy Online
We allow third-party companies, including AddThis, to collect certain anonymous
information when you visit our website. These companies may use non-personally
identifiable information during your visits to this and other websites in order
to provide advertisements about goods and services likely to be of greater
interest to you. These companies typically use a cookie, third party web beacon
or pixel tags, to collect this information. To learn more about this behavioral
advertising practice, you can visit www.networkadvertising.org.
Confidentiality and Security
With regard to our internal security procedures, First Trust restricts access to
your nonpublic personal information to those First Trust employees who need to
know that information to provide products or services to you. We maintain
physical, electronic and procedural safeguards to protect your nonpublic
personal information.
Policy Updates and Inquiries
As required by federal law, we will notify you of our privacy policy annually.
We reserve the right to modify this policy at any time, however, if we do change
it, we will tell you promptly. For questions about our policy, or for additional
copies of this notice, please go to www.ftportfolios.com, or contact us at
1-800-621-1675 (First Trust Portfolios) or 1-800-222-6822 (First Trust
Advisors).
Page 38
This Page Left Blank Intentionally.
This Page Left Blank Intentionally.
FIRST TRUST
INVESTMENT ADVISOR
First Trust Advisors L.P.
120 E. Liberty Drive, Suite 400
Wheaton, IL 60187
INVESTMENT SUB-ADVISOR
MacKay Shields LLC
1345 Avenue of the Americas
43rd floor
New York, NY 10105
ADMINISTRATOR,
FUND ACCOUNTANT &
TRANSFER AGENT
BNY Mellon Investment Servicing (US) Inc.
301 Bellevue Parkway
Wilmington, DE 19809
CUSTODIAN
The Bank of New York Mellon
101 Barclay Street, 20th Floor
New York, NY 10286
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
111 S. Wacker Drive
Chicago, IL 60606
LEGAL COUNSEL
Chapman and Cutler LLP
111 W. Monroe Street
Chicago, IL 60603
[BLANK BACK COVER]
ITEM 2. CODE OF ETHICS.
(a) The registrant, as of the end of the period covered by this report, has
adopted a code of ethics that applies to the registrant's principal
executive officer, principal financial officer, principal accounting
officer or controller, or persons performing similar functions,
regardless of whether these individuals are employed by the registrant or
a third party.
(c) There have been no amendments, during the period covered by this report,
to a provision of the code of ethics that applies to the registrant's
principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar
functions, regardless of whether these individuals are employed by the
registrant or a third party, and that relates to any element of the code
of ethics description.
(d) The registrant has not granted any waivers, including an implicit waiver,
from a provision of the code of ethics that applies to the registrant's
principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar
functions, regardless of whether these individuals are employed by the
registrant or a third party, that relates to one or more of the items set
forth in paragraph (b) of this item's instructions.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
As of the end of the period covered by the report, the Registrant's board of
trustees has determined that Thomas R. Kadlec and Robert F. Keith are qualified
to serve as audit committee financial experts serving on its audit committee and
that each of them is "independent," as defined by Item 3 of Form N-CSR.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
(a) Audit Fees (Registrant) -- The aggregate fees billed for each of the
last two fiscal years for professional services rendered by the principal
accountant for the audit of the registrant's annual financial statements or
services that are normally provided by the accountant in connection with
statutory and regulatory filings or engagements for those fiscal years were
$51,000 for the fiscal year ended October 31, 2011 and $52,000 for the fiscal
year ended October 31, 2012.
(b) Audit-Related Fees (Registrant) -- The aggregate fees billed in each
of the last two fiscal years for assurance and related services by the principal
accountant that are reasonably related to the performance of the audit of the
registrant's financial statements and are not reported under paragraph (a) of
this Item were $0 for the fiscal year ended October 31, 2011 and $0 for the
fiscal year ended October 31, 2012.
Audit-Related Fees (Investment Adviser) -- The aggregate fees billed
in each of the last two fiscal years for assurance and related services by the
principal accountant that are reasonably related to the performance of the audit
of the registrant's financial statements and are not reported under paragraph
(a) of this Item were $10,000 for the fiscal year ended October 31, 2011 and $0
for the fiscal year ended October 31, 2012.
(c) Tax Fees (Registrant) -- The aggregate fees billed in each of the last
two fiscal years for professional services rendered by the principal accountant
for tax compliance, tax advice, and tax planning were $5,200 for the fiscal year
ended October 31, 2011 and $0 for the fiscal year ended October 31, 2012. The
fees for 2011 were for tax return preparation.
Tax Fees (Investment Adviser) -- The aggregate fees billed in each of
the last two fiscal years for professional services rendered by the principal
accountant for tax compliance, tax advice, and tax planning were $0 for the
fiscal year ended October 31, 2011 and $0 for the fiscal year ended October 31,
2012.
(d) All Other Fees (Registrant) -- The aggregate fees billed in each of
the last two fiscal years for products and services provided by the principal
accountant to the Registrant, other than the services reported in paragraphs (a)
through (c) of this Item were $0 for the fiscal year ended October 31, 2011 and
$0 for the fiscal year ended October 31, 2012.
