The changes of the fair value of investments for which the
Trust has used Level 3 inputs to determine the fair value are as follows:
The following table summarizes the quantitative
inputs and assumptions used for investments categorized in Level 3 of the fair value hierarchy as of the end of the reporting period.
In addition to the techniques and inputs noted in the table below, according to the Trust’s valuation policy, the Trust may use
other valuation techniques and methodologies when determining the Trust’s fair value measurements as provided for in the valuation
policy and approved by the Board of Trustees. The table below is not intended to be all-inclusive, but rather provides information on
the significant Level 3 inputs as they relate to the fair value measurements as of the end of the reporting period.
Significant increases or decreases in any of the unobservable
inputs in isolation may result in a significantly lower or higher fair value measurement.
XA Investments LLC (“XAI”
or the “Adviser”) serves as the investment adviser to the Trust and is responsible for overseeing the Trust’s overall
investment strategy and its implementation. Octagon Credit Investors, LLC (“Octagon” or the “Sub-Adviser”) serves
as the investment sub-adviser of the Trust and is responsible for investing the Trust’s assets. The Trust pays an advisory fee to
the Adviser. The Adviser pays to the Sub-Adviser a sub- advisory fee out of the advisory fee received by the Adviser.
Pursuant to an investment advisory agreement
between the Trust and the Adviser, the Trust pays the Adviser a fee, payable monthly in arrears, in an annual amount equal to 1.70% of
the Trust’s average daily Managed Assets. “Managed Assets” means the total assets of the Trust, including assets attributable
to the Trust’s use of leverage and preferred shares, minus the sum of its accrued liabilities (other than liabilities incurred for
the purpose of creating leverage). For the year ended September 30, 2021, the Trust incurred $3,707,426 in advisory fees.
Pursuant to an investment sub-advisory
agreement among the Trust, the Adviser and the Sub-Adviser, the sub-advisory fee, payable monthly in arrears to the Sub-Adviser, is calculated
as a specified percentage of the advisory fee payable by the Trust to the Adviser (before giving effect to any fees waived or expenses
reimbursed by the Adviser). The specified percentage is equal to the blended percentage computed by applying the following percentages
to the aggregate average daily Managed Assets of all registered investment companies in the XAI fund complex for which the Sub-Adviser
(or an affiliate of the Sub-Adviser) serves as investment sub-adviser, including the Trust (“Eligible Funds”):
As of September 30, 2021, the Trust was the
only Eligible Fund, and the sub-advisory fee equals 60% of the advisory fee payable to the Adviser. The Sub-Adviser fees are paid by
the Adviser. Pursuant to the investment sub-advisory agreement, from time to time the Trust may reimburse the Sub- Adviser for certain
costs and expenses incurred by the Sub-Adviser in connection with the management of the Trust’s assets. For the year ended September
30, 2021, the Trust incurred $114,909 in reimbursements made to the Sub-Adviser. These costs are included in Other Expenses in the Statement
of Operations.
The Trust does not pay a performance or incentive fee to the
Adviser or the Sub-Adviser.
The Trust pays all costs and expenses
of its operations in addition to the advisory fee and investor support services and secondary market support services fee paid to the
Adviser. For the period from September 27, 2017 to September 27, 2019, the Adviser and the Trust entered into a fee waiver agreement.
The fee waiver agreement expired on September 27, 2019. Under the fee waiver agreement, the Adviser had contractually agreed to waive
a portion of the advisory fee and/or reimburse the Trust for certain operating expenses so that the annual expenses of the Trust did not
exceed 0.30% of the Trust’s Managed Assets (exclusive of investment advisory fees, investor support and secondary market services
fees, taxes, expenses incurred directly or indirectly by the Trust as a result of an investment in a permitted investment (including,
without limitation, acquired fund fees and expenses), expenses associated with the acquisition or disposition of portfolio investments
(including, without limitation, brokerage commissions and other trading or transaction expenses), leverage expenses (including, without
limitation, costs associated with the issuance or incurrence of leverage, commitment fees, interest expense or dividends on preferred
shares), expenses incurred in connection with issuances and sales of shares of the Trust (including, without limitation, fees, commissions
and offering costs), dividends on short sales, if any, securities lending costs, if any, expenses of holding and soliciting proxies for
meetings of shareholders of the Trust (except to the extent relating to routine items such as the election of Trustees), expenses of a
reorganization, restructuring, reconciling or merger of the Trust or the acquisition of all or substantially all of the assets of another
fund, or any extraordinary expenses not incurred in the ordinary course of the Trust’s business (including, without limitation,
expenses related to litigation, derivative actions, demands related to litigation, regulatory or other government investigations and proceeding)).
The Adviser may recoup waived or reimbursed amounts for three years following the date of such waiver or reimbursement, provided total
expenses, including such recoupment, do not exceed the lesser of the annual expense limit at the time such expenses were waived or reimbursed
or the annual expense limit at the time of recoupment. As of September 30, 2021, $718,370 was available for recoupment by the Adviser,
which will expire as of September 30, 2022.
The Trust has also retained the Adviser
to provide investor support services and secondary market support services in connection with the ongoing operation of the Trust. Such
services include providing ongoing contact with respect to the Trust with financial intermediaries, communicating with the NYSE specialist
for the shares and with the closed-end fund analyst community regarding the Trust on a regular basis, and hosting and maintaining a website
for the Trust. The Trust pays the Adviser an investor support services and secondary market support services fee, payable monthly in arrears,
in an annual amount equal to 0.20% of the Trust’s average daily Managed Assets. For the year ended September 30, 2021, the Trust
incurred $436,168 in investor support services. A Trustee and certain officers of the Trust are affiliated with the Adviser and receive
no compensation from the Trust for serving as officers and/or Trustee.
SS&C ALPS Fund Services, Inc. (“ALPS”)
serves as the Trust’s administrator and accounting agent and receives customary fees from the Trust for such services. Administrative
and accounting fees paid by the Trust for the year ended September 30, 2021 are disclosed in the Statement of Operations.
An employee of ALPS serves as the Trust’s
chief compliance officer. ALPS provides services that assist the Trust’s chief compliance officer in monitoring and testing the
policies and procedures of the Trust in conjunction with requirements under Rule 38a-1 under the 1940 Act and receives an annual base
fee. ALPS is reimbursed for certain out-of-pocket expenses by the Trust. Compliance service fees paid by the Trust for the year ended
September 30, 2021 are disclosed in the Statement of Operations.
An employee of PINE Advisor Solutions,
LLC (“PINE”) serves as the Trust’s principal financial officer. PINE receives an annual base fee for the services provided
to the Trust. PINE is reimbursed for certain out-of-pocket expenses by the Trust. Service fees paid by the Trust for the year ended September
30, 2021 are disclosed in the Statement of Operations.
DST Systems Inc., an affiliate of ALPS,
serves as transfer, dividend paying and shareholder servicing agent for the Trust. U.S. Bank N.A. serves as the Trust’s custodian.
Transfer agent fees paid by the Trust for the year ended September 30, 2021 are disclosed in the Statement of Operations.
The Trust intends to pay substantially all of
its net investment income, if any, to holders of common shares (“Common Shareholders”) through periodic distributions. The
Trust intends to distribute any net long-term capital gains to Common Shareholders at least annually. The Trust intends to declare distributions
monthly. To permit the Trust to maintain more stable monthly distributions, the Trust may distribute more or less than the amount of
the net income earned in a particular period. There is no assurance the Trust will continue to pay regular monthly distributions or that
it will do so at a particular rate. Distributions may be paid by the Trust from any permitted source and, from time to time, all or a
portion of a distribution may be a return of capital. Shareholders should not assume that the source of the distribution from the Trust
is net income or profit.
The Series 2026 Term Preferred Shares
pay a quarterly dividend at a fixed annual rate of 6.50% of the Liquidation Preference, or $1.625 per share per year, which is referred
to as the “Fixed Dividend Rate.” The Fixed Dividend Rate is subject to adjustment under certain circumstances.
For the year ended September 30, 2021, the Trust paid the following
distributions or dividends totaling $0.876 per common share and $0.40 per preferred share, or $16,008,876 and $957,198 respectively, in
the aggregate:
The Trust expects that distributions paid
on the Common Shares (as defined below) will consist primarily of (i) investment company taxable income, which includes ordinary income
(such as interest, dividends, and certain income from hedging or derivatives transactions) and the excess, if any, of net short-term capital
gain over net long-term capital loss, and (ii) net capital gain (which is the excess of net long-term capital gain over net short- term
capital loss). All or a portion of a distribution may be a return of capital, which is determined on a tax basis.
Cumulative cash
dividends or distributions on each Series 2026 Term Preferred Share are payable quarterly, when, as and if declared, or under
authority granted, by the Board of Trustees out of funds legally available for such payment and in preference to dividends and
distributions on Common Shares. If the Trust is unable to distribute the full dividend amount due in a dividend period on the
Trust’s Series 2026 Term Preferred Shares, the dividends will be distributed on a pro rata basis among the preferred
shareholders. The Trust pays dividends on the Series 2026 Term Preferred Shares every January 31, April 30, July 31 and October 31,
commencing July 31, 2021.
The Trust’s net investment income
and capital gain can vary significantly over time, however, the Trust seeks to maintain more stable monthly common share distributions
over time. To permit the Trust to maintain more stable monthly common share distributions, the Trust may initially distribute less than
the entire amount of the net investment income earned in a particular period. The undistributed net investment income may be available
to supplement future common share distributions. Undistributed net investment income is included in the Common Shares’ net asset
value, and, correspondingly, distributions from net investment income will reduce the Common Shares’ net asset value.
The Trust’s investments in CLOs
may be subject to complex tax rules and the calculation of taxable income attributed to an investment in CLO subordinated notes can be
dramatically different from the calculation of income for financial reporting purposes under accounting principles generally accepted
in the United States (“U.S. GAAP”), and, as a result, there may be significant differences between the Trust’s GAAP
income and its taxable income. The Trust’s final taxable income for the current fiscal year will not be known until the Trust’s
tax returns are filed.
All or a portion of a distribution may
be a return of capital, which is in effect a partial return of the amount a shareholder invested in the Trust, up to the amount of the
shareholder’s tax basis in their shares, which would reduce such tax basis. Although a return of capital may not be taxable, it
will generally increase the shareholder’s potential gain, or reduce the shareholder’s potential loss, on any subsequent sale
or other disposition of shares. Shareholders who periodically receive the payment of a distribution consisting of a return of capital
may be under the impression that they are receiving net income or profits when they are not. Shareholders should not assume that the source
of a distribution from the Trust is net income or profit.
Pursuant to the requirements of the 1940
Act, in the event the Trust makes distributions from sources other than income, such as return of capital, a notice will be provided in
connection with each monthly distribution with respect to the estimated source of the distribution made. Such notices will describe the
portion, if any, of the monthly dividend which, in the Trust’s good faith judgment, constitutes long-term capital gain, short-term
capital gain, investment company taxable income or a return of capital. The characterization of distributions paid to shareholders reflect
estimates made by the Trust. Such estimates are subject to be characterized differently for federal income tax purposes at year-end. The
actual character of such dividend distributions for U.S. federal income tax purposes will only be determined finally by the Trust at the
close of its fiscal year, based on the Trust’s full year performance and its actual net investment company taxable income and net
capital gains for the year, which may result in a recharacterization of amounts distributed during such fiscal year from the characterization
in the monthly estimates.
The Trust may, but is not required to,
seek to obtain exemptive relief to permit the Trust to make periodic distributions of long-term capital gains with respect to its Common
Shares as frequently as monthly. Such relief, if obtained, would permit the Trust to implement a “managed distribution policy”
pursuant to which the Trust would distribute a fixed percentage of the net asset value (or market price if then applicable) of the Common
Shares at a particular point in time or a fixed monthly amount, any of which may be adjusted from time to time. It is anticipated that
under such a distribution policy, the minimum annual distribution rate with respect to the Common Shares would be independent of the Trust’s
performance during any particular period but would be expected to correlate with the Trust’s performance over time.
The Trust reserves the right to change
its distribution policy and the basis for establishing the rate of distributions at any time and may do so without prior notice to Common
Shareholders. Future distributions will be made if and when declared by the Trust’s Board of Trustees, based on a consideration
of number of factors, including the Trust’s continued compliance with terms and financial covenants of its senior securities, the
Trust’s net investment income, financial performance and available cash. There can be no assurance that the amount or timing of
distributions in the future will be equal or similar to that of past distributions or that the Board of Trustees will not decide to suspend
or discontinue the payment of distributions in the future.
Common share distributions shall be paid
on their payment date unless the payment of such distribution is deferred by the Board of Trustees upon a determination that such deferral
is required in order to comply with applicable law or the applicable terms or financial covenants of the Trust’s senior securities
or to ensure that the Trust remains solvent and able to pay its debts as they become due and continue as a going concern.
Pursuant to the Trust’s Agreement
and Declaration of Trust, the Trust is authorized to issue an unlimited number of shares of beneficial interest, par value $0.01 per share.
The table below provides information of the Trust's outstanding
common shares of beneficial interest par value of $0.01 per share ("Common Shares").
The Board of Trustees is authorized to
classify and reclassify any unissued shares into other classes or series of shares and authorize the issuance of shares without obtaining
stockholder approval. During the period, the Board of Trustees classified 1,596,000 of the Trust’s shares of beneficial interest
as Series 2026 Term Preferred Shares.
On November 15, 2019, the Trust entered
into an underwriting agreement among the Adviser, the Sub-Adviser and the underwriters listed therein to sell 960,000 Common Shares (exclusive
of 144,000 Common Shares that the underwriters had the right to purchase pursuant to a 45-day option to cover overallotments, if any)
at a price to the public of $8.36 per share. On November 18, 2019, the underwriters partially exercised the overallotment option to purchase
138,500 Common Shares. On November 19, 2019, the Trust issued and sold to the underwriters 1,098,500 Common Shares at a total public offering
price (before deduction of the sales load and offering expenses) of $9,183,460.
On January 17, 2020, the Trust entered
into an Amended and Restated Distribution Agreement with Foreside Fund Services, LLC (the “Distributor”), pursuant to which
the Trust could offer and sell up to 4,250,000 Common Shares, from time to time, through the Distributor, in transactions that are deemed
to be “at-the-market” as defined in Rule 415 under the Securities Act of 1933.
On December 4, 2020, the Trust entered
into a Second Amended and Restated Distribution Agreement with Foreside Fund Services, LLC (the "Distributor"), pursuant to
which the Trust could offer and sell up to 5,250,000 Common Shares, from time to time, through the Distributor, in transactions that are
deemed to be at-the-market as defined in Rule 415 under the Securities Act of 1933.
On December 18, 2020, the Trust filed
with the SEC a new shelf registration statement on Form N-2 allowing for delayed or continuous offering of up to $100,000,000 aggregate
initial offering price of Common Shares, preferred shares, subscription rights for Common Shares and subscription rights for preferred
shares. The shelf registration statement was declared effective on February 2, 2021.
On February 5, 2021, the Trust entered
into a new Distribution Agreement with the Distributor, pursuant to which the Trust may offer and sell up to 8,000,000 Common Shares,
from time to time, through the Distributor, in transactions that are deemed to be “at-the-market” as defined in Rule 415 under
the Securities Act of 1933. The minimum price on any day at which Common Shares may be sold will not be less than the then current net
asset value per Common Share plus any commissions to be paid to the Distributor. The Trust’s at-the-market program shares issued
and proceeds generated were as follows:
On February 25, 2021, the Trust entered
into an underwriting agreement among the Trust, the Adviser, the Sub-Adviser and the underwriters listed therein to sell 2,900,250 Common
Shares (exclusive of 435,038 Common Shares that the underwriters had the right to purchase pursuant to a 30-day option to cover overallotments,
if any) at a price to the public of $8.62 per share. On March 29, 2021, the Trust issued and sold to the underwriters 2,900,250 Common
Shares at a total public offering price (before deduction of the sales load and offering expenses) of $25,000,155.
On March 1, 2021, the underwriters partially
exercised the overallotment option to purchase 369,052 Common Shares at a total public offering price (before deduction of the sales
load and offering expenses) of $3,181,228.
On March 23, 2021, the Trust entered into
an underwriting agreement among the Trust, the Adviser, the Sub-Adviser and the underwriters listed therein to sell 1,040,000 Series 2026
Term Preferred Shares (exclusive of 156,000 Series 2026 Term Preferred Shares that the underwriters had the right to purchase pursuant
to a 30-day option to cover overallotments, if any) at a price to the public of $25.00 per share. On March 29, 2021, the Trust issued
and sold to the underwriters 1,040,000 Series 2026 Term Preferred Shares at a total public offering price (before deduction of the sales
load and offering expenses) of $26,000,000. On April 3, 2021, the underwriters partially exercised the overallotment option to purchase
156,000 Series 2026 Term Preferred Shares totaling $3,900,000 (before deduction of the sales load and offering expenses).
On July 21, 2021, the Trust entered into
an underwriting agreement among the Trust, the Adviser, the Sub-Adviser and the underwriters listed therein to sell 3,100,000 Common Shares
(exclusive of 465,000 Common Shares that the underwriters had the right to purchase pursuant to a 30-day option to cover overallotments,
if any) at a price to the public of $8.50 per share. On July 23, 2021, the Trust issued and sold to the underwriters 3,565,000 Common
Shares (including the overallotment of 465,000 Common Shares, which was exercised on July 21, 2021) at a total public offering price (before
deduction of the sales load and offering expenses) of $30,302,500.
On September 8, 2021, the Trust entered
into a direct purchase agreement between the Trust and the purchasers listed therein to sell in a privately negotiated transaction 400,000
Series 2026 Term Preferred Shares at a price $25.00 per Share (plus accrued dividends equal to $0.17604 per share). On September 9, 2021,
the Trust issued and sold to the purchasers 400,000 Series 2026 Term Preferred Shares for total gross proceeds (before deduction of offering
expenses) of $10,000,000 (plus accrued dividends).
The Trust paid $846,889 in offering costs
during the year relating to the at-the-market program, the common share and preferred share underwriting agreements, and the direct purchase
agreement; offering costs are charged to paid-in capital upon the issuance of shares. For the year ended September 30, 2021, the Trust
deducted $641,795 of offering costs from paid-in capital. The Statement of Assets and Liabilities as of September 30, 2021 reflect $269,918
of deferred offering costs outstanding.
The Trust uses leverage to seek to enhance
total return and income. The Trust may use leverage through (i) the issuance of senior securities representing indebtedness, including
through borrowing from financial institutions or issuance of debt securities, including notes or commercial paper (collectively, “Indebtedness”),
(ii) the issuance of preferred shares (“Preferred Shares”) and/or (iii) reverse repurchase agreements, securities lending,
short sales or derivatives, such as swaps, futures or forward contracts, that have the effect of leverage (“portfolio leverage”).
The Trust currently intends to use leverage through Indebtedness and may use Indebtedness to the maximum extent permitted under the 1940
Act. Under the 1940 Act, the Trust may utilize Indebtedness up to 33 1/3% of its Managed Assets (specifically, the Trust may not incur
Indebtedness if, immediately after incurring such Indebtedness, the Trust would have asset coverage (as defined in the 1940 Act) of less
than 300% and the preferred asset coverage shall not be less than 200%). The Trust will not utilize leverage, either through Indebtedness,
Preferred Shares or portfolio leverage, in an aggregate amount in excess of 40% of the Trust’s Managed Assets (including the proceeds
of leverage).
The Trust entered into a Credit Agreement
dated October 6, 2017 as amended from time to time (the “Credit Agreement”) with Société Générale
(the “Lender”) that establishes a revolving credit facility (the “Facility”). Currently, the Trust may borrow
up to $125,000,000. The Facility’s maturity date is March 22, 2023, subject to certain reciprocal termination rights. The Trust
pays interest on amounts borrowed based on one-month LIBOR plus 1.25%. Interest charged to the Trust during the year is presented on the
Statement of Operations under Interest expense and amortization of deferred leverage costs. The Trust’s borrowings are secured by
eligible securities held in its portfolio of investments. The Credit Agreement includes usual and customary covenants. Among other things,
these covenants place limitations or restrictions on the Trust’s ability to (i) incur other indebtedness, (ii) change certain investment
policies, or (iii) pledge or create liens upon the assets of the Trust. In addition, the Trust is required to deliver financial information
to the Lender, maintain an asset coverage ratios with respect to its Indebtedness and Preferred Shares as required by the 1940 Act, meet
certain other coverage tests and financial covenants and maintain its registration as a closed-end management investment company. No violations
of the credit agreement occurred during the year ended September 30, 2021.
For the year ended September 30, 2021,
the average amount borrowed under the Credit Agreement and the average interest rate for the amount borrowed was $59,188,356 and 1.32%,
respectively. As of September 30, 2021, the amount of such outstanding borrowings was $98,150,000. The interest rate applicable to the
borrowings on September 30, 2021 was 1.38%. All securities held as of September 30, 2021 are pledged as collateral for the leverage facility.
The maximum borrowed during the year ended was $101,150,000.
On March 29, 2021, the Trust issued 1,040,000
shares of Series 2026 Term Preferred Shares (exclusive of 156,000 Series 2026 Term Preferred Shares that the underwriters had the right
to purchase pursuant to a 30 day option to cover overallotments, if any), listed under trading symbol XFLTPRA on the NYSE, with a liquidation
preference of $25.00 per share plus accrued and unpaid dividends (whether or not declared). On April 3, 2021, the underwriters partially
exercised an overallotment option to purchase 156,000 Series 2026 Term Preferred Shares. On September 9, 2021, the Trust issued an additional
400,000 shares of the Series 2026 Term Preferred Shares. The Series 2026 Term Preferred Shares are entitled to a dividend at a rate of
6.50% per year, paid quarterly, based on the $25.00 liquidation preference before the common stock is entitled to receive any dividends.
The Series 2026 Term Preferred Shares are generally not redeemable at the Trust’s option prior to the close of business on March
31, 2023, and are subject to mandatory redemption by the Trust in certain circumstances. On or after September 30, 2026, the Trust may
redeem in whole, or from time to time in part, outstanding Series 2026 Term Preferred Shares at a redemption price per share equal to
the per share liquidation preference of $25.00 per share, plus accumulated and unpaid dividends, if any, through the date of redemption.
Issuance costs related to the Series 2026 Term Preferred Shares of $1,285,375 are deferred and amortized over the period the Preferred
Shares are outstanding.
Opinion on the Financial Statements
We have audited the accompanying statement of
assets and liabilities, including the schedule of investments, of XAI Octagon Floating Rate & Alternative Income Term Trust (the
“Fund”) as of September 30, 2021, the related statements of operations, changes in net assets applicable to common shareholders
and cash flows, the related notes, and the financial highlights for the year then ended (collectively referred to as the “financial
statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the
Fund as of September 30, 2021, the results of its operations, the changes in net assets applicable to common shareholders and cash flows,
and the financial highlights for the year then ended, in conformity with accounting principles generally accepted in the United States
of America.
The Fund’s financial statements and financial
highlights for the periods ended September 30, 2020 and prior, were audited by other auditors whose report dated November 27, 2020, expressed
an unqualified opinion on those financial statements and financial highlights.
Basis for Opinion
These financial statements are the responsibility
of the Fund’s management. Our responsibility is to express an opinion on the Fund’s financial statements based on our audit.
We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and
are required to be independent with respect to the Fund in accordance with the U.S. federal securities laws and the applicable rules
and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the
standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement whether due to error or fraud.
Our audit included performing procedures to
assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond
to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements.
Our procedures included confirmation of securities owned as of September 30, 2021, by correspondence with the custodian and agent banks;
when replies were not received from agent banks, we performed other auditing procedures. Our audit also included evaluating the accounting
principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that our audit provides a reasonable basis for our opinion.
We have served as the Fund’s auditor since 2021.
COHEN & COMPANY, LTD.
Cleveland, Ohio
November 24, 2021
|
XAI Octagon Floating Rate &
|
Certain Changes
Occurring
|
|
Alternative
Income Term Trust
|
During
the Prior Fiscal Year
|
|
|
September 30, 2021 (Unaudited)
|
The following information is a summary of certain
changes during the most recent fiscal year. This information may not reflect all of the changes that have occurred since you purchased
shares of the Trust.
CHANGE IN NON-FUNDAMENTAL INVESTMENT POLICIES
None.
|
Annual Report | September 30, 2021
|
47
|
|
XAI Octagon Floating Rate &
|
|
|
Alternative Income Term Trust
|
Fees
and Expenses
|
|
|
September 30, 2021 (Unaudited)
|
The following table contains information about the costs and expenses
that Common Shareholders will bear directly or indirectly. The table is based on the capital structure of the Trust as of September 30,
2021. The purpose of the table and the example below is to help Common Shareholders understand the fees and expenses that they would bear
directly or indirectly.
|
Common Shareholder Transaction Expenses
|
|
|
Sales load paid by Common Shareholders (as a percentage of offering price)
|
—(1)
|
|
Offering expenses borne by the Trust (as a percentage of offering price)
|
—(1)
|
|
Dividend reinvestment plan fees(2)
|
None
|
|
|
As a Percentage of Net Assets
|
|
|
Attributable to Common Shares
|
|
Annual Expenses
|
|
|
Management fees(3)
|
2.59%
|
|
Leverage expense
|
|
|
Interest payment on borrowed Funds(4)
|
0.73%
|
|
Preferred Share dividends(5)
|
0.67%
|
|
Other expenses
|
|
|
Investor Support and Secondary Market Support Services Fee(6)
|
0.30%
|
|
Other(7)(8)
|
0.99%
|
|
Total annual expenses
|
5.28%
|
|
(1)
|
If Common Shares are sold to or through underwriters, a prospectus
or prospectus supplement will set forth any applicable sales load and the estimated offering expenses borne by the Trust.
|
|
(2)
|
Common Shareholders will incur brokerage charges if they direct
DST Systems, as the dividend reinvestment plan agent for the Common Shareholders, to sell their Common Shares held in a dividend reinvestment
account.
|
|
(3)
|
The Trust pays the Adviser an annual management fee, payable
monthly in arrears, in an amount equal to 1.70% of the Trust’s average daily Managed Assets. Common Shareholders bear the portion
of the investment advisory fee attributable to the assets purchased with the proceeds of leverage, which means that Common Shareholders
effectively bear the entire management fee. The contractual management fee rate of 1.70% of the Trust’s Managed Assets represents
an effective management fee rate of 2.58% of net assets attributable to Common Shares, assuming financial leverage of 38.71% of the Trust’s
Managed Assets (the Trust’s outstanding financial leverage as of September 30, 2021). The Adviser pays to the Sub-Adviser a sub-advisory
fee out of the management fee received by the Adviser.
|
|
(4)
|
Based on Indebtedness under the Credit Agreement at September
30, 2021 in an amount equal to $98,125,000, at an annual interest rate of 2.86% as of September 30, 2021. The costs associated with such
Indebtedness are borne entirely by Common Shareholders.
|
|
(5)
|
Based on 1,596,000 shares of 2026 Preferred Shares outstanding
at September 30, 2021 with an aggregate liquidation preference of $39.9 million and an annual dividend rate equal to 6.50% of such liquidation
preference. The costs associated with the 2026 Preferred Shares are borne entirely by Common Shareholders.
|
|
(6)
|
The Trust has retained the Adviser to provide investor support
services and secondary market support services in connection with the ongoing operation of the Trust. The Trust pays the Adviser a service
fee, payable monthly in arrears, in an annual amount equal to 0.20% of the Trust’s average daily Managed Assets.
|
|
(7)
|
Expenses attributable to the Trust’s investments, if
any, in other investment companies, including closed-end funds and exchange-traded funds, are currently estimated not to exceed 0.01%
of net assets attributable to Common Shares.
|
|
(8)
|
The “Other expenses” shown in the table and related
footnotes include operating expenses of the Trust and are based upon estimated amounts for the Trust’s current fiscal year.
|
Example
The following example illustrates the expenses that you would pay on
a $1,000 investment in Common Shares, assuming (1) total annual expenses of 5.28% of net assets attributable to Common Shares and (2)
a 5% annual return. The example assumes that the estimated Total Annual Expenses set forth in the Annual Expenses table are accurate and
that all dividends and distributions are reinvested at net asset value per Common Share. Actual expenses may be greater or less than those
assumed. Moreover, the Trust’s actual rate of return may be greater or less than the hypothetical 5% return shown in the example.
|
1 Year
|
3 Years
|
5 Years
|
10 Years
|
|
$53
|
$158
|
$262
|
$521
|
The Example should not be considered
a representation of future expenses or returns. Actual expenses may be higher or lower than those assumed. Moreover, the
Trust’s actual rate of return may be higher or lower than the hypothetical 5% return shown in the example.
|
XAI Octagon Floating Rate &
|
|
|
Alternative Income Term Trust
|
Market and Net Asset
Value Information
|
|
|
September 30, 2021 (Unaudited)
|
The Trust’s currently outstanding
Common Shares are listed on the NYSE. The Trust’s Common Shares commenced trading on the NYSE on September 27, 2017.
