UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT
COMPANIES
Investment Company Act file number 811-21756
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First Trust Strategic High Income Fund
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(Exact name of registrant as specified in charter)
120 East Liberty Drive, Suite 400
Wheaton, IL 60187
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(Address of principal executive offices) (Zip code)
W. Scott Jardine, Esq.
First Trust Portfolios L.P.
120 East Liberty Drive, Suite 400
Wheaton, IL 60187
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(Name and address of agent for service)
registrant's telephone number, including area code: 630-765-8000
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Date of fiscal year end: October 31
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Date of reporting period: April 30, 2011
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Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549. The OMB has reviewed this collection of information under
the clearance requirements of 44 U.S.C. ss. 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
FIRST TRUST
STRATEGIC
High Income
Fund
SEMI-ANNUAL REPORT
FOR THE SIX MONTHS ENDED
APRIL 30, 2011
FIRST TRUST BROOKFIELD
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TABLE OF CONTENTS
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FIRST TRUST STRATEGIC HIGH INCOME FUND (FHI)
SEMI-ANNUAL REPORT
APRIL 30, 2011
Shareholder Letter........................................................... 1
At A Glance.................................................................. 2
Portfolio Commentary......................................................... 3
Portfolio of Investments..................................................... 6
Statement of Assets and Liabilities.......................................... 14
Statement of Operations...................................................... 15
Statements of Changes in Net Assets.......................................... 16
Statement of Cash Flows...................................................... 17
Financial Highlights......................................................... 18
Notes to Financial Statements................................................ 19
Additional Information....................................................... 27
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements within the meaning of
the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934,
as amended. Forward-looking statements include statements regarding the goals,
beliefs, plans or current expectations of First Trust Advisors L.P. ("First
Trust" or the "Advisor") and/or Brookfield Investment Management Inc.
("Brookfield" or the "Sub-Advisor") and their respective representatives, taking
into account the information currently available to them. Forward-looking
statements include all statements that do not relate solely to current or
historical fact. For example, forward-looking statements include the use of
words such as "anticipate," "estimate," "intend," "expect," "believe," "plan,"
"may," "should," "would" or other words that convey uncertainty of future events
or outcomes.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause the actual results, performance or achievements of
First Trust Strategic High Income Fund (the "Fund") to be materially different
from any future results, performance or achievements expressed or implied by the
forward-looking statements. When evaluating the information included in this
report, you are cautioned not to place undue reliance on these forward-looking
statements, which reflect the judgment of the Advisor and/or Sub-Advisor and
their respective representatives only as of the date hereof. We undertake no
obligation to publicly revise or update these forward-looking statements to
reflect events and circumstances that arise after the date hereof.
PERFORMANCE AND RISK DISCLOSURE
There is no assurance that the Fund will achieve its investment objectives. The
Fund is subject to market risk, which is the possibility that the market values
of securities owned by the Fund will decline and that the value of the Fund
shares may therefore be less than what you paid for them. Accordingly, you can
lose money by investing in the Fund. See "Risk Considerations" in the Notes to
Financial Statements for a discussion of certain other risks of investing in the
Fund.
Performance data quoted represents past performance, which is no guarantee of
future results, and current performance may be lower or higher than the figures
shown. For the most recent month-end performance figures, please visit
http://www.ftportfolios.com or speak with your financial advisor. Investment
returns, net asset value and common share price will fluctuate and Fund shares,
when sold, may be worth more or less than their original cost.
HOW TO READ THIS REPORT
This report contains information that may help you evaluate your investment. It
includes details about the Fund and presents data and analysis that provide
insight into the Fund's performance and investment approach.
By reading the portfolio commentary by the portfolio management team of the
Fund, you may obtain an understanding of how the market environment affected the
Fund's performance. The statistical information that follows may help you
understand the Fund's performance compared to that of relevant market
benchmarks.
It is important to keep in mind that the opinions expressed by personnel of
Brookfield are just that: informed opinions. They should not be considered to be
promises or advice. The opinions, like the statistics, cover the period through
the date on the cover of this report. The risks of investing in the Fund are
spelled out in the prospectus, the statement of additional information, this
report and other Fund regulatory filings.
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SHAREHOLDER LETTER
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FIRST TRUST STRATEGIC HIGH INCOME FUND (FHI)
SEMI-ANNUAL REPORT
APRIL 30, 2011
Dear Shareholders:
I am pleased to present you with the semi-annual report for your investment in
First Trust Strategic High Income Fund (the "Fund").
First Trust Advisors L.P. ("First Trust") has always believed that staying
invested in quality products and having a long-term horizon can help investors
reach their financial goals. Successful investors understand that the success
they have achieved is typically because of their long-term investment
perspective through all kinds of markets. While the past two years have been
challenging, the markets have been recovering from their lows of 2008-2009,
bringing relief to economists and investors alike.
The report you hold contains detailed information about your investment; a
portfolio commentary from the Fund's management team that provides a recap of
the period; a performance analysis and a market and Fund outlook. Additionally,
you will find the Fund's financial statements for the six months this report
covers. I encourage you to read this document and discuss it with your financial
advisor.
First Trust has been through many types of markets. That's why we remain
committed to being a long-term investor and investment manager and to bringing
you quality investment solutions regardless of the inevitable volatility the
market experiences. We offer a variety of products that may fit many financial
plans to help those investors seeking long-term investment success. You may want
to talk to your advisor about the investments First Trust offers that might also
fit your financial goals.
At First Trust we continue to be committed to making available up-to-date
information about your investments so you and your financial advisor have
current information on your portfolio. We value our relationship with you, and
we thank you for the opportunity to assist you in achieving your financial
goals. I look forward to the remainder of 2011 and to the next edition of your
Fund's report.
Sincerely,
/s/ James A. Bowen
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James A. Bowen
President of First Trust Strategic High Income Fund
Page 1
FIRST TRUST STRATEGIC HIGH INCOME FUND
"AT A GLANCE"
AS OF APRIL 30, 2011 (UNAUDITED)
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FUND STATISTICS
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Symbol on New York Stock Exchange FHI
Common Share Price $3.67
Common Share Net Asset Value ("NAV") $4.11
Premium (Discount) to NAV (10.71)%
Net Assets Applicable to Common Shares $37,644,046
Current Monthly Distribution per Common Share (1) $0.030
Current Annualized Distribution per Common Share $0.360
Current Distribution Rate on Closing Common Share Price (2) 9.81%
Current Distribution Rate on NAV (2) 8.76%
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COMMON SHARE PRICE & NAV (WEEKLY CLOSING PRICE)
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Common Share Price NAV
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4/10 3.32 3.52
3.04 3.44
3.03 3.45
2.92 3.40
5/10 3.04 3.39
3.03 3.37
3.04 3.35
3.08 3.41
6/10 3.08 3.43
3.06 3.40
3.08 3.43
3.09 3.47
3.17 3.50
7/10 3.34 3.67
3.35 3.65
3.34 3.63
3.33 3.62
8/10 3.32 3.63
3.33 3.63
3.33 3.66
3.36 3.68
9/10 3.40 3.69
3.41 3.68
3.42 3.75
3.55 3.77
3.50 3.73
10/10 3.45 3.75
3.53 3.77
3.45 3.75
3.39 3.71
11/10 3.41 3.66
3.30 3.66
3.25 3.66
3.27 3.67
3.29 3.68
12/10 3.34 3.70
3.31 3.73
3.28 3.75
3.30 3.76
1/11 3.32 3.79
3.33 3.78
3.38 3.80
3.36 3.83
2/11 3.39 3.83
3.37 3.82
3.37 4.04
3.45 4.03
3/11 3.49 4.05
3.52 4.05
3.48 4.06
3.50 4.08
3.60 4.09
4/11 3.67 4.11
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PERFORMANCE
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Average Annual Total Return
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6 Months Ended 1 Year Ended 5 Years Ended Inception (7/26/2005)
4/30/2011 4/30/2011 4/30/2011 to 4/30/2011
FUND PERFORMANCE (3)
NAV 14.53% 27.72% -14.54% -11.64%
Market Value 11.16% 20.92% -16.67% -14.05%
INDEX PERFORMANCE
Barclays Capital Ba U.S. High Yield Index 4.30% 12.67% 9.68% 8.66%
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% OF TOTAL
ASSET CLASSIFICATION INVESTMENTS
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Corporate Bonds and Notes 72.7%
Residential Mortgage-Backed Securities 9.4
Foreign Corporate Bonds and Notes 6.1
Commercial Mortgage-Backed Securities 5.9
Manufactured Housing Loans 5.1
Senior Floating-Rate Loan Interests 0.4
Franchise Loans 0.2
Collateralized Debt Obligations 0.1
Equity 0.1
U.S. Government Agency Mortgage-Backed Securities 0.0*
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Total 100.0%
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*Amount is less than 0.1%
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% OF TOTAL
FIXED-INCOME
CREDIT QUALITY (4) INVESTMENTS
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AAA 6.1%
A 0.5
BBB+ 0.3
BBB 0.4
BBB- 2.7
BB+ 8.9
BB 3.2
BB- 11.6
B+ 8.5
B 12.6
B- 16.0
CCC+ 6.1
CCC 6.1
CCC- 0.9
CC 5.0
C 9.2
D 1.9
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Total 100.0%
=======
(1) Most recent distribution paid or declared through 4/30/2011. Subject to
change in the future.
(2) Distribution rates are calculated by annualizing the most recent
distribution paid or declared through the report date and then dividing by
Common Share price or NAV, as applicable, as of 4/30/2011. Subject to
change in the future.
(3) Total return is based on the combination of reinvested dividend, capital
gain and return of capital distributions, if any, at prices obtained by
the Dividend Reinvestment Plan, and changes in NAV per share for NAV
returns and changes in Common Share price for market value returns. Total
returns do not reflect sales load and are not annualized for periods less
than one year. Past performance is not indicative of future results.
(4) The credit quality and ratings information presented above reflects the
ratings assigned by one or more nationally recognized statistical rating
organizations (NRSROs), including Standard & Poor's Rating Group, a
division of the McGraw Hill Companies, Inc., Moody's Investors Service,
Inc. or a comparably rated NRSRO. For situations in which a security is
rated by more than one NRSRO and the ratings are not equivalent, the
highest ratings are used. Sub-investment grade ratings are those rated
BB+/Ba1 or lower. Investment grade ratings are those rated BBB-/Baa3 or
higher.
Page 2
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PORTFOLIO COMMENTARY
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SUB-ADVISOR
BROOKFIELD INVESTMENT MANAGEMENT INC.
Brookfield Investment Management Inc. ("Brookfield") is a global investment
manager focused on specialized equity and fixed-income securities investments.
The firm is a subsidiary of Brookfield Asset Management Inc., a leading global
asset manager with over $150 billion in assets under management as of March 31,
2011 and over 100 years of experience in the property, power, and infrastructure
industries. The combination of access to this operational experience, along with
the breadth of our product offerings and depth of our investment teams, provides
enhanced opportunity for investment.
Brookfield is an SEC-registered investment advisor and with its affiliates, had
approximately $23 billion in assets under management as of March 31, 2011.
Headquartered in New York, the firm maintains offices and investment teams in
Chicago, Boston, London, Hong Kong, Sydney, and Toronto.
PORTFOLIO MANAGEMENT TEAM
DANA E. ERIKSON, CFA
MANAGING DIRECTOR
Mr. Erikson, Senior Portfolio Manager and the Head of the Global High Yield
Team, is responsible for the firm's corporate high-yield exposures and the
establishment of portfolio objectives and strategies. Mr. Erikson has 25 years
of investment experience. Prior to joining the firm, he was with Evergreen
Investments or one of its predecessor firms since 1996. He was a senior
portfolio manager and the Head of the High Yield team. Prior to that, he was
Head of High Yield Research. Mr. Erikson received a Bachelor of Arts in
Economics from Brown University and an MBA, with honors, from Northeastern
University. He is a member of the Boston Security Analysts Society.
ANTHONY BREAKS, CFA
DIRECTOR
Mr. Breaks is a Portfolio Manager on the Structured Products Investments team.
Mr. Breaks is one of four team leaders in MBS/ABS and is a member of the team's
securities analysis committee. In his role, Mr. Breaks is one of the team's
portfolio managers. Mr. Breaks also has managed structured product vehicles,
such as SIV, ABCP and CDOs, for Brookfield and has experience in insurance
company asset management. Mr. Breaks earned a Bachelor of Science degree in
Electrical Engineering from the Massachusetts Institute of Technology. He holds
the Chartered Financial Analyst designation.
COMMENTARY
FIRST TRUST STRATEGIC HIGH INCOME FUND
The primary investment objective of the First Trust Strategic High Income Fund
("FHI" or the "Fund") is to seek a high level of current income. The Fund seeks
capital growth as a secondary objective. The Fund seeks to achieve its
investment objectives by investing in a diversified portfolio of
below-investment grade and investment grade debt securities and equity
securities that the Sub-Advisor believes offer attractive yield and/or capital
appreciation potential. The Fund may invest up to 100% of its managed assets in
below-investment grade debt securities (commonly referred to as "high-yield" or
"junk" bonds). Managed assets means the average daily total asset value of the
Fund minus the sum of the Fund's liabilites other than the principal amount of
the borrowings or reverse repurchase agreements, if any. There can be no
assurance that the Fund will achieve its investment objectives. The Fund may
not be appropriate for all investors.
MARKET RECAP AND OUTLOOK
High Yield
If 2009 was the year markets thawed from the deep-freeze of 2008, then the past
twelve months saw the blossoming of summer for high-yield. While returns were
more muted than the record pace of the prior year, the market returned to normal
once again as Wall Street resumed underwriting new issues, and nervous corporate
treasurers tapped the market with relief to extend maturities, having learned
again the age-old wisdom of raising money when you can, not when you need to.