All Other Fees (Investment Adviser) -- The aggregate fees billed in
each of the last two fiscal years for products and services provided by the
principal accountant to the Registrant, other than the services reported in
paragraphs (a) through (c) of this Item were $0 for the fiscal year ended
October 31, 2011 and $0 for the fiscal year ended October 31, 2012.
(e)(1) Disclose the audit committee's pre-approval policies and procedures
described in paragraph (c)(7) of Rule 2-01 of Regulation S-X.
Pursuant to its charter and its Audit and Non-Audit Services Pre-Approval
Policy, the Audit Committee (the "Committee") is responsible for the
pre-approval of all audit services and permitted non-audit services (including
the fees and terms thereof) to be performed for the Registrant by its
independent auditors. The Chairman of the Committee authorized to give such
pre-approvals on behalf of the Committee up to $25,000 and report any such
pre-approval to the full Committee.
The Committee is also responsible for the pre-approval of the independent
auditor's engagements for non-audit services with the Registrant's adviser (not
including a sub-adviser whose role is primarily portfolio management and is
sub-contracted or overseen by another investment adviser) and any entity
controlling, controlled by or under common control with the investment adviser
that provides ongoing services to the Registrant, if the engagement relates
directly to the operations and financial reporting of the Registrant, subject to
the de minimis exceptions for non-audit services described in Rule 2-01 of
Regulation S-X. If the independent auditor has provided non-audit services to
the Registrant's adviser (other than any sub-adviser whose role is primarily
portfolio management and is sub-contracted with or overseen by another
investment adviser) and any entity controlling, controlled by or under common
control with the investment adviser that provides ongoing services to the
Registrant that were not pre-approved pursuant to the de minimis exception, the
Committee will consider whether the provision of such non-audit services is
compatible with the auditor's independence.
(e)(2) The percentage of services described in each of paragraphs (b)
through (d) for the Registrant and the Registrant's investment adviser of this
Item that were approved by the audit committee pursuant to the pre-approval
exceptions included in paragraph (c)(7)(i)(c) or paragraph (c)(7)(ii) of Rule
2-01 of Regulation S-X are as follows:
(b) 0%
(c) 0%
(d) 0%
(f) The percentage of hours expended on the principal accountant's
engagement to audit the registrant's financial statements for the most recent
fiscal year that were attributed to work performed by persons other than the
principal accountant's full-time, permanent employees was less than fifty
percent.
(g) The aggregate non-audit fees billed by the registrant's accountant for
services rendered to the registrant, and rendered to the registrant's investment
adviser (not including any sub-adviser whose role is primarily portfolio
management and is subcontracted with or overseen by another investment adviser),
and any entity controlling, controlled by, or under common control with the
adviser that provides ongoing services to the registrant for the Registrant's
fiscal year ended October 31, 2011 were $5,200 for the Registrant and $3,720 for
the Registrant's investment adviser and for the Registrant's fiscal year ended
October 31, 2012 were $0 for the Registrant and $6,600 for the Registrant's
investment adviser.
(h) The Registrant's audit committee of its Board of Trustees has
determined that the provision of non-audit services that were rendered to the
Registrant's investment adviser (not including any sub-adviser whose role is
primarily portfolio management and is subcontracted with or overseen by another
investment adviser), and any entity controlling, controlled by, or under common
control with the investment adviser that provides ongoing services to the
Registrant that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule
2-01 of Regulation S-X is compatible with maintaining the principal accountant's
independence.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
(a) The Registrant has a separately designated audit committee consisting of
all the independent directors of the Registrant. The members of the audit
committee are: Thomas R. Kadlec, Niel B. Nielson, Richard E. Erickson and
Robert F. Keith.
ITEM 6. INVESTMENTS.
(a) Schedule of Investments in securities of unaffiliated issuers as of the
close of the reporting period is included as part of the report to
shareholders filed under Item 1 of this form.
(b) Not applicable.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
MACKAY SHIELDS LLC
PROXY VOTING POLICIES AND PROCEDURES
1. INTRODUCTION
MacKay Shields LLC ("MacKay Shields" or the "Firm"), has adopted these "Proxy
Voting Policy and Procedures" (the "Policy") to ensure the Firm's compliance
with Rule 206(4)-6 under the Investment Advisers Act of 1940, as amended (the
"Advisers Act") and other applicable fiduciary obligations. The Policy applies
to proxies relating to securities held by clients of MacKay Shields who have
delegated the responsibility of voting proxies to the Firm. The Policy is
designed to assist Firm employees in meeting their specific responsibilities in
this area and to reasonably ensure that proxies are voted in the best interests
of the Firm's clients.
2. STATEMENT OF POLICY
2.1 It is the policy of MacKay Shields that where the Firm has voting authority,
all proxies are to be voted in the best interest of the client without regard to
the interests of MacKay Shields or other related parties. Specifically, MacKay
Shields shall not subordinate the interests of clients to unrelated objectives,
including MacKay Shields' interests. MacKay Shields shall act with the care,
skill, prudence and diligence under the circumstances then prevailing that a
prudent person acting in a like capacity and familiar with such matters would
use in the conduct of an enterprise of a like character and with like aims. For
purposes of the Policy, the "best interests of clients" shall mean, unless
otherwise specified by the client, the clients' best economic interests over the
long term - that is, the common interest that all MacKay Shields clients share
in seeing the value of a common investment increase over time. It is further the
policy of the Firm that complete and accurate disclosure concerning its proxy
voting policies and procedures and proxy voting records as required by the
Advisers Act, be made available to its clients.