The Common Shares have traded both at
a premium and at a discount to the Trust’s net asset value per share. Although the Common Shares recently have traded at a premium
to net asset value, there can be no assurance that this will continue after the offering nor that the Common Shares will not trade at
a discount in the future. Shares of closed-end investment companies frequently trade at a discount to net asset value. The Trust’s
net asset value will be reduced immediately following an offering of the Common Shares due to the costs of such offering, which will be
borne entirely by the Trust. The sale of Common Shares by the Trust (or the perception that such sales may occur) may have an adverse
effect on prices of Common Shares in the secondary market. An increase in the number of Common Shares available may result in downward
pressure on the market price for Common Shares.
The following table sets forth, for
each of the periods indicated, the high and low closing market prices for the Common Shares on the NYSE, the net asset value per Common
Share and the premium or discount to net asset value per Common Share at which the Common Shares were trading.
|
|
|
|
|
|
|
|
|
Corresponding Net Asset Value
|
|
|
Corresponding Premium/(Discount)
|
|
|
|
|
Market Price
|
|
|
Per Common Share
|
|
|
as a Percentage of Net Asset Value
|
|
|
Fiscal Quarter Ended
|
|
High
|
|
|
Low
|
|
|
High
|
|
|
Low
|
|
|
High
|
|
|
Low
|
|
|
September 30, 2021
|
|
$
|
9.77
|
|
|
$
|
8.51
|
|
|
$
|
8.06
|
|
|
$
|
8.14
|
|
|
|
21.22
|
%
|
|
|
4.55
|
%
|
|
June 30, 2021
|
|
$
|
9.55
|
|
|
$
|
8.48
|
|
|
$
|
8.08
|
|
|
$
|
7.92
|
|
|
|
18.19
|
%
|
|
|
7.07
|
%
|
|
March 31, 2021
|
|
$
|
9.34
|
|
|
$
|
7.44
|
|
|
$
|
7.88
|
|
|
$
|
7.34
|
|
|
|
18.53
|
%
|
|
|
1.36
|
%
|
|
December 31, 2020
|
|
$
|
8.00
|
|
|
$
|
6.04
|
|
|
$
|
7.31
|
|
|
$
|
6.55
|
|
|
|
9.44
|
%
|
|
|
-7.79
|
%
|
|
September 30, 2020
|
|
$
|
6.55
|
|
|
$
|
5.85
|
|
|
$
|
5.89
|
|
|
$
|
5.87
|
|
|
|
11.21
|
%
|
|
|
-0.34
|
%
|
|
June 30, 2020
|
|
$
|
5.73
|
|
|
$
|
4.27
|
|
|
$
|
5.62
|
|
|
$
|
4.83
|
|
|
|
1.96
|
%
|
|
|
-11.59
|
%
|
|
March 31, 2020
|
|
$
|
8.35
|
|
|
$
|
4.08
|
|
|
$
|
8.03
|
|
|
$
|
4.51
|
|
|
|
3.99
|
%
|
|
|
-9.53
|
%
|
|
December 31, 2019
|
|
$
|
9.01
|
|
|
$
|
7.99
|
|
|
$
|
8.15
|
|
|
$
|
7.74
|
|
|
|
10.55
|
%
|
|
|
3.23
|
%
|
As of September 30, 2021, the last reported
sale price, net asset value per Common Share and percentage discount to net asset value per Common Share was $8.58, $8.19 and 4.76%, respectively.
The Trust cannot predict whether its
Common Shares will trade in the future at a premium to or discount from net asset value, or the level of any premium or discount. Shares
of closed-end investment companies frequently trade at a discount from net asset value. As a result of recent market conditions, the Trust’s
net asset value may fluctuate significantly.
|
Annual Report | September 30, 2021
|
49
|
|
XAI Octagon Floating Rate &
|
|
|
Alternative Income Term Trust
|
Investment Objective
and Policies
|
|
|
September 30, 2021 (Unaudited)
|
INVESTMENT OBJECTIVE
The investment objective of the Trust is to
seek attractive total return with an emphasis on income generation across multiple stages of the credit cycle. There can be no assurance
that the Trust will achieve its investment objective. The investment objective of the Trust may be changed by the Board of Trustees on
60 days’ prior written notice to shareholders.
INVESTMENT STRATEGY
The Trust seeks to achieve its investment objective
by investing in a dynamically managed portfolio of opportunities primarily within the private credit markets. Under normal market conditions,
the Trust will invest at least 80% of its Managed Assets in floating rate credit instruments and other structured credit investments.
Credit Instruments
The Trust’s investments may include (i) structured credit investments,
including CLO debt and subordinated (i.e., residual or equity) securities; (ii) traditional corporate credit investments, including leveraged
loans and high yield bonds; (iii) opportunistic credit investments, including stressed and distressed credit situations and long/short
credit investments; and (iv) other credit-related instruments. The Trust may invest without limitation in loans, bonds and other debt
securities, CLO securities, including debt and subordinated (i.e., residual or equity) CLO securities, credit default swaps and other
credit and credit-related instruments. The Trust may invest in senior, junior, secured and unsecured credit instruments. Floating rate
credit instruments have floating or variable interest rates, and include floating rate instruments the interest rates of which vary periodically
based upon, or inverse to, a benchmark indicator of prevailing interest rates.
Below-Investment Grade Investments
The Trust currently intends to pursue its investment objective by
investing primarily in below investment grade credit instruments, but may invest without limitation in investment grade credit instruments.
A credit instrument is considered below investment grade quality if it is rated below investment grade (that is, below Baa3- by Moody’s
or below BBB- by S&P or Fitch) or, if unrated, judged to be below investment grade quality by the Sub-Adviser. Below investment grade
credit instruments are often referred to as “high yield” securities or “junk bonds.” Below investment grade credit
instruments are regarded as having predominantly speculative characteristics with respect to capacity to pay interest and to repay principal.
The Trust will not invest more than 20% of its
Managed Assets in credit instruments rated below Caa2 by Moody’s or CCC by S&P or Fitch. In the case of a security receiving
two or more different ratings from different rating agencies, the Trust will apply the higher of the ratings for the purposes of the foregoing
policy. The foregoing policy applies only at the time an instrument is purchased, and the Trust is not required to dispose of a security
if a rating agency downgrades its assessment of that instrument. In determining whether to retain or sell an instrument that has been
downgraded, the Sub-Adviser may consider such factors as its assessment of the credit quality of the instrument, the price at which the
instrument could be sold, and the rating, if any, assigned to the instrument by other ratings agencies.
Rating agencies, such as Moody’s, S&P
or Fitch, are private services that provide ratings of the credit quality of debt obligations. Ratings assigned by a rating agency are
not absolute standards of credit quality but represent the opinion of the rating agency as to the quality of the obligation. Rating agencies
may fail to make timely changes in credit ratings and an issuer’s current financial condition may be better or worse than a rating
indicates. To the extent that the issuer of a security pays a rating agency for the analysis of its security, an inherent conflict of
interest may exist that could affect the reliability of the rating. Ratings are relative and subjective and, although ratings may be useful
in evaluating the safety of interest and principal payments, they do not evaluate the market value risk or liquidity of such obligations.
To the extent that the Trust invests in unrated
lower grade securities, the Trust’s ability to achieve its investment objective will be more dependent on the Sub-Adviser’s
credit analysis than would be the case when the Trust invests in rated securities.
Illiquid Investments
The Trust may invest without limitation in illiquid credit instruments,
including instruments that are unregistered, restricted, for which there is no readily available trading market or that are otherwise
illiquid.
|
XAI Octagon Floating Rate &
|
|
|
Alternative Income Term Trust
|
Investment Objective
and Policies
|
|
|
September 30, 2021 (Unaudited)
|
Maturity and Duration
The Trust may invest in credit instruments of any maturity, and does
not manage its portfolio seeking to maintain a targeted dollar-weighted average maturity level. The Trust does not have a fixed duration
target, and the portfolio’s duration may vary significantly over time based on the Sub-Adviser’s assessment of the current
market conditions. In comparison to maturity, interest rate duration is a measure of the price volatility of a credit instrument as a
result of changes in market interest rates, based on the weighted average timing of the instrument’s expected principal and interest
payments. For example, if interest rates increase by 1%, the net asset value of a portfolio with a duration of five years would decrease
by approximately 5%. Conversely, if interest rates decline by 1%, the net asset value of a portfolio with a duration of five years would
increase by approximately 5%. The longer the duration, the more susceptible the
portfolio will be to changes in interest rates. Duration is expressed as a number of years but differs from maturity in that it considers
an instrument’s yield, coupon payments, principal payments and call features in addition to the amount of time until the instrument
matures. As the value of an instrument changes over time, so will its duration. Prices of instruments with longer durations tend to be
more sensitive to interest rate changes than instrument with shorter durations. Longer-maturity investments generally have longer interest
rate durations because the investment’s fixed rate is locked in for longer periods of time. Floating-rate or adjustable-rate securities,
however, generally have shorter interest rate durations because their interest rates are not fixed but rather float up and down with the
level of prevailing interest rates. The Trust intends to invest a significant portion of its assets in floating rate or adjustable rate
securities and CLO subordinated notes, the income from which will vary based on income received from the underlying collateral and the
payments made to the secured notes, both of which may be based on floating rates, which may mitigate risk associated with increases in
prevailing short-term interest rates.
Opportunistic Credit Investments
The Trust may invest up to 20% of its Managed Assets in opportunistic
credit investments, including stressed and distressed credit situations.
Short Sales
The Trust may, from time to time, engage in short sales of credit
instruments in an amount not to exceed 10% of its Managed Assets. A short sale is a transaction in which the Trust sells an instrument
that it does not own in anticipation that the market price will decline.
Non-U.S. Investments
While the investment strategy of the Trust does not focus primarily
on non-U.S. corporate credit investments, under certain circumstances where such opportunities are favorable, the Trust may invest up
to 20% of its Managed Assets in corporate credit instruments issued by non-U.S. issuers and in markets outside the United States. The
Trust’s investments in structured credit instruments, which are commonly issued by special purpose vehicles formed in jurisdictions
outside of the United States, are not subject to or limited by this policy.
Other Investment Companies
As an alternative to holding investments directly, the Trust may also
obtain investment exposure to securities in which it may invest directly by investing up to 10% of its Managed Assets in other investment
companies. The Trust may invest in mutual funds, closed-end funds and exchange- traded funds.
Derivatives Transactions
The Trust may, but is not required to, use various derivatives transactions
for hedging and risk management purposes, to facilitate portfolio management and to earn income or enhance total return. The use of derivatives
transactions to earn income or enhance total return may be particularly speculative. Derivatives are financial instruments the value
of which is derived from a reference instrument. The Trust may engage in a variety of derivatives transactions, including options, swaps,
futures contracts, options on futures contracts and forward currency contracts and options on forward currency contracts. The Trust may
purchase and sell exchange-listed and off-exchange derivatives. The Trust may utilize derivatives that reference one or more securities,
indices, commodities, currencies or interest rates. In addition, the Trust may utilize new techniques, transactions, instruments or strategies
that are developed or permitted as regulatory changes occur.
Temporary Defensive Investments
During periods in which
the Sub-Adviser believes that changes in economic, financial or political conditions make it advisable to maintain a temporary defensive
posture, or in order to keep the Trust’s cash fully invested, including the period during which the net proceeds of an offering
of securities are being invested, the Trust may, without limitation, hold cash or invest its assets in short term investments and repurchase
agreements in respect of those instruments.
Portfolio Turnover
The Trust will buy and sell securities to seek to accomplish its investment
objective. Portfolio turnover rate is not considered a limiting factor in the execution of investment decisions for the Trust. Portfolio
turnover generally involves some expense to the Trust, including brokerage commissions or dealer mark-ups and other transaction costs
on the sale of securities and reinvestment in other securities. Higher portfolio turnover may decrease the after-tax return to individual
investors in the Trust to the extent it results in an increase in the short-term capital gains portion of distributions to shareholders.
The Trust’s portfolio turnover rate may vary greatly from year to year. For the Trust’s fiscal years ended September 30,
2020 and September 30, 2021, the Trust’s portfolio turnover rate was approximately 60% and 34%, respectively.
Unless otherwise stated herein, the Trust’s investment policies
and parameters shall apply at the time of investment, and the Trust will not be required to reduce a position solely due to market price
fluctuations.
|
Annual Report | September 30, 2021
|
51
|
|
XAI Octagon Floating Rate &
|
|
|
Alternative Income Term Trust
|
Investment Objective
and Policies
|
|
|
September 30, 2021 (Unaudited)
|
INVESTMENT PHILOSOPHY AND PROCESS
At the heart of Octagon’s investment philosophy
is a deep understanding of fundamental credit analysis, enhanced by a process focused on maximizing risk adjusted returns. Octagon’s
investment philosophy combines relative value focus and active portfolio management. Over Octagon’s 25-plus-year history, Octagon
believes that it has developed a proven, repeatable and scalable credit selection and investment process.
Octagon’s investment process involves four key steps:
|
|
●
|
ongoing assessment of investment opportunities;
|
|
|
●
|
research, analysis and written recommendations with defined
investment thesis;
|
|
|
●
|
investment committee recommendation and approval of credits
considered for investment; and
|
|
|
●
|
continual monitoring which is a collaborative team effort
to enhance decision making and risk management.
|
The Octagon portfolio management team manages
positions in an effort to optimize relative value. Octagon’s process benefits from the firm’s history and experience in credit
markets dating back to the mid-1990s. Octagon has made a significant investment in technology and human capital with respect to fundamental
credit analysis which happens both at the loan-level and the CLO-level. To enhance their bottom-up security level analysis, Octagon has
built over time a proprietary database with credit analysis of most of the corporate issuers in the broadly syndicated loan marketplace.
Furthermore, for every credit security that Octagon analyzes, the investment team assigns proprietary credit ratings, liquidity ratings,
collateral quality ratings, and documentation ratings. Octagon refreshes these internal ratings on an ongoing basis to identify buy and
sell opportunities. The Octagon research method is robust, involving various key factors including the assessment of industry dynamics,
competitive factors, performance history, deal sponsor, company management, cash flow estimates, liquidity, collateral values, quality,
downside protection, capital structure, macroeconomic factors, technical supply and demand and potential political or regulatory influences.
Investment process
Octagon employs a disciplined asset selection process based on fundamental
credit analysis and collaborative investment team input to identify attractive relative value opportunities, while seeking to minimize
downside risk and produce returns that outperform industry benchmarks. In evaluating potential investments, Octagon assesses industry
dynamics and competitive environments, performance history and prospects, investment sponsors and management, projected cash flow generation,
quality and value of underlying collateral, downside protection and relative value opportunities within an issuer’s capital structure.
Octagon seeks to identify investment opportunities
in both the primary and secondary leveraged credit markets through rigorous industry and company analysis guided by information from issuers,
underwriters, agents, and sales and trading desks. Identified investment opportunities are initially screened with a focus on the applicable
industry. Octagon utilizes industry expertise, discussions with company management, independent research, relative value data, and input
from Octagon investment professionals to efficiently extract information that facilitates credit judgments and recommendations. Octagon
considers the business’ competitive position, its ability to generate cash flow, the character of its sponsor and management team,
the resilience of the capital structure and the asset’s positioning within it, structural and covenant protection, and the value
of collateral in the context of the risk premium offered, as well as macroeconomic backdrop, technical supply and demand, liquidity, industry
dynamics, and political and regulatory influences.
With respect to existing portfolio positions,
Octagon’s analysis is centered on any changes to the underlying credit or industry that would impact the risk/return attributes
of the position, which may lead to a decision to sell an existing position.
Although Octagon’s investment process typically involves investment
committee recommendation and approval of credits considered for investment, a limited amount of the Trust’s assets may be invested
in short-term trading opportunities within the Trust’s investment policies and parameters that seek near-term favorable price movements.
Such investments are sourced by traders and discussed with Octagon’s portfolio managers and principals but are not subject to Octagon’s
investment committee review process as described above. The Trust typically does not hold such investments on a long-term basis and typically
disposes of such investments within several weeks of their acquisition. It is expected that such investments will typically constitute
less than 2% of the Trust’s Managed Assets.
|
XAI Octagon Floating Rate &
|
|
|
Alternative Income Term Trust
|
Investment Objective
and Policies
|
|
|
September 30, 2021 (Unaudited)
|
Risk management
Octagon dynamically manages the Trust’s portfolio based on its
evolving credit market outlook in an effort to produce attractive risk-adjusted returns. The Octagon team meets several times each year
to monitor portfolios using its robust review process and striving to manage risk via its proprietary internal credit rating and portfolio
weighting system. The investment team has a set risk monitoring process which involves the following:
|
|
●
|
Relative Value Meetings to examine new market trends and discuss technical
dynamics with a focus on recent price changes and price target revisions. At these meetings Octagon investment professionals discuss seeking
the best loan and bond relative value and return ideas.
|
|
|
●
|
Loan & Bond Assets Meetings to discuss new leveraged loan and high yield bond issues and trading opportunities.
|
|
|
●
|
Team Network Exchange for daily real-time updates with mobile access to address earnings, news,
trading levels, buy/sell recommendations and watch lists.
|
|
|
●
|
Full and Mini Portfolio Reviews to conduct credit review of all assets (full
review) or lower-rated assets (mini review) in a single investment professional’s portfolio with a focus on action-oriented recommendations.
The objective of these reviews is to affirm or change internal credit ratings and collateral grades.
|
|
|
●
|
Watch List Reviews and Meetings to examine and discuss credits on watch list.
|
|
|
●
|
Strategic Reviews to discuss credit cycle fundamentals and analyze macro factors
including GDP, interest rate and default projections. Strategic reviews are designed to determine and forecast shifts in the economic
cycle, evaluate the impact of the latest economic and market data and to determine tactical and strategic allocations.
|
Benchmark Index
The Trust’s opportunistic credit strategy seeks to outperform
its primary benchmark, the S&P/LSTA U.S. Leveraged Loan 100 Index which is designed to reflect the performance of the largest facilities
in the leveraged loan market. The S&P/LSTA U.S. Leveraged Loan 100 Index is utilized by the Trust as a comparative measure only.
The Trust may from time to time use additional benchmark indices to analyze certain aspects of the Trust’s performance. The Trust
is actively managed and does not track any index. Index information is not meant to represent the performance of the Trust or its underlying
investments.
THE
TRUST’S INVESTMENTS
The Trust’s investment portfolio may consist
of investments in the following types of securities. There is no guarantee the Trust will buy all of the types of securities or use all
of the investment techniques that are described herein.
Collateralized Loan Obligations
The Trust may invest in CLO securities, including debt and subordinated
(i.e., residual or equity) CLO securities. A CLO vehicle generally is an entity that is formed to hold a portfolio consisting principally
(typically, 80% or more of its assets) of loan obligations. The loan obligations within the CLO vehicle are limited to loans which meet
established credit criteria and are subject to concentration limitations in order to limit a CLO vehicle’s exposure to a single
credit. A CLO issues various classes or “tranches” of securities. Each tranche has different payment characteristics and
different credit ratings. These tranches are generally categorized as senior, mezzanine, or subordinated/equity, according to their degree
of risk. The key feature of the CLO structure is the prioritization of the cash flows from a pool of securities among the several tranches
of the CLO. As interest payments are received, the CLO makes contractual interest payments to each tranche of debt based on its seniority.
If there are funds remaining after each tranche of debt receives its contractual interest rate and the CLO meets or exceeds required
collateral coverage levels (or other similar covenants), the remaining funds may be paid to the subordinated tranche (often referred
to as the “residual” or “equity” tranche). The contractual provisions setting out this order of payments are
set out in detail in the relevant CLO’s indenture. These provisions are referred to as the “priority of payments” or
the “waterfall” and determine the terms of payment of any other obligations that may be required to be paid ahead of payments
of interest and principal on the securities issued by a CLO. In addition, for payments to be made to each tranche, after the most senior
tranche of debt, there are various tests that must be complied with, which are different for each CLO.
The
Trust invests in CLO securities issued by CLOs that principally hold senior secured loans (“Senior Loans”), diversified
by industry and borrower. It is also possible that the underlying obligations of CLOs in which the Trust invests will include (i)
second lien and/or subordinated loans, (ii) debt tranches of other CLOs, and (iii) equity securities incidental to investments in
senior loans. The cash flows on the underlying obligations will primarily determine the payments to holders of CLO securities. CLO
securities may have floating interest rates, fixed interest rates or, in the case of subordinated CLO securities, no set interest
rate (but rather participate in residual cash flows of the relevant CLO). The rated tranches of CLO securities are generally
assigned credit ratings by one or more nationally recognized statistical rating organizations (whether or not such tranches are
issued as part of a component of a composite instrument with one or more other instruments). The subordinated tranche does not
receive a rating. The transaction documents relating to the issuance of CLO securities impose eligibility criteria on the assets of
the CLO, restrict the ability of the CLO’s investment manager to trade investments and impose certain portfolio-wide asset
quality requirements.
|
Annual Report | September 30, 2021
|
53
|
|
XAI Octagon Floating Rate &
|
|
|
Alternative Income Term Trust
|
Investment Objective
and Policies
|
|
|
September 30, 2021 (Unaudited)
|
CLO securities are generally
limited recourse obligations of the CLO payable solely from the underlying assets of the CLO or the proceeds thereof. Consequently, holders
of CLO securities must rely solely on distributions on the underlying assets or proceeds thereof for payment in respect thereof. The
cash flows generated by the underlying obligations held in a CLO’s portfolio will generally determine the interest payments on
CLO securities. Payments to holders of tranched CLO securities are made in sequential order of priority.
CLO Subordinated Notes
The Trust may invest in subordinated notes issued by a CLO (often
referred to as the “residual,” “equity” or “subordinated” tranche), which are junior in priority
of payment and are subject to certain payment restrictions generally set forth in an indenture governing the notes. In addition, CLO
subordinated notes generally do not benefit from any creditors’ rights or ability to exercise remedies under the indenture governing
the notes. The subordinated notes are not guaranteed by another party. The subordinated tranche is typically unrated and typically represents
approximately 8% to 11% of a CLO’s capital structure. The subordinated tranche of a CLO represents the first loss position in the
CLO, meaning that it is generally required to absorb the CLO’s losses before any of the CLO’s other tranches, yet it also
has the lowest level of payment priority among the CLO’s tranches. The subordinated tranche is typically the riskiest of CLO investments.
Senior Loans
Senior secured loans are typically made to U.S. and, to a lesser extent,
large non-U.S. corporations, partnerships, limited liability companies and other business entities (“Borrowers”) which operate
in various industries and geographical regions. Senior Loans rated below investment grade are sometimes referred to as “leveraged
loans.”
Senior Loans generally hold the most senior
position in the capital structure of a Borrower, are typically secured with specific collateral and have a claim on the assets and/or
stock of the Borrower that is senior to that held by unsecured creditors, subordinated debt holders and holders of equity of the Borrower.
Typically, in order to borrow money pursuant to a Senior Loan, a Borrower will, for the term of the Senior Loan, pledge collateral (subject
to typical exceptions), including, but not limited to, (i) working capital assets, such as accounts receivable and inventory; (ii) tangible
fixed assets, such as real property, buildings and equipment; (iii) intangible assets, such as trademarks and patent rights; and (iv)
security interests in shares of stock of subsidiaries or affiliates. In the case of Senior Loans made to non-public companies, the company’s
shareholders or owners may provide collateral in the form of secured guarantees and/or security interests in assets that they own. In
many instances, a Senior Loan may be secured only by stock in the Borrower or its subsidiaries. Collateral may consist of assets that
may not be readily liquidated, and there is no assurance that the liquidation of such assets would satisfy fully a Borrower’s obligations
under a Senior Loan.
A Borrower must comply with various covenants
contained in a loan agreement or note purchase agreement between the Borrower and the holders of the Senior Loan (the “Loan Agreement”).
In a typical Senior Loan, an administrative agent (the “Agent”) administers the terms of the Loan Agreement. In such cases,
the Agent is normally responsible for the collection of principal and interest payments from the Borrower and the apportionment of these
payments to the credit of all institutions that are parties to the Loan Agreement. The Trust will generally rely upon the Agent or an
intermediate participant to receive and forward to the Trust its portion of the principal and interest payments on the Senior Loan. Additionally,
the Trust normally will rely on the Agent and the other loan investors to use appropriate credit remedies against the Borrower. The Agent
is typically responsible for monitoring compliance with covenants contained in the Loan Agreement based upon reports prepared by the Borrower.
The Agent may monitor the value of the collateral and, if the value of the collateral declines, may accelerate the Senior Loan, may give
the Borrower an opportunity to provide additional collateral or may seek other protection for the benefit of the participants in the Senior
Loan. The Agent is compensated by the Borrower for providing these services under a Loan Agreement, and such compensation may include
special fees paid upon structuring and funding the Senior Loan and other fees paid on a continuing basis.
Senior Loans typically have rates of interest
that are determined daily, monthly, quarterly or semi-annually by reference to a base lending rate, plus a premium or credit spread. As
a result, as short-term interest rates increase, interest payable to the Trust from its investments in Senior Loans should increase, and
as short-term interest rates decrease, interest payable to the Trust from its investments in Senior Loans should decrease. These base
lending rates are primarily the London Interbank Offered Rate (LIBOR) and secondarily the prime rate offered by one or more major U.S.
banks and the certificate of deposit rate or other base lending rates used by commercial lenders.
