UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT OF REGISTERED

MANAGEMENT INVESTMENT COMPANIES

Investment Company Act file number: 811-23268

HIGHLAND INCOME FUND

(Exact name of registrant as specified in charter)

300 Crescent Court

Suite 700

Dallas, Texas 75201

(Address of principal executive offices) (Zip code)

Highland Capital Management Fund Advisors, L.P.

300 Crescent Court

Suite 700

Dallas, Texas 75201

(Name and Address of Agent for Service)

Registrant's telephone number, including area code: (800) 357-9167

Date of fiscal year end: December 31

Date of reporting period: December 31, 2019

Item 1. Reports to Stockholders.

A copy of the Annual Report transmitted to shareholders pursuant to Rule 30e-1 under the Investment Company Act of 1940, as amended (the "1940 Act"), is attached herewith.

LOGO

 

Highland Income Fund

(formerly, Highland Floating Rate Opportunities Fund)

 

 

Annual Report

December 31, 2019

 

 

Beginning on January 1, 2021, as permitted by regulations adopted by the U.S. Securities and Exchange Commission, paper copies of the Fund’s annual and semi-annual shareholder reports will no longer be sent by mail, unless you specifically request paper copies of the reports. Instead, the reports will be made available on the Funds’ website (highlandfunds.com), and you will be notified by mail each time a report is posted and provided with a website link to access the report.

If you already elected to receive shareholder reports electronically, you will not be affected by this change and you need not take any action. You may elect to receive shareholder reports and other communications from the Fund electronically by contacting your financial intermediary (such as a broker-dealer or bank) or, if you are a direct investor, by contacting the Fund’s transfer agent at 1-800-357-9167.

You may elect to receive all future reports in paper free of charge. If you invest through a financial intermediary, you can contact your financial intermediary to request that you continue to receive paper copies of your shareholder reports. If you invest directly with the Fund, you can call 1-800-357-9167 to let the Fund know you wish to continue receiving paper copies of your shareholder reports. Your election to receive reports in paper will apply to all funds held in your account if you invest through your financial intermediary or all funds held with the fund complex if you invest directly with the Fund.


Highland Income Fund

 

TABLE OF CONTENTS

 

Portfolio Manager Commentary

     1  

Consolidated Fund Profile

     2  

Consolidated Financial Statements

     3  

Consolidated Investment Portfolio

     4  

Consolidated Statement of Assets and Liabilities

     14  

Consolidated Statement of Operations

     15  

Consolidated Statements of Changes in Net Assets

     16  

Consolidated Statement of Cash Flows

     18  

Consolidated Financial Highlights

     19  

Notes to Consolidated Financial Statements

     21  

Report of Independent Registered Public Accounting Firm

     41  

Additional Information

     42  

Approval of Investment Advisory Agreement

     43  

Trustees and Officers

     47  

Important Information About This Report

     52  

Economic and market conditions change frequently.

There is no assurance that the trends described in this report will continue or commence.

Privacy Policy

We recognize and respect your privacy expectations, whether you are a visitor to our web site, a potential shareholder, a current shareholder or even a former shareholder.

Collection of Information. We may collect nonpublic personal information about you from the following sources:

 

   

Account applications and other forms, which may include your name, address and social security number, written and electronic correspondence and telephone contacts;

 

   

Web site information, including any information captured through the use of “cookies”; and

 

   

Account history, including information about the transactions and balances in your accounts with us or our affiliates.

Disclosure of Information. We may share the information we collect with our affiliates. We may also disclose this information as otherwise permitted by law. We do not sell your personal information to third parties for their independent use.

Confidentiality and Security of Information. We restrict access to nonpublic personal information about you to our employees and agents who need to know such information to provide products or services to you. We maintain physical, electronic and procedural safeguards that comply with federal standards to guard your nonpublic personal information, although you should be aware that data protection cannot be guaranteed.

A prospectus must precede or accompany this report. Please read the prospectus carefully before you invest.


