Note 1. Organization
Highland Funds I (the Trust) was organized as a Delaware statutory trust on February 28, 2006. The Trust is registered under the Investment Company Act of 1940, as amended (the 1940
Act), as an open-end management investment company with five portfolios that are currently being offered, each of which is non-diversified. The financial
statements herein are those of the Highland/iBoxx Senior Loan ETF (the Fund). The Fund is a non-diversified exchange-traded fund (ETF). The financial statements of the remaining funds
of the Trust are presented separately.
Investment Objective
The investment objective of the Fund is to provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the Markit iBoxx USD Liquid Leveraged Loan Index (the
Underlying Index).
Fund Shares
Shares of the Fund are listed and traded on NASDAQ, Inc. Market prices for the shares of the Fund may be different from their net asset value (NAV). The
Fund issues and redeems shares on a continuous basis at NAV only to authorized participants who have entered into agreements with the Funds distributor (Authorized Participants) in exchange for the deposit or delivery of a basket
of assets (securities and/or cash) in large blocks, known as Creation Units, each of which comprises 100,000 shares for the Fund. Once created, shares will trade in a secondary market at market prices that change throughout the day in amounts less
than a Creation Unit.
Creation Units
Except
when aggregated in Creation Units, shares are not redeemable securities of the Fund. Creation Units of the Fund may only be purchased or redeemed directly from the Fund by Authorized Participants. An Authorized Participant is either (i) a
broker-dealer or other participant in the clearing process through the Continuous Net Settlement System of the National Securities Clearing Corporation or (ii) a Depository Trust Company (DTC) participant and, in each case, must
have executed an Authorized Participant Agreement with the Funds distributor. Most retail investors will not qualify as Authorized Participants or have the resources to buy and sell whole Creation Units. Therefore, they will be unable to
purchase or redeem the shares directly from the Fund. Rather, most retail investors will purchase shares in the secondary market with the assistance of a broker and will be subject to customary brokerage commissions or fees.
Note 2. Significant Accounting Policies
The following summarizes the significant accounting policies consistently followed by the Fund in the preparation of its financial statements.
Use of Estimates
The Fund is an investment company that follows the accounting and reporting guidance of
Accounting Standards Codification Topic 946 applicable to investment companies. The Funds financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP),
which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue
and expenses during the reporting period. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ materially.
Valuation of Investments
In computing the Funds net
assets attributable to shares, securities with readily available market quotations on the New York Stock Exchange, National Association of Securities Dealers Automatic Quotation Systerm (NASDAQ) or other nationally recognized exchange
use the closing quotations on the respective exchange for valuation of those securities. Securities for which there are no readily available market quotation will be valued pursuant to policies adopted by the Funds Board of Trustees (the
Board). Typically, such securities will be valued at the mean between the most recently quoted bid and ask prices provided by the principal market makers. If there is more than one such principal market maker, the value shall be the
average of such means. Securities without a sale price or quotations from principal market makers on the valuation day may be priced by an independent pricing service. Investments in mutual funds are valued at their respective net asset values as
determined by those mutual funds each business day. Generally, the Funds loan and bond positions are not traded on exchanges and consequently are valued based on a mean of the bid and ask price from the third-party pricing services or
broker-dealer sources that Highland Capital Management Fund Advisors, L.P. (HCMFA or the Investment Adviser) has determined generally have the capability to provide appropriate pricing services and have been approved by the
Board.
Securities for which market quotations are not readily available and for which the Fund has determined the price received from a pricing service
or broker-dealer is stale or otherwise does not represent fair value (such as when events materially affecting the value of securities occur
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
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December 31, 2019
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Highland/iBoxx Senior Loan ETF
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between the time when market price is determined and calculation of the Funds NAV), will be valued by the Fund at fair value, as determined by the Board or its designee in good faith in
accordance with procedures approved by the Board, taking into account factors reasonably determined to be relevant, including, among other things: (i) the fundamental analytical data relating to the investment; (ii) the nature and duration
of restrictions on disposition of the securities; and (iii) an evaluation of the forces that influence the market in which these securities are purchased and sold. In these cases, the Funds NAV will reflect the affected portfolio
securities fair value as determined in the judgment of the Board or its designee instead of being determined by the market. Determination of fair value is uncertain because it involves subjective judgments and estimates.
There can be no assurance that the Funds valuation of a security will not differ from the amount that it realizes upon the sale of such security. Those
differences could have a material impact on the Fund.
The NAV shown in the Funds financial statements may vary from the NAV published by the Fund
as of the end of the reporting period because portfolio securities transactions are accounted for on the trade date (rather than the day following the trade date) for financial statement purposes.
Fair Value Measurements
The Fund has performed an analysis
of all existing investments to determine the significance and character of all inputs to their fair value determination. The levels of fair value inputs used to measure the Funds investments are characterized into a fair value hierarchy. Where
inputs for an asset or liability fall into more than one level in the fair value hierarchy, the investment is classified in its entirety based on the lowest level input that is significant to that investments valuation. The three levels of the
fair value hierarchy are described below:
Level 1
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Quoted unadjusted prices for identical instruments in active markets to which the Fund has access at the date of measurement;
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Level 2
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Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active, but are
valued based on executed trades; broker quotations that constitute an executable price; and alternative pricing sources supported by observable inputs are classified within Level 2. Level 2 inputs are either directly or indirectly
observable for the asset in connection with market data at the measurement date; and
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Level 3
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Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. In certain cases, investments classified
within Level 3 may include securities for which the Fund has obtained indicative quotes from broker-dealers that do not necessarily represent prices the broker may be willing to trade on, as such quotes can be subject to material management
judgment. Unobservable inputs are those inputs that reflect the Funds own assumptions that market participants would use to price the asset or liability based on the best available information.
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The Investment Adviser has established policies and procedures, as described above and approved by the Board, to ensure that valuation methodologies for investments
and financial instruments that are categorized within all levels of the fair value hierarchy are fair and consistent. A Pricing Committee has been established to provide oversight of the valuation policies, processes and procedures, and is comprised
of personnel from the Investment Adviser. The Pricing Committee meets monthly to review the proposed valuations for investments and financial instruments and is responsible for evaluating the overall fairness and consistent application of
established policies.
As of December 31, 2019, the Funds investments consisted mainly of senior loans. The fair value of the Funds
loans is generally based on quotes received from brokers or independent pricing services. Loans with quotes that are based on actual trades with a sufficient level of activity on or near the measurement date are classified as Level 2 assets.
Loans that are priced using quotes derived from implied values, indicative bids, or a limited number of actual trades are classified as Level 3 assets because the inputs used by the brokers and pricing services to derive the values are not
readily observable.
At the end of each calendar quarter, management evaluates the Level 2 and 3 assets and liabilities for changes in liquidity,
including but not limited to: whether a broker is willing to execute at the quoted price, the depth and consistency of prices from third party services, and the existence of contemporaneous, observable trades in the market. Additionally, management
evaluates the Level 1 and 2 assets and liabilities on a quarterly basis for changes in listings or delistings on national exchanges.
Due to the
inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Funds investments may fluctuate from period to period. Additionally, the fair value of investments may
differ significantly from the values that would
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
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December 31, 2019
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|
Highland/iBoxx Senior Loan ETF
|
have been used had a ready market existed for such investments and may differ materially from the values the Fund may ultimately realize. Further, such investments may be
subject to legal and other restrictions on resale or otherwise be less liquid than publicly traded securities.
The inputs or methodology used for valuing
securities are not necessarily an indication of the risk associated with investing in those securities. Transfers in and out of the levels are recognized at the value of the security at the end of the period. A summary of the levels of inputs used
to value the Funds assets as of December 31, 2019 is as follows:
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Total Market
Value at
12/31/19
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Level 1
Quoted
Prices
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Level 2
Other Significant
Observable
Inputs
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|
Level 3
Significant
Unobservable
Inputs
|
|
Highland/iBoxx Senior Loan ETF
|
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Assets
|
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|
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US Senior Loans*
|
|
$
|
189,651,430
|
|
|
$
|
|
|
|
$
|
189,651,430
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|
|
$
|
|
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Foreign Domiciled Senior Loans*
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|
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10,351,557
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|
|
|
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10,351,557
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Rights*
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421,661
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421,661
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Warrant*
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164,319
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164,319
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Cash Equivalent*
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113,773,356
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113,773,356
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Total
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$
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314,362,323
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$
|
113,773,356
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$
|
200,588,967
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$
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*
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Please refer to the Investment Portfolio for industry/country breakout.