There
may be less readily available information about most Senior Loans and the Borrowers thereunder than is the case for many other types
of securities, including securities issued in transactions registered under the Securities Act or the Securities Exchange Act of
1934 (the “Exchange Act”) and Borrowers subject to the periodic reporting requirements of Section 13 of the Exchange
Act. Senior Loans may be issued by companies that are not subject to SEC reporting requirements and these companies, therefore, do
not file reports with the SEC that must comply with SEC form requirements and, in addition, are subject to a less stringent
liability disclosure regime than companies subject to SEC reporting requirements. As a result, the Sub-Adviser will rely primarily
on its own evaluation of a Borrower’s credit quality rather than on any available independent sources. Therefore, when
investing in Senior Loans the Trust will be particularly dependent on the credit analysis of the Sub-Adviser.
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No active trading market may exist for some
Senior Loans, and some loans may be subject to restrictions on resale. Any secondary market for Senior Loans may be subject to irregular
trading activity, wide bid/ask spreads and extended trade settlement periods, which may impair the ability of a seller to realize full
value and thus cause a material decline in the net asset value of Common Shares. In addition, the Trust may not be able to readily dispose
of its Senior Loans at prices that approximate those at which the Trust could sell such loans if they were more widely traded and, as
a result of such illiquidity, the Trust may have to sell other investments or engage in borrowing transactions if necessary to raise cash
to meet its obligations. A limited supply or relative illiquidity of Senior Loans may adversely affect the Trust’s ability to achieve
its investment objective.
The Trust may purchase and retain in its portfolio
Senior Loans where the Borrower has experienced, or may be perceived to be likely to experience, credit problems, including involvement
in or recent emergence from bankruptcy court proceedings or other forms of debt restructuring. Such investments may provide opportunities
for enhanced income as well as capital appreciation, although they also will be subject to greater risk of loss. At times, in connection
with the restructuring of a Senior Loan either outside of bankruptcy court or in the context of bankruptcy court proceedings, the Trust
may determine or be required to accept equity securities or junior credit securities in exchange for all or a portion of a Senior Loan.
In the process of buying, selling and holding
Senior Loans, the Trust may receive and/or pay certain fees. These fees are in addition to interest payments received and may include
facility fees, commitment fees, amendment fees, commissions and prepayment penalty fees. On an ongoing basis, the Trust may receive a
commitment fee based on the undrawn portion of the underlying line of credit portion of a Senior Loan. In certain circumstances, the Trust
may receive a prepayment penalty fee upon the prepayment of a Senior Loan by a Borrower. Other fees received by the Trust may include
covenant waiver fees, covenant modification fees or other amendment fees.
Direct Assignments
The Trust generally will seek to purchase Senior Loans on a direct
assignment basis. If the Trust purchases a Senior Loan on direct assignment, it typically succeeds to all the rights and obligations
under the Loan Agreement of the assigning lender and becomes a lender under the Loan Agreement with the same rights and obligations as
the assigning lender. Investments in Senior Loans on a direct assignment basis may involve additional risks to the Trust. For example,
if such loan is foreclosed, the Trust could become part owner of any collateral, and would bear the costs and liabilities associated
with owning and disposing of the collateral.
Loan Participations
The Trust may also acquire in participations in Senior Loans. The
participation by the Trust in a lender’s portion of a Senior Loan typically will result in the Trust having a contractual relationship
only with such lender, not with the Borrower. As a result, the Trust may have the right to receive payments of principal, interest and
any fees to which it is entitled only from the lender selling the participation and only upon receipt by such lender of payments from
the Borrower. Such indebtedness may be secured or unsecured. In connection with purchasing participations, the Trust generally will have
no right to enforce compliance by the Borrower with the terms of the Loan Agreement, nor any rights with respect to any funds acquired
by other investors through set-off against the Borrower and the Trust may not directly benefit from the collateral supporting the Senior
Loan in which it has purchased the participation. In the event of the insolvency of the entity selling a participation, the Trust may
be treated as a general creditor of such entity. The selling entity and other persons interpositioned between such entity and the Trust
with respect to such participations will likely conduct their principal business activities in the banking, finance and financial services
industries. Persons engaged in these industries may be more susceptible to, among other things, fluctuations in interest rates, changes
in the Federal Reserve Open Market Committee’s monetary policy, governmental regulations concerning these industries and concerning
capital raising activities generally and fluctuations in the financial markets generally.
Second Lien And Subordinated Loans
The Trust may also invest in second lien and subordinated secured
loans. Second lien and subordinated secured loans generally have similar characteristics as Senior Loans except that such loans are subordinated
in payment and/or lower in lien priority to first lien holders. The Trust may purchase interests in second lien and subordinated secured
loans through assignments or participations.
Unsecured Loans
Unsecured loans
generally have lower priority in right of payment compared to holders of secured debt of the Borrower. Unsecured loans are not
secured by a security interest or lien to or on specified collateral securing the Borrower’s obligation under the loan.
Unsecured loans by their terms may be or may become subordinate in right of payment to other obligations of the borrower, including
Senior Loans, second lien loans and subordinated secured loans. Unsecured loans may have fixed or floating rate interest payments.
Because unsecured loans are subordinate to the secured debt of the borrower, they present a greater degree of investment risk but
often pay interest at higher rates reflecting this additional risk. Such investments generally are of below investment grade
quality. Other than their subordinated and unsecured status, such investments have many characteristics and risks similar to Senior
Loans, second lien loans and subordinated secured loans discussed above. The Trust may purchase interests in unsecured loans through
assignments or participations.
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Corporate Bonds
Corporate bonds typically pay a fixed rate of interest and must be
repaid on or before maturity. The investment return of corporate bonds reflects interest on the security and changes in the market value
of the security. The market value of a corporate bond generally may be expected to rise and fall inversely with interest rates. The value
of intermediate- and longer-term corporate bonds normally fluctuates more in response to changes in interest rates than does the value
of shorter-term corporate bonds. The market value of a corporate bond also may be affected by investors’ perceptions of the creditworthiness
of the issuer, the issuer’s performance and perceptions of the issuer in the market place. There is a risk that the issuers of
corporate bonds may not be able to meet their obligations on interest or principal payments at the time called for by an instrument.
Stressed, Distressed And Defaulted Investments
The Trust may invest in loans, debt securities and other instruments
of companies undergoing, or that have recently completed, bankruptcies, reorganizations, insolvencies, liquidations or other fundamental
changes or similar proceedings or other stressed issuers. In any investment opportunity involving any such type of special situation,
there exists the risk that the contemplated transaction either will be unsuccessful, will take considerable time or will result in a
distribution of cash or new securities, the value of which will be less than the purchase price to the Trust of the securities or other
financial instruments in respect of which such distribution is received. Similarly, if an anticipated transaction does not in fact occur,
the Trust may be required to sell its investment at a loss. The consummation of such transactions can be prevented or delayed by a variety
of factors, including but not limited to (i) intervention of a regulatory agency; (ii) market conditions resulting in material changes
in securities prices; (iii) compliance with any applicable bankruptcy, insolvency or securities laws; and (iv) the inability to obtain
adequate financing. Because there is substantial uncertainty concerning the outcome of transactions involving financially troubled companies
in which the Trust may invest, there is a potential risk of loss by the Trust of its entire investment in such companies.
The Trust may invest in loans, debt securities
and other instruments that are in default or at risk of being in default as to the repayment of principal and/or interest at the time
of acquisition by the Trust. The repayment of defaulted obligations is subject to significant uncertainties. Defaulted obligations might
be repaid only after lengthy bankruptcy or other reorganization proceedings, during which the issuer might not make any interest or other
payments.
Distressed and defaulted instruments generally
present the same risks as investment in below investment grade instruments. However, in most cases, these risks are of a greater magnitude
because of the uncertainties of investing in an issuer undergoing financial distress. Distressed instruments present a risk of loss of
principal value, including potentially a total loss of value. Distressed instruments may be highly illiquid and the prices at which they
may be sold may represent a substantial discount to what the Sub-Adviser believes to be their ultimate value.
Variable, Floating, And Fixed Rate Debt Obligations
Floating rate securities are generally offered at an initial interest
rate which is at or above prevailing market rates. The interest rate paid on floating rate securities is then reset periodically (commonly
every 90 days) to an increment over some predetermined interest rate index. Commonly utilized indices include the three-month Treasury
bill rate, the 180-day Treasury bill rate, the one-month or three-month LIBOR, the prime rate of a bank, the commercial paper rates,
or the longer term rates on U.S. Treasury securities. Variable and floating rate securities are relatively long-term instruments that
often carry demand features permitting the holder to demand payment of principal at any time or at specified intervals prior to maturity.
If the Sub-Adviser incorrectly forecasts interest rate movements, the Trust could be adversely affected by use of variable and floating
rate securities. In addition, the Trust invests in CLO subordinated notes. CLO subordinated notes do not have a fixed coupon and payments
on CLO subordinated notes will be based on the income received from the underlying collateral and the payments made to the secured notes,
both of which may be based on floating rates.
Fixed rate securities pay a fixed rate of interest
and tend to exhibit more price volatility during times of rising or falling interest rates than securities with variable or floating rates
of interest. The value of fixed rate securities will tend to fall when interest rates rise and rise when interest rates fall. The value
of variable or floating rate securities, on the other hand, fluctuates much less in response to market interest rate movements than the
value of fixed rate securities. This is because variable and floating rate securities behave like short-term instruments in that the rate
of interest they pay is subject to periodic adjustments according to a specified formula, usually with reference to some interest rate
index or market interest rate. Fixed rate securities with short-term characteristics are not subject to the same price volatility as fixed
rate securities without such characteristics. Therefore, they behave more like variable or floating rate securities with respect to price
volatility.
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Short Sales
The Trust may engage in short sales of credit instruments and exchange-traded
funds (“ETFs”) in an amount not to exceed 10% of its Managed Assets. to the extent the Sub-Adviser deems it advisable in
connection with the Trust’s investments or as opportunistic investments. A short sale is a transaction in which the Trust sells
an instrument that it does not own in anticipation that the market price will decline. To deliver the securities to the buyer, the Trust
arranges through a broker to borrow the securities and, in so doing, the Trust becomes obligated to replace the securities borrowed at
their market price at the time of replacement. When selling short, the Trust intends to replace the securities at a lower price at a
later date and therefore profit from the difference between the cost to replace the securities and the proceeds received from the earlier
sale of the securities. When the Trust makes a short sale, the proceeds it receives from the sale will be held on behalf of a broker,
and will accrue interest, until the Trust replaces the borrowed securities. The Trust may have to pay a premium to borrow the securities
and must pay any dividends or interest payable on the securities until they are replaced. The Trust’s obligation to replace the
securities borrowed in connection with a short sale will be secured by collateral deposited with the broker that consists of cash and/or
liquid securities. In addition, the Trust will place in a segregated account an amount of cash and/or liquid securities equal to the
difference, if any, between (i) the market value of the securities sold at the time they were sold short, and (ii) any cash and/or liquid
securities deposited as collateral with the broker in connection with the short sale.
The Trust may use derivative transactions, including
futures, options, swaps, credit default swaps, total return swaps, forward sales or other transactions, to effectuate short exposure in
the portfolio.
Other Investment Companies
As an alternative to holding investments directly, the Trust may also
obtain investment exposure to securities in which it may invest directly by investing in other investment companies. The Trust may invest
in mutual funds, closed-end funds and exchange-traded funds. Under the 1940 Act, the Trust generally may invest only up to 10% of its
total assets in the aggregate in shares of other investment companies and only up to 5% of its total assets in any one investment company,
provided the investment does not represent more than 3% of the voting stock of the acquired investment company at the time such shares
are purchased. However, pursuant to certain exemptions set forth in the 1940 Act and the rules and regulations promulgated thereunder,
the Trust may invest in excess of this limitation provided that certain conditions are met. Further, on October 7, 2020, the SEC adopted
Rule 12d1-4, which changed the regulation of investments in other investment companies. Rule 12d1-4 permits closed-end funds to invest
in other investment companies in excess of the 1940 Act limits, including those described above, subject to certain conditions.
Investments in other investment companies involve
operating expenses and fees at the other investment company level that are in addition to the expenses and fees borne by the Trust and
are borne indirectly by Common Shareholders. For purposes of the Trust’s policy of investing at least 80% of its Managed Assets
in floating rate credit instruments and other structured credit investments, the Trust will include the value of its investments in other
investment companies that invest at least 80% of their net assets, plus the amount of any borrowings for investment purposes, in floating
rate credit instruments or other structured credit investments.
Derivative Transactions
The Trust may, but is not required to, use various derivatives transactions
for hedging and risk management purposes, to facilitate portfolio management and to earn income or enhance total return. The use of derivatives
transactions to earn income or enhance total return may be particularly speculative. Derivatives are financial instruments the value
of which is derived from a reference instrument. The Trust may engage in a variety of derivatives transactions, including options, swaps,
swaptions, futures contracts, options on futures contracts and forward currency contracts and options on forward currency contracts.
The Trust may purchase and sell exchange-listed, centrally cleared and off-exchange derivatives. If a derivative is centrally cleared,
a central clearing entity stands between the two parties to the trade as counterparty to each. The Trust may utilize derivatives that
reference one or more securities, indices, commodities, currencies or interest rates. In addition, the Trust may utilize new techniques,
transactions, instruments or strategies that are developed or permitted as regulatory changes occur. Derivatives may allow the Trust
to increase or decrease the level of risk to which the Trust is exposed more quickly and efficiently than transactions in other types
of instruments. If the Trust invests in a derivative for speculative purposes, the Trust will be fully exposed to the risks of loss of
that derivative, which may sometimes be greater than the derivative’s cost. The use of derivatives may involve substantial economic
leverage and consequently substantial volatility.
There is no assurance that these derivative
strategies will be available at any time, that the Sub-Adviser will determine to use them for the Trust or, if used, that the strategies
will be successful.
Options
An option on a security (or an index) is a contract that gives the
holder of the option, in return for a premium, the right to buy from (in the case of a call) or sell to (in the case of a put) the writer
of the option the security underlying the option at a specified exercise or “strike” price. The writer of a call option on
a security has the obligation upon exercise of the option to deliver the underlying security upon payment of the exercise price. The
writer of a put option has the obligation upon exercise of the option to pay the exercise price upon delivery of the underlying security.
The Trust may buy, sell and write exchange-traded and off-exchange call and put options.
If an option written by
the Trust expires unexercised, the Trust realizes on the expiration date a capital gain equal to the premium the Trust received at the
time the option was written. If an option purchased by the Trust expires unexercised, the Trust realizes a capital loss equal to the
premium paid. Prior to the earlier of exercise or expiration, an exchange-traded option may be closed out by an offsetting purchase or
sale of an option of the same series (type, exchange, underlying security or index, exercise price and expiration). There can be no assurance,
however, that a closing purchase or sale transaction can be effected when the Trust desires.
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The Trust may sell put or call options it has
previously purchased, which could result in a net gain or loss depending on whether the amount realized on the sale is more or less than
the premium and other transaction costs paid on the put or call option which is sold. Prior to exercise or expiration, an option may be
closed out by an offsetting purchase or sale of an option of the same series. The Trust will realize a capital gain from a closing purchase
transaction if the cost of the closing option is less than the premium received from writing the option, or, if it is more, the Trust
will realize a capital loss. If the premium received from a closing sale transaction is more than the premium paid to purchase the option,
the Trust will realize a capital gain or, if it is less, the Trust will realize a capital loss. The principal factors affecting the market
value of a put or a call option include supply and demand, interest rates, the current market price of the underlying security or index
in relation to the exercise price of the option, the volatility of the underlying security or index and the time remaining until the expiration
date.
The Trust may buy or write straddles consisting
of a combination of a call and a put written on the same underlying security. A straddle will be covered when sufficient assets are deposited
to meet the Trust’s immediate obligations. The Trust may use the same liquid assets to cover both the call and put options where
the exercise price of the call and put are the same, or the exercise price of the call is higher than that of the put. In such cases,
the Trust will also segregate liquid assets equivalent to the amount, if any, by which the put is “in the money.”
The Trust may “cover” its obligations
when it writes call options or put options. In the case of a call option on a credit instrument or other security, the option is covered
if the Trust owns the instrument underlying the call or has an absolute and immediate right to acquire that security without additional
cash consideration (or, if additional cash consideration is required, cash or other liquid assets in such amount are segregated by its
custodian) upon conversion or exchange of other instruments held by the Trust.
A call option written on an instrument is also
“covered” if the Trust does not hold the underlying instrument or have the right to acquire it (a so- called “naked”
call option), but the Trust segregates liquid assets in an amount equal to the contract value of the position (minus any collateral deposited
with a broker-dealer), on a mark-to-market basis.
For a call option on an index, the option is
covered if the Trust segregates liquid assets in an amount equal to the contract value of the index. A call option is also covered if
the Trust holds a call on the same index or security as the call written where the exercise price of the call held is (i) equal to or
less than the exercise price of the call written, or (ii) greater than the exercise price of the call written, provided the difference
is maintained by the Trust in segregated liquid assets. A put option on a security or an index is covered if the Trust segregates liquid
assets equal to the exercise price. A put option is also covered if the Trust holds a put on the same security or index as the put written
where the exercise price of the put held is (i) equal to or greater than the exercise price of the put written, or (ii) less than the
exercise price of the put written, provided the difference is maintained by the Trust in segregated liquid assets. Obligations under written
call and put options so covered will not be construed to be “senior securities” for purposes of the Trust’s investment
restrictions concerning senior securities and borrowings.
A put option written by the Trust is “covered”
if the Trust segregates liquid assets equal to the exercise price. A put option is also covered if the Trust holds a put on the same security
as the put written where the exercise price of the put held is (i) equal to or greater than the exercise price of the put written, or
(ii) less than the exercise price of the put written, provided the difference is maintained by the Trust in segregated liquid assets.
Futures and Options on Futures
The Trust may buy, sell and write futures contracts
that relate to: interest rates, credit instruments and related indices, volatility indices, credit-linked notes and individual stocks
and stock indices.
A futures contract is an agreement between two
parties to buy and sell a security, index or interest rate (each a “financial instrument”) for a set price on a future date.
Certain futures contracts, such as futures contracts relating to individual securities, call for making or taking delivery of the underlying
financial instrument. However, these contracts generally are closed out before delivery by entering into an offsetting purchase or sale
of a matching futures contract (same exchange, underlying financial instrument, and delivery month). Other futures contracts, such as
futures contracts on interest rates and indices, do not call for making or taking delivery of the underlying financial instrument, but
rather are agreements pursuant to which two parties agree to take or make delivery of an amount of cash equal to the difference between
the value of the financial instrument at the close of the last trading day of the contract and the price at which the contract was originally
written. These contracts also may be settled by entering into an offsetting futures contract.
Unlike when the Trust
purchases or sells a security, no price is paid or received by the Trust upon the purchase or sale of a futures contract. Initially,
the Trust will be required to deposit with the futures broker, known as a futures commission merchant (“FCM”), an amount
of cash or securities equal to a varying specified percentage of the contract amount. This amount is known as initial margin. The
margin deposit is intended to ensure completion of the contract. Minimum initial margin requirements are established by the futures
exchanges and may be revised. In addition, FCMs may establish margin deposit requirements that are higher than the exchange
minimums. Cash held in the margin account generally is not income producing. However, coupon-bearing securities, such as Treasury
securities, held in margin accounts generally will earn income. Subsequent payments to and from the FCM, called variation margin,
will be made on a daily basis as the price of the underlying financial instrument fluctuates, making the futures contract more or
less valuable, a process known as marking the contract to market. Changes in variation margin are recorded by the Trust as
unrealized gains or losses. At any time prior to expiration of the futures contract, the Trust may elect to close the position by
taking an opposite position that will operate to terminate its position in the futures contract. A final determination of variation
margin is then made, additional cash is required to be paid by or released to the Trust, and the Trust realizes a gain or loss. In
the event of the bankruptcy or insolvency of an FCM that holds margin on behalf of the Trust, the Trust may be entitled to the
return of margin owed to it only in proportion to the amount received by the FCM’s other customers, potentially resulting in
losses to the Trust. Futures transactions also involve brokerage costs and the Trust may have to segregate additional liquid assets
in accordance with applicable SEC requirements under the 1940 Act.
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The Trust also may buy and write options on
the futures contracts in which it may invest (“futures options”) and may buy or write straddles, which consist of a call and
a put option on the same futures contract. A futures option gives the purchaser of such option the right, in return for the premium paid,
to assume a long position (call) or short position (put) in a futures contract at a specified exercise price at any time during the period
of the option. Upon exercise of a call futures option, the purchaser acquires a long position in the futures contract and the writer is
assigned the opposite short position. Upon the exercise of a put futures option, the opposite is true. The Trust will only write futures
options and straddles which are “covered.” This means that, when writing a call option, the Trust must either segregate liquid
assets with a value equal to the fluctuating market value of the optioned futures contract, or the Trust must own an option to purchase
the same futures contract having an exercise price that is (i) equal to or less than the exercise price of the call written, or (ii) greater
than the exercise price of the call written, provided the difference is maintained by the Trust in segregated liquid assets. When writing
a put option, the Trust must segregate liquid assets in an amount not less than the exercise price, or own a put option on the same futures
contract where the exercise price of the put held is (i) equal to or greater than the exercise price of the put written, or (ii) less
than the exercise price of the put written, provided the difference is maintained by the Trust in segregated liquid assets. A straddle
will be covered when sufficient assets are deposited to meet the Trust’s immediate obligations. The Trust may use the same liquid
assets to cover both the call and put options in a straddle where the exercise price of the call and put are the same, or the exercise
price of the call is higher than that of the put. In such cases, the Trust will also segregate liquid assets equivalent to the amount,
if any, by which the put is “in the money.”
Swaps
Swap agreements are two party contracts entered into primarily by
institutional investors for periods ranging from a few weeks to more than one year. In a standard “swap” transaction, two
parties agree to exchange the returns (or differentials in rates of return) earned or realized on particular predetermined investments
or instruments. The gross returns to be exchanged or “swapped” between the parties are calculated with respect to a “notional
amount” (i.e., the dollar amount invested at a particular interest rate, in a particular foreign currency, or in a “basket”
of securities representing a particular index). The “notional amount” of the swap agreement is only a basis on which to calculate
the obligations that the parties to a swap agreement have agreed to exchange. The Trust’s obligations (or rights) under a swap
agreement generally will be equal only to the “net amount” to be paid or received under the agreement based on the relative
values of the positions held by each party to the agreement. The Trust’s obligations under a swap agreement will be accrued daily
(offset against any amounts owing to the Trust) and any accrued but unpaid net amounts owed to a swap counterparty will be covered by
marking as segregated liquid, unencumbered assets.
Credit Default Swaps
The Trust may enter into credit default swap agreements and similar
agreements. Among other purposes, credit default swaps provide investment exposure to changes in credit spreads and relative interest
rates. The credit default swap agreement or similar instrument may have as reference obligations one or more securities that are not
currently held by the Trust (including a “basket” of securities representing an index). The protection “buyer”
in a credit default contract may be obligated to pay the protection “seller” an upfront payment or a periodic stream of payments
over the term of the contract provided generally that no credit event on a reference obligation has occurred. If a credit event occurs,
the seller generally must pay the buyer the “par value” (full notional value) of the swap in exchange for an equal face amount
of deliverable obligations of the reference entity described in the swap, or the seller may be required to deliver the related net cash
amount, if the swap is cash settled. The Trust may be either the buyer or seller in the transaction. If the Trust is a buyer and no credit
event occurs, the Trust recovers nothing if the swap is held through its termination date. However, if a credit event occurs, the Trust
may elect to receive the full notional value of the swap in exchange for delivery of an equal face amount of deliverable obligations
of the reference entity that may have little or no value. As a seller, the Trust generally receives an upfront payment or a fixed rate
of income throughout the term of the swap, which typically is between six months and three years, provided that there is no credit event.
If a credit event occurs, generally the seller must pay the buyer the full notional value of the swap in exchange for an equal face amount
of deliverable obligations of the reference entity that may have little or no value.
Total Return Swaps
The Trust may enter
into total return swaps. Total return swaps are used as substitutes for owning a particular physical security, or the securities
comprising a given market index, or to obtain exposure in markets where no physical securities are available such as an interest
rate index. Total return refers to the payment (or receipt) of the total return on the security, index or other instrument
underlying the swap, which is then exchanged for the receipt (or payment) of a floating interest rate. Total return swaps provide
the Trust with the additional flexibility of gaining exposure to a particular security or index by using the most cost-effective
vehicle available. Total return swaps provide the Trust with the opportunity to actively manage the cash maintained by the Trust as
a result of not having to purchase the actual securities or other instruments underlying the swap. The cash backing total return
swaps is actively managed to seek to earn a return in excess of the floating rate paid on the swap.
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Interest Rate Swap
Interest rate swaps involve the exchange by the Trust with another
party of respective commitments to pay or receive interest (e.g., an exchange of fixed rate payments for floating rate payments).
Currency Swaps
Currency swaps involve the exchange of the two parties’ respective
commitments to pay or receive fluctuations with respect to a notional amount of two different currencies (e.g., an exchange of payments
with respect to fluctuations in the value of the U.S. dollar relative to the Japanese yen).
Swaptions
The Trust may enter into “swaptions,” which are options
on swap agreements. A swaption is a contract that gives a counterparty the right (but not the obligation) to enter into a new swap agreement
or to shorten, extend, cancel or otherwise modify an existing swap agreement, at some designated future time on specified terms. The
Trust may write (sell) and purchase put and call swaptions. Depending on the terms of the particular option agreement, the Trust generally
will incur a greater degree of risk when it writes a swaption than it will incur when it purchases a swaption. When the Trust purchases
a swaption, it risks losing only the amount of the premium it has paid should it decide to let the option expire unexercised. When the
Trust writes a swaption, upon exercise of the option the Trust will become obligated according to the terms of the underlying agreement.
Credit-Linked Securities
Credit-linked securities are issued by a limited purpose trust or
other vehicle that, in turn, invests in a derivative or basket of derivatives, such as credit default swaps, interest rate swaps and
other securities, in order to provide exposure to certain fixed income markets. Like an investment in a bond, investments in these credit-linked
securities represent the right to receive periodic income payments (in the form of distributions) and payment of principal at the end
of the term of the security. However, these payments are conditioned on the issuer’s receipt of payments from, and the issuer’s
potential obligations to, the counterparties to the derivatives and other securities in which the issuer invests. For instance, the issuer
may sell one or more credit default swaps, under which the issuer would receive a stream of payments over the term of the swap agreements
provided that no event of default has occurred with respect to the referenced debt obligation upon which the swap is based. If a default
occurs, the stream of payments may stop and the issuer would be obligated to pay the counterparty the par (or other agreed upon value)
of the referenced debt obligation. This, in turn, would reduce the amount of income and principal that the Trust would receive. The Trust’s
investments in these instruments are indirectly subject to the risks associated with derivatives, including, among others, counterparty
risk, credit risk and leverage risk. There may be no established trading market for these securities.
Synthetic Investments
As an alternative to holding investments directly, the Trust may also
obtain investment exposure to investments in which the Trust may invest directly through the use of derivative instruments. The Trust
may utilize swaps, options, forwards, notional principal contracts or other derivative instruments to replicate, modify or replace the
economic attributes associated with an investment in which the Trust may invest directly. To the extent that the Trust invests in synthetic
investments with economic characteristics similar to floating rate instruments or other structured credit investments, the value of such
investments will be counted for purposes of the Trust’s policy of investing at least 80% of its Managed Assets in floating rate
credit instruments and other structured credit investments.