PORTFOLIO MANAGER COMMENTARY (unaudited)

 

 

 

As of December 31, 2019   Highland Income Fund (NYSE: HFRO)

 

Performance Overview

For the twelve-month period ended December 31, 2019, Highland Income Fund (the “Fund” or “HFRO”) experienced a total price return of 1.48% and a total NAV return of 4.30%. Over the same period, the Fund’s benchmark, the Credit Suisse Leveraged Loan Index (the “Index”), returned 8.17%. As of December 31, 2019, the Fund held investments in 91 issuers generating a 12-month yield of 7.33%. The weighted average loan price in the portfolio was $93.79, and the average price of collateralized loan obligation (“CLO”) debt was $87.98. In terms of composition, the Fund was allocated to 35.4% loans, 23.4% CLO debt, 39.2% equities, and 2.1% bonds.

Manager’s Discussion

The year 2019 was a bit of a roller coaster year in the leveraged loan market. Following the Federal Reserve System (the “Fed”) signaling it would continue raising interest rates at the end of 2018 and the ensuing market volatility, credit markets experienced a significant rebound to start 2019 as the Fed reassessed the environment and determined that it was warranted to pause further interest rate hikes. Over the next couple of months and as additional dovish commentary followed, risk market sentiment continued to improve. However, in late spring markets began to succumb to the uncertainty of a potentially prolonged trade dispute with China. While equity markets eventually recovered, the softness in the loan market persisted. In addition to macroeconomic uncertainty, retail loan outflows remained a consistent headwind as the Fed pause and subsequent rate cuts caused investors to reduce floating rate debt exposure. The price weakness finally reversed in December as we gained clarity on the trade front, boosting returns for loans to over 8%. Despite the better than expected result, the composition of that return was quite unusual. BB and B-rated issuances substantially outperformed their CCC-rated counterparts. Some of that trend reversed in December, but investor cautiousness remained a consistent theme throughout 2019.

As a result of the weak start and strong end to the year, the average loan price for the S&P/LSTA Leveraged Loan Price Index improved from 93.84 to 96.72. In addition to improving risk sentiment, CLO demand and lower issuance were able to mitigate the impact of persistent retail outflows. Net CLO issuance remained robust in 2019 and, at the lower end of forecasts, was down less than 10%. Meanwhile, net loan issuance was down over 30%. Although 2019 experienced a heightened level of defaults, commodity-sensitive sectors (energy and metals/mining) accounted for the majority and loan default rates remain modest at 1.64% on a trailing 12-month basis (slightly lower than where they began the year). Absent a material deterioration in economic performance, we do not anticipate an appreciable rise in the default rate during the near-term.

We continue to follow from the Highland Floating Rate Opportunities Fund an investment approach centered around a diverse set of opportunities. To this end and in addition to its traditional core portfolios of leveraged loans, CLO debt, and special situations, the Fund expanded its investment strategy in May and changed its name to the Highland Income Fund. The Fund’s ticker and investment objective (i.e., to provide a high level of current income consistent with the preservation of capital) did not change, but the policy of investing at least 80% of net assets in floating rate instruments was removed. Under the new strategy, the Fund has expanded upon its focus on floating rate investments to also include investments in securities or related instruments directly or indirectly secured by real estate. It is not envisioned that it will become a real estate only fund. However, at this point in the credit cycle, we believed it prudent to expand the investment scope to include other assets with similar income characteristics that may not be as correlated to traditional floating rate investments. We believe that this approach leverages Highland’s existing real estate capabilities and positions the Fund to better weather bouts of market turbulence should they arise in the future.

As we begin a new year, we are cautiously optimistic about returns in the credit markets. We expect the positive, but relatively low, economic growth environment to persist. We are entering an election year and are likely to continue to face trade headlines (possibly away from China), which may constrain further growth acceleration. However, this is not necessarily a negative for credit, as a hesitant Fed (combined with easy money globally) should provide a supportive backdrop for risk assets. Obviously, a reacceleration in growth and a concurrent rise in yields could be a good outcome for loans as well. Nonetheless, we expect the loan market technical to be more balanced in 2020. Most expect net loan and CLO issuance to drop in 2020. While loan retail outflows may continue, we believe the magnitude should be smaller going forward. Such outflows may prevent the price discount from narrowing much, but we believe a positive coupon is not unreasonable. However, we do expect some reversal of the quality trade experienced for much of last year. We believe that further upside for double-Bs is likely limited and that investors will increasingly look into the more downtrodden single-Bs for alpha generation. However, we do not believe there will be a widespread rally in CCC credits. There may be some catalyst-driven instances that have a successful outcome, but there still seems to be some persisting cautiousness amongst credit investors. Regardless of the opportunity set, we expect that the Fund’s flexible investment strategy will position it to positively traverse this next stage of the credit cycle. We continue to believe that upcoming opportunities will be defined around more idiosyncratic situations that favor a more active approach to investment management, and the ability to pursue those opportunities (and avoid others), regardless of asset class, should be beneficial and enhance the total return potential for the Fund.