Even the leveraged loan market, which was badly hit by defaults in 2008,
re-opened at the end of the first quarter of 2011 as lenders began to look at
financing new paper again.
Risk assets worldwide benefitted from a deluge of liquidity as central banks
across the globe moved to avoid a double-dip recession. The excess liquidity
found its way into the capital markets, assisting high-yield investors. Wall
Street and corporate treasuries remained restricted, thereby reducing
idiosyncratic risk to investors from re-leveraging and producing a positive
environment for bondholders. Corporate liquidity increased for those companies
which survived the default peak, and modest economic growth has allowed
companies to retain their cash and their flexibility without committing to new
plants, equipment, working capital or employees.
Page 3
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PORTFOLIO COMMENTARY (Continued)
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Nevertheless, there is some uncertainty looking ahead, with particular focus on
economic indicators, such as job growth, which continue to lag. There is
pressure to accelerate growth; however, options are limited due to significant
federal deficits, and money growth and interest rates are near zero. If there is
agreement on anything, it is that interest rates are likely to rise. This is a
nearly universal consensus, and has been so for over a year, although it is yet
to occur. Ironically, this market expectation may be behind some of the money
that has flowed into the high-yield market for the past two and a half years.
Savvy investors recognize that historically, high-yield bonds have had a low
correlation to treasury bonds, which they view in a positive light.
Corporate credit has been improving since late 2009, with defaults falling to
less than 1% at the end of the period. With defaults as low as they can
reasonably expect to be in a market cycle, we believe that the bulk of
improvement in this area is behind us and will likely remain low for several
years, with periodic bumps. The environment for corporate credit remains
optimistic despite modest economic growth, which paradoxically is a positive for
credit; modest growth translates into modest investment in plants, equipment and
working capital, leaving more money to service debt. Credit is further helped by
a lighter-than-average volume of re-leveraging activity on the part of buyout
and private equity firms, many of which are still recovering from 2008.
Indications are that re-leveraging volume is beginning to gain momentum now,
although not enough to negatively impact overall credit. At the end of April
2011, the rating agencies were upgrading 1.5 times as many high-yield companies
as they were downgrading, the highest rate of credit improvement in 13 years.
During the six months ended April 30, 2011, 65% of new issue proceeds were
derived from refinancing, up from 64% during the same period in the prior year.
Refinancing has the effect of reducing overall credit risk in the market by
providing companies with longer-term capital and removing near-term "hammers" of
debt maturities. We saw some continued signs of relaxed credit standards in the
new issue market, with financing for lower-quality credits rising to 20% of the
total, up from 18% last year and 11% in 2009. For comparison, this metric peaked
at a record 36% in 2007 at the last credit top. Mitigating our concern in this
area, however, is that 64% of lower-quality issuance went to refinancing rather
than re-leveraging events and has the effect of reducing, not increasing,
overall credit risk in the market.
While the degree to which new issue buyers have relaxed credit standards is not
yet concerning, Brookfield believes that this is one indicator of future health
for the high-yield market and is monitoring this trend in both the high-yield
bond market and the leveraged loan market as one input into the degree of risk
we seek to put into our portfolios.
While we continue to maintain our positive view of high-yield credit, our
enthusiasm for the market has been tempered by the move of the market to a
premium, which limits further upside pricing potential and by the move of yield
spreads to less than their long-term average. We do not view either of these as
a sell signal, however, as we recognize that yield spreads typically remain
below average for extended periods in the middle of a credit cycle and do not
necessarily widen significantly in the absence of an exogenous shock or credit
surprise. Further, unlike equities, high-yield bonds do not need to increase in
price to offer attractive returns to investors; their yield advantage over other
fixed-income alternatives can be attractive by itself.
We are concerned about the prospect for higher interest rates in general. The
European Central Bank has already raised rates overseas, as have central banks
in several emerging market economies. Many observers expect the U.S. Federal
Reserve to wrap up its easing programs known as QE2 (quantitative easing)
shortly, which could place upward pressure on short rates in the U.S. Brookfield
observes, however, that high-yield bonds have a near-zero correlation to
Treasury bonds and actually are more correlated to equities. Indeed, some
research indicates that, historically, there have been periods where the
high-yield market rises during periods of rising interest rates, if rates are
rising due to firming economic growth. Our concern about rate increases is not
that it will push high-yield prices lower, although that is a possibility;
rather, that higher Treasury rates will tighten spreads and remove value that
currently exists in the market.
Risks to our neutral outlook include possible disruptions to world markets from
exogenous events as we saw with the Japanese tsunami, surprise restructurings
emanating from Europe, an error by the Federal Reserve as it removes its
stimulus, and margin pressure should companies be unable to pass through higher
energy and raw material cost increases.
Commercial MBS/Residential MBS
Despite a volatile first quarter, commercial mortgage-backed securities ("CMBS")
and residential mortgage-backed securities ("RMBS"), offered reasonably stable
market performance for the period ending April 30, 2011.
January and February brought impressive prices, with spreads and yield
tightening and we saw stronger loan performance projections being used for
valuation. Prime mortgage-backed securities ("MBS") were an especially good
performer. March was more challenging, given the overall economic and political
instability and the environmental catastrophe in Japan. However, positive
indicators were the continued availability of repurchase financing and LIBOR
remaining essentially unchanged. Market prices for credit-sensitive bonds fell a
point or two; however, they seem to have bounced back. Notably, one hedge fund
was required to liquidate its $2 billion mortgage portfolio due to price
volatility and the market took the sales in stride.
New issuance has been minimal for RMBS in 2011, although $8 billion of CMBS was
issued in the first quarter. Interestingly, one source of buying demand has been
insurance companies. Many insurance companies are now increasing exposure to MBS
and CMBS due to their yields. The regulatory body for insurance companies has
issued new risk-based capital charges for RMBS and CMBS that take into account
the low probability of large losses for senior securities as well as their
discount price. This results in a dramatically lower capital charge than a pure
ratings-based approach would require, causing RMBS and CMBS to become much more
Page 4
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PORTFOLIO COMMENTARY (Continued)
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attractive from a return on capital perspective. In particular, insurance
companies have been buying CMBS and prime RMBS and to a lesser degree Option-Arm
and Alt-A. At today's prices, we view RMBS and CMBS as attractive for closed-end
funds. With leverage available through insurance company balance sheets and to
money managers through repurchase loans, we see room for prices to increase as
required yields go down.
On the policy front, an official draft of the new risk retention rules was
released in March 2011, the first of a number of proposed rules that will remake
the mortgage landscape. Going forward, most new loans will be subject to risk
retention, if the law is enacted in its current form. The new rules also
prohibit sellers from transferring loans to securitizations at a premium.
Importantly, we see a great opportunity for investors that are natural holders
of risk, such as closed-end funds, to participate in the future of
securitization and the mortgage market in general, because they are well suited
to serve as the required risk retention entity where banks, the target of this
legislation, fair poorly.
As 2011 progresses, we have a positive outlook for mortgage-backed securities.
Investor appetite continues to increase and we will continue to take advantage
of that in security selection. In addition, we are placing emphasis on
securities where we see an undervalued option on a continued economic recovery.
PERFORMANCE ANALYSIS
For the six months ended April 30, 2011, the Fund's net asset value ("NAV")
increased by 9.60%, resulting in an NAV total return of 14.53%. For the period,
the Fund traded from a discount to NAV of 8.00% to a discount to NAV of 10.71%,
resulting in a market value total return(1) of 11.16%. The Fund's allocation to
CMBS contributed strongly to performance during the period, particularly due to
several deep credit legacy bonds receiving bids well above where we saw value.
Sales of such securities as LB-UBS Commercial Mortgage Trust, Series 2001-C7,
Class Q, Morgan Stanley Capital I, Inc., Series 2003-IQ5, Class O, and Banc of
America Large Loan, Inc., Series 2005-MIB1, Class L, were notable contributors
to the Fund's performance.
In a generally strong market, there were few detractors to performance and their
impact was not particularly large. However, exposure to Green Tree Financial
Corp, Series 1999-3, Class M1, FannieMae-ACES, Series 1998-M7, Class N, and
Government National Mortgage Association TBA detracted from the Fund's
performance during the period. FNW 1998-M7 N is a true CMBS Interest Only ("IO")
security and essentially all of the remaining loans in the deal prepaid during
the period. Government National Mortgage Association TBAs had some small losses
primarily due to interest rate movements. Green Tree Financial Corp, Series
1999-3, Class M1 is a credit IO security backed by manufactured housing ("MH")
and has traded infrequently. While this was a strong trade in 2010, there has
been little support since, and so pricing has tended to drift lower over the
last several months for reasons unrelated to performance or market movements.
The total return for the Fund's benchmark, the Barclays Capital Ba U.S. High
Yield Index, was 4.30% for the six months ended April 30, 2011. While the
benchmark contains mostly corporate debt, the Fund had significant exposure to
structured finance and mortgage-related securities during the period. As
investor risk appetite continued to return to the market during the period
covered by this report, corporate credit spreads continued to tighten, resulting
in strong performance by the Fund's benchmark. Lower quality names performed the
best, as evidenced by the 9.48% return of the Barclays Capital Caa U.S. High
Yield Index.
For the six months ended April 30, 2011, the Fund maintained a stable monthly
distribution of $0.025 per share, which has been subsequently increased to
$0.030 per share for the distributions paid in May and June, as mentioned in
footnote 9, "Subsequent Events", in the Notes to Financial Statements.Various
factors affect the Fund's level of distributable income, including but not
limited to, the asset mix and average maturity of the portfolio holdings and its
use of leverage and hedging. Although the net income for the six month period
outpaced distributions, it is anticipated that interest income of the Fund
generated by certain credit impaired securities is likely to decrease over time,
resulting in a material decrease in the amount of distributable income in the
future, absent any changes to the factors mentioned above. Additionally,
distributable income is determined in accordance with tax regulations, which may
differ from Generally Accepted Accounting Principles. These differences will
determine how distributions will ultimately be characterized for tax purposes.
For example, principal write-downs by issuers of the Fund's residential mortgage
and other structured securities have significantly contributed to the Fund's
historical return of capital distributions. The tax character of the Fund's
fiscal year to date distributions will depend on the Fund's investment
experience during the remainder of its fiscal year, including any additional
principal write-downs by the issuers of the Fund's securities. While it is
uncertain as to what will transpire over the remainder of the Fund's fiscal
year, it is likely that the Fund's current fiscal year distributions will
include a return of capital component.
-------------------
(1) Total return is based on the combination of reinvested dividend, capital
gain and return of capital distributions, if any, at prices obtained by
the Dividend Reinvestment Plan and changes in NAV per share for NAV
returns and changes in Common Share price for market value returns. Total
returns do not reflect sales load and are not annualized for periods less
than one year. Past performance is not indicative of future results.