2.2 When proxies with respect to securities held by clients of MacKay Shields
have not been received by MacKay Shields or its proxy voting service provider,
MacKay Shields will make reasonable efforts to obtain missing proxies. MacKay
Shields is not responsible for voting proxies it or its proxy voting service
provider does not receive.
2.3 MacKay Shields may choose not to vote proxies under the following
circumstances:
o If the effect on the client's economic interests or the value of the
portfolio holding is indeterminable or insignificant;
o If the cost of voting the proxy outweighs the possible benefit to
the client; or
o If a jurisdiction imposes share blocking restrictions which prevent
the Firm from trading shares.
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3. USE OF THIRD PARTY PROXY VOTING SERVICE PROVIDER
To discharge its responsibility, MacKay Shields has examined third-party
services that assist in the researching and voting of proxies and the
development of voting guidelines. After such review, the Firm has selected
Institutional Shareholder Services, Inc., a wholly owned subsidiary of MSCI,
Inc. ("ISS"), to research voting proposals, analyze the financial implications
of voting proposals and vote proxies. MacKay Shields utilizes the research and
analytical services, operational implementation, administration, record- keeping
and reporting services provided by ISS.
4. PROXY VOTING GUIDELINES
4.1 MacKay Shields has determined that, except as set forth in Sections 6 and 7,
proxies for non-union clients who so specify will be voted in accordance with
the voting recommendations contained in the applicable ISS non-union domestic or
global proxy voting guidelines, as in effect from time to time ("Non-Union
Guidelines"). A summary of the current Non-Union Guidelines is attached as
Exhibit A.
4.2 MacKay Shields has determined that, except as set forth in Sections 6 and 7,
proxies for union or Taft-Hartley clients who so specify will be voted in
accordance with the voting recommendations contained in the applicable ISS
Taft-Hartley domestic or global proxy voting guidelines, as in effect from time
to time ("Union Guidelines"). A summary of the current Union Guidelines is
attached as Exhibit B.
4.3 For purposes of the Policy, the Non-Union and Union Guidelines are
collectively referred to as the Standard Guidelines.
4.4 A client may choose to use proxy voting guidelines different from the
Standard Guidelines ("Custom Guidelines"). Any Custom Guidelines must be
furnished by the client to MacKay Shields in writing.
4.5 In the event the Standard Guidelines or any client's Custom Guidelines do
not address how a proxy should be voted or state that the vote is to be
determined on a "case- by-case" basis, the proxy will be voted in accordance
with ISS recommendations, subject to Section 6. In the event that ISS has not
made a recommendation, MacKay Shields will follow the procedure set forth in
Section 7.
4.6 Notwithstanding the foregoing, MacKay Shields will vote a proxy with respect
to a particular security held by a client in accordance with such client's
specific request even if it is in a manner inconsistent with the Standard
Guidelines or the client's Custom Guidelines, as the case may be. Any such
specific requests must be furnished to MacKay Shields by the client in writing
and must be received by MacKay on a timely basis for instructing ISS how to cast
the vote.
4.7 In order to avoid possible conflicts of interest, MacKay Shields votes
proxies based on the Standard Guidelines or a client's Custom Guidelines, as the
case may be. However, it is recognized that the Firm's portfolio management team
has the ultimate responsibility for proxy voting.
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4.8 For clients using the Standard Guidelines, the Firm will instruct ISS to
cast votes in accordance with the Standard Guidelines. For clients using Custom
Guidelines, the Firm will provide ISS with a copy of such Custom Guidelines and
will instruct ISS to cast votes in accordance with such Custom Guidelines. ISS
will cast votes in accordance with the Standard Guidelines or Custom Guidelines,
as the case may be, unless instructed otherwise by MacKay Shields as set forth
in Sections 6 and 7. Upon receipt of a specific request from a client pursuant
to Section 4.6, the Firm will instruct ISS to cast such client's proxy in
accordance with such request.
5. CLIENT ACCOUNT SET-UP AND REVIEW
5.1 Initially, MacKay Shields must determine whether the client seeks to retain
the responsibility of voting proxies, or seeks to delegate that responsibility
to the Firm. The marketing or client service person responsible for setting up
the account, in conjunction with MacKay's Legal/Compliance Department, will have
primary responsibility for making that determination. In its sole discretion,
the Firm may decline to accept authority to vote a client's proxies. Any such
refusal shall be in writing.
5.2 If MacKay Shields has authority to vote a client's proxies, the marketing or
client service person responsible for setting up the account will ask the client
to specify in writing (which may be by e-mail) whether the Firm should vote
proxies in accordance with the Non-Union Guidelines, Union Guidelines or Custom
Guidelines.