Unfunded Commitments
From time to time, the Trust’s investments may involve unfunded
commitments, which are contractual obligations of the Trust to make loans up to a specified amount at future dates. Certain of the loan
participations or assignments acquired by the Trust may involve unfunded commitments of the lenders or revolving credit facilities under
which a Borrower may from time to time borrow and repay amounts up to the maximum amount of the facility. In such cases, the Trust would
have an obligation to provide its portion of such additional borrowings when drawn upon in the future, upon the terms specified in the
loan documentation. Such an obligation may have the effect of requiring the Trust to increase its investment in a company at a time when
it might not be desirable to do so (including at a time when the company’s financial condition makes it unlikely that such amounts
will be repaid).
Equity Securities
Incidental to the
Trust’s investments in credit instruments, the Trust may acquire or hold equity securities, or warrants to purchase equity
securities, of a Borrower or issuer. Equity securities held by the Trust may include common equity securities and preferred
securities. Common stock represents an equity ownership interest in a company. Warrants give holders the right, but not the
obligation, to buy common stock of an issuer at a given price, usually higher than the market price at the time of issuance, during
a specified period. Preferred securities are generally equity securities of the issuer that have priority over the issuer’s
common shares as to the payment of dividends (i.e., the issuer cannot pay dividends on its common shares until the dividends on the
preferred shares are current) and as to the payout of proceeds of bankruptcy or other liquidation, but are subordinate to an
issuer’s senior debt and junior debt as to both types of payments. The equity interests held by the Trust, if any, may not pay
dividends or otherwise generate income.
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Temporary Defensive Investments
During periods in which the Sub-Adviser believes that changes in economic,
financial or political conditions make it advisable to maintain a temporary defensive posture, or in order to keep the Trust’s
cash fully invested, including the period during which the net proceeds of an offering of securities are being invested, the Trust may,
without limitation, hold cash or invest its assets in in short-term investments, including high quality, short-term securities or may
invest in short-, intermediate-, or long-term U.S. Treasury bonds and repurchase agreements in respect of those instruments. Short- term
investments in which the Trust may invest including obligations of the U.S. Government, its agencies or instrumentalities; commercial
paper; and certificates of deposit and bankers’ acceptances. During a temporary defensive period, the Trust may also invest in
shares of money market mutual funds. Money market mutual funds are investment companies. As a shareholder in a mutual fund, the Trust
will bear its ratable share of its expenses, including management fees. There can be no assurance that such strategies will be successful.
The Trust may not achieve its investment objective during a temporary defensive period or be able to sustain its historical distribution
levels.
U.S. Government Securities
U.S. government securities
include (1) U.S. Treasury obligations, which differ in their interest rates, maturities and times of issuance: U.S. Treasury bills (maturities
of one year or less), U.S. Treasury notes (maturities of one year to ten years) and U.S. Treasury bonds (generally maturities of greater
than ten years) and (2) obligations issued or guaranteed by U.S. government agencies and instrumentalities that are supported by any
of the following: (i) the full faith and credit of the U.S. Treasury, (ii) the right of the issuer to borrow an amount limited to a specific
line of credit from the U.S. Treasury, (iii) discretionary authority of the U.S. government to purchase certain obligations of the U.S.
government agency or instrumentality or (iv) the credit of the agency or instrumentality. The Trust also may invest in any other security
or agreement collateralized or otherwise secured by U.S. government securities. Agencies and instrumentalities of the U.S. government
include but are not limited to: Federal Land Banks, Federal Financing Banks, Banks for Cooperatives, Federal Intermediate Credit Banks,
Farm Credit Banks, Federal Home Loan Banks, FHLMC, FNMA, GNMA, Student Loan Marketing Association, United States Postal Service, Small
Business Administration, Tennessee Valley Authority and any other enterprise established or sponsored by the U.S. government. Because
the U.S. government generally is not obligated to provide support to its instrumentalities, the Trust will invest in obligations issued
by these instrumentalities only if the Sub-Adviser determines that the credit risk with respect to such obligations is minimal.
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Investors should consider the following risk
factors and special considerations associated with investing in the Trust. Investors should be aware that in light of the current uncertainty,
volatility and distress in economies, financial markets, and labor and health conditions over the world, the risks below are heightened
significantly compared to normal conditions and therefore subject the Trust’s investments and a shareholder’s investment in
the Trust to elevated investment risk, including the possible loss of your entire investment.
Investment and Market Risk
An investment in Common Shares is subject to investment risk, particularly
under current economic, financial, labor and health conditions, including the possible loss of the entire principal amount that you invest.
Your investment in Common Shares represents an indirect investment in the securities owned by the Trust. The value of, or income generated
by, the investments held by the Trust are subject to the possibility of rapid and unpredictable fluctuation. These movements may result
from factors affecting individual companies, or from broader influences, including real or perceived changes in prevailing interest rates,
changes in inflation or expectations about inflation, investor confidence or economic, political, social or financial market conditions,
environmental disasters, governmental actions, public health emergencies (such as the spread of infectious diseases, pandemics and epidemics)
and other similar events, that each of which may be temporary or last for extended periods of time. For example, the risks of a borrower’s
default or bankruptcy or non-payment of scheduled interest or principal payments from senior floating rate interests held by the Trust
are especially acute under these conditions. Furthermore, interest rates and bond yields may fall as a result of types of events, including
responses by governmental entities to such events, which would magnify the Trust’s fixed-income instruments’ susceptibility
to interest rate risk and diminish their yield and performance. Moreover, the Trust’s investments in asset-backed securities are
subject to many of the same risks that are applicable to investments in securities generally, including interest rate risk, credit risk,
foreign currency risk, below-investment grade securities risk, financial leverage risk, prepayment and regulatory risk, which would be
elevated under the foregoing circumstances.
Different sectors, industries and security types
may react differently to such developments and, when the market performs well, there is no assurance that the Trust’s investments
will increase in value along with the broader markets. Volatility of financial markets, including potentially extreme volatility caused
by the events described above, can expose the Trust to greater market risk than normal, possibly resulting in greatly reduced liquidity.
Moreover, changing economic, political, social or financial market conditions in one country or geographic region could adversely affect
the value, yield and return of the investments held by the Trust in a different country or geographic region because of the increasingly
interconnected global economies and financial markets. The Adviser potentially could be prevented from considering, managing and executing
investment decisions at an advantageous time or price or at all as a result of any domestic or global market or other disruptions, particularly
disruptions causing heightened market volatility and reduced market liquidity, such as the current conditions, which have also resulted
in impediments to the normal functioning of workforces, including personnel and systems of the Trust’s service providers and market
intermediaries.
Your Common Shares at any point in time may
be worth less than your original investment, even after taking into account the reinvestment of distributions. A prospective investor
should invest in the Common Shares only if the investor can sustain a complete loss in its investment.
Market Discount Risk
Shares of closed-end management investment companies frequently trade
at a discount from their net asset value, which is a risk separate and distinct from the risk that the Trust’s net asset value
could decrease as a result of its investment activities. Although the value of the Trust’s net assets is generally considered by
market participants in determining whether to purchase or sell Common Shares, whether investors will realize gains or losses upon the
sale of Common Shares will depend entirely upon whether the market price of Common Shares at the time of sale is above or below the investor’s
purchase price for Common Shares. Because the market price of Common Shares will be determined by factors such as net asset value, dividend
and distribution levels (which are dependent, in part, on expenses), supply of and demand for Common Shares, stability of dividends or
distributions, trading volume of Common Shares, general market and economic conditions and other factors beyond the control of the Trust,
the Trust cannot predict whether Common Shares will trade at, below or above net asset value or at, below or above the initial public
offering price. This risk may be greater for investors expecting to sell their Common Shares soon after the completion of a public offering,
as the net asset value of the Common Shares will be reduced immediately following an offering as a result of the payment of certain offering
costs. Common Shares of the Trust are designed primarily for long-term investors; investors in Common Shares should not view the Trust
as a vehicle for trading purposes.
Below Investment Grade Securities Risk
The Trust invests primarily in below investment grade credit instruments,
which are commonly referred to as “high-yield” securities or “junk” bonds. Investment in securities of below
investment grade quality involves substantial risk of loss, the risk of which is particularly high in volatile market conditions. Securities
of below investment grade quality are considered predominantly speculative with respect to the issuer’s capacity to pay interest
and repay principal when due and therefore involve a greater risk of default or decline in market value due to adverse economic and issuer-specific
developments. Issuers of below investment grade securities are not perceived to be as strong financially as those with higher credit
ratings. These issuers face ongoing uncertainties and exposure to adverse business, financial or economic conditions and are more vulnerable
to financial setbacks and recession than more creditworthy issuers, which may impair their ability to make interest and principal payments.
Securities of below investment grade quality display increased price sensitivity to changing interest rates and to a deteriorating economic
environment. The market values of certain below investment grade securities tend to reflect individual issuer developments to a greater
extent than do higher-rated securities, which react primarily to fluctuations in the general level of interest rates. The market values
for securities of below investment grade quality tend to be more volatile and such securities tend to be less liquid than investment
grade debt securities, which could result in the Trust being unable to sell such securities for an extended period of time, if at all.
The market for high-yield securities has historically been subject to disruptions that have caused substantial volatility in the prices
of such securities. Consolidation in the financial services industry has resulted in there being fewer market makers for high-yield securities,
which may result in further risk of illiquidity and volatility with respect to high-yield securities, and this trend may continue in
the future. To the extent that a secondary market does exist for certain below investment grade securities, the market for them may be
subject to irregular trading activity, wide bid/ask spreads and extended trade settlement periods. Because of the substantial risks associated
with investments in below investment grade securities, you could have an increased risk of losing money on your investment in Common
Shares, both in the short- term and the long-term.
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The ratings of Moody’s, S&P, Fitch
and other nationally recognized statistical rating organizations (“NRSRO”) represent their opinions as to the quality of the
obligations which they undertake to rate. Ratings are relative and subjective and, although ratings may be useful in evaluating the safety
of interest and principal payments, they do not evaluate the market value risk of such obligations. To the extent that the Trust invests
in securities that have not been rated by an NRSRO, the Trust’s ability to achieve its investment objectives will be more dependent
on the Sub-Adviser’s credit analysis than would be the case when the Trust invests in rated securities.
The Trust may invest in securities rated in
the lower rating categories (rated Caa1/CCC+ or below, or unrated but judged to be of comparable quality by the Sub-Adviser). For these
securities, the risks associated with below investment grade instruments are more pronounced. Investments in the securities of financially
distressed issuers involve substantial risks. See “Risks—Stressed and Distressed Investments Risk.”
Structured Credit Instruments Risk
Holders of structured credit instruments bear risks of the underlying
investments, index or reference obligation as well as risks associated with the issuer of the instrument, which is often a special purpose
vehicle, and may also be subject to counterparty risk. As an investor in structured credit instruments, the Trust typically will have
the right to receive payments only from the issuer of the structured credit instrument, and generally would not have direct rights against
the issuer of or entity that sold the underlying assets. While certain structured credit instruments enable the Trust to obtain exposure
to a pool of credit instruments without the brokerage and other expenses associated with directly holding the same instruments, investors
in structured credit instruments generally pay their share of the administrative and other expenses of the issuer of the instrument.
The prices of indices and instruments underlying structured credit instruments, and, therefore, the prices of structured credit instruments,
will be influenced by, and will rise and fall in response to, the same types of political and economic events that affect issuers of
securities and capital markets generally. If the issuer of a structured credit instrument uses shorter term financing to purchase longer
term instruments, the issuer may be forced to sell its instruments at below market prices if it experiences difficulty in obtaining short-term
financing, which may adversely affect the value of the structured credit instruments owned by the Trust. Certain structured credit instruments
may be thinly traded or have a limited trading market.
The Trust may invest in structured credit instruments
collateralized by low grade or defaulted loans or securities. Investments in such structured credit instruments are subject to the risks
associated with below investment grade securities. Such securities are characterized by high risk.
The Trust may invest in senior classes and subordinated
classes, including residual or equity interests, issued by structured credit vehicles. The payment of cash flows from the underlying assets
to senior classes take precedence over those of subordinated classes, and therefore subordinated classes are subject to greater risk.
Furthermore, the leveraged nature of each subordinated class may magnify the adverse impact on such class of changes in the value of the
assets, changes in the distributions on the assets, defaults and recoveries on the assets, capital gains and losses on the assets, prepayment
on the assets and availability, price and interest rates of the assets.
CLO Risk
CLOs often involve risks that are different from or more acute than
risks associated with other types of credit instruments, including: (1) the possibility that distributions from collateral assets will
not be adequate to make interest or other payments; (2) the quality of the collateral may decline in value or default; (3) investments
in CLO junior debt tranches and CLO subordinated notes will likely be subordinate in right of payment to other senior classes of CLO
debt; and (4) the complex structure of a particular security may not be fully understood at the time of investment and may produce disputes
with the issuer or unexpected investment results.
There may be less information available to the
Trust regarding the underlying investments held by CLOs than if the Trust had invested directly in credit securities of the underlying
issuers. Trust shareholders will not know the details of the underlying investments of the CLOs in which the Trust invests. Due to their
often complicated structures, various CLOs may be difficult to value and may constitute illiquid investments. In addition, there can be
no assurance that a liquid market will exist in any CLO when the Trust seeks to sell its interest therein. Moreover, the value of CLOs
may decrease if the ratings agencies reviewing such securities revise their ratings criteria and, as a result, lower their original rating
of a CLO in which the Trust has invested. Further, the complex structure of the security may produce unexpected investment results. Also,
it is possible that the Trust’s investment in a CLO will be subject to certain contractual limitations on transfer.
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The market value of CLO securities may
be affected by, among other things, changes in the market value of the underlying assets held by the CLOs, changes in the distributions
on the underlying assets, defaults and recoveries on the underlying assets, capital gains and losses on the underlying assets, prepayments
on underlying assets and the availability, prices and interest rate of underlying assets. Therefore, changes in the market value of the
Trust’s CLO investments could be greater than the change in the market value of the underlying instruments.
The Trust invests in CLO securities issued
by CLOs that principally hold Senior Loans. As a result, as an investor in such CLOs, the Trust is subject to the risk of default on the
Senior Loans by the Borrowers. While interest rates remain below historical averages, the Federal Reserve has recently implemented several
increases to the Federal Funds rate. Increases in interest rates may adversely impact the ability of Borrowers to meet interest payment
obligations on Senior Loans held by a CLO and increase the likelihood of default. Although a CLO’s holdings are typically diversified
by industry and borrower, an increase in interest rates coupled with a general economic downturn may result in an increase in defaults
on Senior Loans across various sectors of the economy. See “Risks—Senior Loan Risk” for a discussion of risks related
to Senior Loans.
CLOs in which the Trust invests in may
hold underlying instruments that are concentrated in a limited number of industries or borrowers. A downturn in any particular industry
or borrower in which a CLO is heavily invested may subject that vehicle, and in turn the Trust, to a risk of significant loss and could
significantly impact the aggregate returns realized by the Trust.
Investments in primary issuances of CLO
securities may involve certain additional risks. Between the pricing date and the effective date of a CLO, the CLO collateral manager
will generally expect to purchase additional collateral obligations for the CLO. During this period, the price and availability of these
collateral obligations may be adversely affected by a number of market factors, including price volatility and availability of investments
suitable for the CLO, which could hamper the ability of the collateral manager to acquire a portfolio of collateral obligations that will
satisfy specified concentration limitations and allow the CLO to reach the target initial par amount of collateral prior to the effective
date. An inability or delay in reaching the target initial par amount of collateral may adversely affect the timing and amount of interest
or principal payments received by the holders of the CLO debt securities and distributions on the CLO subordinated notes and could result
in early redemptions which may cause CLO debt and subordinated note investors to receive less than face value of their investment.
The failure by a CLO to satisfy financial
covenants, including with respect to adequate collateralization and/or interest coverage tests, could lead to a reduction in its payments
to securityholders, including the Trust. In the event that a CLO fails certain tests, holders of CLO senior debt may be entitled to additional
payments that would, in turn, reduce the payments that holders of junior debt and subordinated securities would otherwise be entitled
to receive.
In recent years there has been a marked
increase in the number of, and flow of capital into, investment vehicles established to pursue investments in CLO securities whereas the
size of this market is relatively limited. Such increase may result in greater competition for investment opportunities, which may result
in an increase in the price of such investments relative to the risk taken on by holders of such investments. In addition, the volume
of new CLO issuances varies over time as a result of a variety of factors including new regulations, changes in interest rates, and other
market forces. Such competition may also result under certain circumstances in increased price volatility or decreased liquidity with
respect to certain positions.
The Trust invests in CLO debt and subordinated
(i.e., residual or equity) securities. While the Trust may invest in CLO debt securities having any rating, the Trust currently intends
to focus its investments in CLO debt securities that are rated below investment grade. CLO subordinated notes are generally not rated.
Below investment grade and unrated instruments are often referred to as “junk” bonds and are regarded as having predominantly
speculative characteristics with respect to capacity to pay interest and to repay principal. See “Risks—Below Investment Grade
Securities Risk.”
Restructuring of Investments Held by
CLOs. The manager of a CLO has broad authority to direct and supervise the investment and reinvestment of the investments held by
the CLO, which may include the execution of amendments, waivers, modifications and other changes to the investment documentation in accordance
with the collateral management agreement. During periods of economic uncertainty and recession, the incidence of amendments, waivers,
modifications and restructurings of investments may increase. Such amendments, waivers, modifications and other restructurings will change
the terms of the investments and in some cases may result in the CLO holding assets not meeting the CLO’s criteria for investments.
This could adversely impact the coverage tests under an indenture governing the notes issued by the CLO. Any amendment, waiver, modification
or other restructuring that reduces the CLO’s compliance with certain financial tests will make it more likely that the CLO will
need to utilize cash to pay down the unpaid principal amount of secured notes to cure any breach in such test instead of making payments
on subordinated notes. Any such use of cash would reduce distributions available and delay the timing of payments to the Trust.
The Trust cannot be certain that any particular
restructuring strategy pursued by the CLO manager will maximize the value of or recovery on any investment. Any restructuring can fundamentally
alter the nature of the related investment, and restructurings are not subject to the same underwriting standards that are employed in
connection with the origination or acquisition of investments. Any restructuring could alter, reduce or delay the payment of interest
or principal on any investment, which could delay the timing and reduce the amount of payments made to the Trust. Restructurings of investments
might also result in extensions of the term thereof, which could delay the timing of payments made to the Trust.
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If as a result of any such restructurings,
the Sub-Adviser determines that continuing to hold instruments issued by such CLO is no longer in the best interest of the Trust, the
Sub-Adviser may dispose of such CLO instruments. In certain instances, the Trust may be unable to dispose of such investments at advantageous
prices and/or may be required to reinvest the proceeds of such disposition in lower-yielding investments.
CLO Management Risk. The activities
of any CLO in which the Trust may invest will generally be directed by a collateral manager. In the Trust’s capacity as holder of
CLO securities, the Trust is generally not able to make decisions with respect to the management, disposition or other realization of
any investment, or other decisions regarding the business and affairs, of that CLO. Consequently, the success of any CLOs in which the
Trust invests will depend, in large part, on the financial and managerial expertise of the collateral manager’s investment professionals.
Subject to certain exceptions, any change in the investment professionals of the collateral manager will not present grounds for termination
of the collateral management agreement. In addition, such investment professionals may not devote all of their professional time to the
affairs of the CLOs in which the Trust invests. There can be no assurance that for any CLO, in the event that underlying instruments are
prepaid, the collateral manager will be able to reinvest such proceeds in new instruments with equivalent investment returns. If the collateral
manager cannot reinvest in new instruments with equivalent investment returns, the interest proceeds available to pay interest on the
CLO securities may be adversely affected.
The transaction documents relating to
the issuance of CLO securities may impose eligibility criteria on the assets of the CLO, restrict the ability of the CLO’s investment
manager to trade investments and impose certain portfolio-wide asset quality requirements. These criteria, restrictions and requirements
may limit the ability of the CLO’s investment manager to maximize returns on the CLO securities. In addition, other parties involved
in CLOs, such as third-party credit enhancers and investors in the rated tranches, may impose requirements that have an adverse effect
on the returns of the various tranches of CLO securities. Furthermore, CLO securities issuance transaction documents generally contain
provisions that, in the event that certain tests are not met (generally interest coverage and over-collateralization tests at varying
levels in the capital structure), proceeds that would otherwise be distributed to holders of a junior tranche must be diverted to pay
down the senior tranches until such tests are satisfied. Failure (or increased likelihood of failure) of a CLO to make timely payments
on a particular tranche will have an adverse effect on the liquidity and market value of such tranche.
The CLOs in which the Trust invests are
generally not registered as investment companies under the 1940 Act. As investors in these CLOs, the Trust is not afforded the protections
that shareholders in an investment company registered under the 1940 Act would have.
The terms of CLOs set forth in their applicable
transaction documents, including with respect to collateralization and/or interest coverage tests and asset eligibility criteria, may
vary from CLO to CLO. Similarly the terms of the Senior Loans that constitute the underlying assets held by CLOs may vary. The Senior
Loan and/or CLO market and loan market may evolve in ways that result in typical terms being less protective for the holders of CLO securities.
As a result, the Trust will be reliant upon the Sub-Adviser’s ability to obtain and evaluate the terms of the CLOs in which the
Trust invests, the terms of and creditworthiness of the borrowers with respect to the underlying assets held by those CLOs and information
about the collateral managers of the CLOs.
CLO Interest Rate Risk. Although
senior secured loans are generally floating rate instruments, the Trust’s investments in senior secured loans through CLOs are sensitive
to interest rate levels and volatility. Although CLOs are generally structured to mitigate the risk of interest rate mismatch, there may
be some difference between the timing of interest rate resets on the assets and liabilities of a CLO. Such a mismatch in timing could
have a negative effect on the amount of funds distributed to CLO subordinated notes. In addition, CLOs may not be able to enter into hedge
agreements, even if it may otherwise be in the best interests of the CLO to hedge such interest rate risk. Furthermore, in the event of
a significant rising interest rate environment and/or economic downturn, loan defaults may increase and result in credit losses.
Because CLOs generally issue debt on a
floating rate basis, an increase in LIBOR will increase the financing costs of CLOs. Many of the senior secured loans held by these CLOs
have LIBOR floors such that, when LIBOR is below the stated LIBOR floor, the stated LIBOR floor (rather than LIBOR itself) is used to
determine the interest payable under the loans. Therefore, if LIBOR increases but stays below the average LIBOR floor rate of the senior
secured loans held by a CLO, there would not be a corresponding increase in the investment income of such CLOs. The combination of increased
financing costs without a corresponding increase in investment income in such a scenario would result in smaller distributions to holders
of the CLO subordinated notes.
Many underlying corporate borrowers can
elect to pay interest based on 1-month LIBOR, 3-month LIBOR and/or other rates in respect of the loans held by CLOs in which we are invested,
in each case plus an applicable spread, whereas CLOs generally pay interest to holders of the CLO’s debt tranches based on 3-month
LIBOR plus a spread. The 3-month LIBOR currently exceeds the 1-month LIBOR by a significant amount, which may result in many underlying
corporate borrowers electing to pay interest based on 1-month LIBOR. This mismatch in the rate at which CLOs earn interest and the rate
at which they pay interest on their debt tranches negatively impacts the cash flows on a CLO’s subordinated note tranche. Unless
spreads are adjusted to account for such increases, these negative impacts may worsen to the extent the amount by which the 3-month LIBOR
exceeds the 1-month LIBOR increases.
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CLO Subordinated Notes Risk
The Trust may invest in subordinated notes
issued by a CLO (often referred to as the “residual,” “equity” or “subordinated” tranche), which are
junior in priority of payment and are subject to certain payment restrictions generally set forth in an indenture governing the notes.
In addition, CLO subordinated notes generally do not benefit from any creditors’ rights or ability to exercise remedies under the
indenture governing the notes. The subordinated notes are not guaranteed by another party. Subordinated notes are subject to greater risk
that the senior notes issued by the CLO. CLOs are typically highly levered, utilizing up to approximately 10 times leverage, and therefore
subordinated notes are subject to a higher risk of total loss. There can be no assurance that distributions on the assets held by the
CLO will be sufficient to make any distributions or that the yield on the subordinated notes will meet the Trust’s expectations.
CLOs typically have no significant assets
other than their underlying instruments. Accordingly, payments on CLO investments are and will be payable solely from the cash flows from
such instruments, net of all management fees and other expenses. CLOs generally may make payments on subordinated notes only to the extent
permitted by the payment priority provisions of an indenture governing the notes issued by the CLO. CLO indentures generally provide that
principal payments on subordinated notes may not be made on any payment date unless all amounts owing under secured notes are paid in
full. In addition, if a CLO does not meet the asset coverage tests or the interest coverage test set forth in the indenture governing
the notes issued by the CLO, cash would be diverted from the subordinated notes to first pay the secured notes in amounts sufficient to
cause such tests to be satisfied.
The subordinated notes are unsecured and
rank behind all of the secured creditors, known or unknown, of the issuer, including the holders of the secured notes it has issued. Consequently,
to the extent that the value of the issuer’s portfolio of loan investments has been reduced as a result of conditions in the credit
markets, defaulted loans, capital gains and losses on the underlying assets, prepayment or changes in interest rates, the value of the
subordinated notes realized at their redemption could be reduced. Accordingly, the subordinated notes may not be paid in full and may
be subject to up to 100% loss. As a result, relatively small numbers of defaults of instruments underlying CLOs in which the Trust holds
subordinated notes may adversely impact the Trust’s returns.
The market value of subordinated notes
may be significantly affected by a variety of factors, including changes in the market value of the investments held by the issuer, changes
in distributions on the investments held by the issuer, defaults and recoveries on those investments, capital gains and losses on those
investments, prepayments on those investments and other risks associated with those investments. The leveraged nature of subordinated
notes are likely to magnify the adverse impact on the subordinated notes of changes in the market value of the investments held by the
issuer, changes in the distributions on those investments, defaults and recoveries on those investments, capital gains and losses on those
investments, prepayments on those investments and availability, prices and interest rates of those investments. The Trust must be prepared
to hold subordinated notes for an indefinite period of time or until their stated maturity.
CLO subordinated notes do not have a fixed
coupon and payments on CLO subordinated notes will be based on the income received from the underlying collateral and the payments made
to the secured notes, both of which may be based on floating rates. While the payments on CLO subordinated notes will be variable, CLO
subordinated notes may not offer the same level of protection against changes in interest rates as other floating rate instruments. An
increase in interest rates would materially increase the financing costs of CLOs. Since underlying instruments held by a CLO may have
LIBOR floors, there may not be corresponding increases in investment income to the CLO (if LIBOR increases but stays below the LIBOR floor
rate of such instruments) resulting in smaller distribution payments on CLO subordinated notes.
Subordinated notes are illiquid investments
and subject to extensive transfer restrictions, and no party is under any obligation to make a market for subordinated notes. At times,
there may be no market for subordinated notes, and the Trust may not be able to sell or otherwise transfer subordinated notes at their
fair value, or at all, in the event that it determines to sell them. Since 2007, subordinated notes issued in securitization transactions
generally have experienced historically high volatility and significant fluctuations in market value. Additionally, some potential buyers
of such notes may view securitization products as an inappropriate investment, thereby reducing the number of potential buyers and/or
potentially affecting liquidity in the secondary market.