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Amount designated as are $0.
For the six-month period ended December 31, 2019, there were no
transfers within the Fund between Level 1, Level 2 and/or Level 3.
Security Transactions
Security transactions are accounted for on the trade date. Realized gains/(losses) on investments sold are recorded on the basis of the specific identification
method for both financial statement and U.S. federal income tax purposes taking into account any foreign taxes withheld.
Cash and Cash Equivalents
The Fund considers liquid assets deposited with a bank, and certain short-term debt instruments with original maturities of 3 months or less to be
cash equivalents. These investments represent amounts held with financial institutions that are readily accessible to pay Fund expenses or purchase investments. Cash and cash equivalents are valued at cost plus accrued interest, which approximates
market value. The value of cash equivalents denominated in foreign currencies is determined by converting to U.S. dollars on the date of the Statement of Assets and Liabilities.
Foreign Currency
Accounting records of the Fund are maintained in U.S. dollars. Foreign currencies,
investments and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars at the exchange rates using the current 4:00 PM London Time Spot Rate. Fluctuations in the value of the foreign currencies and other
assets and liabilities resulting
from changes in exchange rates, between trade and settlement dates on securities transactions and between the accrual and payment dates on dividends, interest income and foreign withholding
taxes, are recorded as unrealized foreign currency gains/(losses). Realized gains/(losses) and unrealized appreciation/(depreciation) on investment securities and income and expenses are translated on the respective dates of such transactions. The
effects of changes in foreign currency exchange rates on investments in securities are segregated in the Statement of Operations from the effects of changes in market prices of those securities, included within the net realized and unrealized gain
or loss on investment securities.
Income Recognition
Dividend income is recorded on the ex-dividend date. Interest income is recorded on the accrual basis and includes accretion of discounts and amortization of premiums of debt
instruments.
U.S. Federal Income Tax Status
The
Fund intends to continue to qualify each year as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended, and will distribute substantially all of its taxable income and gains, if any, for the
tax year, and as such will not be subject to U.S. federal income taxes. In addition, the Fund intends to distribute, in each calendar year, all of its net investment income, capital gains and certain other amounts, if any, such that it should not be
subject to U.S. federal excise tax. There-
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
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December 31, 2019
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|
Highland/iBoxx Senior Loan ETF
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fore, no U.S. federal income or excise tax provisions are recorded.
Management has analyzed the
Funds tax positions taken on federal income tax returns for all open tax years (current and prior tax year), and has concluded that no provision for federal income tax is required in the Funds financial statements. The Funds
federal and state income and federal excise tax returns for tax years for which the applicable statutes of limitations have not expired are subject to examination by the Internal Revenue Service and state departments of revenue.
Distributions to Shareholders
The Fund intends to pay
distributions from net investment income, if any, on a monthly basis. The Fund intends to pay net realized capital gains, if any, on an annual basis.
Note 3. U.S. Federal Tax Information
The timing and character of income and capital gain distributions are determined in accordance with income tax regulations, which may differ from U.S. GAAP. As a result, net investment income (loss) and net
realized gain/(loss) on investment transactions for a reporting period may differ significantly from distributions during such period.
Reclassifications
are made to the Funds capital accounts for permanent tax differences to reflect income and gains available for distribution (or available capital loss carryforwards) under income tax regulations.
The tax character of distributions paid during
the prior two fiscal years ended June 30, was as follows:
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Distributions paid from:
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Ordinary
Income*
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Long-
Term
Capital
Gains
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Return of
Capital
|
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Highland/iBoxx Senior Loan ETF
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2019
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$
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23,252,153
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$
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$
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2018
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26,385,761
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191,058
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*
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For tax purposes, short-term capital gains distributions, if any, are considered ordinary income distributions.
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As of June 30, 2019, the Funds most recent tax year end, the components of distributable earnings on a tax basis were as follows:
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Capital Loss
Carryforward
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Net
Unrealized
Appreciation/
(Depreciation)
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Undistributed
Ordinary
Income
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Post October
Losses
|
|
Highland/iBoxx Senior Loan ETF
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|
$
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(23,089,797
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)
|
|
$
|
(8,239,762
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)
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$
|
120,126
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|
|
$
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(16,722,315
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)
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Under the Regulated Investment Company Modernization Act of 2010, the Fund is permitted to carry forward capital
losses incurred in taxable years beginning after December 22, 2010 for an unlimited period. Additionally, post-enactment capital losses that are carried forward will retain their character as either short-term or long-term capital losses rather
than being considered all short-term as under previous law. Losses carried forward under these new provisions as of June 30, 2019 are as follows:
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Short-Term
Loss
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Long-Term
Loss
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Total
|
|
Highland/iBoxx
Senior Loan ETF
|
|
$
|
13,821,732
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|
|
$
|
9,268,065
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|
|
$
|
23,089,797
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For federal income tax purposes, the cost of securities owned at December 31, 2019, and the net realized gains
or losses on securities sold for the period, were different from amounts reported for financial reporting purposes, primarily due to wash sales which cannot be used for federal income tax purposes in the current period and have been deferred for use
in future periods.
Unrealized appreciation and depreciation at
December 31, 2019, based on cost of investments, including cash equivalents, for U.S. federal income tax purposes was:
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Gross
Appreciation
|
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Gross
Depreciation
|
|
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Net
Appreciation
|
|
|
Cost
|
|
Highland/iBoxx Senior Loan ETF
|
|
$
|
2,967,146
|
|
|
$
|
(1,912,973
|
)
|
|
$
|
1,054,173
|
|
|
$
|
313,308,150
|
|
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
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|
|
December 31, 2019
|
|
Highland/iBoxx Senior Loan ETF
|
Note 4. Advisory, Administration, Service and Distribution, Trustee, and Other Fees
Investment Advisory Fees
The Investment Adviser receives
from the Fund monthly investment advisory fees, computed and accrued daily based on the Average Daily Managed Assets of the Fund, at the annual rate of 0.45%.
Average Daily Managed Assets of a Fund means the average daily value of the total assets of the Fund less all accrued liabilities of the Fund (other than the aggregate amount of any outstanding
borrowings constituting financial leverage).
Administration Fees
SEI Investments Global Funds Services (the Administrator) serves as the Funds Administrator pursuant to an Administration Agreement. For its services under the Administration Agreement, the
Administrator receives a monthly administration fee from the Fund, calculated and assessed in arrears based on the aggregate net assets of the Fund, subject to an annual minimum fee. For the six-month period
ended December 31, 2019, the Fund paid $86,034 for these services.
Service and Distribution Fees
SEI Investments Distribution Co. (the Distributor) serves as the Funds underwriter and distributor of shares pursuant to a Distribution Agreement. Under
the Distribution Agreement, the Distributor, as agent, receives orders to create and redeem shares in Creation Unit Aggregations and transmits such orders to the Funds custodian and transfer agent. The Distributor has no obligation to sell any
specific quantity of Fund shares. The Distributor bears the following costs and expenses relating to the distribution of shares: (i) the costs of processing and maintaining records of creations of Creation Units; (ii) all cost of
maintaining the records required of a registered broker/dealer; (iii) the expenses of maintaining its registration or qualification as a dealer or broker under Federal or state laws; (iv) filing fees; and (v) all other expenses
incurred in connection with the distribution services as contemplated in the Distribution Agreement. The Distributor does not maintain any secondary market in Fund shares.
Expense Limits and Fee Reimbursements
The Investment Adviser has contractually agreed to limit the total
annual operating expenses (exclusive of taxes, brokerage commissions and other transaction costs, acquired fund fees and expenses and extraordinary expenses (collectively, the Excluded Expenses)) of the Fund to 0.55% of average daily net
assets of the Fund (the Expense Cap). The Expense Cap will continue through at least October 31, 2020,
and may not be terminated prior to this date without the action or consent of the Board. Under the Expense Cap, the Investment Adviser may recoup waived and/or reimbursed amounts with respect to
the Fund within thirty-six months of the date such amounts were waived or reimbursed, provided the Funds total annual operating expenses, including such recoupment, do not exceed the Expense Cap in
effect at the time of such waiver/reimbursement.