Page 5
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a)
APRIL 30, 2011 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
---------------- ------------------------------------------------------- ------ -------- --------------
CORPORATE BONDS AND NOTES - 91.2%
AUTOMOTIVE - 3.9%
$ 425,000 American Axle & Manufacturing, Inc..................... 7.88% 03/01/17 $ 438,812
400,000 Ford Motor Co.......................................... 6.50% 08/01/18 428,116
105,000 Pittsburgh Glass Works LLC (b)......................... 8.50% 04/15/16 110,250
425,000 Tenneco, Inc........................................... 6.88% 12/15/20 437,750
70,000 Visteon Corp. (b)...................................... 6.75% 04/15/19 69,650
--------------
1,484,578
--------------
BASIC INDUSTRY - 13.1%
455,000 AK Steel Corp.......................................... 7.63% 05/15/20 480,594
425,000 Arch Coal, Inc. (c).................................... 8.75% 08/01/16 478,125
215,000 Georgia-Pacific LLC.................................... 7.38% 12/01/25 232,200
185,000 Georgia-Pacific LLC.................................... 7.25% 06/01/28 196,794
275,000 Hexion U.S. Finance Corp./Hexion Nova
Scotia Finance ULC (c).............................. 8.88% 02/01/18 299,750
425,000 Huntsman International LLC (b)......................... 8.63% 03/15/21 479,187
425,000 Mercer International, Inc.............................. 9.50% 12/01/17 468,562
425,000 Ply Gem Industries, Inc. (b) (c)....................... 8.25% 02/15/18 438,813
425,000 Polymer Group, Inc. (b)................................ 7.75% 02/01/19 444,125
325,000 Steel Dynamics, Inc.................................... 7.63% 03/15/20 357,500
600,000 United States Steel Corp. (c).......................... 7.00% 02/01/18 632,250
400,000 Westlake Chemical Corp. (c)............................ 6.63% 01/15/16 414,500
--------------
4,922,400
--------------
CAPITAL GOODS - 9.7%
425,000 Berry Plastics Corp.................................... 9.50% 05/15/18 429,781
245,000 Coleman Cable, Inc. (c)................................ 9.00% 02/15/18 260,313
425,000 Crown Cork & Seal Co., Inc............................. 7.38% 12/15/26 423,938
215,000 Mueller Water Products, Inc. (c)....................... 7.38% 06/01/17 214,463
825,000 Owens-Illinois, Inc. (c)............................... 7.80% 05/15/18 909,562
225,000 RBS Global, Inc./Rexnord LLC (c)....................... 8.50% 05/01/18 245,250
400,000 Terex Corp. (c)........................................ 8.00% 11/15/17 425,000
275,000 Trimas Corp. (c)....................................... 9.75% 12/15/17 303,875
425,000 USG Corp. (c) (d)...................................... 9.75% 01/15/18 449,437
--------------
3,661,619
--------------
CONSUMER CYCLICAL - 7.3%
425,000 ACCO Brands Corp. (c).................................. 10.63% 03/15/15 481,312
400,000 Easton-Bell Sports, Inc. (c)........................... 9.75% 12/01/16 450,000
425,000 Levi Strauss & Co...................................... 7.63% 05/15/20 430,312
425,000 Limited Brands, Inc. (c)............................... 7.60% 07/15/37 421,813
220,000 Neiman Marcus Group, Inc. (c).......................... 10.38% 10/15/15 233,200
250,000 Phillips-Van Heusen Corp............................... 7.38% 05/15/20 271,875
425,000 Reynolds Group Issuer, Inc./Reynolds
Group Issuer LLC (b) (c)............................ 9.00% 04/15/19 449,969
--------------
2,738,481
--------------
CONSUMER NON-CYCLICAL - 5.0%
425,000 B&G Foods, Inc. (c).................................... 7.63% 01/15/18 458,469
500,000 C&S Group Enterprises LLC (b) (c) ..................... 8.38% 05/01/17 526,250
425,000 Cott Beverages, Inc.................................... 8.13% 09/01/18 457,937
Page 6 See Notes to Financial Statements
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (Continued)
APRIL 30, 2011 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
---------------- ------------------------------------------------------- ------ -------- --------------
CORPORATE BONDS AND NOTES - (Continued)
CONSUMER NON-CYCLICAL - (Continued)
$ 215,000 Rite Aid Corp. (c) .................................... 8.63% 03/01/15 $ 203,175
200,000 Rite Aid Corp. (c) .................................... 9.75% 06/12/16 226,250
--------------
1,872,081
--------------
ENERGY - 16.3%
250,000 Breitburn Energy Partners LP/Breitburn
Finance Corp........................................ 8.63% 10/15/20 267,500
425,000 Calfrac Holdings LP (b) ............................... 7.50% 12/01/20 446,250
500,000 Calumet Specialty Products Partners LP/
Calumet Finance Corp (b) (c) ....................... 9.38% 05/01/19 525,000
200,000 Chaparral Energy, Inc. (c) ............................ 8.88% 02/01/17 213,000
425,000 Crosstex Energy LP/Crosstex Energy
Finance Corp. (c) .................................. 8.88% 02/15/18 466,437
225,000 Edgen Murray Corp. (c) ................................ 12.25% 01/15/15 227,813
140,000 EV Energy Partners LP/EV Energy
Finance Corp. (b)................................... 8.00% 04/15/19 144,900
215,000 GMX Resources, Inc. (b) (c) ........................... 11.38% 02/15/19 215,538
275,000 Hercules Offshore LLC (b) (c) ......................... 10.50% 10/15/17 290,125
425,000 Hilcorp Energy I LP/Hilcorp Finance Co. (b) ........... 8.00% 02/15/20 457,937
425,000 Key Energy Services, Inc............................... 6.75% 03/01/21 437,750
120,000 Linn Energy LLC/Linn Energy Finance Corp............... 8.63% 04/15/20 133,200
400,000 McJunkin Red Man Corp. (b) (c) ........................ 9.50% 12/15/16 413,000
495,000 Niska Gas Storage US LLC/Niska Gas
Storage Canada ULC (c).............................. 8.88% 03/15/18 538,931
425,000 Pioneer Natural Resources Co........................... 6.65% 03/15/17 468,342
425,000 Plains Exploration & Production Co. (c) ............... 7.63% 06/01/18 457,938
425,000 Venoco, Inc. (b) ...................................... 8.88% 02/15/19 427,125
--------------
6,130,786
--------------
MEDIA - 9.8%
425,000 American Reprographics Co. (b) (c) .................... 10.50% 12/15/16 453,688
425,000 Cablevision Systems Corp............................... 8.63% 09/15/17 478,125
425,000 CCO Holdings LLC/CCO Holdings
Capital Corp. (c) .................................. 8.13% 04/30/20 474,937
425,000 Clear Channel Communications, Inc. (b) ................ 9.00% 03/01/21 434,563
425,000 Deluxe Corp. (c) ...................................... 7.38% 06/01/15 442,531
425,000 Insight Communications Co., Inc. (b) (c) .............. 9.38% 07/15/18 477,062
425,000 Lamar Media Corp. (c) ................................. 7.88% 04/15/18 459,000
425,000 Mediacom LLC/Mediacom Capital Corp. (c) ............... 9.13% 08/15/19 463,250
--------------
3,683,156
--------------
SERVICES - 16.2%
400,000 AMC Entertainment, Inc. (c)............................ 8.75% 06/01/19 436,000
425,000 Avis Budget Car Rental LLC/Avis Budget
Finance, Inc. (c) .................................. 9.63% 03/15/18 473,875
200,000 Beazer Homes USA, Inc. (c) ............................ 9.13% 06/15/18 200,500
See Notes to Financial Statements Page 7
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (Continued)
APRIL 30, 2011 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
---------------- ------------------------------------------------------- ------ -------- --------------
CORPORATE BONDS AND NOTES - (Continued)
SERVICES - (Continued)
$ 425,000 Citycenter Holdings LLC/Citycenter
Finance Corp (b) (c) ............................... 7.63% 01/15/16 $ 445,187
400,000 Harrah's Operating Co., Inc. (c) ...................... 11.25% 06/01/17 458,000
400,000 Iron Mountain, Inc. (c) ............................... 8.75% 07/15/18 421,000
425,000 K Hovnanian Enterprises, Inc........................... 10.63% 10/15/16 454,750
425,000 Marina District Finance Co., Inc. (b) ................. 9.88% 08/15/18 457,937
300,000 Maxim Crane Works LP (b) (c) .......................... 12.25% 04/15/15 312,750
225,000 MGM Resorts International (c) ......................... 5.88% 02/27/14 221,063
225,000 MGM Resorts International (c) ......................... 10.38% 05/15/14 261,281
425,000 Palace Entertainment Holdings LLC/Palace
Entertainment Holdings Corp. (b) ................... 8.88% 04/15/17 443,062
425,000 Pulte Group, Inc. (c) ................................. 6.38% 05/15/33 351,688
225,000 RSC Equipment Rental, Inc./RSC
Holdings III LLC (c) ............................... 10.25% 11/15/19 259,313
425,000 Standard Pacific Corp. (c) ............................ 8.38% 05/15/18 442,000
425,000 United Rentals North America, Inc. (c) ................ 8.38% 09/15/20 454,750
--------------
6,093,156
--------------
TECHNOLOGY & ELECTRONICS - 2.7%
22,000 First Data Corp........................................ 9.88% 09/24/15 22,853
425,000 First Data Corp. (b) .................................. 8.25% 01/15/21 425,000
500,000 Freescale Semiconductor, Inc. (b) (c) ................. 9.25% 04/15/18 557,500
--------------
1,005,353
--------------
TELECOMMUNICATIONS - 5.6%
215,000 Cincinnati Bell, Inc. (c) ............................. 8.25% 10/15/17 219,300
210,000 Cincinnati Bell, Inc. (c) ............................. 8.38% 10/15/20 211,050
400,000 Frontier Communications (c) ........................... 7.13% 03/15/19 411,000
200,000 PAETEC Holding Corp. (c) .............................. 9.50% 07/15/15 211,000
200,000 PAETEC Holding Corp. (c) .............................. 8.88% 06/30/17 219,250
400,000 Qwest Corp............................................. 6.88% 09/15/33 394,000
425,000 Windstream Corp........................................ 7.00% 03/15/19 435,625
--------------
2,101,225
--------------
UTILITY - 1.6%
425,000 Calpine Corp. (b) (c) ................................. 7.25% 10/15/17 448,375
225,000 Edison Mission Energy ................................. 7.00% 05/15/17 179,438
--------------
627,813
--------------
TOTAL CORPORATE BONDS AND NOTES.......................................... 34,320,648
(Cost $32,522,878) --------------
MORTGAGE-BACKED SECURITIES - 16.8%
COLLATERALIZED MORTGAGE OBLIGATIONS - 9.4%
258,567 Adjustable Rate Mortgage Trust
Series 2006-2, Class 1A1 (e) ....................... 5.49% 05/25/36 236,481
130,685 Chase Mortgage Finance Corp.
Series 2007-S2, Class 1A8........................... 6.00% 03/25/37 120,738
Page 8 See Notes to Financial Statements
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (Continued)
APRIL 30, 2011 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
---------------- ------------------------------------------------------- ------ -------- --------------
MORTGAGE-BACKED SECURITIES - (Continued)
COLLATERALIZED MORTGAGE OBLIGATIONS - (Continued)
Citicorp Mortgage Securities, Inc.
$ 660,000 Series 2007-2, Class 1A3........................... 6.00% 02/25/37 $ 651,203
Citigroup Mortgage Loan Trust, Inc.
267,026 Series 2006-AR6, Class 1A1 (e) ..................... 5.92% 08/25/36 247,981
279,656 Series 2007-AR4, Class 1A1A (e) .................... 5.81% 03/25/37 252,566
Countrywide Alternative Loan Trust
91,269 Series 2006-41CB, Class 2A14........................ 6.00% 01/25/37 73,092
Countrywide Home Loan Mortgage Pass Through Trust
447,900 Series 2005-27, Class 2A1 .......................... 5.50% 12/25/35 409,357
314,000 Series 2007-10, Class A5............................ 6.00% 07/25/37 263,718
HarborView Mortgage Loan Trust
3,643,456 Series 2005-9, Class B10 (e) ....................... 1.96% 06/20/35 309,122
JP Morgan Mortgage Trust
73,263 Series 2006-S3, Class 1A30 ......................... 6.50% 08/25/36 69,176
Residential Asset Securitization Trust
387,182 Series 2005-A8CB, Class A11......................... 6.00% 07/25/35 348,362
Structured Asset Securities Corp.
61,087 Series 2003-10, Class A............................. 6.00% 04/25/33 64,487
Wells Fargo Mortgage Backed Securities Trust
308,000 Series 2006-8, Class A15............................ 6.00% 07/25/36 293,694
196,898 Series 2007-7, Class A38............................ 6.00% 06/25/37 191,338
26,865 Series 2007-8, Class 1A16 .......................... 6.00% 07/25/37 25,419
--------------
3,556,734
--------------
COMMERCIAL MORTGAGE-BACKED SECURITIES - 7.4%
Banc of America Large Loan, Inc.
2,000,000 Series 2005-MIB1, Class L (e) (f) (g) .............. 3.22% 03/15/22 797,958
Citigroup/Deutsche Bank Commercial Mortgage Trust
310,000 Series 2007-CD4, Class A4 .......................... 5.32% 12/11/49 333,262
Commercial Mortgage Pass Through Certificates
330,000 Series 2007-C9, Class A4 (e) ....................... 5.81% 12/10/49 367,497
Credit Suisse Mortgage Capital Certificates
60,000 Series 2006-C5, Class AJ............................ 5.37% 12/15/39 53,992
Greenwich Capital Commercial Funding Corp.
200,000 Series 2007-GG11, Class A4.......................... 5.74% 12/10/49 217,021
330,000 Series 2007-GG11, Class AJ (e) ..................... 6.00% 12/10/49 300,637
GS Mortgage Securities Corp II
780,000 Series 2006-GG8, Class AJ........................... 5.62% 11/10/39 709,668
--------------
2,780,035
--------------
TOTAL MORTGAGE-BACKED SECURITIES......................................... 6,336,769
(Cost $6,986,211) --------------
See Notes to Financial Statements Page 9
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (Continued)
APRIL 30, 2011 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
---------------- ------------------------------------------------------- ------ -------- --------------
ASSET-BACKED SECURITIES - 9.2%
Ace Securities Corp.
$ 322,000 Series 2003-MH1, Class A4 (b) ...................... 6.50% 08/15/30 $ 345,582
Bombardier Capital Mortgage Securitization Corp.
306,123 Series 1999-B, Class A1B ........................... 6.61% 12/15/29 187,495
1,097,258 Series 1999-B, Class A3............................. 7.18% 12/15/29 693,337
Conseco Finance Securitizations Corp.
2,637,338 Series 2000-6, Class M1............................. 7.72% 09/01/31 666,391
Countrywide Asset-Backed Certificates
229,044 Series 2006-13, Class 3AV2 (e) ..................... 0.36% 01/25/37 154,603
Credit Suisse First Boston Mortgage Securities Corp.
97,838 Series 2002-MH3, Class A ........................... 6.70% 12/25/31 103,601
Falcon Franchise Loan Trust
4,905,000 Series 2000-1, Class E (b) (g) ..................... 6.50% 04/05/16 98,100
4,231,000 Series 2003-1, Class E (f) (h) ..................... 6.00% 01/05/25 5,500
Green Tree Financial Corp.
190,221 Series 1997-4, Class B1 ............................ 7.23% 02/15/29 19,841
837,028 Series 1998-4, Class M1 ............................ 6.83% 04/01/30 378,469
3,569,733 Series 1999-3, Class M1 ............................ 6.96% 02/01/31 454,888
GSAMP Trust
440,199 Series 2004-AR2, Class B4 (f) ...................... 4.76% 08/25/34 7,915
966,688 Series 2006-S3, Class A2 (g) ....................... 6.27% 05/25/36 55,359
846,333 Series 2006-S5, Class A1 (e) ....................... 0.30% 09/25/36 22,764
Independence III CDO, Ltd.