Subordinated notes are subject to certain
transfer restrictions and can only be transferred to certain specified transferees. The issuer may, in the future, impose additional transfer
restrictions to comply with changes in applicable law. Restrictions on the transfer of subordinated notes may further limit their liquidity.
Investments in CLO subordinated notes may have complicated accounting and tax implications.
Corporate Credit Investment Risk
Corporate debt instruments pay fixed,
variable or floating rates of interest. Some debt securities, such as zero coupon bonds, do not make regular interest payments but are
issued at a discount to their principal or maturity value. The value of fixed-income securities in which the Trust invests will change
in response to fluctuations in interest rates. In addition, the value of certain fixed-income securities can fluctuate in response to
perceptions of creditworthiness, political stability or soundness of economic policies. Fixed-income securities are subject to the risk
of the issuer’s inability to meet principal and interest payments on its obligations (i.e., credit risk) and are subject to price
volatility due to such factors as interest rate sensitivity, market perception of the creditworthiness of the issuer and general market
liquidity (i.e., market risk).
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The reorganization of an issuer under
the Federal or other bankruptcy laws may result in the issuer’s debt securities being cancelled without repayment, repaid only in
part, or repaid in part or in whole through an exchange thereof for any combination of cash, debt securities, convertible securities,
equity securities, or other instruments or rights in respect of the same issuer or a related entity. Fixed income securities generally
are not traded on exchanges. The off-exchange market may be illiquid and there may be times when no counterparty is willing to purchase
or sell certain securities. The nature of the market may make valuations difficult or unreliable.
Senior Loan Risk
Senior Loans are generally of below investment
grade credit quality and therefore are subject to greater risks than investment grade corporate obligations. The prices of these investments
may be volatile and will generally fluctuate due to a variety of factors that are inherently difficult to predict, including, but not
limited to, changes in interest rates, prevailing credit spreads, general economic conditions, financial market conditions, U.S. and non-U.S.
economic or political events, developments or trends in any particular industry, and the financial condition of certain Borrowers. Additionally,
Senior Loans have significant liquidity and market value risks since they are not traded in organized exchange markets but are traded
by banks and other institutional counterparties. Furthermore, because such loans are privately syndicated and the applicable loan agreements
are privately negotiated and customized, such loans are not purchased or sold as easily as publicly listed securities.
While such loans are generally intended
to be secured by collateral, losses could result from default and foreclosure. Therefore, the value of the underlying collateral, the
creditworthiness of the Borrower and the priority of the lien are each of great importance. The Adviser and the Sub-Adviser cannot guarantee
the adequacy of the protection of the Trust’s interests. If the terms of a Senior Loan do not require the Borrower to pledge additional
collateral in the event of a decline in the value of the already pledged collateral, the Trust will be exposed to the risk that the value
of the collateral will not at all times equal or exceed the amount of the Borrower’s obligations under the Senior Loans. Furthermore,
the Adviser and the Sub-Adviser cannot assure investors that claims may not be asserted that might interfere with enforcement of the Trust’s
rights. In the event of a foreclosure, the Trust may assume direct ownership of the underlying collateral. The liquidation proceeds upon
sale of collateral may not satisfy the entire outstanding balance of principal and interest on the loan, resulting in a loss. Any costs
or delays involved in the effectuation of a foreclosure of the loan or a liquidation of the underlying property will further reduce the
proceeds and thus increase the loss. To the extent that a Senior Loan is collateralized by stock in the Borrower or its subsidiaries,
such stock may lose all of its value in the event of the bankruptcy of the Borrower. Such Senior Loans involve a greater risk of loss.
While interest rates remain below historical
averages, the Federal Reserve has recently implemented several increases to the Federal Funds rate. Increases in interest rates may adversely
impact the ability of Borrowers to meet interest payment obligations and/or refinance their outstanding Senior Loans on attractive terms,
which may adversely impact Borrowers and increase defaults on Senior Loans. The terms and covenants of Senior Loans may vary, and market
expectations for such terms and covenants may change over time. More permissive covenants, with respect to the financial condition, operations
and use of collateral by Borrowers, may provide Borrowers with additional flexibility, which may reduce the likelihood of default, but
may also reduce the extent to which the holders of Senior Loans can recover in the event of a default. In the event of an economic downturn,
recoveries upon default of Senior Loans may be less than in past market cycles.
Senior Loans are subject to legislative
risk. If legislation or state or federal regulations impose additional requirements or restrictions on the ability of financial institutions
to make loans, the availability of Senior Loans for investment by the Trust may be adversely affected. In addition, such requirements
or restrictions could reduce or eliminate sources of financing for certain Borrowers. This would increase the risk of default. If legislation
or federal or state regulations require financial institutions to increase their capital requirements this may cause financial institutions
to dispose of Senior Loans that are considered highly levered transactions. Such sales could result in prices that, in the opinion of
the Adviser and the Sub-Adviser, do not represent fair value. If the Trust attempts to sell a Senior Loan at a time when a financial institution
is engaging in such a sale, the price the Trust could receive for the Senior Loan may be adversely affected.
Second Lien Loans Risk
Second lien loans are secured by liens
on the collateral securing the loan that are subordinated to the liens of at least one other class of obligations of the related obligor,
and thus, the ability of the Trust to exercise remedies after a second lien loan becomes a defaulted loan is subordinated to, and limited
by, the rights of the senior creditors holding such other classes of obligations. In many circumstances, the Trust may be prevented from
foreclosing on the collateral securing a second lien loan until the related senior loan is paid in full. Moreover, any amounts that might
be realized as a result of collection efforts or in connection with a bankruptcy or insolvency proceeding involving a second lien loan
must generally be turned over to the senior secured lender until the senior secured lender has realized the full value of its own claims.
In addition, certain of the second lien loans may contain provisions requiring the Trust’s interest in the collateral to be released
in certain circumstances. These lien and payment obligation subordination provisions may materially and adversely affect the ability of
the Trust to realize value from second lien loans.
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Unsecured Loan Risk
Unsecured
loans do not benefit from any security interest in the assets of the Borrower. Liens on such Borrowers’ assets, if any, will
secure the applicable Borrower’s obligations under its outstanding secured debt and may secure certain future debt that is
permitted to be incurred by the Borrower under its secured loan agreements. The holders of obligations secured by such liens will
generally control the liquidation of, and be entitled to receive proceeds from, any realization of such collateral to repay their
obligations in full before repayment of unsecured instruments held by the Trust. In addition, the value of such collateral in the
event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no
assurance that the proceeds, if any, from sales of such collateral would be sufficient to satisfy the Trust’s unsecured
obligations after payment in full of all secured loan obligations. If such proceeds were not sufficient to repay the outstanding
secured loan obligations, then the Trust’s unsecured claims would rank equally with the unpaid portion of such secured
creditors’ claims against the borrower’s remaining assets, if any.
Loan Participation and Assignment Risk
The Trust may purchase Senior Loans, second
lien loans and unsecured loans on a direct assignment basis from a participant in the original syndicate of lenders or from subsequent
assignees of such interests. The Trust may also purchase, without limitation, participations in Senior Loans, second lien loans and unsecured
loans. The purchaser of an assignment typically succeeds to all the rights and obligations of the assigning institution and becomes a
lender under the credit agreement with respect to the debt obligation; however, the purchaser’s rights can be more restricted than
those of the assigning institution, and, in any event, the Trust may not be able to unilaterally enforce all rights and remedies under
the loan and with regard to any associated collateral. A participation typically results in a contractual relationship only with the institution
participating out the interest, not with the Borrower. In purchasing participations, the Trust generally will have no right to enforce
compliance by the Borrower with the terms of the loan agreement against the Borrower, and the Trust may not directly benefit from the
collateral supporting the debt obligation in which it has purchased the participation. As a result, the Trust will be exposed to the credit
risk of both the Borrower and the institution selling the participation. Further, in purchasing participations in lending syndicates,
the Trust may not be able to conduct the same due diligence on the Borrower with respect to a loan that the Trust would otherwise conduct.
In addition, as a holder of the participations, the Trust may not have voting rights or inspection rights that the Trust would otherwise
have if it were investing directly in the loan, which may result in the Trust being exposed to greater credit or fraud risk with respect
to the Borrower. Investments in bank loans may not be securities as defined within the Securities Act and therefore may not have the protections
afforded by the federal securities laws.
Illiquid Investments Risk
The Trust may invest in restricted, as
well as thinly traded, instruments and securities (including privately placed securities and instruments that are subject to Rule 144A).
There may be no trading market for these securities and instruments, and the Trust might only be able to liquidate these positions, if
at all, at disadvantageous prices. As a result, the Trust may be required to hold such securities despite adverse price movements. Privately
issued securities have additional risk considerations than investments in comparable public investments. Whenever the Trust invests in
companies that do not publicly report financial and other material information, it assumes a greater degree of investment risk and reliance
upon the Sub-Adviser’s ability to obtain and evaluate applicable information concerning such companies’ creditworthiness and
other investment considerations.
Certain stressed and distressed investments,
for various reasons, may not be capable of an advantageous disposition prior to the date the Trust is to be dissolved. The Trust may be
required to sell, distribute in kind or otherwise dispose of investments at a disadvantageous time as a result of any such dissolution.
Stressed and Distressed Investments Risk
The Trust may invest in stressed and distressed
credit instruments. The ability of the Trust to obtain a profit from these investments may often depend upon factors that are intrinsic
to the particular issuer, rather than the market as a whole. Appreciation in the value of such investments may be contingent upon the
occurrence of certain events, such as a successful reorganization or merger. If the expected event does not occur, the Trust may incur
a loss on the position. Stressed and distressed investments may have a limited trading market, resulting in limited liquidity and presenting
difficulties to the Trust in valuing its positions. Stressed and distressed investments by the nature of their issuers’ leveraged
capital structures, will involve a high degree of financial risk. These investments may be unsecured and subordinated to substantial amounts
of senior indebtedness, all or a significant portion of which may be secured. In addition, these investments may not be protected by financial
covenants or limitations upon additional indebtedness, may have limited liquidity and may not be rated by a credit rating agency. Adverse
changes in the financial condition of an issuer or in general economic conditions (or both) may impair the ability of such issuer to make
payments on the subordinated securities and result in defaults on and declines in the value of such securities more quickly than in the
case of the senior obligations of such issuer.
Uncertain Exit Strategies. Due
to the illiquid nature of many stressed and distressed investments, as well as the uncertainties of the reorganization and active management
process, the Sub-Adviser may be unable to predict with confidence what the exit strategy will ultimately be for any given position, or
that one will definitely be available. Exit strategies that appear to be viable when an investment is initiated may be precluded by the
time the investment is ready to be realized, due to economic, legal, political or other factors.
Control
Position Risk. Certain stressed and distressed investment opportunities may allow a holder to have significant influence on the
management, operations and strategic direction of the portfolio companies in which it invests. The exercise of control and/or
significant influence over a company imposes additional risks of liability for environmental damage, product defects, failure to
supervise management and other types of liability in which the limited liability generally characteristic of business operations may
be ignored. The exercise of control and/or significant influence over a portfolio company could expose the assets of the Trust to
claims by such portfolio company, its securities holders and its creditors. While the Sub-Adviser intends to manage the Trust in a
way that will minimize exposure to these risks, the possibility of successful claims cannot be precluded.
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Leverage Risk
The Trust utilizes leverage to seek to
enhance total return and income. The Trust currently utilizes leverage through (i) the issuance of Indebtedness and (ii) the issuance
of Preferred Shares. There can be no assurance that the Adviser’s and the Sub-Adviser’s expectations will be realized or that
a leveraging strategy will be successful in any particular time period. Use of leverage creates an opportunity for increased income and
capital appreciation but, at the same time, creates special risks. Leverage is a speculative technique that exposes the Trust to greater
risk and increased costs than if it were not implemented. There can be no assurance that a leveraging strategy will be utilized or will
be successful.
The use of leverage by the Trust will
cause the net asset value of the Common Shares to fluctuate significantly in response to changes in interest rates and other economic
indicators. As a result, the net asset value, market price and dividend rate of the Common Shares is likely to be more volatile than those
of a closed-end management investment company that is not exposed to leverage. In a declining market the use of leverage may result in
a greater decline in the net asset value and market price of the Common Shares than if the Trust were not leveraged.
Leverage will increase operating costs,
which may reduce total return. The Trust will have to pay interest on its Indebtedness, if any, which may reduce the Trust’s return.
This interest expense may be greater than the Trust’s return on the underlying investment, which would negatively affect the performance
of the Trust. Increases in interest rates that the Trust must pay on its Indebtedness will increase the cost of leverage and may reduce
the return to Common Shareholders. This risk may be greater in the current market environment because while interest rates remain below
historical averages, the Federal Reserve has recently implemented several increases to the Federal Funds rate.
Certain types of Indebtedness subject
the Trust to covenants in credit agreements relating to asset coverage and portfolio composition requirements. Certain Indebtedness issued
by the Trust also may be subject to certain restrictions on investments imposed by guidelines of one or more rating agencies, which may
issue ratings for such Indebtedness. These guidelines may impose asset coverage or portfolio composition requirements that are more stringent
than those imposed by the 1940 Act.
The Trust may have leverage outstanding
during a shorter-term period during which such leverage may not be beneficial if the Trust believes that the long-term benefits of such
leverage would outweigh the costs and portfolio disruptions associated with redeeming and reissuing such leverage. However, there can
be no assurance that the Trust’s judgment in weighing such costs and benefits will be correct.
During the time in which the Trust is
utilizing leverage, the amount of the fees paid to the Adviser, and thereby to the Sub-Adviser, for investment advisory services will
be higher than if the Trust did not utilize leverage because the fees paid will be calculated based on the Trust’s Managed Assets,
including proceeds of leverage. This may create a conflict of interest between the Adviser and the Sub-Adviser on the one hand and the
Common Shareholders, as holders of Indebtedness, Preferred Shares or other forms of leverage do not bear the management fee. Rather, Common
Shareholders bear the portion of the management fee attributable to assets purchased with the proceeds of leverage, which means that Common
Shareholders effectively bear the entire management fee. There can be no assurance that a leveraging strategy will be utilized or, if
utilized, will be successful.
To the extent that the Trust increases
its net assets as a result of sales of additional Common Shares, the Trust will be required to incur additional financial leverage in
order to maintain its current levels of financial leverage as a percentage of Managed Assets. There can be no assurance that the Trust
will be able to incur such additional financial leverage or to do so on favorable terms.
In addition, the Trust may engage in certain
derivatives transactions that have economic characteristics similar to leverage. To the extent the terms of any such transaction obligate
the Trust to make payments, the Trust intends to earmark or segregate cash or liquid securities in an amount at least equal to the current
value of the amount then payable by the Trust under the terms of such transactions or otherwise cover such transactions in accordance
with applicable interpretations of the staff of the SEC. To the extent the terms of any such transaction obligate the Trust to deliver
particular securities to extinguish the Trust’s obligations under such transactions, the Trust may “cover” its obligations
under such transaction by either (i) owning the securities or collateral underlying such transactions or (ii) having an absolute and immediate
right to acquire such securities or collateral without additional cash consideration.
Other Investment Companies Risk
Investments
in other investment companies present certain special considerations and risks not present in making direct investments in
securities in which the Trust may invest. Investments in other investment companies involve operating expenses and fees that are in
addition to the expenses and fees borne by the Trust. Such expenses and fees attributable to the Trust’s investments in other
investment companies are borne indirectly by Common Shareholders. Accordingly, investment in such entities involves expense and fee
layering. Investments in other investment companies may expose the Trust to an additional layer of financial leverage. To the extent
management fees of other investment companies are based on total gross assets, it may create an incentive for such entities’
managers to employ financial leverage, thereby adding additional expense and increasing volatility and risk. Investments in other
investment companies also expose the Trust to additional management risk; the success of the Trust’s investments in other
investment companies will depend in large part on the investment skills and implementation abilities of the advisers or managers of
such entities. Decisions made by the advisers or managers of such entities may cause the Trust to incur losses or to miss profit
opportunities. To the extent the Trust invests in ETFs or other investment companies that seek to track a specified index, such
investments will be subject to tracking error risk.
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Exchange-Traded Fund Risk
For ETFs tracking an index of securities,
the cumulative percentage increase or decrease in the net asset value of the shares of an ETF may over time diverge significantly from
the cumulative percentage increase or decrease in the relevant index due to the compounding effect experienced by an ETF which results
from a number of factors, including, leverage (if applicable), daily rebalancing, fees, expenses and interest income, which in turn results
in greater non-correlation between the return of an ETF and its corresponding index. Moreover, because an ETF’s portfolio turnover
rate may be very high due to daily rebalancing, holding both long and short futures contracts, leverage (if applicable) and and/or market
volatility, such ETF will incur additional brokerage costs, operating costs and may generate increased taxable capital gains, which, in
turn, would adversely affect the value of the shares of such ETF. In addition, fixed-income ETFs that track an index often require some
type of sampling or optimization because they are typically market benchmarks but not tradable portfolios. Such ETFs often include many
more securities than equity ETFs, and the securities included are often less liquid, resulting in fewer opportunities and greater costs
to replicate the relevant index. Many instruments in fixed-income indices are illiquid or hard to obtain, as many investors may buy them
at issuance and hold them to maturity.
Short Sales Risk
Short sales involve selling securities
of an issuer short in the expectation of covering the short sale with securities purchased in the open market at a price lower than that
received in the short sale. If the price of the issuer’s securities declines, the Trust may then cover the short position with securities
purchased in the market. The profit realized on a short sale will be the difference between the price received in the sale and the cost
of the securities purchased to cover the sale. The possible losses from selling short a security differ from losses that could be incurred
from a cash investment in the security; the former may be unlimited, whereas the latter can only equal the total amount of the cash investment.
Short selling activities are also subject to restrictions imposed by the federal securities laws and the various national and regional
securities exchanges, which restrictions could limit the Trust’s investment activities. There can be no assurance that securities
necessary to cover a short position will be available for purchase.
Synthetically created short positions
will involve both hedging situations, where the position is intended to wholly or partially offset risk associated with another position
in a related security, and speculative situations, where the Sub-Adviser uses shorting techniques to take advantage of the decline in
the price of particular assets. The Trust will generally realize a profit or a loss as a result of a synthetically created short position
if the value of the underlying asset decreases or increases respectively during the relevant term of the short position. In addition,
the Trust will be required to post collateral on such positions as required pursuant to the agreement with the relevant transaction counterparty.
The use of short selling through credit default swaps and total return swaps will subject the Trust to counterparty credit risk in the
event of a default by the counterparty which could result in the loss of collateral posted with such counterparty and gains to which the
Trust would otherwise be entitled absent the default of the counterparty. In addition, depending on the nature of the synthetic instrument
used by the Trust to create short exposure, the Trust could be subject to the risk of unlimited losses.
Derivatives Risk
Derivatives are financial contracts in
which the value depends on, or is derived from, the value of an underlying asset, reference rate or index. The Trust may, but is not required
to, engage in various derivatives transactions for hedging and risk management purposes, to facilitate portfolio management and to seek
to enhance total return of earn income. The Trust’s use of derivative instruments involves risks different from, or possibly greater
than, the risks associated with investing directly in securities and other traditional investments. Derivatives are subject to a number
of risks, such as interest rate risk, market risk, counterparty risk, and credit risk. They also involve the risk of mispricing or improper
valuation and the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index.
If the Trust invests in a derivative instrument it could lose more than the principal amount invested. Also, suitable derivative transactions
may not be available in all circumstances and there can be no assurance that the Trust will engage in these transactions to reduce exposure
to other risks when that would be beneficial.
The instruments, indices and rates underlying
derivative transactions expected to be entered into by the Trust may be extremely volatile in the sense that they are subject to sudden
fluctuations of varying magnitude, and may be influenced by, among other things, government trade, fiscal, monetary and exchange control
programs and policies; national and international political and economic events; and changes in interest rates. The volatility of such
instruments, indices or rates, which may render it difficult or impossible to predict or anticipate fluctuations in the value of instruments
traded by the Trust, could result in losses.
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Off-Exchange Derivatives Risk
The Trust may invest a portion of its
assets in investments which are not traded on organized exchanges and as such are not standardized. Such transactions may include forward
contracts, swaps or options. While some markets for such derivatives are highly liquid, transactions in off-exchange derivatives may involve
greater risk than investing in exchange-traded derivatives because there is no exchange market on which to close out an open position.
It may be impossible to liquidate an existing position, to assess the value of the position arising from an off-exchange transaction or
to assess the exposure to risk. Bid and offer prices need not be quoted and, even where they are, they will be established by dealers
in these instruments and consequently it may be difficult to establish what is a fair price. In respect of such trading, the Trust is
subject to the risk of counterparty failure or the inability or refusal by a counterparty to perform with respect to such contracts. Market
illiquidity or disruption could result in major losses to the Trust.
Options Risk
Trading in options involves a number of
risks. Specific market movements of the option and the instruments underlying an option cannot be predicted. No assurance can be given
that a liquid offset market will exist for any particular option or at any particular time. If no liquid offset market exists, the Trust
might not be able to effect an offsetting transaction in a particular option. To realize any profit in the case of an option, therefore,
the option holder would need to exercise the option and comply with margin requirements for the underlying instrument. A writer could
not terminate the obligation until the option expired or the writer was assigned an exercise notice. The purchaser of an option is subject
to the risk of losing the entire purchase price of the option. The writer of an option is subject to the risk of loss resulting from the
difference between the premium received for the option and the price of the futures contract underlying the option that the writer must
purchase or deliver upon exercise of the option. The writer of a naked option may have to purchase the underlying contract in the market
for substantially more than the exercise price of the option in order to satisfy his delivery obligations. This could result in a large
net loss.
Futures Risk
Futures contracts markets are highly volatile
and are influenced by a variety of factors, including national and international political and economic developments. In addition, because
of the low margin deposits normally required in futures trading, a high degree of leverage is typical of a futures trading account. As
a result, a relatively small price movement in a futures contract may result in substantial losses to the trader. Moreover, futures positions
are marked to market each day and variation margin payment must be paid to or by a trader. Positions in futures contracts may be closed
out only on the exchange on which they were entered into or through a linked exchange, and no secondary market exists for such contracts.
Certain futures exchanges do not permit trading in particular futures contracts at prices that represent a fluctuation in price during
a single day’s trading beyond certain set limits. If prices fluctuate during a single day’s trading beyond those limits, the
Trust could be prevented from promptly liquidating unfavorable positions and thus be subjected to substantial losses. When used for hedging
purposes, an imperfect or variable degree of correlation between price movements of the futures contracts and the underlying investment
sought to be hedged may prevent the Trust from achieving the intended hedging effect or expose the Trust to the risk of loss.
Swaps Risk
The Trust may utilize swap agreements
including, without limitation, interest rate, index and currency swap agreements. Swap agreements are two- party contracts entered into
primarily by institutional investors for periods ranging from a few weeks to more than a year. In a standard swap transaction, two parties
agree to exchange the returns earned on specified assets, such as the return on, or increase in value of, a particular dollar amount invested
at a particular interest rate, in a particular foreign currency. The use of swaps is a highly specialized activity that involves investment
techniques and risks different from those associated with ordinary securities transactions. There are risks relating to the financial
soundness and creditworthiness of the counterparty to swap agreements. If the other party to an interest rate swap defaults, the Trust’s
risk of credit loss may be the amount of interest payments that the Trust is contractually obligated to receive on a net basis. However,
where swap agreements require one party’s payments to be “up-front” and timed differently than the other party’s
payments (such as is often the case with currency swaps), the entire principal value of the swap may be subject to the risk that the other
party to the swap will default on its contractual delivery obligations. The investment performance of the Trust, however, may be adversely
affected by the use of swaps if the Sub-Adviser’s forecasts of market values, interest rates or currency exchange rates are inaccurate.
Credit Default Swaps Risk
The Trust may enter into credit default
swap agreements. The “buyer” in a credit default contract is obligated to pay the “seller” a periodic stream of
payments over the term of the contract provided that no event of default on an underlying reference obligation has occurred. The Trust
may be either the buyer or seller in a credit default swap transaction. If the Trust is a buyer and no event of default occurs, the Trust
may lose its investment and recover nothing. However, if an event of default occurs, the Trust (if the buyer) will receive the full notional
value of the reference obligation that may have little or no value. As a seller, the Trust receives a fixed rate of income throughout
the term of the contract provided that there is no default event. If an event of default occurs, the Trust must pay the buyer the full
notional value of the reference obligation. Credit default swap transactions involve greater risks than if a Trust had invested in the
reference obligation directly. Credit default swaps are subject to the risk of non-performance by the swap counterparty, including risks
relating to the financial soundness and creditworthiness of the swap counterparty.
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Hedging Transactions Risk
The success of any hedging strategy utilized
by the Trust’s will be subject to the Sub-Adviser’s ability to correctly assess the degree of correlation between the performance
of the instruments used in the hedging strategy and the performance of the investments in the portfolio being hedged. Since the characteristics
of many securities change as markets change or time passes, the success of the Trust’s hedging strategy will also be subject to
the Sub-Adviser’s ability to continually recalculate, readjust, and execute hedges in an efficient and timely manner.
While the Trust may enter into hedging
transactions to seek to reduce risk, such transactions may result in a poorer overall performance for the Trust than if it had not engaged
in any such hedging transactions. Hedging against a decline in the value of a portfolio position does not eliminate fluctuations in the
values of those portfolio positions or prevent losses if the values of those positions decline. Rather, it establishes other positions
designed to gain from those same declines, thus seeking to moderate the decline in the portfolio position’s value. Such hedging
transactions also limit the opportunity for gain if the value of the portfolio position should increase. For a variety of reasons, the
Sub-Adviser may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged.
Such imperfect correlation may prevent the Trust from achieving the intended hedge or expose the Trust to risk of loss. In addition, it
is not possible to hedge fully or perfectly against any risk, and hedging entails its own costs. The Sub-Adviser may determine, in its
sole discretion, not to hedge against certain risks and certain risks may exist that cannot be hedged. Furthermore, the Sub-Adviser may
not anticipate a particular risk so as to hedge against it effectively. The successful utilization of hedging and risk management transactions
requires skills complementary to those needed in the selection of the Trust’s portfolio holdings.
The Trust may seek to hedge currency risks
by investing in currencies, currency exchange forward or futures contracts, swaps, swaptions or any combination thereof (whether or not
exchange-traded), but these or other instruments necessary to hedge such currency risks may not generally be available, may not provide
a perfect hedge or may not be, in the Sub-Adviser’s judgment, economically priced. There can be no assurance that these strategies
will be effective, and such techniques entail costs and additional risks.