As of December 31, 2019, pursuant to the above, fees previously waived and reimbursed by the
Investment Adviser that may be subject to possible future reimbursement to the Investment Adviser were as follows:
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Expiring Fiscal Years Ended June 30,
|
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|
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2020
|
|
|
2021
|
|
|
2022
|
|
Highland/iBoxx
Senior Loan ETF
|
|
$
|
1,125,416
|
|
|
$
|
1,093,912
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|
|
$
|
1,066,580
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During the six-month period ended December 31, 2019, $339,619 of fees previously waived
and or reimbursed by the Investment Adviser that were eligible for recoupment expired.
Fees Paid to Officers and Trustees
Each Trustee who is not an interested person of the Fund as defined in the 1940 Act (the Independent Trustees) receives an annual retainer
of $150,000 payable in quarterly installments and allocated among each portfolio in the Highland Funds Complex based on relative net assets. The Highland Funds Complex consists of all of the registered investment companies and NexPoint
Capital, Inc., a closed-end management investment company that has elected to be treated as a business development company under the 1940 Act, which are each advised by the Investment Adviser or its affiliated
advisers as of the date of this report. Prior to December 8, 2017, Mr. Powell was treated as an interested person of the Fund for all purposes other than compensation and the Trusts Code of Ethics. The Fund pays no
compensation to its officers, all of whom are employees of the Investment Adviser.
Expedited Settlement Agreements
On June 15, 2017 and May 14, 2019, the Fund entered into Expedited Settlement Agreements with two major dealers in the floating rate loan market, pursuant
to which the Fund has the right to designate certain loans it sells to the dealer to settle on or prior to three days from the trade date in exchange for a quarterly fee (the Expedited Settlement Agreements). The Expedited Settlement
Agreements are designed to reduce settlement times from the standard seven days to three days for eligible loans. For the six-month period ended December 31, 2019, the Fund paid $205,597 to the dealer as
part of the Expedited Settlement Agreements.
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
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|
|
|
|
December 31, 2019
|
|
Highland/iBoxx Senior Loan ETF
|
While the Expedited Settlement Agreements are intended to provide the Fund with additional liquidity with respect to
such loans, and may not represent the exclusive method of expedited settlement of such loans, no assurance can be given that the Expedited Settlement Agreements or other methods for expediting settlements will provide the Fund with sufficient
liquidity in the event of abnormally large redemptions.
Note 5. Portfolio Information
For the six-month period ended December 31, 2019, the cost of purchases and the proceeds from sales of the Funds portfolio securities amounted to the following:
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|
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U.S. Government
Securities*
|
|
|
Other Securities
|
|
|
|
Purchases
|
|
|
Sales
|
|
|
Purchases
|
|
|
Sales
|
|
Highland/iBoxx
Senior Loan ETF
|
|
$
|
|
|
|
$
|
|
|
|
$
|
412,938,402
|
|
|
$
|
372,089,910
|
|
*
|
The Fund did not have any purchases or sales of U.S. Government Securities for the six-month period ended
December 31, 2019.
|
Note 6. Indemnification
Under the Trusts organizational documents, the officers and Trustees have been granted certain indemnification rights against certain liabilities that may rise out of performance of their duties to the Fund.
Additionally, in the normal course of business, the Fund may enter into contracts with service providers that contain a variety of indemnification clauses. The Funds maximum exposure under these arrangements is dependent on future claims that
may be made against the Fund and, therefore, cannot be estimated.
Note 7. Disclosure of Significant Risks and Contingencies
Asset Class Risk
Securities in the Underlying Index or
in the Funds portfolio may underperform in comparison to the general securities markets or other asset classes.
Cash Transaction Risk
Unlike most exchange-traded funds (ETFs), the Fund currently intends to effect creations and redemptions principally for cash, rather
than principally for in-kind securities, because of the nature of the Funds investments. As a result, investments in Fund shares may be less tax-efficient than
investments in conventional ETFs. Paying redemption proceeds in cash rather than through in-kind delivery of portfolio securities may require the Fund to dispose of or sell portfolio investments to obtain the
cash needed to distribute redemption proceeds at an inopportune time. This may cause the Fund to recognize gains or losses that it might not have incurred if it had made a redemption in-kind.
Commodities Risk
Commodities markets historically have been extremely volatile, and the performance of securities and other instruments that provide exposure to those markets therefore also may be highly volatile. The commodities
markets may fluctuate widely based on a variety of factors. These include changes in overall market movements, domestic and foreign political and economic events and policies, war, acts of terrorism, changes in domestic or foreign interest rates
and/or investor expectations concerning interest rates, domestic and foreign inflation rates and/or investor expectations concerning inflation rates and investment and trading activities of mutual funds, hedge funds and commodities funds. Commodity
linked derivative instruments have a high degree of price variability and are subject to rapid and substantial price changes. Commodity-linked derivative instruments may employ leverage, which creates the possibility for losses greater than the
amount invested.
Counterparty Risk
A
counterparty (the other party to a transaction or an agreement or the party with whom a Fund executes transactions) to a transaction with a Fund may be unable or unwilling to make timely principal, interest or settlement payments, or otherwise honor
its obligations.
Credit Risk
The issuers of
certain securities or the counterparties of a derivatives contract or repurchase contract might be unable or unwilling (or perceived as being unable or unwilling) to make interest and/or principal payments when due, or to otherwise honor its
obligations. Debt securities are subject to the risk of non-payment of scheduled interest and/or principal. Non-payment would result in a reduction of income to the
Fund, a reduction in the value of the obligation experiencing non-payment and a potential decrease in the Funds net asset value (NAV) and the market price of the Funds shares.
Debt Securities and Leveraged Loans Risk
The
value of debt securities typically changes in response to various factors, including, by way of example, market-related factors (such as changes in interest rates or changes in the risk appetite of investors generally) and changes in the actual or
perceived ability of the issuer (or of issuers generally) to meet its (or their) obligations. During periods of rising interest rates, debt securities generally decline in value. Conversely, during periods of falling interest rates, debt securities
generally rise in value. This kind of market risk is generally greater for funds investing in debt securities with longer maturities. In addition, the interest rates of floating rate loans typically only adjust to changes in short-term interest
rates; long-term interest rates can vary dramatically
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
|
|
|
|
|
December 31, 2019
|
|
Highland/iBoxx Senior Loan ETF
|
from short-term interest rates. Leveraged Loans are subject to the same risks typically associated with debt securities. In addition, Leveraged Loans, which typically hold a senior position in
the capital structure of a borrower, are subject to the risk that a court could subordinate such loans to presently existing or future indebtedness or take other action detrimental to the holders of Leveraged Loans. Leveraged Loans are also
especially subject to the risk that the value of the collateral, if any, securing a loan may decline, be insufficient to meet the obligations of the borrower or be difficult to liquidate.
Because loans are not ordinarily registered with the SEC or any state securities commission or listed on any securities exchange, there is usually less publicly available information about such instruments. In
addition, loans may not be considered securities for purposes of the anti-fraud protections of the federal securities laws and, as a result, as a purchaser of these instruments, we may not be entitled to the anti-fraud protections of the
federal securities laws. In the course of investing in such instruments, we may come into possession of material nonpublic information and, because of prohibitions on trading in securities of issuers while in possession of such information, we may
be unable to enter into a transaction in a publicly-traded security of that issuer when it would otherwise be advantageous for us to do so. Alternatively, we may choose not to receive material nonpublic information about an issuer of such loans,
with the result that we may have less information about such issuers than other investors who transact in such assets.