5,000,000 Series 3A, Class C1 (e) (f) (i) .................... 2.80% 10/03/37 14,650
Long Beach Mortgage Loan Trust
1,907,171 Series 2006-A, Class A2 (g) ........................ 6.05% 05/25/36 111,689
Park Place Securities, Inc.
1,512,153 Series 2004-WCW1, Class M8 (e) ..................... 3.71% 09/25/34 34,525
1,301,976 Series 2004-WCW2, Class M10 (e) (f) ................ 2.96% 10/25/34 67,730
Stanfield Azure CLO, Ltd.
39,216 Series 2006-1A, Class X (b) ........................ 5.34% 05/27/20 39,322
Summit CBO I, Ltd.
4,219,712 Series 1A, Class B (e) (f) (g) ..................... 1.44% 05/23/11 42
--------------
TOTAL ASSET-BACKED SECURITIES............................................ 3,461,803
(Cost $3,313,529) --------------
FOREIGN CORPORATE BONDS AND NOTES - 7.7%
BASIC INDUSTRY - 4.7%
425,000 Cascades, Inc.......................................... 7.88% 01/15/20 455,812
425,000 Masonite International Corp. (b) ...................... 8.25% 04/15/21 436,422
355,000 Millar Western Forest Products Ltd. (b) ............... 8.50% 04/01/21 357,219
450,000 Tembec Industries, Inc. (c) ............................ 11.25% 12/15/18 511,875
--------------
1,761,328
--------------
CAPITAL GOODS - 1.3%
425,000 Bombardier, Inc. (b) (c) .............................. 7.75% 03/15/20 475,469
Page 10 See Notes to Financial Statements
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (Continued)
APRIL 30, 2011 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
---------------- ------------------------------------------------------- ------ -------- --------------
FOREIGN CORPORATE BONDS AND NOTES - (Continued)
ENERGY - 0.5%
$ 170,000 Precision Drilling Corp. (b) .......................... 6.63% 11/15/20 $ 176,375
--------------
TELECOMMUNICATIONS - 1.2%
400,000 Global Crossing Ltd. (c) .............................. 12.00% 09/15/15 470,000
--------------
TOTAL FOREIGN CORPORATE BONDS AND NOTES ................................. 2,883,172
(Cost $2,741,248) --------------
SENIOR FLOATING-RATE LOAN INTERESTS - 0.5%
UTILITY - 0.5%
222,692 Texas Competitive Electric Holdings Co., LLC
Tranche B2 (e) ..................................... 3.27% 10/10/14 189,623
--------------
TOTAL SENIOR FLOATING-RATE LOAN INTERESTS................................ 189,623
(Cost $195,932) --------------
STRUCTURED NOTES - 0.0%
3,750,000 Preferred Term Securities XXV, Ltd. (f) ............... (j) 06/22/37 375
--------------
TOTAL STRUCTURED NOTES................................................... 375
(Cost $0) --------------
U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITIES - 0.0%
COMMERCIAL MORTGAGE-BACKED SECURITIES - 0.0%
FannieMae-ACES
80,454 Series 1998-M7, Class N, IO (e) .................... 0.32% 05/25/36 8
--------------
TOTAL U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITIES ................. 8
(Cost $105,867) --------------
SHARES DESCRIPTION VALUE
---------------- ------------------------------------------------------------------------- --------------
PREFERRED SECURITIES - 0.1%
2,000 Soloso CDO, Ltd., Series 2005-1 (f) (j) ................................. 20,000
3,000 White Marlin CDO, Ltd., Series AI (f) (i) (j) ........................... 15,000
--------------
TOTAL PREFERRED SECURITIES............................................... 35,000
(Cost $0) --------------
TOTAL INVESTMENTS - 125.5% .............................................. 47,227,398
(Cost $45,865,665) (k) --------------
OUTSTANDING LOAN - (28.7%) .............................................. (10,800,000)
NET OTHER ASSETS AND LIABILITIES - 3.2% ................................. 1,216,648
NET ASSETS - 100.0% ..................................................... $ 37,644,046
See Notes to Financial Statements Page 11
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (Continued)
APRIL 30, 2011 (UNAUDITED)
-----------------------------
(a) All percentages shown in the Portfolio of Investments are based on net
assets.
(b) This security, sold within the terms of a private placement memorandum, is
exempt from regiupon resale under Rule 144A under the Securities Act of
1933, as amended (the "1933 Act"), and may be resold in transactions
exempt from registration, normally to qualified institutional buyers.
Pursuant to procedures adopted by the Fund's Board of Trustees, this
security has been determined to be liquid by Brookfield Investment
Management Inc., the Fund's sub-advisor. Although market instability can
result in periods of increased overall market illiquidity, liquidity for
each security is determined based on security specific factors and
assumptions, which require subjective judgment. At April 30, 2011,
securities noted as such amounted to $11,869,544 or 31.53% of net assets.
(c) All or a portion of this security is available to serve as collateral on
the outstanding loan.
(d) Multi-Step Coupon Bond - coupon steps up or down based upon ratings
changes by Standard & Poor's Ratings Group or Moody's Investors Service,
Inc. The interest rate shown reflects the rate in effect at April 30,
2011.
(e) Floating rate security. The interest rate shown reflects the rate in
effect at April 30, 2011.
(f) This security, sold within the terms of a private placement memorandum, is
exempt from registration upon resale under Rule 144A under the 1933 Act,
and may be resold in transactions exempt from registration, normally to
qualified institutional buyers (see Note 2C - Restricted Securities in the
Notes to Financial Statements).
(g) Security is receiving less than the stated coupon.
(h) Security missed one or more of its interest payments.
(i) The issuer is in default. Income is not being accrued.
(j) Zero coupon security.
(k) Aggregate cost for financial reporting purposes, which approximates the
aggregate cost for federal income tax purposes. As of April 30, 2011, the
aggregate gross unrealized appreciation for all securities in which there
was an excess of value over tax cost was $2,971,199 and the aggregate
gross unrealized depreciation for all securities in which there was an
excess of tax cost over value was $1,609,466.
ACES Alternative Credit Enhancement Securities
CBO Collateralized Bond Obligation
CDO Collateralized Debt Obligation
CLO Collateralized Loan Obligation
IO Interest-Only Security - Principal amount shown represents par value on
which interest payments are based.
VALUATION INPUTS
A summary of the inputs used to value the Fund's investments as of April 30,
2011 is as follows (see Note 2A - Portfolio Valuation in the Notes to Financial
Statements):
LEVEL 2 LEVEL 3
TOTAL LEVEL 1 SIGNIFICANT SIGNIFICANT
VALUE AT QUOTED OBSERVABLE UNOBSERVABLE
4/30/2011 PRICES INPUTS INPUTS
------------- ----------- ------------ -------------
Corporate Bonds and Notes*............................. $ 34,320,648 $ -- $ 34,320,648 $ --
Mortgage-Backed Securities:
Collateralized Mortgage Obligations ................ 3,556,734 -- 3,556,734 --
Commercial Mortgage-Backed Securities .............. 2,780,035 -- 2,780,035 --
Asset-Backed Securities................................ 3,461,803 -- 3,358,203 103,600
Foreign Corporate Bonds and Notes*..................... 2,883,172 -- 2,883,172 --
Senior Floating-Rate Loan Interests*................... 189,623 -- 189,623 --
Structured Notes....................................... 375 -- 375 --
U.S. Government Agency Mortgage-Backed Securities...... 8 -- 8 --
Preferred Securities................................... 35,000 -- -- 35,000
------------- ----------- ------------ ------------
TOTAL INVESTMENTS...................................... $ 47,227,398 $ -- $ 47,088,798 $ 138,600
------------- ----------- ------------ ------------
* See the Portfolio of Investments for industry breakout.
Page 12 See Notes to Financial Statements
FIRST TRUST STRATEGIC HIGH INCOME FUND
PORTFOLIO OF INVESTMENTS (a) - (Continued)
APRIL 30, 2011 (UNAUDITED)
The following table presents the activity of the Fund's investments measured at
fair value on a recurring basis using significant unobservable inputs (Level 3)
for the period presented.
CHANGE IN
TRANSFERS NET UNREALIZED NET BALANCE
INVESTMENTS AT FAIR VALUE USING BALANCE AS OF IN (OUT) NET REALIZED APPRECIATION PURCHASES AS OF
SIGNIFICANT UNOBSERVABLE INPUTS (LEVEL 3) OCTOBER 31, 2010 OF LEVEL 3 GAINS (LOSSES) (DEPRECIATION) (SALES) APRIL 30, 2011
------------------------------------------------------------------------------------------------------------------------------------
Asset-Backed Securities................. $ 87,636 $ (42) $ (137) $ 43,463 $ (27,320) $ 103,600
Preferred Securities.................... 35,000 -- -- -- -- 35,000
----------------------------------------------------------------------------------------
Total................................... $ 122,636 $ (42) $ (137) $ 43,463 $ (27,320) $ 138,600
========================================================================================
Net change in unrealized appreciation from Level 3 investments held as of April
30, 2011 was $40,050 and is included in "Net change in unrealized appreciation
(depreciation) on investments" on the Statement of Operations.
See Notes to Financial Statements Page 13
FIRST TRUST STRATEGIC HIGH INCOME FUND
STATEMENT OF ASSETS AND LIABILITIES
APRIL 30, 2011 (UNAUDITED)
ASSETS:
Investments, at value
(Cost $45,865,665).......................................................................... $ 47,227,398
Cash .......................................................................................... 373,887
Prepaid expenses............................................................................... 19,256
Receivables:
Interest.................................................................................... 935,293
ICI insurance............................................................................... 625,725
Investment securities sold.................................................................. 337,465
------------
Total Assets.............................................................................. 49,519,024
------------
LIABILITIES:
Outstanding loan............................................................................... 10,800,000
Payables:
Litigation settlement....................................................................... 625,725
Investment securities purchased............................................................. 346,038
Investment advisory fees.................................................................... 34,927
Audit and tax fees.......................................................................... 31,922
Printing fees............................................................................... 15,343
Administrative fees......................................................................... 8,270
Transfer agent fees......................................................................... 3,813
Trustees' fees and expenses................................................................. 3,373
Custodian fees.............................................................................. 2,079
Interest and fees on loan................................................................... 1,379
Other liabilities.............................................................................. 2,109
------------
Total Liabilities........................................................................... 11,874,978
------------
NET ASSETS..................................................................................... $ 37,644,046
============
NET ASSETS CONSIST OF:
Paid-in capital................................................................................ $120,206,150
Par value...................................................................................... 91,506
Accumulated net investment income (loss)....................................................... (3,375,996)
Accumulated net realized gain (loss) on investments............................................ (80,639,347)
Net unrealized appreciation (depreciation) on investments...................................... 1,361,733
------------
NET ASSETS..................................................................................... $ 37,644,046
============
NET ASSET VALUE, per Common Share (par value $0.01 per Common Share)........................... $ 4.11
============
Number of Common Shares outstanding (unlimited number of Common Shares has been authorized).... 9,150,594
============
Page 14 See Notes to Financial Statements
FIRST TRUST STRATEGIC HIGH INCOME FUND
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED APRIL 30, 2011 (UNAUDITED)
INVESTMENT INCOME:
Interest....................................................................................... $ 2,259,761
Other.......................................................................................... 7,409
------------
Total investment income..................................................................... 2,267,170
------------
EXPENSES:
Litigation settlement.......................................................................... 625,725
Investment advisory fees....................................................................... 197,494
Administrative fees............................................................................ 49,624
Interest expense on reverse repurchase agreements.............................................. 35,791
Audit and tax fees............................................................................. 27,373
Printing fees.................................................................................. 24,024
Trustees' fees and expenses.................................................................... 19,688
Transfer agent fees............................................................................ 17,562
Interest and fees on loan...................................................................... 14,222
Custodian fees................................................................................. 6,210
Legal fees..................................................................................... 2,239
Other.......................................................................................... 43,305
------------
Total expenses.............................................................................. 1,063,257
ICN insurance recovery...................................................................... (625,725)
------------
Net expenses................................................................................ 437,532
------------
NET INVESTMENT INCOME (LOSS)................................................................... 1,829,638
------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain (loss) on investments..................................................... 2,776,377
Net change in unrealized appreciation (depreciation) on investments......................... 88,835
------------
NET REALIZED AND UNREALIZED GAIN (LOSS)........................................................ 2,865,212
------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS............................... $ 4,694,850
============
See Notes to Financial Statements Page 15
FIRST TRUST STRATEGIC HIGH INCOME FUND
STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS
ENDED YEAR
4/30/2011 ENDED
(UNAUDITED) 10/31/2009
-------------- -------------
OPERATIONS:
Net investment income (loss)....................................................... $ 1,829,638 $ 3,510,434
Net realized gain (loss)........................................................... 2,776,377 (12,133,350)
Net change in unrealized appreciation (depreciation)............................... 88,835 18,952,376
-------------- -------------
Net increase (decrease) in net assets resulting from operations.................... 4,694,850 10,329,460
-------------- -------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income.............................................................. (1,372,589) --
Net realized gain.................................................................. -- --
Return of capital.................................................................. -- (2,745,178)
-------------- -------------
Total distributions to shareholders................................................ (1,372,589) (2,745,178)