We thank you for your continued support and investment in the Fund.

 

Annual Report       1


CONSOLIDATED FUND PROFILE (unaudited)

 

 

 

  Highland Income Fund

 

Objective

Highland Income Fund seeks to provide a high level of current income, consistent with preservation of capital.

 

Net Assets as of December 31, 2019

$995.4 million

 

Portfolio Data as of December 31, 2019

The information below provides a snapshot of Highland Income Fund at the end of the reporting period. Highland Income Fund is actively managed and the composition of its portfolio will change over time. Current and future holdings are subject to risk.

 

Quality Breakdown as of 12/31/2019(%)(1)  

AAA

       0.52  

BBB

       0.96  

BB

       16.69  

B

       42.80  

CCC

       6.30  

D

       1.75  

NR

       30.98  
Top 5 Sectors as of 12/31/2019(%)(1)(2)  

Real Estate

       46.5  

Financial

       40.9  

Information Technology

       10.2  

Healthcare

       8.3  

Communication Services

       5.9  
 

 

Top 10 Holdings as of 12/31/2019(%)(1)(2)(3)  

Creek Pine Holdings, LLC 10.25%, (Preferred Stock)

     20.9  

NFRO REIT SUB, LLC (Common Stock)

     9.6  

FREMF Mortgage Trust 7.70%, 2/25/2026 (Agency Collateralized Mortgage Obligations)

     6.1  

EDS Legacy Partners 7.50%, 12/14/2023 (U.S. Senior Loans)

     5.7  

SFR WLIF II, LLC (LLC Interest)

     5.2  

FREMF Mortgage Trust, 11/25/2029 (Agency Collateralized Mortgage Obligations)

     5.1  

CCS Medical, Inc., Term Loan 12.50%, 5/31/2020 (U.S. Senior Loans)

     4.8  

Metro-Goldwyn-Mayer, Inc. (Common Stock)

     3.9  

SFR WLIF III, LLC (LLC Interest)

     2.5  

Jernigan Capital, Inc. 7.00%, (Preferred Stock)

     2.5  

 

(1)  

Quality is calculated as a percentage of total credit instruments held by the portfolio. Sectors and holdings are calculated as a percentage of total net assets. The quality ratings reflected were issued by Standard & Poors, a nationally recognized statistical rating organization. Ratings are measured on a scale that generally ranges from AAA (highest) to D (lowest). Quality ratings reflect the credit quality of the underlying bonds in the Fund’s portfolio and not that of the Fund itself. Credit quality ratings assigned by a rating agency are subjective opinions, not statements of fact, and are subject to change, including daily. The ratings assigned by credit rating agencies are but one of the considerations that the Fund’s investment adviser incorporates into its credit analysis process, along with such other issuer specific factors as cash flows, capital structure and leverage ratios, ability to deleverage through free cash flow, quality of management, market positioning and access to capital, as well as such security-specific factors as the terms of the security (e.g., interest rate, and time to maturity) and the amount of any collateral.

 

(2) 

Sectors and holdings are calculated as a percentage of total net assets.

 

(3) 

Excludes the Fund’s investment in a cash equivalent.