Counterparty Risk
Counterparty risk is the risk that a counterparty
to a Trust transaction (e.g., prime brokerage or securities lending arrangement or derivatives transaction) will be unable or unwilling
to perform its contractual obligation to the Trust. The Trust is exposed to credit risks that the counterparty may be unwilling or unable
to make timely payments or otherwise meet its contractual obligations. If the counterparty becomes bankrupt or defaults on (or otherwise
becomes unable or unwilling to perform, the risk of which is particularly acute under current conditions) its payment or other obligations
to the Trust, the Trust may not receive the full amount that it is entitled to receive or may experience delays in recovering the collateral
or other assets held by, or on behalf of, the counterparty. The Trust bears the risk that counterparties may be adversely affected by
legislative or regulatory changes, adverse market conditions (such as the current conditions), increased competition, and/or wide scale
credit losses resulting from financial difficulties of the counterparties’ other trading partners or borrowers. If a counterparty’s
credit becomes significantly impaired, requests for collateral posting could increase the risk that the Trust will not receive adequate
collateral. Concerns about, or a default by, one large market participant could lead to significant liquidity problems for other participants.
The counterparty risk for cleared derivatives
is generally lower than for uncleared derivatives transactions since generally a clearing organization becomes substituted for each counterparty
to a cleared derivative contract and, in effect, guarantees the parties’ performance under the contract as each party to a trade
looks only to the clearing organization for performance of financial obligations under the derivative contract. However, there can be
no assurance that a clearing organization, or its members, will satisfy its obligations to the Trust.
Synthetic Investment Risk
The Trust may be exposed to certain additional
risks should the Sub-Adviser uses derivatives transactions as a means to synthetically implement the Trust’s investment strategies.
Customized derivative instruments will likely be highly illiquid, and it is possible that the Trust will not be able to terminate such
derivative instruments prior to their expiration date or that the penalties associated with such a termination might impact the Trust’s
performance in a materially adverse manner. Synthetic investments may be imperfectly correlated to the investment the Sub-Adviser is seeking
to replicate. There can be no assurance that the Sub-Adviser’s judgments regarding the correlation of any particular synthetic investment
will be correct. The Trust may be exposed to certain additional risks associated with derivatives transactions should the Sub-Adviser
use derivatives as a means to synthetically implement the Trust’s investment strategies. The Trust would be subject to counterparty
risk in connection with such transactions. If the Trust enters into a derivative instrument whereby it agrees to receive the return of
a security or financial instrument or a basket of securities or financial instruments, it will typically contract to receive such returns
for a predetermined period of time. During such period, the Trust may not have the ability to increase or decrease its exposure. In addition,
such customized derivative instruments will likely be highly illiquid, and it is possible that the Trust will not be able to terminate
such derivative instruments prior to their expiration date or that the penalties associated with such a termination might impact the Trust’s
performance in a material adverse manner. Furthermore, certain derivative instruments typically contain provisions giving the counterparty
the right to terminate the contract upon the occurrence of certain events, such as a decline in the value of the reference securities
and material violations of the terms of the contract or the portfolio guidelines as well as other events determined by the counterparty.
If a termination were to occur, the Trust’s return could be adversely affected as it would lose the benefit of the indirect exposure
to the reference securities and it may incur significant termination expenses.
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Segregation and Cover Risk
In connection with certain derivatives
transactions, the Trust may be required to segregate liquid assets or otherwise cover such transactions and/or to deposit amounts as premiums
or to be held in margin accounts. Regulators have adopted rules that generally require margin to be posted and collected for off-exchange
derivatives. Such amounts may not otherwise be available to the Trust for investment purposes. The Trust may earn a lower return on its
portfolio than it might otherwise earn if it did not have to segregate assets in respect of, or otherwise cover, its derivatives transactions
positions. To the extent the Trust’s assets are segregated or committed as cover, it could limit the Trust’s investment flexibility.
Segregating assets and covering positions will not limit or offset losses on related positions.
Interest Rate Risk
Interest rate risk is the risk that credit
securities will decline in value because of changes in market interest rates. When market interest rates rise, the market value of fixed
income credit securities generally will fall. These risks may be greater in the current market environment because while interest rates
are near historic lows, the Federal Reserve may increase the Federal Funds rate. Prevailing interest rates may be adversely impacted by
market and economic factors. If interest rates rise the markets may experience increased volatility, which may adversely affect the value
and/or liquidity of certain of the Trust’s investments. The prices of longer-term securities fluctuate more than prices of shorter-term
securities as interest rates change. The Trust’s use of leverage will tend to increase the interest rate risk to which its Common
Shares are subject. The Trust invests primarily in variable and floating rate credit instruments and other structured credit investments,
which generally are less sensitive to interest rate changes than fixed rate instruments, but generally will not increase in value if interest
rates decline.
Prepayment Risk
The frequency at which prepayments (including
voluntary prepayments by the obligors and accelerations due to defaults) occur on bonds and loans will be affected by a variety of factors
including the prevailing level of interest rates and spreads as well as economic, demographic, tax, social, legal and other factors. Generally,
obligors tend to prepay their fixed rate obligations when prevailing interest rates fall below the coupon rates on their obligations.
Similarly, floating rate issuers and borrowers tend to prepay their obligations when spreads narrow.
In general, “premium” securities
(securities whose market values exceed their principal or par amounts) are adversely affected by faster than anticipated prepayments,
and “discount” securities (securities whose principal or par amounts exceed their market values) are adversely affected by
slower than anticipated prepayments. Since many fixed rate obligations will be discount securities when interest rates and/or spreads
are high, and will be premium securities when interest rates and/or spreads are low, such securities and asset-backed securities may be
adversely affected by changes in prepayments in any interest rate environment.
The adverse effects of prepayments may
impact the Trust’s portfolio in several ways. During periods of declining interest rates, when the issuer of a security exercises
its option to prepay principal earlier than scheduled, the Trust may be required to reinvest the proceeds of such prepayment in lower-yielding
securities. Particular investments may experience outright losses, as in the case of an interest-only security in an environment of faster
actual or anticipated prepayments. In addition, particular investments may underperform relative to hedges that the Sub-Adviser may have
constructed for these investments, resulting in a loss to the Trust’s overall portfolio. In particular, prepayments (at par) may
limit the potential upside of many securities to their principal or par amounts, whereas their corresponding hedges often have the potential
for unlimited loss.
Inflation/Deflation Risk
Inflation risk is the risk that the value
of assets or income from investments will be worth less in the future as inflation decreases the value of money. As inflation increases,
the real value of Common Shares and distributions can decline. Inflation rates may change frequently and significantly as a result of
various factors, including unexpected shifts in the U.S. or global economy and changes in monetary or economic policies (or expectations
that these policies may change), and the Trust’s investments may not keep pace with inflation, which would adversely affect the
Trust. This risk is significantly elevated compared to normal conditions because of recent monetary policy measures and the current low
interest rate environment. In addition, during any periods of rising inflation, the dividend rates or borrowing costs associated with
the Trust’s use of leverage would likely increase, which would tend to further reduce returns to Common Shareholders. Deflation
risk is the risk that prices throughout the economy decline over time—the opposite of inflation. Deflation may have an adverse effect
on the creditworthiness of issuers and may make issuer default more likely, which may result in a decline in the value of the Trust’s
portfolio.
Duration and Maturity Risk
The
Trust has no set policy regarding maturity or duration of credit instruments in which it may invest or of the Trust’s
portfolio generally. The price of fixed rate securities with longer maturities or duration generally is more significantly impacted
by changes in interest rates than those of fixed rate securities with shorter maturities or duration. Therefore, generally speaking,
the longer the duration of the Trust’s portfolio, the more exposure the Trust will have to interest rate risk described above.
The Sub-Adviser may seek to adjust the portfolio’s duration or maturity based on its assessment of current and projected
market conditions and all factors that the Sub-Adviser deems relevant. Any decisions as to the targeted duration or maturity of any
particular category of investments or of the Trust’s portfolio generally will be made based on all pertinent market factors at
any given time. The Trust may incur costs in seeking to adjust the portfolio average duration or maturity. There can be no assurance
that the Sub-Adviser’s assessment of current and projected market conditions will be correct or that any strategy to adjust
the portfolio’s duration or maturity will be successful at any given time.
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Credit Risk
Credit risk is the risk that an issuer
of securities in which the Trust invests or an asset underlying a CLO in which the Trust invests will be unable to pay principal and interest
when due, or that the value of the security will suffer because investors believe the issuer is less able to pay. This is broadly gauged
by the credit ratings of the securities in which the Trust invests. However, ratings are only the opinions of the agencies issuing them,
may change less quickly than relevant circumstances and are not absolute guarantees of the quality of the securities. Furthermore, the
Trust’s investments may not be rated by any rating agency or may be below investment grade. The Trust will be more dependent upon
the judgment of the Sub-Adviser as to the credit quality of such unrated securities. A default, downgrade or credit impairment of any
of its investments could result in a significant or even total loss of the investment.
Non-U.S. Investments Risk
Issuers of foreign securities are not
subject to United States reporting and accounting requirements. Foreign reporting requirements may result in less information being available
or in a lack of uniformity in the manner in which information is presented. The risk of loss associated with investments in securities
of foreign issuers, particularly in less developed markets, include currency exchange risks, expropriation, or limits on repatriating
an investment, government intervention, confiscatory taxation, political, economic or social instability, illiquidity, less efficient
markets, price volatility and market manipulation.
Some foreign securities may be subject
to brokerage or stock transfer taxes levied by foreign governments, which would have the effect of increasing the cost of investment and
which may reduce the realized gain or increase the loss on such securities at the time of sale. The issuers of some of these securities,
such as banks and other financial institutions, may be subject to less stringent or different regulations than would be the case for U.S.
issuers and therefore potentially carry greater risk. Custodial expenses for a portfolio of non-U.S. securities generally are higher than
for a portfolio of U.S. securities. In addition, dividend and interest payments from, and capital gains in respect of, certain foreign
securities may be subject to foreign taxes that may or may not be reclaimable.
In addition, costs associated with transactions
in non-U.S. markets (including brokerage, execution, clearing and custodial costs) may be substantially higher than costs associated with
transactions in U.S. markets. Such non-U.S. transactions may also involve additional costs for the purchase or sale of currencies in which
the Trust’s assets are denominated in order to settle such transactions. Furthermore, clearing and registration procedures may be
under-developed enhancing the risks of error, fraud, or default.
Many of the laws that govern foreign investment,
securities transactions and other contractual relationships in non-U.S. securities markets are different than or not as fully developed
as those in the United States. As a result, the Trust may be subject to a number of risks, including inadequate investor protection, contradictory
legislation, incomplete, unclear and changing laws, ignorance or breaches of regulations on the part of other market participants, lack
of established or effective avenues for legal redress, lack of standard practices and confidentiality customs characteristic of U.S. markets,
and lack of enforcement of existing regulations. There can be no assurance that this difficulty in protecting and enforcing rights will
not have a material adverse effect on the Trust and its operations. In addition, the income and gains of the Trust may be subject to withholding
taxes imposed by foreign governments for which investors may not receive a full foreign tax credit. Furthermore, it may be more difficult
to obtain and enforce a judgment in a court outside of the United States than to enforce one in the United States.
Bankruptcy Cases Risk
Many of the events within a bankruptcy
case are adversarial and often beyond the control of the creditors. While creditors generally are afforded an opportunity to object to
significant actions, there can be no assurance that a bankruptcy court would not approve actions that may be contrary to the interests
of the partners. Furthermore, there are instances where creditors lose their ranking and priority as such if they are considered to have
taken over management and functional operating control of a debtor. Generally, the duration of a bankruptcy case can only be roughly estimated.
The reorganization of a Borrower usually involves the development and negotiation of a plan of reorganization, plan approval by creditors
and confirmation by the bankruptcy court. This process can involve substantial legal, professional and administrative costs to the Borrower
and the Trust; it is subject to unpredictable and lengthy delays; and during the process the Borrower’s competitive position may
erode, key management may depart and the company may not be able to invest adequately.
U.S. bankruptcy law permits the classification
of “substantially similar” claims in determining the classification of claims in a reorganization for the purpose of voting
on a plan of reorganization. Because the standard for classification is vague, there exists a significant risk that the Trust’s
influence with respect to a class of securities can be lost by the inflation of the number and the amount of claims in, or other gerrymandering
of, the class.
In
addition, certain administrative costs and claims that have priority by law over the claims of certain creditors (for example,
claims for taxes) may be quite high. The administrative costs in connection with a bankruptcy proceeding are frequently high and
will be paid out of the debtor’s estate prior to any return to creditors (other than out of assets or proceeds thereof, which
are subject to valid and enforceable liens and other security interests). In addition, certain claims that have priority by law over
the claims of certain creditors (for example, claims for taxes) may be quite high.
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Creditor Committee Risk
The Sub-Adviser, on behalf of the Trust
as a holder of distressed investments and other credit instruments, may participate on committees formed by creditors to negotiate with
the management of financially troubled companies that may or may not be in bankruptcy or seek to negotiate directly with debtors with
respect to restructuring issues. In situations where the Sub-Adviser chooses to join creditors’ committees, the Trust would likely
be only one of many participants, each of whom would be interested in obtaining an outcome that is in its individual best interests. There
can be no assurance that participation on a creditors’ committee will yield favorable results in such proceedings, and such participation
may entail significant legal fees and other expenses. Participation on such committees may expose the Trust to liability to other creditors.
Participation in restructuring activities
may provide the Sub-Adviser with material non-public information that may restrict the Trust’s ability to trade in the Borrower’s
securities or other instruments. Determination of whether information is material and non-public and how long knowledge of such information
restricts trading is a matter of considerable uncertainty and judgment. While the Sub-Adviser intends to comply with all applicable securities
laws and to make judgments concerning restrictions on trading in good faith, there may be circumstances where the Trust may trade in a
Borrower’s securities or instruments while engaged in restructuring activities relating to that Borrower. Such trading creates a
risk of litigation and liability that may result in significant legal fees and potential losses.
Board Participation Risk
From time to time, an investment by the
Trust may provide the Trust with the right to appoint or more members of the board of directors of a portfolio company or to appoint representatives
to serve as observers to such boards of directors. Although such positions in certain circumstances enhance the ability to manage such
investment, due to the duties imposed on the Trust’s representatives on boards of directors or receipt of material nonpublic information
by such representatives, these positions may also have the effect of impairing the Trust’s ability to sell the related securities
or instruments when, and upon the terms, it may otherwise desire. These restrictions may subject the Trust or its representatives to claims
they would not otherwise be subject to as an investor, including claims of breach of duty of loyalty, securities claims and other director
related claims.
Certain Other Creditor Risks
Debt securities are also subject
to other creditor risks, including, without limitation, (a) the possible invalidation of an investment transaction as a “fraudulent
conveyance” under relevant creditors’ rights laws, (b) so-called “lender liability” claims by the issuer of the
obligations and (c) environmental liabilities that may arise with respect to collateral securing the obligations.
Equity Investments Risk
Incidental to the Trust’s
investments in credit instruments, the Trust may acquire or hold equity securities, or warrants to purchase equity securities, of a Borrower
or issuer. Common equity securities prices fluctuate for a number of reasons, including changes in investors’ perceptions of the
financial condition of an issuer, the general condition of the relevant stock market and broader domestic and international political
and economic events. They may also decline due to factors which affect a particular industry or industries, such as labor shortages or
increased production costs and competitive conditions within an industry. The value of a particular common stock held by the Trust may
decline for a number of other reasons which directly relate to the issuer, such as management performance, financial leverage, the issuer’s
historical and prospective earnings, the value of its assets and reduced demand for its goods and services. In addition, common stock
prices may be particularly sensitive to rising interest rates, as the cost of capital rises and borrowing costs increase. The prices
of common equity securities are also sensitive to general movements in the stock market, so a drop in the stock market may depress the
prices of common stocks and other equity securities to which the Trust has exposure. Dividends on common equity securities are not fixed
but are declared at the discretion of an issuer’s board of directors. There is no guarantee that the issuers of the common equity
securities will declare dividends in the future or that, if declared, they will remain at current levels or increase over time.
Warrants give holders the right, but not
the obligation, to buy common stock of an issuer at a given price, usually higher than the market price at the time of issuance, during
a specified period. The risk of investing in a warrant is that the warrant may expire prior to the market value of the common stock exceeding
the price fixed by the warrant. Warrants have a subordinate claim on a borrower’s assets compared with debt securities. As a result,
the values of warrants generally are dependent on the financial condition of the borrower and less dependent on fluctuations in interest
rates than are the values of many debt securities. The values of warrants may be more volatile than those of Senior Loans or corporate
bonds and this may increase the volatility of the net asset value of the Common Shares.
The Trust’s goal is ultimately to
dispose of equity interests and realize gains upon its disposition of such interests. However, the equity interests the Trust receives
may not appreciate in value and, in fact, may decline in value. Accordingly, the Trust may not be able to realize gains from its equity
interests, and any gains that it does realize on the disposition of any equity interests may not be sufficient to offset any other losses
the Trust experiences.
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Allegation of Equitable Subordination Risk
Under common law principles that, in some
cases, form the basis for lender liability claims, certain actions by creditors may result in the subordination of the claim of the offending
lending institution to the claims of the disadvantaged creditor or creditors, called equitable subordination. Because of the nature of
certain distressed investments, a fund holding such investments could be subject to allegations of lender liability and/or subject to
claims from creditors of an obligor that investments issued by such obligor should be equitably subordinated. A portion of the Trust’s
investments may involve situations in which the Trust will not be the lead creditor. Accordingly, it is possible that lender liability
or equitable subordination claims that affect the Trust’s investments could arise without the direct involvement of the Trust.
Limited Term Risk
Unless the Trust completes an Eligible
Tender Offer and converts to perpetual existence, the Trust will terminate on or about the Termination Date. The Trust should not be confused
with a so called “target date” or “life cycle” fund whose asset allocation becomes more conservative over time
as the fund’s target date, often associated with retirement, approaches, and does not typically terminate on the target date. In
addition, the Trust should not be confused with a “target term” fund whose investment objective is to return the fund’s
original net asset value on the termination date. The Trust’s investment objective and policies are not designed to seek to return
to investors their initial investment on the Termination Date or in an Eligible Tender Offer. Investors may receive more or less than
their original investment upon termination or in an Eligible Tender Offer.
Because the assets of the Trust will be
liquidated in connection with the termination, the Trust will incur transaction costs in connection with dispositions of portfolio securities.
The Trust does not limit its investments to securities having a maturity date prior to the Termination Date and may be required to sell
portfolio securities when it otherwise would not, including at times when market conditions are not favorable, which may cause the Trust
to lose money. In particular, the Trust’s portfolio may still have significant remaining average maturity and duration, and large
exposures to below investment grade securities, as the Termination Date approaches, losses due to portfolio liquidation may be significant.
Beginning one year before the Termination Date (the “wind-down period”), the Trust may begin liquidating all or a portion
of the Trust’s portfolio, and may deviate from its investment policies, including its policy of investing at least 80% of its Managed
Assets in floating rate credit instruments and other structured credit investments and may not achieve its investment objective. During
the wind-down period, the Trust’s portfolio composition may change as more of its portfolio holdings are called or sold and portfolio
holdings are disposed of in anticipation of liquidation. Rather than reinvesting the proceeds of matured, called or sold securities, the
Trust may invest such proceeds in short term or other lower yielding securities or hold the proceeds in cash, which may adversely affect
its performance. The Trust may distribute the proceeds in one or more liquidating distributions prior to the final liquidation, which
may cause fixed expenses to increase when expressed as a percentage of assets under management. Upon a termination, it is anticipated
that the Trust will have distributed substantially all of its net assets to shareholders, although securities for which no market exists
or securities trading at depressed prices, if any, may be placed in a liquidating trust. Common Shareholders will bear the costs associated
with establishing and maintaining a liquidating trust, if necessary. Securities placed in a liquidating trust may be held for an indefinite
period of time until they can be sold or pay out all of their cash flows. The Trust cannot predict the amount, if any, of securities that
will be required to be placed in a liquidating trust.
If the Trust conducts an Eligible Tender
Offer, the Trust anticipates that funds to pay the aggregate purchase price of Common Shares accepted for purchase pursuant to the tender
offer will be first derived from any cash on hand and then from the proceeds from the sale of portfolio investments held by the Trust.
In addition, the Trust may be required to dispose of portfolio investments in connection with any reduction in the Trust’s outstanding
leverage necessary in order to maintain the Trust’s desired leverage ratios following a tender offer. The disposition of portfolio
investments by the Trust could cause market prices of such instruments, and hence the net asset value of the Common Shares, to decline.
In addition, disposition of portfolio investments will cause the Trust to incur increased brokerage and related transaction expenses.
The Trust may receive proceeds from the disposition of portfolio investments that are less than the valuations of such investments by
the Trust. It is likely that during the pendency of a tender offer, and possibly for a time thereafter, the Trust will hold a greater
than normal percentage of its total assets in cash and cash equivalents, which may impede the Trust’s ability to achieve its investment
objective and decrease returns to shareholders. If the Trust’s tax basis for the investments sold is less than the sale proceeds,
the Trust will recognize capital gains, which the Trust will be required to distribute to shareholders. In addition, the Trust’s
purchase of tendered Common Shares pursuant to a tender offer will have tax consequences for tendering shareholders and may have tax consequences
for non-tendering shareholders. The purchase of Common Shares by the Trust pursuant to a tender offer will have the effect of increasing
the proportionate interest in the Trust of non-tendering shareholders. All shareholders remaining after a tender offer will be subject
to proportionately higher expenses due to the reduction in the Trust’s total assets resulting from payment for the tendered Common
Shares. Such reduction in the Trust’s total assets may also result in less investment flexibility, reduced diversification and greater
volatility for the Trust, and may have an adverse effect on the Trust’s investment performance.
The
Trust is not required to conduct an Eligible Tender Offer. If the Trust conducts an Eligible Tender Offer, there can be no assurance
that tendered Common Shares will not exceed the Termination Threshold, in which case the Eligible Tender Offer will be terminated,
no Common Shares will be repurchased pursuant to the Eligible Tender Offer and the Trust will terminate on or before the Termination
Date (subject to possible extensions). Following the completion of an Eligible Tender Offer in which the tendered Common Shares do
not exceed the Termination Threshold, the Board of Trustees may eliminate the Termination Date upon the affirmative vote of a
majority of the Board of Trustees and without a shareholder vote. Thereafter, the Trust will have a perpetual existence. The Trust
is not required to conduct additional tender offers following an Eligible Tender Offer and conversion to perpetual existence.
Therefore, remaining shareholders may not have another opportunity to participate in a tender offer. Shares of closed-end management
investment companies frequently trade at a discount from their net asset value, and as a result remaining shareholders may only be
able to sell their Common Shares at a discount to net asset value.
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Management Risk
The Trust is subject to management risk
because the Trust has an actively managed portfolio. The Adviser and Sub-Adviser will apply investment techniques and risk analysis in
making investment decisions for the Trust, but there can be no guarantee that these will produce the desired results.
Valuation Risk
Because the secondary markets for certain
investments may be limited, they may be difficult to value. Where market quotations are not readily available or deemed unreliable, the
Trust will value such securities in accordance with fair value procedures adopted by the Board of Trustees. The Trust generally uses non-binding
indicative bid prices provided by an independent pricing service or broker as the primary basis for determining the value of CLO debt
and subordinated securities, which may be adjusted for pending distributions, as applicable, as of the applicable valuation date. These
bid prices are non-binding, and may not be determinative of fair value. Valuations of some or all of the Trust’s investments may
require input from the Sub-Adviser and third parties, which may be based on subjective inputs of the Sub-Adviser or such third parties.
Valuation of such securities may require more research than for more liquid investments. In valuing the Trust’s investments in CLO
debt and subordinated securities, in addition to non-binding indicative bid prices provided by an independent pricing service or broker,
the Valuation Committee also may consider a variety of relevant factors, including recent trading prices for specific investments, recent
purchases and sales known to the Trust in similar securities, other information known to the Trust relating to the securities, and discounted
cash flows based on output from a third-party financial model, using projected future cash flows. Elements of judgment may play a greater
role in valuation in such cases than for investments with a more active secondary market because there is less reliable objective data
available. In some cases, valuation of certain investments may be based upon models, indicative quotes or estimates of value and not actual
executed historical trades. Reasonable efforts will be made to base such inputs on observable market prices and inputs but there can be
no assurances that such information will be readily available. Generally, there is not a public market for the CLO securities in which
the Trust invests. A security that is fair valued may be valued at a price higher or lower than the value determined by other funds using
their own fair valuation procedures. Prices obtained by the Trust upon the sale of such securities may not equal the value at which the
Trust carried the investment on its books, which would adversely affect the net asset value of the Trust. The Trust may incur costs in
connection with valuing its investments, including costs associated with the retention of valuation firms to value certain of the Trust’s
investments.
Dependence on Occurrence of Events Risk
The ability to realize a profit on many
of the Trust’s investments is dependent upon the occurrence (or non-occurrence) of certain events, including, among other things,
reorganization transactions involving portfolio companies, restructurings or renegotiations of the terms of loans or debt securities issued
by portfolio companies or the successful implementation of business strategies or completion of certain projects by portfolio companies.
If the event that the Sub-Adviser is expecting does not occur (or an unexpected event occurs), the Trust may sustain a significant loss.
Competition Risk
Since an inherent part of the Sub-Adviser’s
strategy will be to identify securities that provide for attractive risk adjusted yield, competitive investment activity by other firms
may reduce the Trust’s opportunity for profit by reducing mispricings in the market as well as the margins available on such mispricings
as can still be identified.
Conflicts of Interest Risk
Various potential and actual conflicts
of interest may arise from the overall investment activity of the Trust, the Sub-Adviser and its affiliates. Certain inherent conflicts
of interest may arise from the fact that the Sub-Adviser and its affiliates may in the future carry on substantial investment activities
for other client accounts, including discretionary accounts and other investment vehicles (collectively, the “Other Accounts”).
Some of the Other Accounts may invest
in the same or different securities as the Trust, compete with the Trust for the same investment opportunities (which may be limited)
and/or engage in transactions or other activities or pursue investment strategies which are inconsistent with those effected for the Trust
or which are contrary to or conflict with the interests of the Trust.
The Sub-Adviser and its affiliates may
give advice to or effect transactions on behalf of Other Accounts that are inconsistent with or contrary to advice given or transactions
effected on behalf of the Trust.
The Sub-Adviser or its affiliates could
manage one or more Other Accounts that may invest in different levels of the capital structure of a portfolio company, the debt or equity
of which is held by the Trust. If a common portfolio company were to experience financial difficulty, the interests of the Trust could
be different from the interest in such portfolio company held by one or more Other Accounts. To the extent that such a conflict arises,
the Sub-Adviser and its affiliates will seek to resolve such conflicts on a case-by-case basis in the best interest of Trust and such
Other Accounts, and in accordance with the restrictions of the 1940 Act.
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Allocation of Investment Opportunities.
The Sub-Adviser and its affiliates are not obligated to allocate all investment opportunities that may be appropriate for the Trust to
the Trust. Allocation of investment opportunities among the Trust and the Other Accounts will be subject to the Sub- Adviser’s allocation
procedures which generally provide that investments will be allocated on a fair and equitable basis over time (but not necessarily on
a pro rata basis), having regard to such matters as available capital, relative exposure to market trends, risk tolerance, expected duration
of the Trust or the investments, the investment programs and portfolio positions of the Trust and the affiliated entities for which participation
is appropriate, guidelines, concentration limits and other limitations established by the respective entities, and applicable tax and
regulatory considerations.