Derivatives Risk
Derivatives Risk is a combination of several risks, including the risks that: (1) an investment in a derivative instrument may not correlate
well with the performance of the securities or asset class to which the Fund seeks exposure, (2) derivative contracts, including options, may expire worthless and the use of derivatives may result in losses to the Fund, (3) a derivative
instrument entailing leverage may result in a loss greater than the principal amount invested, (4) derivatives not traded on an exchange may be subject to credit risk, for example, if the counterparty does not meet its obligations (see also
Counterparty Risk), and (5) derivatives not traded on an exchange may be subject to liquidity risk and the related risk that the instrument is difficult or impossible to value accurately. As a general matter, when the Fund
establishes certain derivative instrument positions, such as certain futures and options contract positions, it will segregate liquid assets (such as cash, U.S. Treasury bonds or commercial paper) equivalent to the Funds outstanding
obligations under the contract or in connection with the position. In addition, recent legislation has called for a new
regulatory framework for the derivatives market. The impact of the new regulations are still unknown, but has the potential to increase the costs of using derivatives, may limit the availability
of some forms of derivatives or the Funds ability to use derivatives, and may adversely affect the performance of some derivative instruments used by the Fund as well as the Funds ability to pursue its investment objective through the
use of such instruments.
Exchange-Traded Funds Risk
The price movement of an exchange-traded fund may not exactly track the underlying index and may result in a loss. In addition, shareholders bear both their proportionate share of the Funds expenses and
similar expenses of the underlying investment company when the Fund invests in shares of another investment company.
Fixed Income Market Risk
Fixed income markets may, in response to governmental intervention, economic or market developments (including potentially a reduction in the number
of broker-dealers willing to engage in market-making activity), or other factors, experience periods of increased volatility and reduced liquidity. During those periods, the Fund may experience increased levels of shareholder redemptions, and may
have to sell securities at times when it would otherwise not do so, and at unfavorable prices. Fixed income securities may be difficult to value during such periods. As of the date of this Prospectus, market interest rates in the United States are
at or near historic lows, which may increase the Funds exposure to risks associated with rising market interest rates. Rising market interest rates could have unpredictable effects on the markets and may expose fixed-income and related markets
to heightened volatility, which could reduce liquidity for certain investments, adversely affect values, and increase costs. Increased redemptions may cause the Fund to liquidate portfolio positions when it may not be advantageous to do so and may
lower returns. If dealer capacity in fixed-income and related markets is insufficient for market conditions, it may further inhibit liquidity and increase volatility in the fixed-income and related markets. Further, recent and potential future
changes in government policy may affect interest rates.
Focused Investment Risk
The Funds investments in Senior Loans arranged through private negotiations between a Borrower and several financial institutions may expose the Fund to risks associated with the financial services industry.
The financial services industry is subject to extensive government regulation, which can limit both the amounts and types of loans and other financial commitments financial services companies can make and the interest rates and fees they can charge.
Profitability is largely
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
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December 31, 2019
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Highland/iBoxx Senior Loan ETF
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dependent on the availability and cost of capital funds, and can fluctuate significantly when interest rates change. Because financial services companies are highly dependent on short-term
interest rates, they can be adversely affected by downturns in the U.S. and foreign economies or changes in banking regulations. Losses resulting from financial difficulties of Borrowers can negatively affect financial services companies.
High-Yield Debt Securities Risk
Below
investment grade securities or unrated securities of similar credit quality (commonly known as high-yield securities or junk securities) are more likely to default than higher rated securities. The Funds ability to
invest in high-yield debt securities generally subjects the Fund to greater risk than securities with higher ratings. Such securities are regarded by the rating organizations as predominantly speculative with respect to capacity to pay interest and
repay principal in accordance with the terms of the obligation. The market value of these securities is more sensitive to corporate developments and economic conditions and can be volatile. Market conditions can diminish liquidity and make accurate
valuations difficult to obtain.
Illiquid Securities Risk
The Adviser may not be able to sell illiquid securities at the price it would like or may have to sell them at a loss. Securities of non-U.S. issuers and emerging markets
securities in particular, are subject to greater liquidity risk.
Industry Concentration Risk
Because the Fund may invest 25% or more of the value of its assets in an industry or group of industries to the extent that the Underlying Index concentrates in an
industry or group of industries, the Funds performance largely depends on the overall condition of such industry or group of industries and a Fund is susceptible to economic, political and regulatory risks or other occurrences associated with
that industry or group of industries.
Intellectual Property Risk
The Adviser relies on a license, which may be terminated by the Index Provider, that permits the Fund to use the Underlying Index and associated trade names, trademarks and service marks (the Intellectual
Property) in connection with the name and investment strategies of the Fund. In the event the license is terminated or the Index Provider does not have rights to license the Intellectual Property, it may have a significant effect on the
operation of the Fund.
Interest Rate Risk
When
interest rates decline, the value of fixed rate securities already held by the Fund can be expected to rise. Conversely, when interest rates rise, the value of existing fixed
rate portfolio securities can be expected to decline. A fund with a longer average portfolio duration will be more sensitive to changes in interest rates than a fund with a shorter average
portfolio duration. In addition, the interest rates of floating rate loans typically only adjust to changes in short-term interest rates; long-term interest rates can vary dramatically from short-term interest rates.
Lender Liability Risk
A number of judicial decisions have
upheld the right of Borrowers to sue lending institutions on the basis of various evolving legal theories founded upon the premise that an institutional Lender has violated a duty of good faith and fair dealing owed to the Borrower or has assumed a
degree of control over the Borrower resulting in a creation of a fiduciary duty owed to the Borrower or its other creditors or shareholders. Because of the nature of certain of the Funds investments, the Fund or the Adviser could be subject to
such liability.
Limited Information Risk
The
types of Senior Loans in which the Fund will invest historically may not have been rated by a NRSRO, have not been registered with the SEC or any state securities commission, and have not been listed on any national securities exchange. Although the
Fund will generally have access to financial and other information made available to the Lenders in connection with Senior Loans, the amount of public information available with respect to Senior Loans will generally be less extensive than that
available for rated, registered or exchange-listed securities.
Liquidity Risk
Liquidity risk is the risk that low trading volume, lack of a market maker, large position size, or legal restrictions (including daily price fluctuation limits or circuit breakers) limits or prevents
the Fund from selling particular securities or unwinding derivative positions at desirable prices. At times, a major portion of any portfolio security may be held by relatively few institutional purchasers. Even if the Fund considers such securities
liquid because of the availability of an institutional market, such securities may become difficult to value or sell in adverse market or economic conditions. Because loan transactions often take longer to settle than transactions in other
securities, the Fund may not receive the proceeds from the sale of a loan for a significant period of time. As a result, the Fund may maintain higher levels of cash and short-term investments than mutual funds that invest in securities with shorter
settlement cycles and/or may enter into a line of credit to permit the Fund to finance redemptions pending settlement of the sale of portfolio securities, each of which may adversely affect the Funds performance. No assurance can be given that
these
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
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December 31, 2019
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Highland/iBoxx Senior Loan ETF
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measures will provide the Fund with sufficient liquidity in the event of abnormally large redemptions.
Loan Participation Risk
In addition to the risks typically associated with debt securities, Participations
involve the risk that there may not be a readily available market for Participation interests and, in some cases, the Fund may have to dispose of such securities at a substantial discount from face value. Participations also involve the credit risk
associated with the underlying corporate borrower.
Management Risk
Management risk is the risk associated with the fact that the Fund relies on the Advisers ability to achieve its investment objective. The Adviser may be incorrect in its assessment of the intrinsic value of
companies whose securities the Fund holds, which may result in a decline in the value of Fund shares and failure to achieve its investment objective. The Funds portfolio manager uses quantitative analyses and/or models. Any imperfections or
limitations in such analyses and models could affect the ability of the portfolio manager to implement strategies.
Market Price Variance Risk
Fund shares will be listed for trading on NASDAQ, Inc. (the Exchange) and can be bought and sold in the secondary market at market
prices. The market prices of shares will fluctuate in response to changes in the NAV and supply and demand for shares. As a result, the trading prices of Shares may deviate significantly from NAV during periods of market volatility. The Adviser
cannot predict whether shares will trade above, below or at their NAV. Given the fact that shares can be created and redeemed in Creation Units, the Adviser believes that large discounts or premiums to the NAV of shares should not be sustained in
the long term. In addition, the securities held by the Fund may be traded in markets that close at a different time than NASDAQ. Liquidity in those securities may be reduced after the applicable closing times. Accordingly, during the time when
NASDAQ is open but after the applicable market closing, fixing or settlement times, bid-ask spreads and the resulting premium or discount to the Shares NAV may widen. Further, secondary markets may be
subject to irregular trading activity, wide bid/ask spreads and extended trade settlement periods, which could cause a material decline in the Funds NAV. The bid/ask spread of the Fund may be wider in comparison to the bid/ask spread of other
ETFs, given the liquidity of the Funds assets. The Funds investment results are measured based upon the daily NAV of the Fund. Investors purchasing and selling shares in the secondary market may not experience investment results
consistent with those experienced by those purchasing and redeeming directly with the Fund.