-------------- -------------
CAPITAL TRANSACTIONS:
Proceeds from Common Shares reinvested............................................. -- --
-------------- -------------
Net increase (decrease) in net assets resulting from capital transactions.......... -- --
-------------- -------------
Total increase (decrease) in net assets............................................ 3,322,261 7,584,252
NET ASSETS:
Beginning of period................................................................ 34,321,785 26,737,503
-------------- -------------
End of period...................................................................... $ 37,644,046 $ 34,321,785
============== =============
Accumulated net investment income (loss) at end of period.......................... $ (3,375,996) $ (3,833,045)
============== =============
CAPITAL TRANSACTIONS WERE AS FOLLOWS:
Common Shares at beginning of period............................................... 9,150,594 9,150,594
Common Shares issued as reinvestment under the Dividend Reinvestment Plan.......... -- --
-------------- -------------
Common Shares at end of period..................................................... 9,150,594 9,150,594
============== =============
Page 16 See Notes to Financial Statements
FIRST TRUST STRATEGIC HIGH INCOME FUND
STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED APRIL 30, 2011 (UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net increase (decrease) in net assets resulting from operations................. $ 4,694,850
Adjustments to reconcile net increase (decrease) in net assets resulting from
operations to net cash used in operating activities:
Purchases of investments.................................................. (30,443,901)
Sales, maturities and paydowns of investments............................. 26,047,135
Net amortization/accretion of premiums/discounts on investments........... 240,211
Net realized gain/loss on investments..................................... (2,776,377)
Net change in unrealized appreciation/depreciation on investments......... (88,835)
CHANGES IN ASSETS AND LIABILITIES:
Decrease in interest receivable........................................... 7,750
Increase in prepaid expenses.............................................. (12,617)
Increase in ICI insurance receivable...................................... (625,725)
Increase in litigation settlement payable................................. 625,725
Decrease in interest payable on reverse repurchase agreements............. (9,278)
Increase in interest and fees on loan payable............................. 1,379
Increase in investment advisory fees payable.............................. 3,023
Decrease in audit and tax fees payable.................................... (23,278)
Decrease in legal fees payable............................................ (1,958)
Decrease in printing fees payable......................................... (5,945)
Decrease in administrative fees payable................................... (63)
Increase in custodian fees payable........................................ 29
Increase in transfer agent fees payable................................... 964
Increase in Trustees fees and expenses payable............................ 15
Decrease in other liabilities............................................. (2,931)
--------------
CASH USED IN OPERATING ACTIVITIES............................................... $ (2,369,827)
--------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Distributions to Common Shareholders from net investment income........... (1,372,589)
Repurchases of reverse repurchase agreements.............................. (36,475,163)
Reverse repurchase agreements borrowings.................................. 28,927,032
Issuances of loan......................................................... 10,800,000
--------------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES..................................... 1,879,280
--------------
Decrease in cash................................................................ (490,547)
Cash at beginning of period..................................................... 864,434
--------------
CASH AT END OF PERIOD........................................................... $ 373,887
==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest and fees............................... $ 57,912
==============
See Notes to Financial Statements Page 17
FIRST TRUST STRATEGIC HIGH INCOME FUND
FINANCIAL HIGHLIGHTS
FOR A COMMON SHARE OUTSTANDING THROUGHOUT EACH PERIOD
SIX MONTHS
ENDED YEAR YEAR YEAR YEAR YEAR
4/30/2011 ENDED ENDED ENDED ENDED ENDED
(UNAUDITED) 10/31/2010 (a) 10/31/2009 (b) 10/31/2008 10/31/2007 10/31/2006
----------- -------------- -------------- ---------- ---------- ----------
Net asset value, beginning of period $ 3.75 $ 2.92 $ 6.57 $ 15.16 $ 19.82 $ 19.13
--------- ---------- ---------- ---------- ---------- ----------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) ............... 0.20 0.38 1.07 2.05 2.17 2.08
Net realized and unrealized gain (loss) .... 0.31 0.75 (3.64) (8.72) (4.84) 0.76
--------- ---------- ---------- ---------- ---------- ----------
Total from investment operations ........... 0.51 1.13 (2.57) (6.67) (2.67) 2.84
--------- ---------- ---------- ---------- ---------- ----------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income ...................... (0.15) -- -- (0.81) (1.97) (2.15)
Net realized gain .......................... -- -- -- -- (0.02) --
Return of capital .......................... -- (0.30) (1.08) (1.11) -- --
--------- ---------- ---------- ---------- ---------- ----------
Total from distributions ................... (0.15) (0.30) (1.08) (1.92) (1.99) (2.15)
--------- ---------- ---------- ---------- ---------- ----------
Net asset value, end of period ............. $ 4.11 $ 3.75 $ 2.92 $ 6.57 $ 15.16 $ 19.82
========= ========== ========== ========== ========== ==========
Market value, end of period ................ $ 3.67 $ 3.45 $ 2.63 $ 6.34 $ 14.19 $ 21.19
========= ========== ========== ========== ========== ==========
TOTAL RETURN BASED ON NET ASSET VALUE (c) .. 14.53% 41.21% (42.52)% (47.16)% (14.65)% 15.73%
========= ========== ========== ========== ========== ==========
TOTAL RETURN BASED ON MARKET VALUE (c) ..... 11.16% 44.24% (46.35)% (45.56)% (25.30)% 26.16%
========= ========== ========== ========== ========== ==========
--------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) ....... $ 37,644 $ 34,322 $ 26,738 $ 59,381 $ 136,145 $ 176,375
Ratio of total expenses to average net
assets................................... 6.13% (f) 2.68% 1.78% 4.32% 3.10% 1.20%
Ratio of net expenses to average
net assets .............................. 2.52% (f) 2.68% 1.78% 4.32% 3.70% 1.20%
Ratio of total expenses to average net
assets excluding interest expense and
litigation settlement ................... 2.23% (f) 2.61% 1.72% 2.21% 1.68% 1.20%
Ratio of net investment income (loss) to
average net assets ...................... 10.54% (f) 11.23% 28.82% 19.21% 11.78% 10.84%
Portfolio turnover rate .................... 60% (d) 302% (d) 127% (d) 4% 19% 78%
INDEBTEDNESS:
Total loan outstanding (in 000's) .......... $ 10,800 N/A N/A $ 15,000 $ 61,200 N/A
Asset coverage per $1,000 of indebtedness (e) $ 4,486 N/A N/A $ 4,959 $ 3,225 N/A
----------------------------------------------------------
(a) On September 20, 2010, the Fund's Board of Trustees approved an interim
investment management agreement with First Trust Advisors L.P. and an
interim investment sub-advisory agreement with Brookfield Investment
Management Inc. (formerly known as Hyperion Brookfield Asset Management,
Inc.) ("Brookfield"), and on December 20, 2010, the Shareholders voted to
approve new such agreements. (See Note 3 in the Notes to Financial
Statements.)
(b) On June 29, 2009, the Fund's Board of Trustees approved an interim
sub-advisory agreement with Brookfield, and on October 14, 2009, the
Shareholders voted to approve a new sub-advisory agreement with
Brookfield.
(c) Total return is based on the combination of reinvested dividend, capital
gain and return of capital distributions, if any, at prices obtained by
the Dividend Reinvestment Plan, and changes in net asset value per share
for net asset value returns and changes in Common Share price for market
value returns. Total returns do not reflect sales load and are not
annualized for periods less than one year. Past performance is not
indicative of future results.
(d) For the six months ended April 30, 2011 and the fiscal years ended October
31, 2010 and 2009, the Fund's portfolio turnover rate reflects mortgage
pool forward commitments as purchases and sales. This caused the reported
portfolio turnover rate to be higher than in previous fiscal years. The
turnover rate may vary greatly from year to year as well as within a year.
(e) Calculated by subtracting the Fund's total liabilities (not including the
loan outstanding) from the Fund's total assets, and dividing by the
outstanding loan balance in 000's.
(f) Annualized.
N/A Not Applicable.
Page 18 See Notes to Financial Statements
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2011 (UNAUDITED)
1. FUND DESCRIPTION
First Trust Strategic High Income Fund (the "Fund") is a diversified, closed-end
management investment company organized as a Massachusetts business trust on
April 15, 2005, and is registered with the Securities and Exchange Commission
("SEC") under the Investment Company Act of 1940, as amended (the "1940 Act").
The Fund trades under the ticker symbol FHI on the New York Stock Exchange
("NYSE").
The Fund's primary investment objective is to seek a high level of current
income. The Fund seeks capital growth as a secondary objective. The Fund seeks
to achieve its investment objectives by investing in a diversified portfolio of
below-investment grade and investment grade debt securities, and equity
securities that Brookfield Investment Management Inc. ("Brookfield" or the
"Sub-Advisor") believes offer attractive yield and/or capital appreciation
potential. The Fund may invest up to 100% of its managed assets in
below-investment grade debt securities (commonly referred to as "high-yield" or
"junk" bonds). Managed assets means the average daily total asset value of the
Fund minus the sum of the Fund's liabilities other than principal amount of
borrowings or reverse repurchase agreements, if any. There can be no assurance
that the Fund will achieve its investment objectives. The Fund may not be
appropriate for all investors.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts and disclosures in
the financial statements. Actual results could differ from those estimates.
A. PORTFOLIO VALUATION:
The net asset value ("NAV") of the Common Shares of the Fund is determined
daily, as of the close of regular trading on the NYSE, normally 4:00 p.m.
Eastern time, on each day the NYSE is open for trading. If the NYSE closes early
on a valuation day, the NAV is determined as of that time. Domestic debt
securities and foreign securities are priced using data reflecting the earlier
closing of the principal markets for those securities. The NAV per Common Share
is calculated by dividing the value of all assets of the Fund (including accrued
interest and dividends), less all liabilities (including accrued expenses,
dividends declared but unpaid and any borrowings of the Fund), by the total
number of Common Shares outstanding.
The Fund's investments are valued daily in accordance with valuation procedures
adopted by the Fund's Board of Trustees, and in accordance with provisions of
the 1940 Act. Securities for which market quotations are readily available are
valued using the last reported sale price on the business day as of which such
value is being determined. If no sales are reported on such business day (as in
the case of some securities traded over-the-counter), the last reported bid
price is used, except that certain U.S. Government securities are valued at the
mean between the last reported bid and asked prices. Mortgage-backed securities
("MBS") and other debt securities not traded in an organized market are valued
on the basis of valuations provided by dealers who make markets in such
securities or by an independent pricing service approved by the Fund's Board of
Trustees, which may use the following valuation inputs when available:
1) benchmark yields;
2) reported trades;
3) broker/dealer quotes;
4) issuer spreads;
5) benchmark securities;
6) bids and offers; and
7) reference data including market research publications.
A ready market does not exist for some of these investments. As such, these
values may differ from the values that would have been used had a ready market
for these investments existed, and the differences could be material.
Debt securities having a remaining maturity of sixty days or less when purchased
are valued at cost adjusted for amortization of premiums and accretion of
discounts.
In the event that market quotations are not readily available, the pricing
service or dealer does not provide a valuation, or the valuations received are
deemed unreliable, the Fund's Board of Trustees has designated First Trust
Advisors L.P. ("First Trust") to use a fair value method to value the Fund's
securities. Additionally, if events occur after the close of the principal
markets for certain securities (e.g., domestic debt and foreign securities) that
could materially affect the Fund's NAV, First Trust may use a fair value method
to value the Fund's securities. The use of fair value pricing is governed by
Page 19
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (Continued)
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2011 (UNAUDITED)
valuation procedures adopted by the Fund's Board of Trustees, and in accordance
with the provisions of the 1940 Act. As a general principle, the fair value of a
security is the amount which the Fund might reasonably expect to receive for the
security upon its current sale. However, in light of the judgement involved in
fair valuations, there can be no assurance that a fair value assigned to a
particular security will be the amount which the Fund might be able to receive
upon its current sale. Fair valuation of a security is based on the
consideration of all available information, including, but not limited to, the
following:
1) the fundamental business data relating to the issuer;
2) an evaluation of the forces which influence the market in which
these securities are purchased and sold;
3) the type, size and cost of security;
4) the financial statements of the issuer;
5) the credit quality and cash flow of the issuer, based on the
Sub-Advisor's or external analysis;
6) the information as to any transactions in or offers for the
security;
7) the price and extent of public trading in similar securities (or
equity securities) of the issuer/borrower, or comparable companies;
8) the coupon payments;
9) the quality, value and salability of collateral, if any, securing
the security;
10) the business prospects of the issuer, including any ability to
obtain money or resources from a parent or affiliate and an
assessment of the issuer's management;
11) the prospects for the issuer's industry, and multiples (of earnings
and/or cash flows) being paid for similar businesses in that
industry; and
12) other relevant factors.
The Fund invests a significant portion of its assets in below-investment grade
debt securities, including structured finance securities and corporate bonds.
Structured finance securities include: asset-backed securities, including home
equity, auto, equipment lease, credit card, aircraft, franchise, manufactured
housing, etc.; commercial mortgage-backed securities; residential
mortgage-backed or private-label collateralized mortgage obligations;
collateralized debt obligations and collateralized loan obligations. The value
and related income of these securities is sensitive to changes in economic
conditions, including delinquencies and/or defaults. Instability in the markets
for fixed-income securities, particularly mortgage-backed and asset-backed
securities, has resulted in increased volatility and periods of illiquidity that
have adversely impacted the valuation of certain securities held by the Fund.