5.3 In most cases, the delegation of voting authority to MacKay Shields, and the
Firm's use of a third-party proxy voting service provider shall be memorialized
in the client's investment management agreement.
5.4 MacKay Shields shall notify ISS of new client accounts using such form as
ISS shall specify from time to time. Designated personnel within the Firm will
be responsible for ensuring that each new client's account for which the Firm
has proxy voting authority is established on the appropriate systems and that
each such account is properly coded for voting under the appropriate Non-Union
Guidelines, Union Guidelines or Custom Guidelines, as the case may be.
6. OVERRIDING GUIDELINES
A portfolio manager may propose that a particular proxy vote be cast in a manner
different from the Standard Guidelines or a ISS voting recommendation, or may
propose an abstention from voting, if he/she believes that to do so, based on
all facts and circumstances, is in the best interest of the Firm's clients as a
whole. Any portfolio manager who proposes to override the Standard Guidelines or
a ISS voting recommendation on a particular vote or to abstain from voting must
complete a Proxy Vote Override/Decision Form, which is set forth in Schedule C.
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7. REFERRAL OF VOTING DECISION BY ISS TO MACKAY SHIELDS
7.1 In the event that the Standard Guidelines or a client's Custom Guidelines do
not address how a proxy should be voted on a specific proposal for an issuer and
ISS has not made a recommendation as to how such proxy should be voted, ISS will
so advise MacKay Shields. In that event, the Legal/Compliance Department will
request that the appropriate portfolio manager make a voting recommendation and
complete a Proxy Vote Override/Decision Form.
7.2 In the event that the Standard Guidelines or a client's Custom Guidelines
require a "case-by-case" determination on a particular proxy vote and ISS has
not made a recommendation as to how such proxy should be voted, ISS will so
advise MacKay Shields. In that event, the Legal/Compliance Department will
request that the appropriate portfolio manager make a voting recommendation and
complete a Proxy Vote Override/Decision Form.
7.3 In the event that ISS determines that a conflict of interest exists as a
result of which ISS is precluded from making a recommendation as to how a proxy
should be voted on a specific proposal for an issuer, ISS will so advise MacKay
Shields. In that event, the Legal/Compliance Department will request that the
appropriate portfolio manager make a voting recommendation and complete a Proxy
Vote Override/Decision Form.
8. CONFLICTS OF INTEREST
8.1 The Firm's portfolio managers may make proxy voting decisions in connection
with (i) overriding the Standard Guidelines or an ISS voting recommendation
pursuant to Section 6, or (ii) deciding on a vote pursuant to Section 7. In such
event, the portfolio managers have an affirmative duty to disclose any potential
conflict of interest known to them that exists between the Firm and the client
on whose behalf the proxy is to be voted ("Conflict").
8.2. By way of example, Conflicts may exist in situations where the Firm is
called to vote on a proxy involving an issuer or proponent of a proxy proposal
regarding the issuer where MacKay Shields or an affiliated person of the Firm
also:
o Manages the issuer's or proponent's pension plan;
o Administers the issuer's or proponent's employee benefit plan;
o Provided brokerage, underwriting, insurance or banking services to
the issuer or proponent; or
o Manages money for an employee group.
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Additional Conflicts may exist, among others, if an executive of the Firm or its
control affiliates is a close relative of, or has a personal or business
relationship with:
o An executive of the issuer or proponent;
o A director of the issuer or proponent;
o A person who is a candidate to be a director of the issuer;
o A participant in the proxy contest; or
o A proponent of a proxy proposal.
8.3 Whether a relationship creates a Conflict will depend on the facts and
circumstances. Even if these parties do not attempt to influence the Firm with
respect to voting, the value of the relationship to MacKay Shields or an
affiliate can create a Conflict.
8.4 After a Proxy Vote Override/Decision Form is completed pursuant to Sections
6 or 7, such Form, which elicits information as to whether a potential Conflict
exists, must be submitted to the Legal/Compliance Department for review. If the
Firm's General Counsel ("GC") or Chief Compliance Officer ("CCO") determines
that there is no potential Conflict, the GC or CCO or their designee may
instruct ISS to vote the proxy issue as set forth in the completed Form.
8.5 If the GC or CCO determines that there exists or may exist a Conflict, he or
she will refer the issue to the Compliance Committee for consideration by
convening (in person or via telephone) an emergency meeting of the Compliance
Committee. For purposes of this Policy, a majority vote of those members present
shall resolve any Conflict. The Compliance Committee will consider the facts and
circumstances of the pending proxy vote and the potential or actual Conflict and
make a determination as to how to vote the proxy - i.e., whether to permit or
deny the recommendation of the portfolio manager, or whether to take other
action, such as delegating the proxy vote to an independent third party or
obtaining voting instructions from clients.
8.6 In considering the proxy vote and potential Conflict, the Compliance
Committee may review the following factors, including but not limited to:
o The percentage of outstanding securities of the issuer held on
behalf of clients by the Firm.
o The nature of the relationship of the issuer or proponent with the
Firm, its affiliates or its executive officers.
o Whether there has been any attempt to directly or indirectly
influence the portfolio manager's decision.
o Whether the direction (for or against) of the proposed vote would
appear to benefit the Firm or a related party.
o Whether an objective decision to vote in a certain way will still
create a strong appearance of a Conflict.