Non-Diversification Risk
As a non-diversified fund for purposes of the 1940 Act, the Fund may invest a larger portion of its assets in the securities
of fewer issuers than a diversified fund. The Funds investment in fewer issuers may result in the Funds shares being more sensitive to the economic results of those issuers. An investment in the Fund could fluctuate in value more than an
investment in a diversified fund.
Non-Payment Risk
Debt securities are subject to the risk of non-payment of scheduled interest and/or principal. Non-payment would result in a reduction of income to the Fund, a reduction in the value of the obligation experiencing non-payment and a potential decrease in the Funds
NAV and the market price of the Funds shares.
Ongoing Monitoring Risk
Ongoing monitoring risk is the risk associated with ongoing monitoring of the Agent. On behalf of the several Lenders, the Agent generally will be required to administer and manage the Senior Loans and, with
respect to collateralized Senior Loans, to service or monitor the collateral. Financial difficulties of Agents can pose a risk to the Fund. Unless, under the terms of the loan, the Fund has direct recourse against the Borrower, the Fund may have to
rely on the Agent or other financial intermediary to apply appropriate credit remedies against a Borrower.
Operational and Technology Risk
Cyber-attacks, disruptions, or failures that affect the Funds service providers, counterparties, market participants, or issuers of securities
held by the Fund may adversely affect the Fund and its shareholders, including by causing losses for the Fund or impairing Fund operations.
Options
Risk
Options, such as covered calls and covered puts, are subject to the risk that significant differences between the securities and options
markets that could result in an imperfect correlation between these markets.
Passive Investment Risk
The Fund is not actively managed and HCMFA does not attempt to take defensive positions under any market conditions, including during declining markets.
Portfolio Turnover Risk
High portfolio turnover will
increase the Funds transaction costs and may result in increased realization of net short-term capital gains (which are taxable to shareholders as ordinary income when distributed to them), higher taxable distributions and lower after-tax performance.
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
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December 31, 2019
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Highland/iBoxx Senior Loan ETF
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Prepayment Risk
During periods of falling interest rates, issuers of debt securities may repay higher rate securities before their maturity dates. This may cause the Fund to lose
potential price appreciation and to be forced to reinvest the unanticipated proceeds at lower interest rates. This may result in a decrease in the Funds income.
Regulatory Risk
To the extent that legislation or state or federal regulators impose additional requirements
or restrictions with respect to the ability of financial institutions to make loans in connection with highly leveraged transactions, the availability of Senior Loan interests for investment by the Fund may be adversely affected.
To the extent that legislation or state or federal regulators impose additional requirements or restrictions with respect to the ability of financial institutions
to make loans in connection with highly leveraged transactions, the availability of Senior Loan interests for investment by the Fund may be adversely affected. In addition, such requirements or restrictions may reduce or eliminate sources of
financing for affected Borrowers. Further, to the extent that legislation or federal or state regulators require such institutions to dispose of Senior Loan interests relating to highly leveraged transactions or subject such Senior Loan interests to
increased regulatory scrutiny, such financial institutions may determine to sell Senior Loan interests in a manner that results in a price that, in the opinion of the Adviser, is not indicative of fair value. Were the Fund to attempt to sell a
Senior Loan interest at a time when a financial institution was engaging in such a sale with respect to the Senior Loan interest, the price at which the Fund could consummate such a sale might be adversely affected. See Industry Concentration
Risk above.
Securities Market Risk
The
value of securities owned by the Fund may go up or down, sometimes rapidly or unpredictably, due to factors affecting particular companies or the securities markets generally. A general downturn in the securities market may cause multiple asset
classes to decline in value simultaneously. Many factors can affect this value and you may lose money by investing in the Fund.
Senior Loans
Risk
The Funds investments in Senior Loans are typically below investment grade and are considered speculative because of the credit risk of
their issuers. As with any debt instrument, Senior Loans are generally subject to the risk of price declines and to increases in interest rates, particularly long-term rates. Senior loans are also subject to the risk that, as
interest rates rise, the cost of borrowing increases, which may increase the risk of default. In addition, the interest rates of floating rate loans typically only adjust to changes in short-term
interest rates; long-term interest rates can vary dramatically from short-term interest rates. Therefore, Senior Loans may not mitigate price declines in a rising long-term interest rate environment. The secondary market for loans is generally less
liquid than the market for higher grade debt. Less liquidity in the secondary trading market could adversely affect the price at which the Fund could sell a loan, and could adversely affect the Funds income. The volume and frequency of
secondary market trading in such loans varies significantly over time and among loans. Although Senior Loans in which the Fund will invest will often be secured by collateral, there can be no assurance that liquidation of such collateral would
satisfy the Borrowers obligation in the event of a default or that such collateral could be readily liquidated.
Swaps Risk
Investments in swaps involve both the risks associated with an investment in the underlying investments or instruments (including equity investments) and
counterparty risk. In a standard over-the-counter (OTC) swap transaction, two parties agree to exchange the returns, differentials in rates of return or some
other amount calculated based on the notional amount of predetermined investments or instruments, which may be adjusted for an interest factor. Swaps can involve greater risks than direct investments in securities, because swaps may be
leveraged and OTC swaps are subject to counterparty risk (i.e., the risk of a counterpartys defaulting on the obligation or bankruptcy), credit risk and pricing risk (i.e., swaps may be difficult to value). Swaps may also be considered
illiquid. Certain swap transactions, including interest rate swaps and index credit default swaps, may be subject to mandatory clearing and exchange trading, although the swaps in which the Fund will invest are not currently subject to mandatory
clearing and exchange trading. The use of swaps is a highly specialized activity which involves investment techniques, risk analyses and tax planning different from those associated with ordinary portfolio securities transactions. The value of
swaps, like many other derivatives, may move in unexpected ways and may result in losses for the Fund.
Tracking Error Risk
The performance of the Fund may diverge from that of the Underlying Index. Because the Fund employs a representative sampling strategy, the Fund may experience
tracking error to a greater extent than a fund that seeks to replicate an index. The Adviser may not be able to cause the Funds performance to correlate to that of the Funds benchmark, either on a daily or aggregate basis. Because the
Underlying
NOTES TO FINANCIAL STATEMENTS (unaudited) (concluded)
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December 31, 2019
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Highland/iBoxx Senior Loan ETF
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Index rebalances monthly but the Fund is not obligated to do the same, the risk of tracking error may increase following the rebalancing of the Underlying Index.
An investment in the Fund is not a bank deposit and is not insured or guaranteed by the FDIC or any other government agency. As with any investment company, there
is no guarantee that the Fund will achieve its goal.
Note 8. Regulatory Matters
On August 17, 2018, the SEC adopted amendments to Regulation S-X. These changes are effective for periods ending on or after November 5, 2018. The updates to
Registered Investment Companies were mainly focused on simplifying the presentation of distributable earnings by eliminating the need to present the components of distributable earnings on a book basis in the Statements of Assets and Liabilities.
The update also impacted the presentation of undistributed net investment income and distribution to shareholders on the Statements of Changes in Net Assets. The amounts presented in the current Statements of Changes in Net Assets represent the
aggregated total distributions of net investment income and realized capital gains, except for distributions classified as return of capital which are still presented separately.
Note 9. New Accounting Pronouncements
In December 2016, the FASB issued Accounting Standards Update 2016-19, Technical Corrections and Improvements. The amendments in this update include an amendment to FASB ASC Topic 820, Fair Value Measurement and Disclosures to clarify the difference between a valuation
approach and a valuation technique. The amendment also requires an entity to disclose when there has been a change in either or both a valuation approach and/or a valuation technique. For public entities, this update will be effective for fiscal
years beginning after December 15, 2017, and for interim periods within those fiscal years. For all other entities, this update is effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years
beginning after December 15, 2019. The Investment Adviser has evaluated the impact of this new guidance and there was no impact on the Funds financial statements.