The Fund is subject to fair value accounting standards that define fair value,
establish the framework for measuring fair value and provide a three-level
hierarchy for fair valuation based upon the inputs to the valuation as of the
measurement date. The three levels of the fair value hierarchy are as follows:
o Level 1 - Level 1 inputs are quoted prices in active markets for
identical securities. An active market is a market in which
transactions for the security occur with sufficient frequency and
volume to provide pricing information on an ongoing basis.
o Level 2 - Level 2 inputs are observable inputs, either directly or
indirectly, and include the following
o Quoted prices for similar securities in active markets.
o Quoted prices for identical or similar securities in markets
that are non-active. A non-active market is a market where
there are few transactions for the security, the prices are
not current, or price quotations vary substantially either
over time or among market makers, or in which little
information is released publicly.
o Inputs other than quoted prices that are observable for the
security (for example, interest rates and yield curves
observable at commonly quoted intervals, volatilities,
prepayment speeds, loss severities, credit risks, and default
rates).
o Inputs that are derived principally from or corroborated by
observable market data by correlation or other means.
o Level 3 - Level 3 inputs are unobservable inputs. Unobservable
inputs may reflect the reporting entity's own assumptions about the
assumptions that market participants would use in pricing the
security.
The inputs or methodology used for valuing securities are not necessarily an
indication of the risk associated with investing in those securities. A summary
of the inputs used to value the Fund's investments as of April 30, 2011, is
included with the Fund's Portfolio of Investments.
B. SECURITIES TRANSACTIONS AND INVESTMENT INCOME:
Securities transactions are recorded as of the trade date. Realized gains and
losses from securities transactions are recorded on the identified cost basis.
Interest income is recorded daily on the accrual basis. Amortization of premiums
and accretion of discounts are recorded using the effective interest method.
Page 20
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (Continued)
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2011 (UNAUDITED)
The Fund invests in certain lower credit quality securitized assets (for
example, asset-backed securities, collateralized mortgage obligations and
commercial mortgage-backed securities), as well as interest-only securities,
that have contractual cash flows. For these securities, if there is a change in
the estimated cash flows, based on an evaluation of current information, then
the estimated yield is adjusted on a prospective basis over the remaining life
of the security. Additionally, if the evaluation of current information
indicates a permanent impairment of the security, the cost basis of the security
is written down and a loss is recognized. Debt obligations may be placed on
non-accrual status, and related interest income may be reduced by ceasing
current accruals and amortization/accretion and writing off interest receivables
when the collection of all or a portion of interest has become doubtful based on
consistently applied procedures. A debt obligation is removed from non-accrual
status when the issuer resumes interest payments or when collectability of
interest is reasonably assured.
Securities purchased on a when-issued, delayed-delivery or forward purchase
commitment basis may have extended settlement periods. The value of the security
so purchased is subject to market fluctuations during this period. The Fund
maintains liquid assets with a current value at least equal to the amount of its
when-issued, delayed-delivery or forward purchase commitments until payment is
made. At April 30, 2011, the Fund had no when-issued, delayed-delivery or
forward purchase commitments.
C. RESTRICTED SECURITIES:
The Fund invests in restricted securities, which are securities that may not be
offered for public sale without first being registered under the 1933 Act. Prior
to registration, restricted securities may only be resold in transactions exempt
from registration under Rule 144A under the 1933 Act, normally to qualified
institutional buyers. As of April 30, 2011, the Fund held restricted securities
as shown in the following table that the Sub-Advisor has deemed illiquid
pursuant to procedures adopted by the Fund's Board of Trustees. Although market
instability can result in periods of increased overall market illiquidity,
liquidity for each security is determined based on security-specific factors and
assumptions, which require subjective judgment. The Fund does not have the right
to demand that such securities be registered. These securities are valued
according to the valuation procedures as stated in the Portfolio Valuation
footnote (Note 2A) and are not expressed as a discount to the carrying value of
a comparable unrestricted security. There are no unrestricted securities with
the same maturity dates and yields for these issuers.
% OF
ACQUISITION PRINCIPAL CARRYING NET
SECURITY DATE VALUE/SHARES PRICE COST VALUE ASSETS
---------------------------------------------------------------------------------------------------------------------------
Banc of America Large Loan, Inc.
Series 2005-MIB1, Class L, 3.22%, 03/15/22 08/26/06 $ 2,000,000 $ 39.90 $ 526,047 $ 797,958 2.12%
Falcon Franchise Loan Trust
Series 2003-1, Class E, 6.00%, 01/05/25 08/09/05 $ 4,231,000 0.13 -- 5,500 0.02
GSAMP Trust
Series 2004-AR2, Class B4, 4.76%, 08/25/34 08/17/05 $ 440,199 1.80 -- 7,915 0.02
Independence III CDO, Ltd.
Series 3A, Class C1, 2.80%, 10/03/37 12/27/06 $ 5,000,000 0.29 -- 14,650 0.04
Park Place Securities, Inc.
Series 2004-WCW2, Class M10, 2.96%, 10/25/34 03/24/06 $ 1,301,976 5.20 147,108 67,730 0.18
Preferred Term Securities XXV, Ltd.
Zero Coupon, 06/22/37 03/22/07 $ 3,750,000 0.00* -- 375 0.00 **
Soloso CDO, Ltd., Series 2005-1 11/30/05 2,000 10.00 -- 20,000 0.05
Summit CBO I, Ltd
Series 1A, Class B, 1.44%, 05/23/11 08/03/05 $ 4,219,712 0.00* 58,743 42 0.00 **
White Marlin CDO, Ltd., Series AI 06/01/07 3,000 5.00 -- 15,000 0.04
---------- ----------- ------
$ 731,898 $ 929,170 2.47%
========== =========== ======
* Amount is less than $0.01.
** Amount is less than 0.01%.
D. REVERSE REPURCHASE AGREEMENTS:
Reverse repurchase agreements were utilized as leverage for the Fund. A reverse
repurchase agreement, although structured as a sale and repurchase obligation,
acts as a financing under which Fund assets are pledged as collateral to secure
a short-term loan. Generally, the other party to the agreement makes the loan in
an amount equal to a percentage of the market value of the pledged collateral.
At the maturity of the reverse repurchase agreement, the loan will be repaid and
the collateral will correspondingly be received back to the Fund. While used as
collateral, the assets continue to pay principal and interest which are for the
benefit of the Fund.
Page 21
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (Continued)
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2011 (UNAUDITED)
Information for the six months ended April 30, 2011:
Maximum amount outstanding during the period.................. $10,298,852
Average amount outstanding during the period*................. $ 7,114,952
Average monthly Common Shares outstanding during the period... 9,150,594
Average debt per Common Share outstanding during the period... $0.78
* The average amount outstanding during the period was calculated by adding the
borrowings at the end of each day and dividing the sum by the number of days in
the six months ended April 30, 2011.
During the six months ended April 30, 2011, the interest rate was 1.00% on
borrowings by the Fund under reverse repurchase agreements, which had interest
expense that aggregated $35,791.
E. INTEREST-ONLY SECURITIES:
An interest-only security ("IO Security") is the interest-only portion of an MBS
that receives some or all of the interest portion of the underlying MBS and
little or no principal. A reference principal value called a notional value is
used to calculate the amount of interest due to the IO Security. IO securities
are sold at a deep discount to their notional principal amount. Generally
speaking, when interest rates are falling and prepayment rates are increasing,
the value of an IO Security will fall. Conversely, when interest rates are
rising and prepayment rates are decreasing, generally the value of an IO
Security will rise. These securities, if held in the Fund, are identified on the
Portfolio of Investments.
F. MORTGAGE DOLLAR ROLLS:
The Fund may enter into mortgage dollar rolls in which the Fund sells MBS' for
delivery in the current month, realizing a gain or loss, and simultaneously
contracts to repurchase substantially similar (same type, coupon and maturity)
securities to settle on a specified future date.
The Fund executes its mortgage dollar rolls entirely in the to be announced
market, whereby the Fund makes a forward commitment to purchase a security and,
instead of accepting delivery, the position is offset by a sale of the security
with a simultaneous agreement to repurchase at a future date. The Fund accounts
for mortgage dollar rolls as purchases and sales.
The risk of entering into mortgage dollar rolls is that the market value of the
securities the Fund is obligated to repurchase under the agreement may decline
below the repurchase price. In the event the buyer of securities under a
mortgage dollar roll files for bankruptcy or becomes insolvent, the Fund's use
of the proceeds of the mortgage dollar roll may be restricted pending a
determination by the counterparty, or its trustee or receiver, whether to
enforce the Fund's obligation to repurchase the securities.
G. COLLATERALIZED DEBT OBLIGATIONS:
A collateralized debt obligation ("CDO") is an asset-backed security whose
underlying collateral is typically a portfolio of bonds or bank loans. Where the
underlying collateral is a portfolio of bonds, a CDO is referred to as a
collateralized bond obligation ("CBO"). Where the underlying collateral is a
portfolio of bank loans, a CDO is referred to as a collateralized loan
obligation ("CLO"). Investors in CDOs bear the credit risk of the underlying
collateral. Multiple tranches of securities are issued by the CDO, offering
investors various maturity and credit risk characteristics. Tranches are
categorized as senior, mezzanine, and subordinated/equity, according to their
degree of risk. If there are defaults or the CDO's collateral otherwise
underperforms, scheduled payments to senior tranches take precedence over those
of mezzanine tranches, and scheduled payments to mezzanine tranches take
precedence over those to subordinated/equity tranches. CDOs, similar to other
asset-backed securities, are subject to prepayment risk.
H. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS:
The Fund will distribute to holders of its Common Shares monthly dividends of
all or a portion of its net income after the payment of interest and dividends
in connection with leverage, if any. Distributions will automatically be
reinvested into additional Common Shares pursuant to the Fund's Dividend
Reinvestment Plan unless cash distributions are elected by the shareholder.
Distributions from income and capital gains are determined in accordance with
income tax regulations, which may differ from accounting principles generally
accepted in the United States of America. Certain capital accounts in the
financial statements are periodically adjusted for permanent differences in
order to reflect their tax character. These permanent differences are primarily
due to the varying treatment of income and gain/loss on portfolio securities
held by the Fund and have no impact on net assets or net asset value per share.
Temporary differences, which arise from recognizing certain items of income,
expense and gain/loss in different periods for financial statement and tax
Page 22
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (Continued)
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2011 (UNAUDITED)
purposes, will reverse at some time in the future. The character of
distributions for tax reporting purposes will depend on the Fund's investment
experience during the remainder of its fiscal year, however, based on
information for the fiscal year through April 30, 2011, it is likely that the
Fund's distributions will include a return of capital component for the fiscal
year ending on October 31, 2011.
The tax character of distributions paid during the fiscal year October 31, 2010
was as follows:
Distributions paid from:
Ordinary income................................. $ --
Capital gain.................................... --
Return of capital............................... 2,745,178
As of October 31, 2010, the distributable earnings and net assets on a tax basis
were as follows:
Undistributed ordinary income................... $ --
Undistributed capital gains..................... --
------------
Total undistributed earnings ................... --
Accumulated capital and other losses............ (47,096,138)
Net unrealized appreciation (depreciation)...... (37,851,044)
------------
Total accumulated earnings (losses) ............ (84,947,182)
Other........................................... (1,028,689)
Paid-in capital................................. 120,297,656
------------
Net assets...................................... $ 34,321,785
============
I. INCOME AND OTHER TAXES:
The Fund intends to continue to qualify as a regulated investment company by
complying with the requirements under Subchapter M of the Internal Revenue Code
of 1986, as amended (the "Code"), which includes distributing substantially all
of its net investment income and net realized gains to shareholders.
Accordingly, no provision has been made for federal or state income taxes.
However, due to the timing and amount of distributions, the Fund may be subject
to an excise tax of 4% of the amount by which 98% of the Fund's taxable income
exceeds the distributions from such taxable income for the calendar year.
The Fund intends to utilize provisions of the federal income tax laws which
allow it to carry realized capital losses forward for eight years following the
year of the loss and offset such loss against any future realized capital gains.
The Fund is subject to certain limitations under U.S. tax rules on the use of
capital loss carryforwards and net unrealized built-in losses. These limitations
apply when there has been a 50% change in ownership. At October 31, 2010, the
Fund had a capital loss carryforward for federal income tax purposes of
$47,096,138, expiring as follows:
EXPIRATION DATE AMOUNT
October 31, 2015 $ 2,534,309
October 31, 2016 $15,350,612
October 31, 2017 $14,707,929
October 31, 2018 $14,503,288
The Fund is subject to accounting standards that establish a minimum threshold
for recognizing, and a system for measuring, the benefits of a tax position
taken or expected to be taken in a tax return. Taxable years ending 2007, 2008,
2009 and 2010 remain open to federal and state audit. As of April 30, 2011,
management has evaluated the application of these standards to the Fund and has
determined that no provision for income tax is required in the Fund's financial
statements for uncertain tax positions.
On December 22, 2010, President Obama signed into law the Regulated Investment
Company Modernization Act of 2010 effective for tax years beginning after
December 22, 2010. Management is currently evaluating the impact the Act will
have on future financial statement disclosures, if any.
J. EXPENSES:
The Fund will pay all expenses directly related to its operations.
Page 23
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NOTES TO FINANCIAL STATEMENTS - (Continued)
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FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2011 (UNAUDITED)
K. ACCOUNTING PRONOUNCEMENT:
In January 2010, the Financial Accounting Standards Board ("FASB") issued
Accounting Standards Update ("ASU") No. 2010-06 "Improving Disclosures about
Fair Value Measurements". ASU No. 2010-06 amends FASB Accounting Standards
Codification Topic 820, Fair Value Measurements and Disclosures, to require
additional disclosures regarding fair value measurements. Certain disclosures
required by ASU No. 2010-06 are effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years. Management
is currently evaluating the impact ASU No. 2010-06 will have on its financial
statement disclosures, if any.