MacKay Shields may not abstain from voting any such proxy for the purpose of
avoiding Conflict.
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9. SECURITIES LENDING
If MacKay Shields portfolio managers or their designees become aware of an
upcoming shareholder meeting where there is an important vote to be taken, or
become aware of a request for consent of security holders on a material matter
affecting the investment, MacKay Shields will consider whether to request that
clients call back securities loans, if applicable. In determining whether to
request that clients call back securities loans, the relevant portfolio
manager(s) shall consider whether the benefit to the client in voting the matter
or giving or withholding consent outweighs the benefit to the client in keeping
the security on loan. There may be instances when MacKay Shields may not be
aware of the upcoming shareholder meeting or request for consent with sufficient
time in advance to make such a request, or when MacKay Shields' request that a
client call back a securities loan in sufficient time to vote or give or
withhold consent may not be successful.
10. REPORTING
Upon request, MacKay Shields shall report annually (or more frequently if
specifically requested) to its clients on proxy votes cast on their behalf.
MacKay Shields will provide any client who makes a written or verbal request
with a copy of a report disclosing how MacKay Shields voted securities held in
that client's portfolio. The report will generally contain the following
information:
o The name of the issuer of the security;
o The security's exchange ticker symbol;
o The security's CUSIP number;
o The shareholder meeting date;
o A brief identification of the matter voted on;
o Whether the matter was proposed by the issuer or by a security
holder;
o Whether MacKay Shields cast its vote on the matter on behalf of the
client;
o How MacKay Shields voted on behalf of the client; and
o Whether MacKay Shields voted for or against management on behalf of
the client.
11. RECORD-KEEPING
Either MacKay Shields or ISS as indicated below will maintain the following
records:
o A copy of the Policy and MacKay's Standard Guidelines and Custom
Guidelines;
o A copy of each proxy statement received by MacKay Shields or
forwarded to ISS by the client's custodian regarding client
securities;
o A record of each vote cast by MacKay Shields on behalf of a client;
o A copy of all documents created by MacKay Shields that were material
to making a decision on the proxy voting (or abstaining from voting)
of client securities or that memorialize the basis for that decision
including the resolution of any Conflict, a copy of all guideline
override requests and all supporting documents; and
o A copy of each written request by a client for information on how
MacKay Shields voted proxies on behalf of the client, as well as a
copy of any written
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response by MacKay Shields to any request by a client for
information on how MacKay Shields voted proxies on behalf of the
client; records of oral requests for information or oral responses
will not be kept.
Such records must be maintained for at least eight years, the first two years in
an appropriate office of MacKay Shields.
12. REVIEW OF VOTING AND GUIDELINES
As part of its periodic reviews, MacKay Shields' Legal/Compliance Department
will conduct an annual review of the prior year's proxy voting as well as the
guidelines established for proxy voting. Documentation shall be maintained of
this review and a report setting forth the results of the review will be
presented annually to the Compliance Committee.
13. HOW TO REQUEST INFORMATION ON HOW THE FIRM VOTED PROXIES
Clients may, at anytime, request and receive information from MacKay Shields as
to how the Firm voted proxies for securities held in their account. Any such
proxy information request should be in writing and mailed or faxed
[(212)-754-9205] to MacKay Shields Client Services Department at:
MacKay Shields LLC
9 West 57th Street
New York, NY 10019
ATTN: Client Services
ATTACHMENTS:
Exhibit A - Summary of Standard Guidelines for non-union clients
Exhibit B - Summary of Standard Guidelines for union clients (Taft-Hartley)
Schedule C- Proxy Vote Override/Decision Form
-------------------------
Effective January 3, 2011
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SCHEDULE C
PROXY VOTE OVERRIDE/DECISION FORM
Portfolio Manager Requesting Override/Making Decision:
___________________________________________________________________________
Portfolio Management Product Area (check one):
[_] Municipal [_] Global Fixed Income [_] Convertible
[_] High Yield
Security Issuer: __________________________________________________________
Security's exchange ticker symbol: ________________________________________
Cusip #: __________________________________________________________________
# of Shares held/par amount held: _________________________________________
Percentage of outstanding shares/par amount held: _________________________
Type of accounts holding security: Mutual Funds (name each fund): ________
Separate Accounts (specify number): ___
Other (describe): _____________________
Applicable Guidelines (check one): [_] MacKay Standard (A or B)
[_] Other (specify): _______________
[_] N/A
Shareholder/Bondholder/Lender Meeting Date: _______________________________
Response Deadline: ________________________________________________________
Brief Description of the Matter to be Voted On:
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
Proposal Type (check one):
[_] Management Proposal
[_] Shareholder Proposal (identify proponent: _____________________________)
Recommended vote by issuer's management (check one): [_] For [_] Against [_] N/A
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Recommended vote by ISS (check one): [_] For [_] Against [_] Abstain [_] N/A
[_] No Recommendation
Portfolio manager recommended vote (check one): [_] For [_] Against [_] Abstain
Describe in detail why you believe this override/decision is in the client's
best interest (attach supporting documentation):
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
Are you aware of any relationship between the issuer, or its officers or
directors, and MacKay Shields or any of its affiliates?