In March 2017, the FASB issued Accounting Standards Update 2017-08, Receivables Nonrefundable Fees and Other Costs (Subtopic
310-20). The amendments in this update shorten the amortization period for certain callable debt securities held at premium. Specifically, the amendments require the premium to be amortized to the earliest
call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. For public entities this update will be effective for fiscal years beginning
after December 15, 2018, and for interim periods within those fiscal years. The Investment Adviser has evaluated the impact of this new guidance and there was no impact on the Funds
financial statements.
In February 2018, the FASB issued Accounting Standards Update 2018-03, Technical
Corrections and Improvements to Financial Instruments Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update provide a
variety of technical corrections and improvements to how entities should account for financial instruments. For public entities this update will be effective for fiscal years beginning after December 15, 2017, and for interim periods within
those fiscal years beginning after June 15, 2018. The Investment Adviser has evaluated the impact of this new guidance and there was no impact on the Funds financial statements.
In August 2018, the FASB issued Accounting Standards Update 2018-13, Fair Value Measurement (Topic 820). The new guidance includes additions and modifications to disclosures
requirements for fair value measurements. For public entities, the amendments are effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years.
Note 10. Subsequent Events
Management has evaluated the
impact of all subsequent events on the Fund through the date the financial statements were issued, and has determined that there were no subsequent events requiring recognition or disclosure in the financial statements.
ADDITIONAL INFORMATION (unaudited)
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December 31, 2019
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Highland/iBoxx Senior Loan ETF
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Additional Portfolio Information
Net asset value, or NAV, is the price per share at which the Fund issues and redeems shares. It is calculated in accordance with the standard formula for valuing mutual fund shares. The Market
Price of the Fund generally is determined using the midpoint between the bid and the ask on the stock exchange on which the shares of the Fund are listed for trading, as of the time that the Funds NAV is calculated. The Funds
Market Price may be at, above or below its NAV. The NAV of the Fund will fluctuate with changes in the market value of its holdings. The Market Price of the Fund will fluctuate in accordance with changes in its NAV, as well as market supply and
demand. Shareholders may pay more than NAV when they buy Fund shares and receive less than NAV when they sell those shares, because shares are bought and sold at current Market Prices. Premiums or discounts are the differences (expressed as a
percentage) between the NAV and Market Price of the Fund on a given day, generally at the time NAV is calculated. A premium is the amount that a Fund is trading above the reported NAV, expressed as a percentage of the NAV. A discount is the amount
that a Fund is trading below the reported NAV, expressed as a percentage of the NAV. Further information regarding premiums and discounts for the Fund is available on the Funds website at www.highlandfunds.com The Investment Adviser and its
affiliates manage other accounts, including private funds and individual accounts. Although investment decisions for the Fund are made independently from those of such other accounts, the Investment Adviser may, consistent with applicable law, make
investment recommendations to other clients or accounts that may be the same or different from those made to the Fund, including investments in different levels of the capital structure of a company, such as equity versus senior loans, or that
involve taking contradictory positions in multiple levels of the capital structure. The Investment Adviser has adopted policies and procedures that address the allocation of investment opportunities, execution of portfolio transactions, personal
trading by employees and other potential conflicts of interest that are designed to ensure that all client accounts are treated equitably over time. Nevertheless, this may create situations where a client could be disadvantaged because of the
investment activities conducted by the Investment Adviser for other client accounts. When the Fund and one or more other accounts is prepared to invest in, or desires to dispose of, the same security, available investments or opportunities for each
are allocated in a manner believed by the Investment Adviser to be equitable over time. The Investment Adviser may aggregate orders, which may include orders for accounts in which the Investment Adviser or its affiliates have an interest, to
purchase and sell securities to obtain favorable execution or lower brokerage commissions, to the extent permitted by applicable laws and regulations.
Although the Investment Adviser believes that, over time, the potential benefits of participating in volume transactions and negotiating lower transaction costs should benefit all participating
accounts, in some cases these activities may adversely affect the price paid or received or the size of the position obtained by or disposed of for the Fund. Where trades are aggregated, the investments or proceeds, as well as the expenses incurred,
will be allocated by the Investment Adviser in a manner designed to be equitable and consistent with the Investment Advisers fiduciary duty to the Fund and its other clients (including its duty to seek to obtain best execution of client
trades).
Disclosure of Fund Expenses
As a shareholder of a Fund, you incur two types of costs: (1) transaction costs and (2) ongoing costs, including management fees, and other Fund expenses. This example is intended to help you understand
the ongoing costs (in dollars) of investing in your Fund and to compare these costs with the ongoing costs of investing in other mutual funds.
The
example is based on an investment of $1,000 invested at the beginning of the period and held for the six-month period July 1, 2019 through December 31, 2019, unless otherwise indicated. This table
illustrates your Funds costs in two ways:
Actual Expenses: The first part of the table provides information about actual account values and
actual expenses. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by
$1,000 = 8.6), then multiply the result by the number in the first line under the heading entitled Expenses Paid During Period to estimate the expenses you paid on your account during this period.
Hypothetical Example for Comparison Purposes: The second part of the table provides information about hypothetical account values and hypothetical expenses
based on your Funds actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not your Funds actual return. The actual expense ratio includes voluntary fee waivers or expense reimbursements by the
Funds investment adviser. The expense ratio would be higher had the fee waivers or expense reimbursements not been in effect. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or
expenses you paid for the period. You may use this information to compare the ongoing costs of investing in your Fund and other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder
reports of the other funds.
ADDITIONAL INFORMATION (unaudited) (continued)
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December 31, 2019
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Highland/iBoxx Senior Loan ETF
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Please note that the expenses shown in the table are meant to highlight your ongoing costs only and do not reflect
any transactional costs. Therefore, the second part of the table is useful in comparing ongoing costs only, and will not help you determine the relative total costs of owning different funds. In addition, if these transactional costs were included,
your costs would have been higher.
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Beginning
Account
Value
07/01/19
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Ending
Account
Value
12/31/19
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Annualized
Expense
Ratios
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Expenses
Paid
During
Period*
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Highland/iBoxx Senior Loan ETF
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Actual Fund Return
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$
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1,000.00
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$
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1,021.60
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0.75
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%
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$
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3.81
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Hypothetical
|
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$
|
1,000.00
|
|
|
$
|
1,021.37
|
|
|
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0.75
|
%
|
|
$
|
3.81
|
|
*
|
Expenses are equal to the Funds annualized expense ratio multiplied by the average account value over the hypothetical six-month period, multiplied by 184/366 (to reflect the one-half year period).
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Changes of Independent Registered Public Accounting Firms
On September 28, 2018, Highland Long/Short
Equity Fund, Highland Healthcare Opportunities Fund, Highland Merger Arbitrage Fund, Highland Opportunistic Credit Fund and Highland/iBoxx Senior Loan ETF, each a series of Highland Funds I (the Trust), dismissed KPMG LLP
(KPMG) as the Trusts independent registered public accounting firm, effective on such date. The decision to dismiss KPMG was approved by the audit committee and by the full board of trustees of the Trust (the Board). On
September 27, 2018, the Trust approved the appointment of PricewaterhouseCoopers LLP (PwC) as the Trusts independent registered public accounting firm. KPMGs audit reports on the Trusts financial statements as of
and for the years ended June 30, 2018 and 2017 did not contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles.
During its audits of the Trust as of June 30, 2018, KPMG concluded managements review control over a certain hard-to-value security held by Opportunistic Credit Fund was not designed at an appropriate level of precision to assess the orderly nature of transactions involving the security and reasonableness and
reliability of certain inputs to the fair value model for the security. In connection with this audit, KPMG advised the Trust of the need to expand significantly the scope of its audits. Although Management of the Trust initially disagreed with
KPMGs position, subsequent to KPMGs dismissal Management ultimately took the position that the transactions were orderly and revised certain non-observable inputs to the fair value model for the
security.
KPMG and Management individually identified a material weakness in the control environment of Highland Opportunistic Credit Fund related to
the assessment of orderly
trans-
actions and non-observable inputs used in fair valuation of a fair valued asset held.