 

2       Annual Report


CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

December 31, 2019   Highland Income Fund

 

A guide to understanding the Fund’s consolidated financial statements

 

Consolidated Investment Portfolio      The Investment Portfolio details all of the Fund’s holdings and its market value as of the last day of the reporting period. Portfolio holdings are organized by type of asset and industry to demonstrate areas of concentration and diversification.
Consolidated Statement of Assets and Liabilities      This statement details the Fund’s assets, liabilities, net assets and share price for each share class as of the last day of the reporting period. Net assets are calculated by subtracting all of the Fund’s liabilities (including any unpaid expenses) from the total of the Fund’s investment and noninvestment assets. The net asset value per share for each class is calculated by dividing net assets allocated to that share class by the number of shares outstanding in that class as of the last day of the reporting period.
Consolidated Statement of Operations      This statement reports income earned by the Fund and the expenses incurred by the Fund during the reporting period. The Statement of Operations also shows any net gain or loss the Fund realized on the sales of its holdings during the period as well as any unrealized gains or losses recognized over the period. The total of these results represents the Fund’s net increase or decrease in net assets from operations.
Consolidated Statements of Changes in Net Assets      These statements detail how the Fund’s net assets were affected by its operating results, distributions to shareholders and shareholder transactions (e.g., subscriptions, redemptions and distribution reinvestments) during the reporting period. The Statement of Changes in Net Assets also details changes in the number of shares outstanding.
Consolidated Statement of Cash Flows      This statement reports net cash and foreign currency provided or used by operating, investing and financing activities and the net effect of those flows on cash and foreign currency during the period.
Consolidated Financial Highlights      The Financial Highlights demonstrate how the Fund’s net asset value per share was affected by the Fund’s operating results. The Financial Highlights also disclose the classes’ performance and certain key ratios (e.g., net expenses and net investment income as a percentage of average net assets).
Notes to Consolidated Financial Statements      These notes disclose the organizational background of the Fund, certain of its significant accounting policies (including those surrounding security valuation, income recognition and distributions to shareholders), federal tax information, fees and compensation paid to affiliates and significant risks and contingencies.

 

Annual Report       3


CONSOLIDATED INVESTMENT PORTFOLIO

 

 

 

As of December 31, 2019   Highland Income Fund

 

    Principal Amount ($)    

 

    Value ($)    

 
 

U.S. Senior Loans (a) - 52.6%

 
  COMMERCIAL SERVICES - 2.6%  
  10,076,415    

American Traffic Solutions, Inc., VAR LIBOR USD 3 Month+3.750%, 02/21/25

    10,156,221  
  7,240,664    

EmployBridge LLC, 2018 Refinancing Term Loan, VAR LIBOR USD 3 Month+4.500%, 04/18/25

    7,132,054  
  8,520,740    

Fort Dearborn Holding Company, Inc., Initial Term Loan, VAR LIBOR USD 3 Month+4.000%, 10/19/23

    8,286,419  
   

 

 

 
      25,574,694  
   

 

 

 
  COMMUNICATION SERVICES - 1.1%  
  5,248,005    

iHeartCommunications Inc.,
Initial Term Loan, 1st Lien, 05/01/26

    5,299,383  
  6,119,646    

TerreStar Corporation, Term Loan D, 11.000% PIK, 02/27/20 (b)(d)

    6,107,407  
   

 

 

 
      11,406,790  
   

 

 

 
  CONSUMER DISCRETIONARY - 2.9%  
  13,545,751    

Truck Hero, Inc.,
Initial Term Loan, 1st Lien, VAR LIBOR USD 3 Month+3.750%, 04/22/24

    13,240,972  
  4,076,667    

Truck Hero, Inc.,
Initial Term Loan, 2nd Lien, VAR LIBOR USD 3 Month+8.250%, 04/21/25

    3,913,600  
  11,845,582    

USS Ultimate Holdings, Inc.,
Initial Term Loan, 1st Lien, VAR LIBOR USD 3 Month+3.750%, 08/09/24

    11,906,054  
   

 

 

 
      29,060,626  
   

 

 

 
  CONSUMER PRODUCTS - 1.3%  
  3,334,113    

Dayco Products, LLC,
Term Loan B, VAR LIBOR USD 3 Month+4.250%, 05/08/23

    2,942,355  
  10,068,966    

KIK Custom Products, Inc.,
Initial Term Loan, VAR LIBOR USD 3 Month+4.000%, 05/15/23

    9,912,896  
   

 

 