3. INVESTMENT ADVISORY FEE, AFFILIATED TRANSACTIONS AND OTHER FEE ARRANGEMENTS
First Trust, the investment advisor to the Fund, is a limited partnership with
one limited partner, Grace Partners of DuPage L.P., and one general partner, The
Charger Corporation. First Trust is responsible for the ongoing monitoring of
the Fund's investment portfolio, managing the Fund's business affairs and
providing certain administrative services necessary for the management of the
Fund. For these investment management services, First Trust is entitled to a
monthly fee calculated at an annual rate of 0.90% of the Fund's Managed Assets.
First Trust also provides fund reporting services to the Fund for a flat annual
fee in the amount of $9,250.
Brookfield serves as the Fund's sub-advisor and manages the Fund's portfolio
subject to First Trust's supervision. The Sub-Advisor receives a portfolio
management fee at an annual rate of 0.45% of Managed Assets that is paid by
First Trust from its investment advisory fee.
James A. Bowen, the President of First Trust, on October 12, 2010, acquired 100%
of the voting stock of The Charger Corporation, the general partner of First
Trust (the "Transaction"). The consummation of the Transaction was deemed to be
an "assignment" (as defined in the 1940 Act) of the Fund's investment management
agreement and investment sub-advisory agreement and resulted in the automatic
termination of the agreements.
The Board of Trustees of the Fund approved an interim investment management
agreement with First Trust and an interim investment sub-advisory agreement,
which were entered into effective upon the closing of the Transaction and would
be in effect for a maximum period of 150 days absent shareholder approval of new
such agreements. A new investment management agreement with First Trust and a
new investment sub-advisory agreement have been approved by the Board of
Trustees of the Fund and were submitted to shareholders of the Fund as of the
record date (September 30, 2010) for approval to take effect upon such
shareholder approval. A special shareholder meeting of the Fund to vote on a
proposal to approve the new investment management agreement and the new
investment sub-advisory agreement was held on December 20, 2010, at which time
the new investment management agreement and new investment sub-advisory
agreement were approved by the Fund's shareholders. Until December 20, 2010,
advisory fees payable to First Trust and Brookfield were held in escrow. See
Submission of Matters to a Vote of Shareholders, in the Additional Information
section of this report, for the results.
BNY Mellon Investment Servicing (US) Inc. serves as the Fund's Administrator,
Fund Accountant and Transfer Agent in accordance with certain fee arrangements.
PFPC Trust Company, which will be renamed BNY Mellon Investment Servicing Trust
Company effective July 1, 2011, serves as the Fund's Custodian in accordance
with certain fee arrangements.
Each Trustee who is not an officer or employee of First Trust, any sub-advisor
or any of their affiliates ("Independent Trustee") is paid an annual retainer of
$10,000 per trust for the first 14 trusts of the First Trust Fund Complex and an
annual retainer of $7,500 per trust for each subsequent trust in the First Trust
Fund Complex. The annual retainer is allocated equally among each of the trusts.
No additional meeting fees are paid in connection with Board or Committee
meetings.
Additionally, the Lead Independent Trustee is paid $10,000 annually, the
Chairman of the Audit Committee is paid $5,000 annually, and each of the
Chairmen of the Nominating and Governance Committee and the Valuation Committee
is paid $2,500 annually to serve in such capacities, with such compensation paid
by the trusts in the First Trust Fund Complex and divided among those trusts.
Trustees are also reimbursed by the trusts in the First Trust Fund Complex for
travel and out-of-pocket expenses in connection with all meetings. The Lead
Independent Trustee and each Committee chairman will serve two-year terms before
rotating to serve as chairman of another committee or as Lead Independent
Trustee. The officers and "Interested" Trustee receive no compensation from the
Fund for serving in such capacities.
4. PURCHASES AND SALES OF SECURITIES
The cost of purchases of U.S. Government securities and non-U.S. Government
securities, excluding short-term investments, for the six months ended April 30,
2011 were $8,298,804 and $18,198,075 respectively. The proceeds from sales and
paydowns of U.S. Government securities and non-U.S. Government securities,
excluding short-term investments, for the six months ended April 30, 2011 were
$12,436,737 and 13,947,863, respectively.
Page 24
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NOTES TO FINANCIAL STATEMENTS - (Continued)
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FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2011 (UNAUDITED)
5. BORROWINGS
On March 21, 2011, the Fund entered into a committed facility agreement with BNP
Paribas Prime Brokerage Inc. ("BNP") that has a maximum commitment amount of
$12,000,000 with the ability to increase to $17,000,000 with BNP's consent.
Effective April 27, 2011, BNP consented to increase the maximum commitment
amount to $17,000,000. Absent certain events of default or failure to maintain
certain collateral requirements, BNP may not terminate the committed facility
agreement except upon 180 calendar days' prior notice. The borrowing rate under
the facility is equal to the 3-month LIBOR plus 80 basis points. In addition,
under the facility, the Fund pays a commitment fee of 0.80% on the undrawn
amount of such facility.
The average amount outstanding between March 22, 2011 and April 30, 2011 was
$9,757,500, with a weighted average interest rate of 1.09%. As of April 30,
2011, the Fund had outstanding borrowings of $10,800,000 under this committed
facility agreement. The high and low annual interest rates for the period March
22, 2011 through April 30, 2011 were 1.11% and 1.07%, respectively. The interest
rate at April 30, 2011 was 1.07%.
6. INDEMNIFICATION
The Fund has a variety of indemnification obligations under contracts with its
service providers. The Fund's maximum exposure under these arrangements is
unknown. However, the Fund has not had prior claims or losses pursuant to these
contracts and expects the risk of loss to be remote.
7. LITIGATION
Two class action lawsuits were filed in the United States District Court for the
Northern District of Illinois on behalf of purchasers of shares of First Trust
Strategic High Income Fund, First Trust Strategic High Income
Fund II and First Trust Strategic High Income Fund III. These lawsuits, Gosselin
vs. First Trust Advisors L.P., et al. (filed September 12, 2008) and Evans vs.
First Trust Advisors L.P., et al. (filed September 19, 2008), were consolidated
into one class action complaint, Gosselin vs. First Trust Advisors L.P. et al.
(filed April 30, 2009), that names the following entities as defendants: First
Trust Advisors L.P., First Trust Portfolios L.P., and the three closed-end funds
(the "Funds") named above. The consolidated complaint also names certain
officers of the Funds as defendants. The plaintiffs purport to bring the action
on behalf of a putative class consisting of all persons or entities who acquired
shares of the Funds between July 26, 2005 and July 7, 2008 inclusive.
The plaintiffs assert, among other things, that the registration statements and
prospectuses for the Funds failed to disclose that (a) the Funds lacked
effective controls and hedges to minimize the risk of loss from mortgage
delinquencies, (b) the Funds lacked effective internal controls, (c) the extent
of the Funds' liquidity risk was omitted, and (d) the extent of the Funds' risk
exposure to mortgage-backed assets was misstated. On July 29, 2009, the
defendants filed a motion to dismiss the consolidated complaint. On December 17,
2009, the court denied the defendants' motion to dismiss. The defendants believe
the lawsuit is without merit.
On April 1, 2011, the U.S. District Court for the Northern District of Illinois
preliminarily approved a settlement in the Gosselin vs. First Trust Advisors
L.P. et al. class action lawsuit. The court has scheduled a Settlement Fairness
Hearing for July 28, 2011 to hear any objections to the settlement and consider
whether final approval should be granted. First Trust expects the court to grant
final approval of the settlement at the hearing or shortly thereafter; however,
there can be no guarantee that the court will grant final approval or about the
timing of such approval.
8. RISK CONSIDERATIONS
Risks are inherent in all investing. The following summarizes some, but not all,
of the risks that should be considered for the Fund. For additional information
about the risks associated with investing in the Fund, please see the Fund's
prospectus and statement of additional information, as well as other Fund
regulatory filings.
INVESTMENT AND MARKET RISK: An investment in the Fund's Common Shares is subject
to investment risk, including the possible loss of the entire principal
invested. An investment in Common Shares represents an indirect investment in
the securities owned by the Fund. The value of these securities, like other
market investments, may move up or down, sometimes rapidly and unpredictably.
Common Shares at any point in time may be worth less than the original
investment, even after taking into account the reinvestment of Fund dividends
and distributions. Security prices can fluctuate for several reasons including
the general condition of the securities markets, or when political or economic
events affecting the issuers occur, including the risk that borrowers do not pay
their mortgages. When the Advisor or Sub-Advisor determines that it is
temporarily unable to follow the Fund's investment strategy or that it is
impractical to do so (such as when a market disruption event has occurred and
trading in the securities is extremely limited or absent), the Advisor or
Sub-Advisor may take temporary defensive positions.
Page 25
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NOTES TO FINANCIAL STATEMENTS - (Continued)
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FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2011 (UNAUDITED)
RESIDENTIAL MORTGAGE-BACKED SECURITIES RISK: MBS's may have less potential for
capital appreciation than comparable fixed-income securities due to the
likelihood of increased prepayments of mortgages as interest rates decline. If
the Fund buys MBS's at a premium, mortgage foreclosures and prepayments of
principal by mortgagors (which usually may be made at any time without penalty)
may result in some loss of the Fund's principal investment to the extent of the
premium paid. Alternatively, in a rising interest rate environment, the value of
MBS's may be adversely affected when payments on underlying mortgages do not
occur as anticipated, resulting in the extension of the security's effective
maturity and the related increase in interest rate sensitivity of a longer-term
instrument. The value of MBS's may also change due to shifts in the market's
perception of issuers and regulatory or tax changes adversely affecting the
markets as a whole. In addition, MBS's are subject to the credit risk associated
with the performance of the underlying mortgage properties. In certain
instances, third-party guarantees or other forms of credit support can reduce
the credit risk. The Fund may also invest in MBS's which are interest-only
securities ("IO") and principal-only ("PO") securities. Generally speaking, when
interest rates are falling and prepayment rates are increasing, the value of a
PO security will rise and the value of an IO security will fall. Conversely,
when interest rates are rising and prepayment rates are decreasing, generally
the value of a PO will fall and the value of an IO security will rise. In
addition to the foregoing, residential MBS's are subject to additional risks,
including, but not limited to: (i) the United States residential mortgage market
has recently encountered various difficulties and changed economic conditions.
In addition, recently, residential property values in various states have
declined or remained stable after extended periods of appreciation. A continued
decline or an extended flattening in those values may result in additional
increases in delinquencies and losses on residential mortgage loans generally;
(ii) if a residential mortgage obligation is secured by a junior lien it will be
subordinate to the rights of the mortgagees or beneficiaries under the related
senior mortgages or deeds of trust; and (iii) depending on the length of a
residential mortgage obligation underling a residential MBS, unscheduled or
early payments of principal and interest may shorten the security's effective
maturity and prevailing interest rates may be higher or lower than the current
yield of the Fund's portfolio at the time the Fund receives the payments for
reinvestment.
VALUE INVESTING RISK: The Sub-Advisor focuses the Fund's investments on
securities that they believe are undervalued or inexpensive relative to other
investments. Such securities are subject to the risk of misestimating certain
fundamental factors. Disciplined adherence to a "value" investment mandate
during periods in which that style is "out of favor" can result in significant
underperformance relative to overall market indices and other managed investment
vehicles that pursue growth style investments and/or flexible style mandates.
BELOW-INVESTMENT GRADE SECURITIES RISK: The Fund invests in below-investment
grade securities. The market values for high-yield securities tend to be very
volatile, and these securities are less liquid than investment grade debt
securities. For these reasons, an investment in the Fund is subject to the
following specific risks: (a) increased price sensitivity to changing interest
rates and to a deteriorating economic environment; (b) greater risk of loss due
to default or declining credit quality; (c) adverse issuer specific events are
more likely to render the issuer unable to make interest and/or principal
payments; and (d) a negative perception of the high-yield market may depress the
price and liquidity of high-yield securities.
DISTRESSED SECURITIES RISK: The Fund may invest in securities issued by
companies in a bankruptcy reorganization proceeding, subject to some other form
of a public or private debt restructuring or otherwise in default or in
significant risk of default in the payment of interest or repayment of principal
or trading at prices substantially below other below-investment grade debt
securities of companies in similar industries. Distressed securities frequently
do not produce income while they are outstanding. The Fund may be required to
incur certain extraordinary expenses in order to protect and recover its
investment. Therefore, to the extent the Sub-Advisor seeks capital appreciation
through investment in distressed securities; the ability to achieve current
income may be diminished.
ECONOMIC CONDITIONS RISK: Adverse changes in economic conditions are more likely
to lead to a weakened capacity of a high-yield issuer to make principal payments
and interest payments than an investment grade issuer. An economic downturn
could severely affect the ability of highly leveraged issuers to service their
debt obligations or to repay their obligations upon maturity. Under adverse
market or economic conditions, the secondary market for high-yield securities
could contract further, independent of any specific adverse changes in the
condition of a particular issuer and these securities may become illiquid. As a
result, the Sub-Advisor could find it more difficult to sell these securities or
may be able to sell the securities only at prices lower than if such securities
were widely traded.
FIXED-INCOME SECURITIES RISK: Debt securities, including high-yield securities,
are subject to certain risks, including: (i) issuer risk, which is the risk that
the value of fixed-income securities may decline for a number of reasons which
directly relate to the issuer, such as management performance, financial
leverage and reduced demand for the issuer's goods and services or, in the case
of asset-backed issuers, a decline in the value and/or cash flows of the
underlying assets; (ii) reinvestment risk, which is the risk that income from
the Fund's portfolio will decline if the proceeds from matured, traded or called
bonds are reinvested at market interest rates that are below the portfolio's
current earnings rate; (iii) prepayment risk, which is the risk that during
periods of declining interest rates, the issuer of a security may exercise its
option to prepay principal earlier than scheduled, forcing the reinvestment in
lower yielding securities; and (iv) credit risk, which is the risk that a
security in the Fund's portfolio will decline in price or the issuer fails to
make interest payments when due because the issuer of the security experiences a
decline in its financial status.