Other than the disagreements and reportable events disclosed above, during the Trusts years ended June 30, 2018 and 2017 and the subsequent interim period through September 28, 2018, there were no:
(1) disagreements (as defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions) with KPMG on any matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedures, which disagreements if not resolved to their satisfaction would have caused them to make reference in connection with their opinion to the subject matter of the disagreement, or (2) reportable events (as described
in Item 304(a)(1)(v) of Regulation S-K). The audit committee of the Trust discussed the subject matter of these disagreements and reportable events with KPMG. The Trust has authorized KPMG to respond fully to
the inquiries of PwC concerning the subject matter of these disagreements and reportable events.
During the years ended June 30, 2018 and 2017 and
the subsequent interim period through September 28, 2018, neither Management, the Trust, nor anyone on its behalf, consulted PwC regarding either (i) the application of accounting principles to a specified transaction, either completed or
proposed, or the type of audit opinion that might be rendered on the financial statements of the Trust, and no written report or oral advice was provided to the Trust by PwC that PwC concluded was an important factor considered by the Trust in
reaching a decision as to any accounting, auditing or financial reporting issue; or (ii) any matter that was either the subject of a disagreement (as defined in Item 304(a)(1)(iv) of Regulation S-K and
the related instructions) or a reportable event (as described in Item 304(a)(1)(v) of Regulation S-K).
Approval of Investment Advisory Agreement
The Fund has retained Highland Capital Management Fund Advisors, L.P. (the Investment
Adviser) to manage the assets of the Fund pursuant to an investment advisory agreement between the Investment Adviser and the Fund (the Advisory Agreement). The Advisory Agreement has been approved by the Funds Board of
Trustees, including a majority of the Independent Trustees. The Advisory Agreement continues in effect from year-to-year, provided that such continuance is specifically
approved at least annually by the vote of holders of at least a majority of the outstanding shares of the Fund or by the Board of Trustees and, in either event, by a majority of the Independent Trustees of the Fund casting votes in person at a
meeting called for such purpose.
During a telephonic meeting held on August 15, 2019, the Board of Trustees gave preliminary consideration to
information bearing on the continuation of the Agreement
ADDITIONAL INFORMATION (unaudited) (continued)
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December 31, 2019
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for a one-year period commencing November 1, 2019 with respect to the Fund. The primary objective of the meeting was to ensure that the Trustees had
the opportunity to consider matters they deemed relevant in evaluating the continuation of the Agreement, and to request any additional information they considered reasonably necessary for their deliberations.
At an in-person meeting held on September 19-20, 2019, the Board of Trustees,
including the Independent Trustees, approved the continuance of the Agreement for a one-year period commencing on November 1, 2019. As part of its review process, the Board requested, through its
independent legal counsel, and received from the Investment Adviser, various information and written materials, including: (1) information regarding the financial soundness of the Investment Adviser and the profitability of the Advisory
Agreement to the Investment Adviser; (2) information on the advisory and compliance personnel of the Investment Adviser, including compensation arrangements; (3) information on internal compliance procedures of the Investment Adviser,
including policies and procedures for personal securities transactions and with respect to cybersecurity, business continuity and disaster recovery; (4) comparative information showing how the Funds fees and expenses compare to those of
other registered investment companies and comparable funds managed by the Investment Adviser that follow investment strategies similar to those of the Fund, if any; (5) information regarding the investment performance of the Fund, including
comparisons of the Funds performance against that of other registered investment companies and comparable funds managed by the Investment Adviser that follow investment strategies similar to the Fund, if any; (6) premium and discount
information with respect to the Fund; (7) information regarding brokerage and portfolio transactions; and (8) information on any legal proceedings or regulatory audits or investigations affecting the Investment Adviser or its affiliates.
After the August 2019 meeting, the Trustees requested that the Investment Adviser provide additional information regarding various matters. In addition, the Board of Trustees received an independent report from FUSE Research Network
(FUSE), an independent source of investment company data, relating to the Funds performance and expenses compared to the performance and expenses of a group of funds deemed by FUSE to be comparable to the Fund (the peer
group), and to a larger group of comparable funds (the peer universe).
The Board of Trustees evaluation process with respect to
the Investment Adviser is an ongoing one. In this regard, the Board of Trustees also took into account discussions with management and information provided to the Board of Trustees at periodic meetings of the Board of Trustees over
the course of the year with respect to the services provided by the Investment Adviser to the Fund, including quarterly performance reports prepared by management containing reviews of investment
results and prior presentations from the Investment Adviser with respect to the Fund. The information received and considered by the Board of Trustees in connection with the September 19-20, 2019 meeting and
throughout the year was both written and oral.
The Board of Trustees reviewed various factors that were discussed in a legal memorandum provided by
independent counsel regarding trustee responsibilities in considering the Advisory Agreement, the detailed information provided by the Investment Adviser and other relevant information and factors. The Board of Trustees also considered other factors
(including conditions and trends prevailing generally in the economy, the securities markets, and the industry). The Board of Trustees conclusions as to the approval of the Advisory Agreement were based on a comprehensive consideration of all
information provided to the Trustees without any single factor being dispositive in and of itself.
Some of the factors that figured particularly in the
Board of Trustees deliberations are described below, although individual Trustees may have evaluated the information presented differently from one another, giving different weights to various factors. In addition, the Board of Trustees
conclusions may be based in part on its consideration of the advisory arrangements in prior years and on the Boards ongoing regular review of fund performance and operations throughout the year.
Throughout the process, the Board of Trustees had the opportunity to ask questions of and request additional information from the Investment Adviser. The Board of
Trustees was assisted by legal counsel for the Trust and the Independent Trustees were also separately assisted by independent legal counsel throughout the process. The Independent Trustees were advised by and met in executive sessions with their
independent legal counsel at which no representatives of management were present to discuss the proposed continuation of the Advisory Agreement, including prior to the September 19-20, 2019 meeting
The nature, extent, and quality of the services to be provided by the Investment Adviser. The Board considered the portfolio management services to be
provided by the Investment Adviser under the Advisory Agreement and the activities related to portfolio management, including use of technology, research capabilities and investment management staff. The Board discussed the relevant experience and
qualifications of the personnel who would provide advisory services, including the background and experience of the members of the Funds portfolio management team. The Trustees reviewed the management structure, assets under
ADDITIONAL INFORMATION (unaudited) (continued)
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December 31, 2019
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management and investment philosophies and processes of the Investment Adviser, including with respect to liquidity management. The Board also reviewed and discussed information regarding the
Investment Advisers compliance policies, procedures and personnel, including compensation arrangements and with respect to valuation, cybersecurity, business continuity and disaster recovery. The Board also considered the Investment
Advisers risk management processes. The Board of Trustees took into account the terms of the Advisory Agreement and considered that, the Investment Adviser, subject to the direction of the Board of Trustees, is responsible for providing advice
and guidance with respect to the Fund and for managing the investment of the assets of the Fund. The Board of Trustees also took into account that the scope of services provided by the Investment Adviser and the undertakings required of the
Investment Adviser in connection with those services, including maintaining and monitoring its own and the Funds compliance program, had expanded over time as a result of regulatory, market and other developments. In this regard, they
considered the Advisers preparation with respect to the reporting modernization and liquidity risk management requirements required by new SEC regulations. The Board of Trustees also considered the quality of the Investment Advisers
compliance oversight program with respect to the Funds service providers. The Board of Trustees also considered both the investment advisory services and the nature, quality and extent of any administrative and other non-advisory services, including shareholder servicing and distribution support services, provided to the Fund and its shareholders by the Investment Adviser and its affiliates. The Board also considered the
significant risks assumed by the Investment Adviser in connection with the services provided to the Fund, including entrepreneurial risk and ongoing risks including investment, operational, enterprise, litigation, regulatory and compliance risks
with respect to the Fund. The Board of Trustees also noted various cost-savings initiatives that had been implemented by the Adviser with respect to the Fund and the other funds in the Highland complex over the years.
The Board of Trustees also noted that on a regular basis it receives and reviews information from the Funds Chief Compliance Officer (CCO) regarding the
Funds compliance policies and procedures established pursuant to Rule 38a-1 under the Investment Company Act of 1940.
In considering the nature, extent, and quality of the services provided by the Investment Adviser, the Board also took into account its knowledge of the Investment Advisers management and the quality of the
performance of its duties, through discussions and reports during the preceding year and in past years.