[_] No [_] Yes (describe below)
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
Are you aware of any relationship between the issuer, including its officers or
directors, and any executive officers of MacKay Shields or any of its
affiliates?
[_] No [_] Yes (describe below)
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
Are you aware of any relationship between the proponent of the proxy proposal
(if not the issuer) and MacKay Shields or any of its affiliates?
[_] No [_] Yes (describe below)
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
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Are you aware of any relationship between the proponent of the proxy proposal
(if not the issuer) and any executive officers of MacKay Shields or any of its
affiliates?
[_] No [_] Yes (describe below)
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
Has anyone (outside of your portfolio management area) contacted you in an
attempt to influence your decision to vote this proxy matter?
[_] No [_] Yes
If yes, please describe below who contacted you and on whose behalf, the manner
in which you were contacted (such as by phone, by mail, as part of group,
individually etc.), the subject matter of the communication and any other
relevant information, and attach copies of any written communications.
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
Are you aware of any facts related to this proxy vote that may present a
potential conflict of interest with the interests of the client(s) on whose
behalf the proxies are to be voted?
[_] No [_] Yes (describe below)
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
Certification:
The undersigned hereby certifies that to the best of his or her knowledge, the
above statements are complete and accurate, and that such override/decision is
in the client(s)' best interests without regard to the interests of MacKay
Shields or any related parties.
Date: ______________________
Name: ______________________
Title: _____________________
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Product Head Concurrence with Override Request/Decision:
Date: ______________________
Name: ______________________
Title: _____________________
Legal/Compliance Action:
[_] Override/decision approved
[_] Referred to Compliance Committee for Further Consideration
Date: ______________________
Name: ______________________
Title: _____________________
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ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
(A)(1) IDENTIFICATION OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS AND
DESCRIPTION OF ROLE OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS.
INFORMATION PROVIDED AS OF JANUARY 6, 2013
MacKay Shields LLC ("MacKay Shields" or the "Sub-Advisor") is a registered
investment adviser founded in 1938, and serves as the sub-advisor to the
Registrant. As of October 31, 2012, MacKay Shields had approximately $76.4
billion in assets under management.
DAN ROBERTS, PHD, SENIOR MANAGING DIRECTOR, CHIEF INVESTMENT OFFICER, GLOBAL
FIXED INCOME DIVISION
Mr. Roberts has 36 years of investment experience. During Mr. Roberts' career,
he has served as a Chief Investment Officer/Managing Director and head of
several fixed-income groups. His regulatory and government experience includes
two years at the U.S. Securities and Exchange Commission, serving at The White
House with the President's Council of Economic Advisors and as Executive
Director (Chief of Staff) of the U.S. Congress Joint Economic Committee. Mr.
Roberts holds a BBA and a PhD from University of Iowa. In October 2004, Mr.
Roberts joined MacKay Shields when the firm acquired the fixed income assets of
Pareto Partners.
LOUIS N. COHEN, CFA, SENIOR PORTFOLIO MANAGER, GLOBAL FIXED INCOME DIVISION
Mr. Cohen has 35 years of investment experience. During his career, Mr. Cohen
has served as a Core/Core Plus Portfolio Manager and was Co-Chairman of a Credit
Committee. He has extensive credit experience, beginning in a Commercial Banking
Department. He began to specialize in fixed-income in 1981, and became a
fixed-income credit manager at several major firms. With experience in the
fixed-income markets since 1978, Mr. Cohen is a past President of the Capital
Markets Credit Analyst Society and a member of the New York Society of Security
Analysts. Mr. Cohen received his BA and MBA from New York University. He also
holds the Chartered Financial Analyst designation. Mr. Cohen joined MacKay
Shields in October 2004 when the firm acquired the fixed income assets of Pareto
Partners.
MICHAEL KIMBLE, CFA, MANAGING DIRECTOR, GLOBAL FIXED INCOME DIVISION
Mr. Kimble has 29 years of investment experience. During Mr. Kimble's career, he
has served as a fixed-income credit analyst, a high-yield bond analyst and a
portfolio manager. He has also been Co-Chairman of a Credit Committee. With
fixed-income experience since 1984, Mr. Kimble is a member of the Capital
Markets Credit Analyst Society, the New York Society of Security Analysts and
the New York and Louisiana State Bar Associations. Mr. Kimble received a BA from
Columbia University, an MBA from New York University and a JD from Fordham
School of Law. He also holds the Chartered Financial Analyst designation. Mr.
Kimble joined MacKay Shields in October 2004 when the firm acquired the fixed
income assets of Pareto Partners.
TAYLOR WAGENSEIL, MANAGING DIRECTOR, GLOBAL FIXED INCOME DIVISION
Mr. Wagenseil has 34 years of investment experience. During his career, Mr.
Wagenseil has served as a specialist in troubled loan workouts and recoveries.