Allocation of Personnel. Such Other Accounts
may be managed by current employees of the Sub-Adviser or by new portfolio managers hired by the Sub-Adviser and may follow a similar
investment strategy as that employed by the Trust. The Sub-Adviser may have an incentive to retain such portfolio managers to manage the
assets of such Other Accounts rather than or in addition to managing the assets of the Trust. Although the officers and employees of the
Sub-Adviser will devote as much time to the Trust as the Sub-Adviser deems appropriate, the officers and employees, if any, may have conflicts
in allocating their time and services among the Trust and other accounts now or hereafter advised by the Sub-Adviser and/or its affiliates.
Lack of Information Barriers. Situations
may occur where the Trust may be deemed to have possession of material non-public information, including material non-public information
concerning specific companies, as a result of other activities by the Sub-Adviser, including on behalf of other clients. Under applicable
securities laws, this may limit the Sub-Adviser’s ability to buy or sell securities issued by such companies and the Trust may be
unable to engage in certain transactions they would otherwise find attractive, or may be able to engage in such transactions only during
limited periods of time. Due to these restrictions, the Trust may not be able to initiate a transaction that it otherwise might have initiated
and may not be able to sell an investment that it otherwise might have sold. Similarly, the Sub-Adviser may decline to receive material
nonpublic information in order to avoid trading restrictions with regard to any Other Account, even though access to such information
may have been advantageous to the Trust. Clients and investors may be adversely affected by such restrictions.
While the Sub-Adviser has procedures in place
to manage the risk associated with insider trading, the management of material non-public information could fail and result in the Sub-Adviser
or one of its investment professionals buying and selling a security while, at least constructively, in possession of material non-public
information. Inadvertent trading on material non-public information could have adverse effects on the Sub-Adviser’s reputation,
or result in the imposition of regulatory or financial sanctions, and as a consequence, negatively impact the Sub-Adviser’s ability
to perform its investment management services on behalf of regulations, or decide that it is advisable to establish information barriers
in the future, which may affect how they provides advice.
Restrictions on Transactions with Affiliates.
The 1940 Act limits the Trust’s ability to enter into certain transactions with certain of its affiliates. As a result of these
restrictions, the Trust may be prohibited from buying or selling any security directly from or to any portfolio company of a registered
investment company or other pooled investment vehicle managed by the Sub-Adviser or any of its affiliates. The 1940 Act also prohibits
certain “joint” transactions with certain of the Trust’s affiliates, which could include investments in the same portfolio
company (whether at the same or different times). The analysis of whether a particular transaction constitutes a joint transaction requires
a review of the relevant facts and circumstances then existing. These limitations may limit the scope of investment opportunities that
would otherwise be available to the Trust. For example, these limitations may limit the extent to which the Trust may invest in CLOs for
which the Sub-Adviser or its affiliates act as CLO manager, even if such CLOs were otherwise attractive investments for the Trust.
Confidential Information Risk
The Trust frequently may possess material non-public
information about an issuer as a result of its ownership of a credit instrument of an issuer. Because of prohibitions on trading in securities
while in possession of material non-public information, the Trust might be unable to enter into a transaction in a security of the issuer
when it would otherwise be advantageous to do so.
Tax Risk
The Trust has elected to be treated and intends
to continue to qualify each year as a RIC under the Code. As a RIC, the Trust generally would not be subject to U.S. federal income tax
to the extent that it distributes its investment company taxable income and net capital gains. To qualify for the special tax treatment
available to RICs, the Trust must comply with certain income, distribution, and diversification requirements. If the Trust failed to meet
any of these requirements, subject to the opportunity to cure such failures under applicable provisions of the Code, the Trust would be
subject to U.S. federal income tax at regular corporate rates on its taxable income, including its net capital gain, even if such income
were distributed to shareholders. All distributions by the Trust from earnings and profits, including distributions of net capital gain
(if any), would be taxable to shareholders as dividends.
Certain of the
Trust’s investments will cause the Trust to take into account taxable income in a taxable year in excess of the cash generated
on those investments during that year. In particular, the Trust expects to invest in loans and other debt obligations that will be
treated as having “market discount” and/or original issue discount (“OID”) for U.S. federal income tax
purposes. Because the Trust may be allocated taxable income in respect of these investments before, or without receiving, cash
representing such income, the Trust may have difficulty satisfying the annual distribution requirements applicable to RICs and
avoiding Trust-level U.S. federal income and/or excise taxes. Accordingly, the Trust may be required to sell assets, including at
potentially disadvantageous times or prices, raise additional debt or equity capital or reduce new investments, to obtain the cash
needed to make these income distributions. If the Trust liquidates assets to raise cash, the Trust may realize gain or loss on such
liquidations. In the event the Trust realizes net capital gains from such liquidation transactions, the Trust and, ultimately, its
Common Shareholders, may receive larger capital gain distributions than it or they would in the absence of such transactions.
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The Trust may invest a portion of its net assets
in below investment grade instruments. Investments in these types of instruments may present special tax issues for the Trust. U.S. federal
income tax rules are not entirely clear about issues such as when the Trust may cease to accrue interest, OID or market discount, when
and to what extent deductions may be taken for bad debts or worthless instruments, how payments received on obligations in default should
be allocated between principal and income and whether exchanges of debt obligations in a bankruptcy or workout context are taxable. These
and other issues will be addressed by the Trust to the extent necessary in order to seek to ensure that it distributes sufficient income
that it does not become subject to U.S. federal income or excise tax.
Portfolio Turnover Risk
The Trust may engage in active and frequent
trading of its portfolio securities. High portfolio turnover may result in increased transaction costs to the Trust, including brokerage
commissions, dealer mark-ups and other transaction costs on the sale of securities and on reinvestment in other securities. The sale of
portfolio securities may result in the realization and/or distribution to shareholders of higher capital gains or losses as compared to
a fund with less active trading policies. These effects of higher than normal portfolio turnover may adversely affect Trust performance.
Reliance on Service Providers
The Trust must rely upon the performance of
service providers to perform certain functions, which may include functions that are integral to the operations and financial performance
of the Trust. Fees and expenses of these service providers are borne by the Trust, and therefore indirectly by Common Shareholders. Failure
by any service provider to carry out its obligations to the Trust in accordance with the terms of its appointment, to exercise due care
and skill, or to perform its obligations to the Trust at all as a result of insolvency, bankruptcy or other causes could have a material
adverse effect on the Trust’s performance and ability to achieve its investment objective. The termination of the Trust’s
relationship with any service provider, or any delay in appointing a replacement for such service provider, could materially disrupt the
business of the Trust and could have a material adverse effect on the Trust’s performance and ability to achieve its investment
objective.
The Trust and its service providers are currently
impacted by quarantines and similar measures being enacted by governments in response to COVID- 19, which are obstructing the regular
functioning of business workforces (including requiring employees to work from external locations and their homes). Accordingly, certain
risks described above are heightened under current conditions.
Technology Risk
Markets and market participants are increasingly
reliant upon both publicly available and proprietary information data systems. Data imprecision, software or other technology malfunctions,
programming inaccuracies, unauthorized use or access, and similar circumstances may impair the performance of these systems and may have
an adverse impact upon a single issuer, a group of issuers, or the market at large. As the use of internet technology has become more
prevalent, the Trust and their respective service providers have become more susceptible to potential operational risks through breaches
in cyber security (generally, intentional and unintentional events that may cause the Trust, or a service provider to lose proprietary
information, suffer data corruption or lose operational capacity). There can be no guarantee that any risk management systems established
by the Trust, their service providers, or issuers of the securities in which the Trust invests that are intended to reduce cyber security
risks will succeed. The Trust cannot control such systems put in place by service providers or other third parties whose operations may
affect the Trust and Common Shareholders.
Recent Market, Economic and Social Developments
Risk
Periods of market volatility remain, and may
continue to occur in the future, in response to various political, social and economic events both within and outside the United States.
These conditions have resulted in, and in many cases continue to result in, greater price volatility, less liquidity, widening credit
spreads and a lack of price transparency, with many securities remaining illiquid and of uncertain value. Such market conditions may adversely
affect the Trust, including by making valuation of some of the Trust’s securities uncertain and/or result in sudden and significant
valuation increases or declines in the Trust’s holdings. If there is a significant decline in the value of the Trust’s portfolio,
this may impact the asset coverage levels for the Trust’s outstanding leverage.
Risks resulting from
any future debt or other economic crisis could also have a detrimental impact on the global economic recovery, the financial
condition of financial institutions and the Trust’s business, financial condition and results of operation. Market and
economic disruptions have affected, and may in the future affect, consumer confidence levels and spending, personal bankruptcy
rates, levels of incurrence and default on consumer debt and home prices, among other factors. To the extent uncertainty regarding
the U.S. or global economy negatively impacts consumer confidence and consumer credit factors, the Trust’s business, financial
condition and results of operations could be significantly and adversely affected. Downgrades to the credit ratings of major banks
could result in increased borrowing costs for such banks and negatively affect the broader economy. Moreover, Federal Reserve
policy, including with respect to certain interest rates, may also adversely affect the value, volatility and liquidity of dividend-
and interest-paying securities. Market volatility, rising interest rates and/or unfavorable economic conditions could impair the
Trust’s ability to achieve its investment objective.
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The outbreak of infectious respiratory illness
caused by the coronavirus known as “COVID-19” and the current recovery underway has caused disruption to consumer demand,
economic output and supply chains. Travel restrictions, quarantines and adverse impacts on local and global economies linger despite the
ongoing recovery. As with other serious economic disruptions, governmental authorities and regulators have in the past responded to this
crisis (and may in the future respond to similar crises) with significant fiscal and monetary policy changes, including by providing direct
capital infusions to companies and consumers, introducing new monetary programs and considerably lowering interest rates, which in some
cases resulted in negative interest rates and higher inflation. These actions, including their possible unexpected or sudden reversal
or potential ineffectiveness, could further increase volatility in securities and other financial markets, reduce market liquidity, contribute
to higher inflation, heighten investor uncertainty and adversely affect the value of the Trust’s investments and the performance
of the Trust.
The current economic situation and the unprecedented
measures taken by state, local and national governments around the world to combat the spread of COVID-19, as well as various social,
political and psychological tensions in the United States and around the world, may continue to contribute to severe market disruptions
and volatility and reduced economic activity, may have long-term negative effects on the U.S. and worldwide financial markets and economy
and may cause further economic uncertainties in the United States and worldwide. Ratings agencies have recently undergone reviews of loans
and CLOs in light of the COVID-19 pandemic’s adverse impact on the economic market. Downgrades by rating agencies of loans in which
the Trust has invested or that are held by CLOs in which the Trust has invested may adversely impact the performance of the Trust. The
slowing or reversal of the current U.S. and global economic recovery could adversely impact the Trust’s portfolio. It is difficult
to predict how long the financial markets and economic activity will continue to be impacted by these events and the Trust cannot predict
the effects of these or similar events in the future on the U.S. economy and securities markets. The Adviser intends to monitor developments
and seek to manage the Trust’s portfolio in a manner consistent with achieving the Trust’s investment objective, but there
can be no assurance that it will be successful in doing so.
Equity capital may be difficult to raise during
periods of adverse or volatile market conditions because, subject to some limited exceptions, as a registered investment company, the
Trust generally is not able to issue additional Common Shares at a price less than net asset value without first obtaining approval for
such issuance from Common Shareholders.
Market Disruption and Geopolitical Risk
The aftermath of the war in Iraq, instability
in Afghanistan, Pakistan, Egypt, Libya, Syria, Russia, Ukraine and the Middle East, possible terrorist attacks in the United States and
around the world, growing social and political discord in the United States, the European debt crisis, the response of the international
community—through economic sanctions and otherwise—to Russia’s annexation of the Crimea region of Ukraine and posture
vis-à-vis Ukraine, increasingly strained relations between the United States and a number of foreign countries, including traditional
allies, such as certain European countries, and historical adversaries, such as North Korea, Iran, China and Russia, and the international
community generally, new and continued political unrest in various countries, such as Venezuela and Spain, the United Kingdom’s
pending withdrawal from the European Union (the “EU”) and the resulting profound and uncertain impacts on the economic and
political future of the United Kingdom, the exit or potential exit of one or more countries from the EU or the European Monetary Union
(the “EMU”), the EU and global financial markets, further downgrade of U.S. Government securities, the change in the U.S.
president and the new administration and other similar events, may have long-term effects on the U.S. and worldwide financial markets
and may cause further economic uncertainties in the United States and worldwide. The Trust does not know and cannot predict how long the
securities markets may be affected by these events and the effects of these and similar events in the future on the U.S. economy and securities
markets. The Trust may be adversely affected by abrogation of international agreements and national laws which have created the market
instruments in which the Trust may invest, failure of the designated national and international authorities to enforce compliance with
the same laws and agreements, failure of local, national and international organization to carry out their duties prescribed to them under
the relevant agreements, revisions of these laws and agreements which dilute their effectiveness or conflicting interpretation of provisions
of the same laws and agreements. The Trust may be adversely affected by uncertainties such as terrorism, international political developments,
and changes in government policies, taxation, restrictions on foreign investment and currency repatriation, currency fluctuations and
other developments in the laws and regulations of the countries in which it is invested and the risks associated with financial, economic,
health, labor and other global market developments and disruptions.
UK Departure from EU (“Brexit”)
Risk
On January 31, 2020, the United Kingdom (“UK”)
officially withdrew from the European Union (“EU”) and the two sides entered into a transition phase, where the UK effectively
remained in the EU from an economic perspective, but no longer had any political representation in the EU parliament. The transition period
concluded on December 31, 2020, and EU law no longer applies in the UK.
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On December 30, 2020,
the UK and the EU signed an EU-UK Trade and Cooperation Agreement (“UK/EU Trade Agreement”), which went into effect on
January 1, 2021 and sets out the foundation of the economic and legal framework for trade between the UK and the EU. As the UK/EU
Trade Agreement is a new legal framework, the implementation of the UK/EU Trade Agreement may result in uncertainty in its
application and periods of volatility in both the UK and wider European markets. The UK’s exit from the EU is expected to
result in additional trade costs and disruptions in this trading relationship. Furthermore, there is the possibility that either
party may impose tariffs on trade in the future in the event that regulatory standards between the EU and the UK diverge. The terms
of the future relationship may cause continued uncertainty in the global financial markets, and adversely affect the performance of
the Trust.
In addition to the effects on the Trust’s
investments in European issuers, the unavoidable uncertainties and events related to Brexit could negatively affect the value and liquidity
of the Trust’s other investments, increase taxes and costs of business and cause volatility in currency exchange rates and interest
rates. European, UK or worldwide political, regulatory, economic or market conditions and could contribute to instability in political
institutions, regulatory agencies and financial markets. Brexit could also lead to legal uncertainty and politically divergent national
laws and regulations as the new relationship between the UK and EU is further defined and as the UK determines which EU laws to replace
or replicate. In addition, Brexit could lead to further disintegration of the EU and related political stresses (including those related
to sentiment against cross border capital movements and activities of investors like the Trust), prejudice to financial services businesses
that are conducting business in the EU and which are based in the UK, legal uncertainty regarding achievement of compliance with applicable
financial and commercial laws and regulations in view of the expected steps to be taken pursuant to or in contemplation of Brexit. Any
of these effects of Brexit, and others that cannot be anticipated, could adversely affect the Trust’s business, results of operations
and financial condition.
Redenomination Risk
The result of the Referendum, the progression
of the European debt crisis and the possibility of one or more Eurozone countries exiting the EMU, or even the collapse of the euro as
a common currency, has created significant volatility in currency and financial markets generally. The effects of the collapse of the
euro, or of the exit of one or more countries from the EMU, on the U.S. and global economies and securities markets are impossible to
predict and any such events could have a significant adverse impact on the value and risk profile of the Trust’s portfolio. Any
partial or complete dissolution of the EMU could have significant adverse effects on currency and financial markets, and on the values
of the Trust’s portfolio investments. If one or more EMU countries were to stop using the euro as its primary currency, the Trust’s
investments in such countries may be redenominated into a different or newly adopted currency. As a result, the value of those investments
could decline significantly and unpredictably. In addition, securities or other investments that are redenominated may be subject to foreign
currency risk, liquidity risk and valuation risk to a greater extent than similar investments currently denominated in euros. To the extent
a currency used for redenomination purposes is not specified in respect of certain EMU-related investments, or should the euro cease to
be used entirely, the currency in which such investments are denominated may be unclear, making such investments particularly difficult
to value or dispose of. The Trust may incur additional expenses to the extent it is required to seek judicial or other clarification of
the denomination or value of such securities.
Legislation and Regulation Risk
At any time after the date of this Prospectus
Supplement, legislation may be enacted that could negatively affect the companies in which the Trust invests. Changing approaches to regulation
may also have a negative impact on companies in which the Trust invests. In addition, legislation or regulation may change the way in
which the Trust is regulated. There can be no assurance that future legislation, regulation or deregulation will not have a material adverse
effect on the Trust or will not impair the ability of the Trust to achieve its investment objective.
The Dodd-Frank Wall Street Reform and Consumer
Protection Act (the “Dodd-Frank Act”), which was signed into law in July 2010, has resulted in significant revisions to the
U.S. financial regulatory framework. The Dodd-Frank Act covers a broad range of topics, including, among many others: a reorganization
of federal financial regulators; the creation of a process designed to ensure financial system stability and the resolution of potentially
insolvent financial firms; the enactment of new rules for derivatives trading; the creation of a consumer financial protection watchdog;
the registration and regulation of managers of private funds; the regulation of rating agencies; and the enactment of new federal requirements
for residential mortgage loans. The regulation of various types of derivative instruments pursuant to the Dodd-Frank Act may adversely
affect the Trust or its counterparties.
Section 619 of the Dodd-Frank Act, commonly
referred to as the “Volcker Rule,” generally prohibits, subject to certain exemptions, covered banking entities from engaging
in proprietary trading or sponsoring, or acquiring or retaining an ownership interest in covered funds (which has been broadly defined
in a way which could include many CLOs). On June 25, 2020, the Federal Reserve Board issued a final rule to simplify and tailor compliance
requirements relating to the Volcker Rule.
Given the limitations on banking entities investing
in CLOs that are covered funds, the Volcker Rule may adversely affect the market value or liquidity of CLOs. Although the Volcker Rule
and the implementing rules exempt “loan securitizations” from the definition of covered fund, not all CLOs may qualify for
this exemption. Accordingly, in an effort to qualify for the “loan securitization” exemption, many current CLOs have amended
their transaction documents to restrict the ability of the issuer to acquire bonds and certain other securities and future CLOs may contain
similar restrictions.
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The staff of the SEC has, in correspondence
with registered management investment companies, raised questions about the level of, and special risks associated with, investments in
CLO securities. While it is not possible to predict what conclusions, if any, the staff may reach in these areas, or what recommendations,
if any, the staff might make to the SEC, the imposition of limitations on investments by registered management investment companies in
CLO securities could adversely impact the Trust’s ability to implement its investment strategy and/or the Trust’s ability
to raise capital through public offerings, or could cause the Trust to take certain actions that may result in an adverse impact on the
Trust’s financial condition and results of operations.
In October 2014, six federal agencies adopted
joint final rules implementing certain credit risk retention requirements contemplated in Section 941 of the Dodd-Frank Act (the “Risk
Retention Rules”). A 2018 court ruling vacated the application of Risk Retention Rules to collateral managers of certain CLOs. As
a result, it is possible that some collateral managers of such CLOs will decide to dispose of the interests they had retained in accordance
with the Risk Retention Rules, or decide to take other action with respect to such interests that was not otherwise permitted by the Risk
Retention Rules. In light of the outcome of the litigation described above, proposed legislation designed to modify the Risk Retention
Rules, reports from the Department of the Treasury recommending potential modifications to the Risk Retention Rules and possible future
interpretations by governmental authorities with respect to the Risk Retention Rules, the ultimate impact of the Risk Retention Rules
on market generally remains uncertain.
In the EU, there has also been an increase in
political and regulatory scrutiny of the securitization industry. This has resulted in a number of measures for increased regulation which
are currently at various stages of implementation. CLOs issued in Europe are generally structured in compliance with the applicable EU
securitization retention requirements. Such requirements may reduce the issuance of new CLOs and reduce the liquidity provided by CLOs
to the leveraged loan market generally. Reduced liquidity in the loan market could reduce investment opportunities for collateral managers,
which could negatively affect the return of the Trust’s investments. Any reduction in the volume and liquidity provided by CLOs
to the leveraged loan market could also reduce opportunities to redeem or refinance the securities comprising a CLO in an optional redemption
or refinancing and could negatively affect the ability of obligors to refinance of their collateral obligations.
Moreover, the SEC and its staff are also reportedly
engaged in various initiatives and reviews that seek to improve and modernize the regulatory structure governing investment companies.
These efforts appear to be focused on risk identification and controls in various areas, including embedded leverage through the use of
derivatives and other trading practices, cybersecurity, liquidity, enhanced regulatory and public reporting requirements and the evaluation
of systemic risks. Any new rules, guidance or regulatory initiatives resulting from these efforts could increase the Trust’s expenses
and impact its returns to shareholders or, in the extreme case, impact or limit the Trust’s use of various portfolio management
strategies or techniques and adversely impact the Trust.
In October 2020, the SEC adopted final rules
related to the use of derivatives and certain other transactions by registered investment companies. The compliance date for such rules
is August 19, 2022. Such rules could limit the extent to which the Trust may utilize certain derivative instruments and certain types
of leverage, and therefore may have an adverse impact on the ability of the Trust to achieve its investment objective.
On January 20, 2021, Mr. Joseph R. Biden was
inaugurated as President of the United States. President Biden has called for significant policy changes and the reversal of several of
the prior presidential administration’s policies, including significant changes to U.S. fiscal, tax, trade, healthcare, immigration,
foreign, and government regulatory policy. In this regard, there is significant uncertainty with respect to legislation, regulation and
government policy at the federal level, as well as the state and local levels. Certain of these changes can, and have, been effectuated
through executive order. For example, the current administration has taken steps to address the COVID-19 pandemic, rejoin the Paris climate
accord of 2015, cancel the Keystone XL pipeline and change immigration enforcement priorities. Recent events have created a climate of
heightened uncertainty and introduced new and difficult-to-quantify macroeconomic and political risks with potentially far-reaching implications.
There has been a corresponding meaningful increase in the uncertainty surrounding interest rates, inflation, foreign exchange rates, trade
volumes and fiscal and monetary policy. To the extent the U.S. Congress or the current presidential administration implements changes
to U.S. policy, those changes may impact, among other things, the U.S. and global economy, international trade and relations, unemployment,
immigration, corporate taxes, healthcare, the U.S. regulatory environment, inflation and other areas.
Although the Trust cannot predict the impact,
if any, of these changes to the Trust’s business, they could adversely affect the Trust’s business, financial condition, operating
results and cash flows. Until the Trust knows what policy changes are made and how those changes impact the Trust’s business and
the business of the Trust’s competitors over the long term, the Trust will not know if, overall, the Trust will benefit from them
or be negatively affected by them. The Adviser and the Sub-Adviser intend to monitor developments and seek to manage the Trust’s
portfolio in a manner consistent with achieving the Trust’s investment objectives, but there can be no assurance that they will
be successful in doing so.
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LIBOR Risk
Instruments in which
the Trust invests may pay interest at floating rates based on LIBOR or may be subject to interest caps or floors based on LIBOR. The
Trust and issuers of instruments in which the Trust invests may also obtain financing at floating rates based on LIBOR. Derivative
instruments utilized by the Trust and/or issuers of instruments in which the Trust may invest may also reference LIBOR. The Trust
utilizes leverage or borrowings primarily based on LIBOR. Regulators and law-enforcement agencies from a number of governments,
including entities in the United States, Japan, Canada and the UK, have conducted or are conducting civil and criminal
investigations into whether the banks that contribute to the British Bankers’ Association, or the “BBA,” in
connection with the calculation of daily LIBOR may have been manipulating or attempting to manipulate LIBOR. Several financial
institutions have reached settlements with the Commodity Futures Trading Commission (“CFTC”), the U.S. Department of
Justice Fraud Section and the United Kingdom Financial Conduct Authority in connection with investigations by such authorities into
submissions made by such financial institutions to the bodies that set LIBOR and other interbank offered rates.
ICE Benchmark Administration Limited (“IBA”)
assumed the role of LIBOR administrator from the BBA on February 1, 2014. In July 2017, the head of the United Kingdom Financial Conduct
Authority announced the desire to phase out the use of LIBOR by the end of 2021. On March 5, 2021, IBA announced that it will cease publication
of euro, sterling, Swiss franc and yen LIBORs after December 31, 2021; one week and two month U.S. dollar LIBORs after December 31, 2021;
and all other U.S. dollar LIBORs after June 30, 2023. Therefore, banks are encouraged to cease entering into new contracts that use U.S.
dollar LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021 or June 30, 2023, as applicable. There is
currently no definitive information regarding the future utilization of LIBOR or of any particular replacement rate. Abandonment of or
modifications to LIBOR could have adverse impacts on newly issued financial instruments and existing financial instruments which reference
LIBOR. CLOs generally contemplate a scenario where LIBOR is no longer available by requiring the CLO administrator to calculate a replacement
rate primarily through dealer polling on the applicable measurement date. However, there is uncertainty regarding the effectiveness of
the dealer polling processes, including the willingness of banks to provide such quotations. Recently, some CLOs have included, or have
been amended to include, language permitting the CLO investment manager to implement a market replacement rate upon the occurrence of
certain material disruption events. However, not all CLOs may adopt such provisions, nor can there be any assurance the CLO investment
managers will undertake the suggested amendments when able. In addition, the effect of a phase out of LIBOR on U.S. senior secured loans,
the underlying assets of the CLOs in which we invest, is currently unclear. While some instruments may contemplate a scenario where LIBOR
is no longer available by providing for an alternative rate setting methodology, not all instruments may have such provisions and there
is significant uncertainty regarding the effectiveness of any such alternative methodologies. To the extent that any replacement rate
utilized for senior secured loans differs from that utilized for a CLO that holds those loans, the CLO would experience an interest rate
mismatch between its assets and liabilities. Abandonment of LIBOR could lead to significant short-term and long-term uncertainty and market
instability. It remains uncertain how such changes would be implemented and the effects such changes would have on the Trust, issuers
of instruments in which the Trust invests and financial markets generally.
At this time, no consensus exists as to what
rate or rates will become accepted alternatives to LIBOR, although the U.S. Federal Reserve, in connection with the Alternative Reference
Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing U.S. dollar LIBOR with
the Secured Overnight Financing Rate (“SOFR”). Given the inherent differences between LIBOR and SOFR, or any other alternative
benchmark rate that may be established, there are many uncertainties regarding a transition from LIBOR, including but not limited to the
need to amend all contracts with LIBOR as the referenced rate and how this will impact the cost of variable rate debt and certain derivative
financial instruments. In addition, SOFR or other replacement rates may fail to gain market acceptance. Any failure of SOFR or alternative
reference rates to gain market acceptance could adversely affect the return on, value of and market for securities linked to such rates.