The Board took into account the Investment Advisers risk assessment, monitoring process and regulatory history.
The Board concluded that the Investment Adviser had the quality and depth of personnel and investment methods essential to performing its duties under the Advisory Agreement, and that the nature and the quality of such advisory services supported
the approval of the Advisory Agreement.
The Investment Advisers historical performance. In considering the Funds performance, the
Board of Trustees noted that it reviews at its regularly scheduled meetings information about the Funds performance results. The Board of Trustees reviewed the historical performance of the Fund over various time periods and reflected on
previous discussions regarding matters bearing on the Investment Advisers performance at its meetings throughout the year. The Board of Trustees discussed the performance of the Fund and considered the relative performance of the Fund and its
portfolio management team as compared to that of the Funds peer group as selected by FUSE, as well as comparable indices. The Board of Trustees noted that while it found the data provided by FUSE, the independent third-party data provider,
generally useful, it recognized its limitations, including in particular that the data may vary depending on the end date selected and the results of the performance comparisons may vary depending on the selection of the peer group. The Board of
Trustees also took into account managements discussion of the category in which the Fund was placed for comparative purposes, including any differences between the Funds investment strategy and the strategy of the funds in the
Funds respective category, as well as compared to the peer group selected by FUSE.
Among other data relating specifically to the Funds
performance, the Board considered FUSEs explanatory note that the peer group and universe consist of bank loan funds with similar pricing characteristics and that the universe excludes outliers. The Board of Trustees took into account
FUSEs note that the Funds peer group includes active and passive strategies in order to present a larger comparison. The Board of Trustees considered that the Fund had underperformed its benchmark, the Markit iBoxx USD Liquid Leveraged
Loan Index, and its peer group for the one-, three- and five-year periods ended June 30, 2019. The Board of Trustees also noted that Fund had an overall positive tracking error result with respect to its
benchmark since the Funds inception. The Board also took into account managements discussion of the Funds performance, including the factors that contributed to the Funds underperformance.
The Board of Trustees concluded that the Funds overall performance and other relevant factors, including the Advisers actions to address any
underperformance, sup-
ADDITIONAL INFORMATION (unaudited) (concluded)
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ported the continuation of the Agreement with respect to the Fund for an additional one-year period.
The costs of the services to be provided by the Investment Adviser and the profits to be realized by the Investment Adviser and its affiliates from the
relationship with the Fund. The Board of Trustees also gave consideration to the fees payable under the Agreement, the expenses the Investment Adviser incur in providing advisory services and the profitability to the Investment Adviser from
managing the Fund, including: (1) information regarding the financial condition of the Investment Adviser; (2) information regarding the total fees and payments received by the Investment Adviser for its services and, with respect to the
Investment Adviser, whether such fees are appropriate given economies of scale and other considerations; (3) comparative information showing (a) the fees payable under the Agreement versus the investment advisory fees of certain registered
investment companies and comparable funds that follow investment strategies similar to those of the Fund and (b) the expense ratios of the Fund versus the expense ratios of certain registered investment companies and comparable funds that
follow investment strategies similar to those of the Fund; and (4) information regarding the total fees and payments received and the related amounts waived and/or reimbursed by the Investment Adviser for providing administrative services with
respect to the Fund under separate agreements and whether such fees are appropriate. The Board of Trustees took into account the management fee structure, including that management fees for the Fund were based on the Funds total managed
assets.
Among other data, the Board of Trustees considered that the Funds total net expenses and advisory fee were lower than those of its peer
group median and that its net management fee was lower than that of its peers. The Board noted that the Investment Adviser had agreed to waive fees and/or reimburse expenses to cap total annual fund operating expenses (exclusive of taxes, brokerage
commissions and other transaction costs, acquired fund fees and expenses and extraordinary expenses) of the Fund to 0.55% of the average daily assets attributable to any fund class until at least October 31, 2020, unless otherwise terminated by
the Board of Trustees.
The Board of Trustees also considered the so-called
fall-out benefits to the Investment Adviser with respect to the Fund, such as the reputational value of serving as Investment Adviser to the Fund, potential fees paid to the Investment
Advisers affiliates by the Fund or portfolio companies for services provided, including administrative services provided to the Fund by the Investment Adviser pursuant to separate agreements, the benefits of scale from investment by the Fund
in affiliated funds, and the benefits of research made available to the Investment Adviser by reason of brokerage
commissions (if any) generated by the Funds securities transactions. The Board of Trustees concluded that the benefits received by the Investment Adviser and its affiliates were reasonable
in the context of the relationship between the Investment Adviser and the Fund.
After such review, the Board of Trustees determined that the
profitability to the Investment Adviser and its affiliates from their relationship with the Fund was not excessive. The Trustees also took into consideration the amounts waived and/or reimbursed, if any, where expense caps or advisory fee waivers
had been implemented.
The extent to which economies of scale would be realized as the Fund grows and whether fee levels reflect these economies of
scale for the benefit of shareholders. The Board considered the effective fee under the Advisory Agreement for the Fund as a percentage of assets at different asset levels and possible economies of scale that may be realized if the assets of the
Fund grow. The Board noted that, while the Fund does not currently contain breakpoints in its advisory fee schedule, the Fund does benefit from an expense limitation agreement currently in place until at least October 31, 2020, unless otherwise
terminated by the Board. The Board considered the Investment Advisers discussion of the Funds advisory fee structure. The Board of Trustees concluded that the fee structures are reasonable, and with respect to the Investment Adviser,
should result in a sharing of economies of scale in view of the information provided. The Board determined to continue to review ways, and the extent to which, economies of scale might be shared between the Investment Adviser on the one hand and
shareholders of the Fund on the other.
Conclusion. Following a further discussion of the factors above, it was noted that in considering the
approval of the Advisory Agreement, no single factor was determinative to the decision of the Board of Trustees. Rather, after weighing all factors and considerations, including those discussed above, the Board of Trustees, including separately, the
Independent Trustees, unanimously agreed that the Advisory Agreement, including the advisory fee to be paid to the Investment Adviser, is fair and reasonable to the Fund in light of the services that the Investment Adviser proposes to provide, the
expenses that it incurs and the reasonably foreseeable asset levels of the Fund.
IMPORTANT INFORMATION ABOUT THIS REPORT
Investment Adviser
Highland Capital Management Fund Advisors, L.P.
300 Crescent Court, Suite 700
Dallas, TX 75201
Transfer Agent
Bank of New York Mellon
240 Greenwich Street
New York, NY 10286
Distributor
SEI Investments Distribution Co.
One Freedom Valley Drive
Oaks, PA 19456
Custodian
Bank of New York Mellon
240 Greenwich Street
New York, NY 10286
Independent Registered Public Accounting
Firm
PricewaterhouseCoopers LLP
2121 N. Pearl
Street, Suite 2000
Dallas, TX 752101
Fund Counsel
K&L Gates LLP
1 Lincoln Street
Boston, MA 02111
This report has been prepared for shareholders of the Highland/iBoxx Senior Loan ETF (the Fund). The Fund
mails one shareholder report to each shareholder address. If you would like more than one report, please call shareholder services at
1-855-799-4757 to request that additional reports be sent to you.
A description of the policies and procedures that the Fund uses to determine how to vote proxies relating to its portfolio securities, and the Funds proxy voting records for the most recent 12-month period ended June 30th are available (i) without charge, upon request, by calling
1-855-799-4757 and (ii) on the U.S. Securities and Exchange Commissions website at http://www.sec.gov.
The Fund files its complete schedule of portfolio holdings with the U.S. Securities and Exchange Commission (the Commission) for the first and third
quarters of each fiscal year on Form N-PORT within sixty days after the end of the period. The Funds Forms N-PORT are available on the Commissions website at
http://www.sec.gov and also may be reviewed and copied at the Commissions Public Reference Room in Washington, DC. Information on the Public Reference Room may be obtained by calling 1-800-SEC-0330. Shareholders may also obtain the Form N-Q, upon request and without charge, by visiting the Funds website
at www.highlandfunds.com or by calling 1-855-799-4757.
The Statement of Additional Information includes additional information about the Funds Trustees and is available upon request without charge by calling 1-855-799-4757.
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One Heritage Drive, 1st Floor
North Quincy, MA 02171
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Semi-Annual Report December 31, 2019
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