He headed a High Yield Commercial Paper Research department and has been a
managing director of a Financial Restructuring Group. He was a Senior Portfolio
Manager for High Yield and High Yield Arbitrage Portfolios. His public service
and military experience includes the U.S. Navy (Lieutenant) during the Vietnam
War and five years as the Commissioner, Department of Elderly Affairs for the
City of Boston. Mr. Wagenseil received a BA from Dartmouth College and an MBA
(finance) from the Harvard Business School. Mr. Wagenseil joined MacKay Shields
in October 2004 after the firm acquired the fixed income assets of Pareto
Partners.
(A)(2) OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBER
AND POTENTIAL CONFLICTS OF INTEREST
INFORMATION PROVIDED AS OF OCTOBER 31, 2012.
# of Accounts
Managed for Total Assets for
Total # of which Advisory which Advisory
Name of Portfolio Accounts Fee is Based Fee is Based on
Manager or Team Member* Type of Accounts* Managed Total Assets on Performance Performance
1. Dan Roberts Registered Investment 12 $4,568,670,197 0 $0
Companies:
Other Pooled Investment 17 $12,160,564,068 2 $520,479,991
Vehicles:
Other Accounts: 173 $27,541,215,208 8 $2,233,738,189
2. Louis Cohen Registered Investment 12 $4,568,670,197 0 $0
Companies:
Other Pooled Investment 17 $12,160,564,068 2 $520,479,991
Vehicles:
Other Accounts: 173 $27,541,215,208 8 $2,233,738,189
3. Michael Kimble Registered Investment 12 $4,568,670,197 0 $0
Companies:
Other Pooled Investment 17 $12,160,564,068 2 $520,479,991
Vehicles:
4. Taylor Wagenseil Registered Investment 12 $4,568,670,197 0 $0
Companies:
Other Pooled Investment 17 $12,160,564,068 2 $520,479,991
Vehicles:
Other Accounts: 173 $27,541,215,208 8 $2,233,738,189
* The Global Fixed Income Team utilizes a team approach in all aspects of
investment management and decision-making. No one portfolio manager is
singularly responsible for any particular account.
POTENTIAL CONFLICTS OF INTERESTS
Most of Mackay Shields' clients pay an investment advisory or management fee
that is based on the amount of assets in the clients' accounts. These are
commonly referred to as "asset-based fees". Some of Mackay Shields' clients pay
fees calculated as a percentage of returns, or as a percentage of the increase
in net asset value. These fees may be tied to a client-directed benchmark and
may be subject to a loss carry forward. They are commonly referred to as
"performance-based fees".
Managing accounts that have a performance-based fee at the same time as managing
accounts that only have an asset-based fee is commonly referred to as
"side-by-side management." Mackay Shields' portfolio managers may manage
multiple accounts, including separate accounts, unregistered funds and
registered funds, according to the same or similar investment strategies. This
creates a conflict of interest by giving an incentive to favor those accounts
for which Mackay Shields receives a performance-based fee because Mackay Shields
will receive a higher fee if performance exceeds the applicable benchmark.
Higher fees benefit Mackay Shields as well as Mackay Shields' employees because
the asset-based fees and performance-based fees are included in the pool from
which incentive bonuses are paid to Mackay Shields' employees. In addition, the
long-term incentive plan for our senior employees is based on our company's
financial results.
It is our policy not to favor the interest of one client over another. We
address the conflicts of interest created by "side-by-management" by having a
trade allocation policy designed so that trades are allocated among client
accounts in a fair and equitable manner over time.
Regardless of their fee arrangements, when we manage accounts according to the
same investment strategy, we anticipate that those accounts will generally have
the same investment opportunities and be invested in the same or similar
securities with the same or similar weighting. However, there are often
differences in the nature or amount of securities that we buy or sell for client
accounts, because of a variety of factors, including, among others:
1. Specific client investment objectives
2. Cash available in the account for investment
3. Client-imposed investment restrictions
4. Initial investment periods for new accounts
5. Investment restrictions that laws or regulations impose
6. Actual and anticipated cash inflows and outflows in client accounts
7. Duration and/or average maturity of the client account
8. Size of client account
9. Deal size
10. Current industry or issuer exposure in the client account
11. Rounding to whole lots (for example, 100 shares or 10,000 bonds)
12. Other practical limitations
We allocate securities among client accounts based on the above factors and
usually do so before executing the trade. When it is impractical or not feasible
to allocate prior to the execution of the trade, we will allocate the trade
after the trade is executed but in no event later than the end of the day, in a
fair and equitable manner among all the participating accounts, based on the
above factors. In those situations in which there is a limited supply of a
security, it is our general policy to make a pro rata allocation based on the
original amounts targeted for the accounts. However, if in our portfolio
managers' judgment the amount that would then be allocated to an account would
be too small to properly manage, that account could be excluded from the pro
rata allocation.
In addition, our policies include (a) that we will not permit cross trades
between clients unless the portfolio manager instructing the trade deems it in
the best interest of both clients at the time and obtains advance approval of
the transaction, (b) a general prohibition against same day opposite direction
transactions, and (c) short sale trade procedures requiring pre-approval of
short sales and restricting certain short sales.