 
      12,855,251  
   

 

 

 
  ENERGY - 2.5%  
  15,904,030    

Fieldwood Energy LLC,
Closing Date Loan, 2nd Lien, VAR LIBOR USD 3 Month+7.250%, 04/11/23

    9,154,757  
  17,018,093    

Traverse Midstream Partners LLC, Term Loan, VAR LIBOR USD 3 Month+4.000%, 09/27/24

    15,452,429  
   

 

 

 
      24,607,186  
   

 

 

 
  FINANCIAL - 2.4%  
  9,850,000    

BCP Renaissance Parent LLC,
Term Loan B, VAR LIBOR USD 3 Month+3.500%, 10/31/24

    8,784,969  
  5,940,000    

Edelman Financial Center (The), Initial Term Loan, VAR LIBOR USD 3 Month+3.250%, 07/21/25

    5,983,926  

    Principal Amount ($)    

 

    Value ($)    

 
  FINANCIAL (continued)  
  9,447,348    

Edelman Financial Group (The), Term Loan, 2nd Lien, VAR LIBOR USD 3 Month+6.750%, 06/26/26

    9,459,157  
   

 

 

 
      24,228,052  
   

 

 

 
  GAMING/LEISURE - 1.1%  
  22,791,602    

Ginn-LA CS Borrower LLC,
Tranche A Term Loan Credit-Linked Deposit, 1st Lien, (b)(c)(d)

     
  48,851,124    

Ginn-LA CS Borrower LLC,
Tranche B Term Loan, 1st Lien, (b)(c)(d)

     
  13,442,392    

LLV Holdco, LLC, Revolving Exit Loan, 09/03/20 (b)(d)(e)

    10,753,914  
   

 

 

 
      10,753,914  
   

 

 

 
  HEALTHCARE - 8.2%  
  2,694,724    

American Renal Holdings Inc., Term Loan B, VAR LIBOR USD 3 Month+3.250%, 06/21/24

    2,567,452  
  13,680,556    

BW NHHC Holdco Inc.,
Initial Term Loan, 1st Lien, VAR LIBOR USD 3 Month+5.000%, 05/15/25

    11,286,458  
  58,712,985    

CCS Medical, Inc.,
Term Loan, 05/31/20 (b)(d)(e)

    47,733,657  
  247,500    

First Eagle Holdings, Inc. (fka Arnhold and S. Bleichroeder Holdings, Inc.), Refinancing Term Loan, VAR LIBOR USD 3 Month+2.750%, 12/02/24

    249,253  
  9,914,381    

Radnet Management, Inc.,
Term Loan B-1, 1st Lien, VAR LIBOR USD 3 Month+3.750%, 06/30/23

    9,982,542  
  1,777,778    

Sound Inpatient Physicians Holdings LLC, 2nd Lien, VAR LIBOR USD
3 Month+6.750%, 06/19/26

    1,795,556  
  8,245,988    

Surgery Center Holdings, Inc.
Term Loan B, VAR LIBOR USD
3 Month+3.250%, 09/02/24

    8,227,104  
   

 

 

 
      81,842,022  
   

 

 

 
  INDUSTRIALS - 3.4%  
  14,544,843    

Hayward Industries, Inc.,
Initial Term Loan, 1st Lien, VAR LIBOR USD 3 Month+3.500%, 08/05/24

    14,472,119  
  9,614,694    

Omnimax International, Inc., Unsecured Term Loan, 14.000% PIK, 02/06/21 (b)(d)(e)

    8,105,187  
  4,000,000    

PSC Industrial Holdings Corp.,
Initial Term Loan, 2nd Lien, VAR LIBOR USD 3 Month+8.500%, 10/11/25

    3,850,000  
  6,925,795    

PSC Industrial Holdings Corp., Term Loan, 1st Lien, VAR LIBOR USD
3 Month+3.750%, 10/11/24

    6,896,915  
   

 

 

 
      33,324,221  
   

 

 

 
 

 

4       See Glossary on page 13 for abbreviations along with accompanying Notes to Consolidated Financial  Statements.


CONSOLIDATED INVESTMENT PORTFOLIO (continued)

 

 

 