Page 26
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NOTES TO FINANCIAL STATEMENTS - (Continued)
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FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2011 (UNAUDITED)
INTEREST RATE RISK: The Fund's portfolio is also subject to interest rate risk.
Interest rate risk is the risk that fixed-income securities will decline in
value because of changes in market interest rates. Investments in debt
securities with long-term maturities may experience significant price declines
if long-term interest rates increase.
LEVERAGE RISK: The Fund may borrow an amount up to 33-1/3% (or such other
percentage as permitted by law) of its assets (including the amount borrowed)
less liabilities other than borrowings. The Fund may use leverage for investment
purposes and to meet cash requirements. Its leveraged capital structure creates
special risks not associated with unleveraged funds having similar investment
objectives and policies. These include the possibility of higher volatility of
the NAV of the Fund. The Fund previously leveraged its assets through the use of
reverse repurchase agreements. Reverse repurchase agreements are subject to the
risks that the market value of the securities sold by the Fund may decline below
the price of the securities the Fund is obligated to repurchase, and that the
securities may not be returned to the Fund. Currently the Fund has a committed
facility agreement with BNP. The Fund may from time to time consider changing
the amount of the leverage in response to actual or anticipated changes in
interest rates or the value of the Fund's investment portfolio. There can be no
assurance that the leverage strategies will be successful.
FOREIGN SECURITIES RISK: The Fund may invest in securities (equity or debt) of
foreign issuers. Investing in securities of foreign issuers, which are generally
denominated in foreign currencies, may involve certain risks not typically
associated with investing in securities of U.S. issuers. These risks include:
(i) there may be less publicly available information about foreign issuers or
markets due to less rigorous disclosure or accounting standards or regulatory
practices; (ii) foreign markets may be smaller, less liquid and more volatile
than the U.S. market; (iii) potential adverse effects of fluctuations in
currency exchange rates or controls on the value of the Fund's investments; (iv)
the economies of foreign countries may grow at slower rates than expected or may
experience a downturn or recession; (v) the impact of economic, political,
social or diplomatic events; (vi) certain foreign countries may impose
restrictions on the ability of foreign issuers to make payments of principal and
interest to investors located in the United States due to blockage of foreign
currency exchanges or otherwise; and (vii) withholding and other foreign taxes
may decrease the Fund's return. These risks may be more pronounced to the extent
that the Fund invests a significant amount of its assets in companies located in
one region and to the extent that the Fund invests in securities of issuers in
emerging markets.
9. SUBSEQUENT EVENTS
Management has evaluated the impact of all subsequent events to the Fund through
the date the financial statements were issued, and has determined that there
were subsequent events:
On May 23, 2011 the Fund declared a dividend of $0.03 per share to Common
Shareholders of record on June 3, 2011, payable June 15, 2011.
On June 20, 2011 the Fund declared a dividend of $0.03 per share to Common
Shareholders of record on July 6, 2011, payable July 15, 2011.
Page 27
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ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2011 (UNAUDITED)
DIVIDEND REINVESTMENT PLAN
If your Common Shares are registered directly with the Fund or if you hold your
Common Shares with a brokerage firm that participates in the Fund's Dividend
Reinvestment Plan (the "Plan"), unless you elect, by written notice to the Fund,
to receive cash distributions, all dividends, including any capital gain
distributions, on your Common Shares will be automatically reinvested by BNY
Mellon Investment Servicing (US) Inc. (the "Plan Agent"), in additional Common
Shares under the Plan. If you elect to receive cash distributions, you will
receive all distributions in cash paid by check mailed directly to you by the
Plan Agent, as the dividend paying agent.
If you decide to participate in the Plan, the number of Common Shares you will
receive will be determined as follows:
(1) If If Common Shares are trading at or above net asset value ("NAV")
at the time of valuation, the Fund will issue new shares at a price
equal to the greater of (i) NAV per Common Share on that date or
(ii) 95% of the market price on that date
(2) If Common Shares are trading below NAV at the time of valuation, the
Plan Agent will receive the dividend or distribution in cash and
will purchase Common Shares in the open market, on the NYSE or
elsewhere, for the participants' accounts. It is possible that the
market price for the Common Shares may increase before the Plan
Agent has completed its purchases. Therefore, the average purchase
price per share paid by the Plan Agent may exceed the market price
at the time of valuation, resulting in the purchase of fewer shares
than if the dividend or distribution had been paid in Common Shares
issued by the Fund. The Plan Agent will use all dividends and
distributions received in cash to purchase Common Shares in the open
market within 30 days of the valuation date except where temporary
curtailment or suspension of purchases is necessary to comply with
federal securities laws. Interest will not be paid on any uninvested
cash payments.
You may elect to opt-out of or withdraw from the Plan at any time by giving
written notice to the Plan Agent, or by telephone at (866) 340-1104, in
accordance with such reasonable requirements as the Plan Agent and the Fund may
agree upon. If you withdraw or the Plan is terminated, you will receive a
certificate for each whole share in your account under the Plan, and you will
receive a cash payment for any fraction of a share in your account. If you wish,
the Plan Agent will sell your shares and send you the proceeds, minus brokerage
commissions.
The Plan Agent maintains all Common Shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. Common Shares in your account will be held by the
Plan Agent in non-certificated form. The Plan Agent will forward to each
participant any proxy solicitation material and will vote any shares so held
only in accordance with proxies returned to the Fund. Any proxy you receive will
include all Common Shares you have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or distributions
in Common Shares. However, all participants will pay a pro rata share of
brokerage commissions incurred by the Plan Agent when it makes open market
purchases.
Automatically reinvesting dividends and distributions does not mean that you do
not have to pay income taxes due upon receiving dividends and distributions.
Capital gains and income are realized although cash is not received by you.
Consult your financial advisor for more information.
If you hold your Common Shares with a brokerage firm that does not participate
in the Plan, you will not be able to participate in the Plan and any dividend
reinvestment may be effected on different terms than those described above.
The Fund reserves the right to amend or terminate the Plan if in the judgment of
the Board of Trustees the change is warranted. There is no direct service charge
to participants in the Plan; however, the Fund reserves the right to amend the
Plan to include a service charge payable by the participants. Additional
information about the Plan may be obtained by writing BNY Mellon Investment
Servicing (US) Inc., 301 Bellevue Parkway, Wilmington, Delaware 19809.
--------------------------------------------------------------------------------
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that the Fund uses to determine how
to vote proxies and information on how the Fund voted proxies relating to
portfolio investments during the most recent 12-month period ended June 30 is
available (1) without charge, upon request, by calling (800) 988-5891; (2) on
the Fund's website located at http://www.ftportfolios.com; and (3) on the
Securities and Exchange Commission's ("SEC") website located at
http://www.sec.gov.
Page 28
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ADDITIONAL INFORMATION - (Continued)
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FIRST TRUST STRATEGIC HIGH INCOME FUND
APRIL 30, 2011 (UNAUDITED)
PORTFOLIO HOLDINGS
The Fund files its complete schedule of portfolio holdings with the SEC for the
first and third quarters of each fiscal year on Form N-Q. The Fund's Forms N-Q
are available (1) by calling (800) 988-5891; (2) on the Fund's website located
at http://www.ftportfolios.com; (3) on the SEC's website at http://www.sec.gov;
and (4) for review and copying at the SEC's Public Reference Room ("PRR") in
Washington, DC. Information regarding the operation of the PRR may be obtained
by calling (800) SEC-0330.
SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
A special meeting of shareholders of the Fund was held on December 20, 2010. At
the meeting, shareholders approved a new investment management agreement between
the Fund and First Trust and a new investment sub-advisory agreement between the
Fund, First Trust and Brookfield. 4,730,477 (51.70%) of the outstanding voting
securities were voted at the meeting. The number of votes cast in favor of the
new investment management agreement was 4,151,043, the number of votes against
was 159,441, and the number of abstentions was 419,993. The number of votes cast
in favor of the new investment sub-advisory agreement was 4,129,901, the number
of votes against was 181,476, and the number of abstentions was 419,099. The
terms of the new investment management agreement and new investment sub-advisory
agreement are substantially similar to the terms of the previous agreements.
The Joint Annual Meeting of Shareholders of the Common Shares of Energy Income
and Growth Fund, First Trust Enhanced Equity Income Fund, First Trust/Aberdeen
Global Opportunity Income Fund, First Trust/FIDAC Mortgage Income Fund, First
Trust Strategic High Income Fund, First Trust Strategic High Income Fund II,
First Trust/Aberdeen Emerging Opportunity Fund, First Trust Strategic High
Income Fund III, First Trust Specialty Finance and Financial Opportunities Fund,
First Trust Active Dividend Income Fund and First Trust High Income Long/Short
was held on April 18, 2011. At the Meeting, Robert F. Keith was elected by the
Common Shareholders of the First Trust Strategic High Income Fund as a Class I
Trustee for a three-year term expiring at the Fund's annual meeting of
shareholders in 2014. The number of votes cast in favor of Mr. Keith was
8,266,202, the number of votes against was 233,016 and the number of abstentions
was 651,376. James A. Bowen, Neil B. Nielson, Richard E. Erickson and Thomas R.
Kadlec are the other current and continuing Trustees.
BOARD APPROVAL OF FUND REORGANIZATION; REVERSE STOCK SPLIT FOR SURVIVING FUND
On April 18, 2011, the Board of Trustees of the Fund approved the reorganization
of each of the Fund ("FHI"), the First Trust Strategic High Income Fund II
("FHY") and the First Trust Strategic High Income Fund III ("FHO"). FHY will be
the surviving fund.
Under the terms of the proposed reorganizations, which are expected to be
tax-free, the assets of FHI and FHO will be transferred to, and the liabilities
of FHI and FHO will be assumed by, FHY in exchange for shares of FHY. The FHY
shares would then be distributed to FHI and FHO shareholders and the separate
existence of FHI and FHO would cease. The reorganizations are subject to certain
conditions, including that each reorganization be approved by the shareholders
of FHI and FHO, respectively, and that the shareholders of FHY approve the
issuance of additional FHY shares in connection with the reorganizations. The
consummation of the reorganizations of each of FHI and FHO are not conditioned
on the approval of the shareholders of the other fund. If a reorganization
occurs, each transaction would occur based on the relative net asset values of
FHI, FHO and FHY.
The First Trust Board of Trustees of FHY approved a 1-for-3 reverse stock split,
which is expected to be completed upon the consummation of one or both of the
reorganizations, as applicable. FHY's shares would trade on a split-adjusted
basis under a new CUSIP number at that time. The reverse stock split will result
in every three outstanding shares being converted into one share, thereby
reducing the number of FHY shares outstanding prior to the reverse stock split.
Fractional shares will be issued in the reverse stock split.
It is currently expected that the reorganizations will be concluded in the third
quarter of 2011, subject to requisite shareholder approvals and all regulatory
requirements and customary closing conditions being satisfied. There is no
assurance that the reorganizations will be consummated.
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FIRST TRUST
INVESTMENT ADVISOR
First Trust Advisors L.P.
120 E. Liberty Drive, Suite 400
Wheaton, IL 60187
INVESTMENT SUB-ADVISOR
Brookfield Investment Management Inc.
3 World Financial Center
200 Vesey Street, 10th Floor
New York, NY 10281
ADMINISTRATOR,
FUND ACCOUNTANT &
TRANSFER AGENT
BNY Mellon Investment Servicing (US) Inc.
301 Bellevue Parkway
Wilmington, DE 19809
CUSTODIAN
PFPC Trust Company
8800 Tinicum Boulevard
Philadelphia, PA 19153
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
111 S. Wacker Drive
Chicago, IL 60606
LEGAL COUNSEL
Chapman and Cutler LLP
111 W. Monroe Street
Chicago, IL 60603
[BLANK BACK COVER]
ITEM 2. CODE OF ETHICS.
Not applicable.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
Not applicable.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Not applicable.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
Not applicable.
ITEM 6. INVESTMENTS.
(a) Schedule of Investments in securities of unaffiliated issuers as of the
close of the reporting period is included as part of the report to
shareholders filed under Item 1 of this form.
(b) Not applicable.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
Not applicable.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
There has been no change, as of the date of this filing, in any of the
portfolios managers identified in response to paragraph (a)(1) of this Item in
the Registrant's most recently filed annual report on Form N-CSR.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR
229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)),
or this Item.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers, or
persons performing similar functions, have concluded that the
registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the "1940
Act") (17 CFR 270.30a-3(c))) are effective, as of a date within 90 days
of the filing date of the report that includes the disclosure required by
this paragraph, based on their evaluation of these controls and
procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR
270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities
Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or 240.15d-15(b)).
(b) There were no changes in the registrant's internal control over financial
reporting (as defined in Rule 30a-3(d) under the 1940 Act (17 CFR
270.30a-3(d)) that occurred during the registrant's second fiscal quarter
of the period covered by this report that has materially affected, or is
reasonably likely to materially affect, the registrant's internal control
over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Not applicable.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and
Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) First Trust Strategic High Income Fund
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By (Signature and Title)* /s/ James A. Bowen
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James A. Bowen, Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
Date June, 20, 2011
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Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /s/ James A. Bowen
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James A. Bowen, Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
Date June 20, 2011
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By (Signature and Title)* /s/ Mark R. Bradley
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Mark R. Bradley, Treasurer, Chief Financial Officer
and Chief Accounting Officer
(principal financial officer)
Date June 20, 2011
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* Print the name and title of each signing officer under his or her signature.