Finally, Mackay Shields' Code of Ethics and other policies and procedures
reinforce a manager's obligation to treat all clients fairly and equitably.
These policies, procedures, and the Code are designed to restrict a portfolio
manager from favoring one client over another.
(A)(3) COMPENSATION STRUCTURE OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS
INFORMATION PROVIDED AS OF OCTOBER 31, 2012.
MacKay Shields establishes salaries at competitive levels in an effort to
attract and maintain high caliber professional employees, including the
portfolio management team. In addition, short-term incentive compensation, in
the form of bonus equal to a significant percentage of the firm's pre-tax
profits, is paid annually to the firm's employees. The bonus generally
represents a sizable amount relative to the base salary, and when considered
with the base salary, results in a highly attractive level of total cash
compensation for the firm's professional employees. Most employees, including
the portfolio management team, participate in the bonus pool. This approach
instills a strong sense of commitment on the part of each employee towards the
overall success of the firm.
The compensation received by portfolio managers is based on both quantitative
and qualitative factors. The quantitative factors may include (i) the portfolio
managers' overall investment performance, (ii) the assets under their
management, (iii) the overall profitability of their investment team and the
firm, and (iv) industry benchmarks. The qualitative factors include, among
others, leadership and adherence to the firm's policies and procedures. To the
extent that an increase in the size of an account (including a mutual fund)
managed by a portfolio manager results in an increase in the firm's
profitability, the portfolio manager's compensation may also increase. There is
no difference between the method used in determining portfolio managers'
compensation with respect to one account and other accounts they manage.
Performance-based fees may be calculated as a percentage of returns, or as a
percentage of the increase in net asset value, and may be tied to a
client-directed benchmark or loss carry forward. A portion of these
performance-based fees forms a part of the bonus pool for all employees. Of
course, there are periods in which the firm does not earn any performance fee.
Historically, long-term incentive compensation for some of MacKay Shields'
senior employees, including the senior members of the portfolio management team,
has been phantom stock and options of New York Life Investment Management
Holdings LLC ("NYL Investments Holdings"), the immediate corporate parent of
MacKay, based on the overall performance of NYL Investments Holdings. Beginning
January 1, 2010, MacKay Shields adopted the MacKay Shields Equity Plan, which
provides phantom stock to senior employees, including the senior members of the
portfolio management team, and which replaces the prior plan for our employees.
Awards under the prior plan continue to vest and pay out according to the terms
of that plan.
The senior portfolio managers involved in managing the Registrant's investments
have each entered into Executive Employment Agreements with MacKay Shields,
which include provisions relating to base salary and incentive salary as
described above. The Executive Employment Agreements are for renewable one year
terms and can be terminated on 60 days' prior written notice. There is also a
provision for termination by MacKay Shields for cause, as defined in the
Agreements. The Agreements contain restrictions regarding non-solicitation of
clients and non-hiring of employees following termination of the portfolio
managers' employment. None of the portfolio managers is subject to a non-compete
agreement that could potentially affect the portfolio manager's ability to
manage the Registrant.
(A)(4) DISCLOSURE OF SECURITIES OWNERSHIP
INFORMATION PROVIDED AS OF OCTOBER 31, 2012.
Dollar Range of Fund Shares
Name Beneficially Owned
Dan Roberts $0
---------------------------------------------------------
Taylor Wagenseil $0
---------------------------------------------------------
Louis Cohen $100,001-$500,000
---------------------------------------------------------
Michael Kimble $0
---------------------------------------------------------
(B) Not applicable.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR
229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)),
or this Item.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers, or
persons performing similar functions, have concluded that the
registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the "1940
Act") (17 CFR 270.30a-3(c))) are effective, as of a date within 90 days
of the filing date of the report that includes the disclosure required by
this paragraph, based on their evaluation of these controls and
procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR
270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities
Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or 240.15d-15(b)).
(b) There were no changes in the registrant's internal control over financial
reporting (as defined in Rule 30a-3(d) under the 1940 Act (17 CFR
270.30a-3(d)) that occurred during the registrant's second fiscal quarter
of the period covered by this report that has materially affected, or is
reasonably likely to materially affect, the registrant's internal control
over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Code of ethics, or any amendment thereto, that is the subject of
disclosure required by Item 2 is attached hereto.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached
hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and
Section 906 of the Sarbanes- Oxley Act of 2002 are attached
hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) First Trust High Income Long/Short Fund
------------------------------------------
By (Signature and Title)* /s/ Mark R. Bradley
------------------------------------------
Mark R. Bradley, President and
Chief Executive Officer
(principal executive officer)
Date: December 24, 2012
--------------------
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /s/ Mark R. Bradley
------------------------------------------
Mark R. Bradley, President and
Chief Executive Officer
(principal executive officer)
Date: December 24, 2012
--------------------
By (Signature and Title)* /s/ James M. Dykas
------------------------------------------
James M. Dykas, Treasurer, Chief Financial
Officer and Chief Accounting Officer
(principal financial officer)
Date: December 24, 2012
--------------------
* Print the name and title of each signing officer under his or her signature.