The state of New York recently adopted legislation
that would require LIBOR-based contracts that do not include a fallback to a rate other than LIBOR or an inter-bank quotation poll to
use a SOFR-based rate plus a spread adjustment. Pending legislation in the U.S. Congress may also affect the transition of LIBOR-based
instruments as well by permitting trustees and calculation agents to transition instruments with no LIBOR transition language to an alternative
reference rate selected by such agents. The New York statute and the federal legislative proposal each includes safe harbors from liability,
which may limit the recourse the Trust may have if the alternative reference rate does not fully compensate the Trust for the transition
of an instrument from LIBOR. If enacted, the federal legislation may also preempt the New York statute, which may create uncertainty to
the extent a party has sought to rely on the New York statute to select a replacement benchmark rate.
These developments could negatively affect financial
markets in general and present heightened risks, including with respect to the Trust’s investments. As a result of this uncertainty
and developments relating to the transition process, the Trust and its investments may be adversely affected.
Anti-Takeover Provisions in the Trust’s
Governing Documents Risk
The Trust’s governing documents include
provisions that could limit the ability of other entities or persons to acquire control of the Trust or convert the Trust to open-end
status. These provisions could have the effect of depriving Common Shareholders of opportunities to sell their Common Shares at a premium
over the then current market price of Common Shares.
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Annual Report | September 30, 2021
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83
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XAI Octagon Floating
Rate &
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Alternative
Income Term Trust
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Use
of Leverage
|
|
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September
30, 2021 (Unaudited)
|
The Trust utilizes
leverage to seek to enhance total return and income. The Trust may use leverage through (i) Indebtedness, including through
borrowing from financial institutions or issuance of debt securities, including notes or commercial paper, (ii) the issuance of
Preferred Shares and/or (iii) reverse repurchase agreements, securities lending, short sales or derivatives, such as swaps, futures
or forward contracts, that have the effect of leverage. The Trust will not utilize leverage, either through Indebtedness, Preferred
Shares or portfolio leverage, in an aggregate amount in excess of 40% of the Trust’s Managed Assets (including the proceeds of
leverage). As of September 30, 2021, the Trust had outstanding Indebtedness in amount representing approximately 29% of the
Trust’s Managed Assets.
The Adviser and the Sub-Adviser anticipate that
the use of leverage may result in higher total return to Common Shareholders over time; however, there can be no assurance that such expectations
will be realized or that a leveraging strategy will be successful in any particular time period. Use of leverage creates an opportunity
for increased income and capital appreciation but, at the same time, creates special risks. The use of leverage will cause the Trust’s
net asset value, market price and level of distributions to be more volatile than if leverage were not used. The costs associated with
the issuance of leverage will be borne by the Trust, which will result in a reduction of net asset value of the Common Shares and as a
result such costs will be borne by Common Shareholders. The fees paid to the Adviser, and thereby to the Sub-Adviser, will be calculated
on the basis of the Trust’s Managed Assets, including proceeds from leverage, so the fees paid to the Adviser and Sub-Adviser will
be higher when leverage is utilized. Common Shareholders bear the portion of the investment advisory fee attributable to the assets purchased
with the proceeds of leverage, which means that Common Shareholders effectively bear the entire management fee. There can be no assurance
that a leveraging strategy will be utilized or, if utilized, will be successful.
INDEBTEDNESS
The Trust’s Declaration of Trust provides
that the Board of Trustees may authorize the borrowing of money by the Trust, without the approval of the holders of the Common Shares.
The Trust may issue notes or other evidences of indebtedness (including bank borrowings or commercial paper) and may secure any such borrowings
by mortgaging, pledging or otherwise subjecting the Trust’s assets as security.
Under the 1940 Act the Trust may not incur Indebtedness
if, immediately after incurring such Indebtedness, the Trust would have asset coverage (as defined in the 1940 Act) of less than 300%
(i.e., for every dollar of Indebtedness outstanding, the Trust is required to have at least three dollars of total assets, including the
proceeds of leverage). In addition, the Trust generally is not permitted to declare any cash dividend or other distribution on its common
shares unless, at the time of such declaration and after deducting the amount of such dividend or other distribution, the Trust maintains
asset coverage of 300%. However, the foregoing restriction does not apply with respect to certain types of Indebtedness of the Trust,
including a line of credit or other privately arranged borrowings from a financial institution.
Pursuant to the Trust’s Indebtedness,
lenders would have the right to receive interest on and repayment of principal of any such Indebtedness, which right will be senior to
those of Common Shareholders. The terms of any such Indebtedness may require the Trust to pay a fee to maintain a line of credit, such
as a commitment fee, or to maintain minimum average balances with a lender. Any such requirements would increase the cost of such Indebtedness
over the stated interest rate. If the Trust utilizes Indebtedness, the Common Shareholders will indirectly bear the offering costs of
the issuance of any Indebtedness.
The 1940 Act grants to the lenders, under certain
circumstances, certain voting rights in the event of default in the payment of interest on or repayment of principal. Failure to maintain
certain asset coverage requirements could result in an event of default and entitle the debt holders to elect a majority of the Board
of Trustees.
Credit Facility
The Trust has entered into a credit agreement
dated October 6, 2017, as amended from time to time, with Société Générale pursuant to which the Trust may
borrow up to $125,000,000. As of September 30, 2021, outstanding borrowings under the Credit Agreement were approximately $98 million,
which represented approximately 28% of the Trust’s Managed Assets. The terms of the Credit Agreement require that if the Trust’s
borrowings exceed 33 1/3% of the Trust’s managed assets, the Trust must reduce its borrowings below such ratio within a specified
period of time.
The Trust’s
borrowings are secured by eligible securities held in its portfolio of investments. The Credit Agreement includes usual and
customary covenants. Among other things, these covenants place limitations or restrictions on the Trust’s ability to (i) incur
other indebtedness, (ii) change certain investment policies, (iii) pledge or create liens upon the assets of the Trust. In addition,
the Trust is required to deliver financial information to the Lender, maintain an asset coverage ratio of not less than 300% and
maintain its registration as a closed-end management investment company.
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XAI Octagon Floating
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Alternative
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Use
of Leverage
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September
30, 2021 (Unaudited)
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Notes
The Trust may also issue notes or other
debt securities. As a condition to obtaining financing or obtaining ratings on the notes or other debt securities, the terms of any
notes or other debt securities issued would be expected to include asset coverage maintenance provisions that would require the
redemption of the notes or other debt securities in the event of non-compliance by the Trust and might also prohibit dividends and
other distributions on the Common Shares in such circumstances. In order to meet such redemption requirements, the Trust might have
to liquidate portfolio securities. These liquidations and redemptions, or reductions in Indebtedness, would cause the Trust to incur
related transaction costs and could result in capital losses. Prohibitions on dividends and other distributions could impair the
Trust’s ability to qualify as a regulated investment company (“RIC”) under the Code.
If the Trust issues notes or other debt securities,
it may be subject to certain restrictions imposed by guidelines of one or more ratings agencies that may issue ratings for the notes or
may be subject to covenants or other restrictions imposed by its lenders. These guidelines would be expected to impose asset coverage
or portfolio composition requirements that would be more stringent than those imposed on the Trust by the 1940 Act. It is not anticipated
that these covenants or guidelines would impede the Sub-Adviser from managing the Trust portfolio in accordance with its investment objective
and policies. If the Trust were to issue notes or other debt securities as well as utilize a credit facility, such notes would have an
equal security interest, if any, with and rank pari passu, or equally in right of payment, with any borrowings under the credit facility.
PREFERRED SHARES
The Trust’s Declaration of Trust provides
that the Board of Trustees may authorize and issue an unlimited amount of Preferred Shares with rights as determined by the Board of Trustees,
by action of the Board of Trustees without prior approval of the Common Shareholders as of September 30, 2021, the Trust has issued and
outstanding 1,596,000 shares of its 6.50% Series 2026 Term Preferred Shares. The aggregate liquidation preference of the Preferred Shares
is $39,900,000, which represented 11.19% of the Trust's managed assets as of September 30, 2021.
Under the 1940 Act, the Trust may not issue
Preferred Shares if, immediately after issuance, the Trust would have asset coverage (as defined in the 1940 Act) of less than 200% (i.e.,
for every dollar of Preferred Shares outstanding, the Trust is required to have at least two dollars of total assets, including the proceeds
of leverage). The Trust would not be permitted to declare any distribution (unless payable in stock) on its capital stock or purchase
its capital stock unless, at the time of such declaration or purchase, the Trust has an asset coverage of at least 200% after deducting
the amount of such distribution or purchase price, as applicable.
While the Trust has Preferred Shares outstanding,
two of the Trust’s Trustees will be elected by the holders of Preferred Shares voting separately as a class. The remaining Trustees
of the Trust will be elected by Common Shareholders and preferred shareholders voting together as a single class. In the event dividends
on the Preferred Shares are unpaid in an amount equal to two full years’ dividends on such securities, holders of Preferred Shares
would be entitled to elect a majority of the Trustees of the Trust (subject to any prior rights, if any, of the holders of any other class
of senior securities outstanding) and continue to be so represented until all dividends in arrears shall have been paid or otherwise provided
for. Additionally, the holders of Preferred Shares would have separate voting rights for certain matters pursuant to the 1940 Act and
the terms of the Preferred Shares.
In addition, as a condition to obtaining ratings
on the Preferred Shares, the terms of the Preferred Shares include asset coverage maintenance provisions that would require the redemption
of Preferred Shares in the event of non-compliance by the Trust and might also prohibit dividends and other distributions on the Common
Shares in such circumstances. In order to meet such redemption requirements, the Trust might have to liquidate portfolio securities. These
liquidations and redemptions would cause the Trust to incur related transaction costs and could result in capital losses. Prohibitions
on dividends and other distributions could impair the Trust’s ability to qualify as a RIC under the Code.
If the Trust issues rated Preferred Shares,
it may be subject to certain restrictions imposed by guidelines of one or more ratings agencies that may issue ratings for Preferred Shares
issued by the Trust. These guidelines would be expected to impose asset coverage or portfolio composition requirements that would be more
stringent than those imposed on the Trust by the 1940 Act. It is not anticipated that these covenants or guidelines would impede the Sub-Adviser
from managing the Trust’s portfolio in accordance with its investment objective and policies.
The Trust’s 2026 Term Preferred Shares are not rated.
DERIVATIVES
In addition, the Trust
may engage in certain derivatives transactions that have economic characteristics similar to leverage. To the extent the terms of
such transactions obligate the Trust to make payments, the Trust intends to earmark or segregate cash or liquid securities in an
amount at least equal to the current value of the amount then payable by the Trust under the terms of such transactions or otherwise
cover such transactions in accordance with applicable interpretations of the staff of the SEC. As a result of such segregation or
cover, the Trust’s obligations under such transactions will not be considered indebtedness for purposes of the 1940 Act,
including the asset coverage requirements applicable to indebtedness under the 1940 Act, but the leverage effect of such
transactions will be treated as “portfolio leverage” subject to the Trust’s policy not to use leverage in excess
of 40% of its Managed Assets. To the extent that the Trust’s obligations under such transactions are not so segregated or
covered, such obligations may be considered “senior securities representing indebtedness” under the 1940 Act and
therefore subject to the 300% asset coverage requirement described above. The Trust’s calculation of its “portfolio
leverage” includes leverage incurred by the Trust through portfolio transactions (reverse repurchase agreements, securities
lending, short sales or derivatives, such as swaps, futures or forward contracts), that have the effect of leverage. For the
avoidance of doubt, the Trust’s calculation of its “portfolio leverage” does not include the leveraged nature of
credit instruments, such as structured credit instruments, in which the Trust invests.
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Annual Report | September 30, 2021
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Alternative
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Use
of Leverage
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September
30, 2021 (Unaudited)
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EFFECTS OF LEVERAGE
Assuming financial leverage representing approximately
38.71% of the Trust's Managed Assets (the Trust's outstanding financial leverage as of September 30, 2021), at an annual interest rate
of 2.86% payable on such financial leverage (the interest rate on the Trust's outstanding financial leverage as of September 30, 2021),
the income generated by the Trust's portfolio (net of non-leverage expenses) must exceed 1.11% in order to cover such interest payments
and other expenses specifically related to Indebtedness. Of course, these numbers are merely estimates, used for illustration. Actual
interest rates may vary frequently and may be significantly higher or lower than the rate assumed above.
The following table is furnished in response
to requirements of the SEC. It is designed to illustrate the effect of leverage on Common Share total return, assuming investment portfolio
total returns (comprised of income and changes in the value of securities held in the Trust's portfolio) of -10%, -5%, 0%, 5% and 10%.
The table further reflects the use of financial leverage representing approximately 38.71% of the Trust's Managed Assets (the Trust's
outstanding financial leverage as of September 30, 2021) and an interest rate of 2.86% payable on such financial leverage (the interest
rate on the Trust's outstanding financial leverage as of September 30, 2021). These assumed investment portfolio returns are hypothetical
figures and are not necessarily indicative of the investment portfolio returns experienced or expected to be experienced by the Trust.
See “Risks.”
|
Assumed Portfolio Total Return (Net of Expenses)
|
|
|
(10.00
|
)%
|
|
|
(5.00
|
)%
|
|
|
0.00
|
%
|
|
|
5.00
|
%
|
|
|
10.00
|
%
|
|
Common Share Total Return
|
|
|
(20.98
|
)%
|
|
|
(12.82
|
)%
|
|
|
(4.66
|
)%
|
|
|
3.50
|
%
|
|
|
11.66
|
%
|
Common Share Total Return is composed of two
elements: the distributions paid by the Trust (the amount of which is largely determined by the net investment income of the Trust after
paying interest and other expenses on its leverage) and gains or losses on the value of the securities the Trust owns. As required by
SEC rules, the table above assumes that the Trust is more likely to suffer capital losses than to enjoy capital appreciation. For example,
to assume a total return of 0% the Trust must assume that the interest received on the Trust’s portfolio investments is entirely
offset by losses in the value of those investments.
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XAI Octagon Floating
Rate &
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|
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Alternative
Income Term Trust
|
Limited
Term and Eligible Tender Offer
|
|
|
September
30, 2021 (Unaudited)
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The Trust will terminate on or before December
31, 2029 (the “Termination Date”); provided, that if the Board of Trustees believes that under then- current market conditions
it is in the best interests of the Trust to do so, the Trust may extend the Termination Date (i) once for up to one year (i.e., up to
December 31, 2030), and (ii) once for up to an additional six months (i.e. up to June 30, 2031), in each case upon the affirmative vote
of a majority of the Board of Trustees and without a shareholder vote. In determining whether to extend the Termination Date, the Board
of Trustees may consider the inability to sell the Trust’s assets in a time frame consistent with termination due to lack of market
liquidity or other extenuating circumstances. Additionally, the Board of Trustees may determine that market conditions are such that it
is reasonable to believe that, with an extension, the Trust’s remaining assets will appreciate and generate income in an amount
that, in the aggregate, is meaningful relative to the cost and expense of continuing the operation of the Trust.
Beginning one year before the Termination Date
(the “wind-down period”), the Trust may begin liquidating all or a portion of the Trust’s portfolio, and may deviate
from its investment policies, including its policy of investing at least 80% of its Managed Assets in floating rate credit instruments
and other structured credit investments and may not achieve its investment objective. During the wind-down period, the Trust’s portfolio
composition may change as more of its portfolio holdings are called or sold and portfolio holdings are disposed of in anticipation of
liquidation. Rather than reinvesting the proceeds of matured, called or sold securities, the Trust may invest such proceeds in short term
or other lower yielding securities or hold the proceeds in cash, which may adversely affect its performance.
In addition, within twelve months preceding
the Termination Date, the Board of Trustees may cause the Trust to conduct an Eligible Tender Offer. An Eligible Tender Offer would consist
of a tender offer to purchase 100% of the then outstanding Common Shares of the Trust at a price equal to the net asset value per Common
Share on the expiration date of the tender offer. The terms of an Eligible Tender Offer will include a condition pursuant to which in
the event that the number of Common Shares properly tendered in the Eligible Tender Offer exceeds a stated percentage of the outstanding
Common Shares, with such percentage to be established at the time of such Eligible Tender Offer by the Board of Trustees representing
the minimum threshold for the continued viability of the Trust (the “Termination Threshold”), the Eligible Tender Offer will
be terminated and no Common Shares will be repurchased pursuant to the Eligible Tender Offer. Instead, the Trust will begin (or continue)
liquidating its portfolio and proceed to terminate on or before the Termination Date. The Adviser will pay all costs and expenses associated
with the making of an Eligible Tender Offer, other than brokerage and related transaction costs associated with disposition of portfolio
investments in connection with the Eligible Tender Offer, which will be borne by the Trust and its shareholders.
If the number of properly tendered Common Shares
is less than the Termination Threshold, all Common Shares properly tendered and not withdrawn will be purchased by the Trust pursuant
to the terms of the Eligible Tender Offer. See “Risks—Limited Term Risk.” Following such completion of the Eligible
Tender Offer, the Board of Trustees may eliminate the Termination Date and convert the Trust to a perpetual trust upon the affirmative
vote of a majority of the Board of Trustees and without a shareholder vote. In making such decision, the Board of Trustees will take such
actions with respect to the continued operations of the Trust as it deems to be in the best interests of the Trust, based on market conditions
at such time, the extent of Common Shareholder participation in the Eligible Tender Offer and all other factors deemed relevant by the
Board of Trustees in consultation with the Adviser and Sub-Adviser.
The Trust should not be confused with a so called
“target date” or “life cycle” fund whose asset allocation becomes more conservative over time as the fund’s
target date, often associated with retirement, approaches, and does not typically terminate on the target date. In addition, the Trust
should not be confused with a “target term” fund whose investment objective is to return the fund’s original net asset
value on the termination date. The Trust’s investment objective and policies are not designed to seek to return to investors their
initial investment on the Termination Date or in an Eligible Tender Offer. Investors may receive more or less than their original investment
upon termination or in an Eligible Tender Offer.
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Annual Report | September 30, 2021
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87
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XAI Octagon Floating
Rate &
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Alternative
Income Term Trust
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Dividend
Reinvestment Plan
|
|
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September
30, 2021 (Unaudited)
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Under the Trust’s Dividend Reinvestment
Plan (the “Plan”), a Common Shareholder whose Common Shares are registered in his or her own name will have all distributions
reinvested automatically by DST Systems, Inc., which is agent under the Plan (the “Plan Agent”), unless the Common Shareholder
elects to receive cash.
Distributions with respect to Common Shares
registered in the name of a broker-dealer or other nominee (that is, in “street name”) will be reinvested in additional Common
Shares under the Plan, unless the broker or nominee does not participate in the Plan or the Common Shareholder elects to receive distributions
in cash. Investors who own Common Shares registered in street name should consult their broker-dealers for details regarding reinvestment.
All distributions to investors who do not participate in the Plan will be paid by check mailed directly to the record holder by DST Systems,
Inc., as dividend disbursing agent. A participant in the Plan who wishes to opt out of the Plan and elect to receive distributions in
cash should contact DST Systems, Inc. in writing at the address specified below or by calling the telephone number specified below.
Under the Plan, whenever the market price of
the Common Shares is equal to or exceeds net asset value at the time Common Shares are valued for purposes of determining the number of
Common Shares equivalent to the cash dividend or capital gains distribution, participants in the Plan are issued new Common Shares from
the Trust, valued at the greater of (i) the net asset value as most recently determined or (ii) 95% of the then-current market price of
the Common Shares. The valuation date is the dividend or distribution payment date or, if that date is not a NYSE trading day, the next
preceding trading day. If the net asset value of the Common Shares at the time of valuation exceeds the market price of the Common Shares,
the Plan Agent will buy the Common Shares for the Plan in the open market, on the NYSE or elsewhere, for the participants’ accounts,
except that the Plan Agent will endeavor to terminate purchases in the open market and cause the Trust to issue Common Shares at the greater
of net asset value or 95% of market value if, following the commencement of such purchases, the market value of the Common Shares exceeds
net asset value. If the Trust should declare a distribution or capital gains distribution payable only in cash, the Plan Agent will buy
the Common Shares for the Plan in the open market, on the NYSE or elsewhere, for the participants’ accounts. There is no charge
from the Trust for reinvestment of dividends or distributions in Common Shares pursuant to the Plan and no brokerage charges will be incurred
with respect to Common Shares issued directly by the Trust pursuant to the Plan; however, all participants will pay a pro rata share of
brokerage commissions incurred by the Plan Agent when it makes open-market purchases.
The Plan Agent maintains all shareholder accounts
in the Plan and furnishes written confirmations of all transactions in the account, including information needed by shareholders for personal
and tax records. Common Shares in the account of each Plan participant will be held by the Plan Agent in non-certificated form in the
name of the participant.
In the case of shareholders such as banks, brokers
or nominees, which hold Common Shares for others who are the beneficial owners, and participate in the Plan, the Plan Agent will administer
the Plan on the basis of the number of Common Shares certified from time to time by the Common Shareholder as representing the total amount
registered in the shareholder’s name and held for the account of beneficial owners who participate in the Plan.
Participants that request a sale of shares through the Plan
Agent will incur brokerage charges in connection with such sales.
The automatic reinvestment of dividends and
other distributions will not relieve participants of any income tax that may be payable or required to be withheld on such dividends or
distributions.
Experience under the Plan may indicate that
changes are desirable. Accordingly, the Trust reserves the right to amend or terminate its Plan as applied to any voluntary cash payments
made and any dividend or distribution paid subsequent to written notice of the change sent to the members of such Plan at least 90 days
before the record date for such dividend or distribution. The Plan also may be amended or terminated by the Plan Agent on at least 90
days’ prior written notice to the participants in such Plan. All correspondence concerning the Plan should be directed to the Plan
Agent, DST Systems, Inc., 430 W. 7th Street, Kansas City, Missouri 64105-1594.
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XAI Octagon Floating
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Alternative
Income Term Trust
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Net
Asset Value
|
|
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September
30, 2021 (Unaudited)
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The net asset value of Common Shares of the
Trust is calculated by subtracting the Trust’s total liabilities (including from Indebtedness) and the liquidation preference of
any outstanding Preferred Shares from total assets (the market value of the securities the Trust holds plus cash and other assets). The
per share net asset value of the Common Shares is calculated by dividing the net asset value of the Trust by the number of Common Shares
outstanding and rounding the result to the nearest full cent. The Trust calculates its net asset value as of the close of regular trading
on the NYSE on each day on which there is a regular trading session on the NYSE and at such other times as may be determined by the Board
of Trustees from time to time.
The Trust values debt securities at the last
available bid price for such securities or, if such prices are not available, at prices for securities of comparable maturity, quality,
and type. The Trust values exchange-traded options and other exchange-traded derivative contracts at the midpoint of the best bid and
asked prices at the close on those exchanges on which they are traded.
The Trust values equity securities at the last
reported sale price on the principal exchange or in the principal off-exchange market in which such securities are traded, as of the close
of regular trading on the NYSE on the day the securities are being valued or, if there are no sales, at the mean between the last available
bid and asked prices on that day. Securities traded primarily on the Nasdaq Stock Market (“Nasdaq”) are normally valued by
the Trust at the Nasdaq Official Closing Price (“NOCP”) provided by Nasdaq each business day. The NOCP is the most recently
reported price as of 4:00 p.m., Eastern Time, unless that price is outside the range of the “inside” bid and asked prices
(i.e., the bid and asked prices that dealers quote to each other when trading for their own accounts); in that case, Nasdaq will adjust
the price to equal the inside bid or asked price, whichever is closer. Because of delays in reporting trades, the NOCP may not be based
on the price of the last trade to occur before the market closes.
Generally, trading in many foreign securities
will be substantially completed each day at various times prior to the close of the NYSE. The values of these securities used in determining
the net asset value generally will be computed as of such times. Occasionally, events affecting the value of foreign securities may occur
between such times and the close of the NYSE which will not be reflected in the computation of net asset value unless it is determined
that such events would materially affect the net asset value, in which case adjustments would be made and reflected in such computation
pursuant to the fair valuation procedures described herein. Such adjustments may be based upon factors such as developments in non-U.S.
markets, the performance of U.S. securities markets and the performance of instruments trading in U.S. markets that represent non-U.S.
securities.
Short-term securities with remaining maturities
of less than 60 days may be valued at amortized cost, to the extent that amortized cost is determined to approximate fair value.
The Trust values derivatives transactions in
accordance with valuation guidelines adopted by the Board of Trustees. Accrued payments to the Trust under such transactions will be assets
of the Trust and accrued payments by the Trust will be liabilities of the Trust.
The Trust may utilize bid quotations provided
by independent pricing services or, if independent pricing services are unavailable, dealers to value certain of its securities and other
instruments at their market value. The Trust may use independent pricing services to value certain securities held by the Trust at their
market value. The Trust periodically verifies valuations provided by independent pricing services.
If independent pricing services or dealer quotations
are not available for a given security, such security will be valued in accordance with valuation guidelines adopted by the Board of Trustees
that the Board of Trustees believes are designed to accurately reflect the fair value of securities valued in accordance with such guidelines.
The Board of Trustees has delegated the day-to-day
responsibility for fair value determinations to a valuation committee comprised of representatives from the Adviser, the Sub-Adviser and
the Trust’s administrator. All fair value determinations made by the Valuation Committee are subject to review and monitoring by
the Board of Trustees. As a general principle, the fair value of a portfolio instrument is the amount that an owner might reasonably expect
to receive upon the instrument’s current sale. A range of factors and analysis may be considered when determining fair value, including
relevant market data, interest rates, credit considerations and/or issuer specific news. For certain securities, fair valuations may include
input from the Sub-Adviser utilizing a wide variety of market data including yields or prices of investments of comparable quality, type
of issue, coupon, maturity, rating, indications of value from security dealers, evaluations of anticipated cash flows or collateral, spread
over U.S. Treasury obligations, and other information and analysis. In addition, the Valuation Committee may consider valuations provided
by valuation firms retained to assist in the valuation of certain of the Trust’s investments. Fair valuation involves subjective
judgments. While the Trust’s use of fair valuation is intended to result in calculation of net asset value that fairly reflects
values of the Trust’s portfolio securities as of the time of pricing, the Trust cannot guarantee that any fair valuation will, in
fact, approximate the amount the Trust would actually realize upon the sale of the securities in question. It is possible that the fair
value determined for a portfolio instrument may be materially different from the value that could be realized upon the sale of that instrument.
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Annual Report | September 30, 2021
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Rate &
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Alternative
Income Term Trust
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Net
Asset Value
|
|
|
September
30, 2021 (Unaudited)
|
The Trust generally uses non-binding indicative
bid prices provided by an independent pricing service or broker as the primary basis for determining the value of CLO debt and subordinated
securities, which may be adjusted for pending distributions, as applicable, as of the applicable valuation date. These bid prices are
non-binding, and may not be determinative of an actual transaction price. In valuing the Trust’s investments in CLO debt and subordinated
securities, in addition to non-binding indicative bid prices provided by an independent pricing service or broker, the Valuation Committee
also may consider a variety of relevant factors, as set forth in the Trust’s valuation policy, including recent trading prices for
specific investments, recent purchases and sales known to the Trust in similar securities, other information known to the Trust relating
to the securities, and discounted cash flows based on output from a third-party financial model, using projected future cash flows.
Information that becomes known after the Trust’s
net asset value has been calculated on a particular day will not be used to retroactively adjust the price of a security or the Trust’s
previously determined net asset value.
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XAI Octagon Floating Rate &
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Alternative
Income Term Trust
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Management
of the Trust
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September 30, 2021 (Unaudited)
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