As of December 31, 2019   Highland Income Fund

 

    Principal Amount ($)    

 

    Value ($)    

 
 

U.S. Senior Loans (continued)

 
  INFORMATION TECHNOLOGY - 11.1%  
  13,834,475    

Avaya Inc.,
Tranche B Term Loan, VAR LIBOR USD
3 Month+4.250%, 12/15/24

    13,616,583  
  57,000,000    

EDS Legacy Partners,
VAR LIBOR USD 3 Month+2.750%, 12/14/23 (b)(d)(e)

    56,829,000  
  9,900,000    

Intermedia Holdings, Inc.,
New Term Loan, 1st Lien, VAR LIBOR USD 3 Month+6.000%, 07/21/25

    9,924,750  
  4,800,000    

Kronos Incorporated,
Initial Term Loan, 2nd Lien, VAR LIBOR USD 3 Month+8.250%, 10/18/24

    4,914,000  
  11,381,214    

Neustar, Inc.,
Term Loan B4, VAR LIBOR USD 3 Month+3.500%, 08/08/24

    10,531,891  
  14,794,577    

Procera Networks, Inc.,
Initial Term Loan, VAR LIBOR USD
3 Month+4.500%, 10/30/25

    14,634,352  
   

 

 

 
      110,450,576  
   

 

 

 
  MANUFACTURING - 0.4%  
  3,552,519    

VC GB Holdings, Inc.,
Refinancing Term Loan,
1st Lien, VAR LIBOR USD
3 Month+3.250%, 02/28/24

    3,534,756  
   

 

 

 
  OIL & GAS - 0.9%  
  9,239,286    

Lower Cadence Holdings LLC,
Initial Term Loan, 1st Lien, 05/08/26

    9,164,263  
   

 

 

 
  REAL ESTATE - 2.1%  
  9,138,462    

Forest City Enterprises, L.P.,
Replacement Term Loan, 1st Lien, 12/08/25

    9,201,288  
  11,910,000    

Specialty Building Products Holdings, LLC, Initial Term Loan, VAR LIBOR USD
3 Month+5.750%, 09/25/25

    11,895,112  
   

 

 

 
      21,096,400  
   

 

 

 
  RETAIL - 5.2%  
  18,553,012    

Academy, Ltd.,
Initial Term Loan, VAR LIBOR USD
3 Month+4.000%, 07/01/22

    15,350,761  
  15,580,675    

Dealer Tire, LLC,
Initial Term Loan, VAR LIBOR USD
3 Month+5.500%, 12/04/25

    15,629,442  
  1,178,368    

General Nutrition Centers, Inc.,
FILO Term Loan, VAR LIBOR USD
3 Month+7.000%, 12/31/22

    1,179,269  
  9,900,316    

General Nutrition Centers, Inc.,
Tranche B-2 Term Loan, 1st Lien, VAR LIBOR USD 3 Month+8.750%, 03/04/21

    9,383,669  
  10,127,989    

Jo-Ann Stores, LLC, Initial Loan, 1st Lien, VAR LIBOR USD
3 Month+5.000%, 10/20/23

    7,121,293  
  9,554,955    

Jo-Ann Stores, LLC,
Initial Loan, 2nd Lien, VAR LIBOR USD
3 Month+9.250%, 05/21/24

    3,447,714  
   

 

 

 
      52,112,148  
   

 

 

 

    Principal Amount ($)    

 

    Value ($)    

 
  SERVICE - 3.7%  
  6,650,498    

Advantage Sales & Marketing Inc., Initial Term Loan, 1st Lien, VAR LIBOR USD 3 Month+3.250%, 07/23/21

    6,458,465  
  2,172,325    

Advantage Sales & Marketing Inc., Term Loan B2, 1st Lien, VAR LIBOR USD
3 Month+3.250%, 07/23/21

    2,107,600  
  13,710,000    

Advantage Sales & Marketing Inc.,
Term Loan, 2nd Lien, VAR LIBOR USD 3 Month+6.500%, 07/25/22

    12,259,071  
  10,015,693    

CSC SW Holdco, Inc.
(fka CSC Serviceworks, Inc.), Term Loan B-1, 1st Lien, VAR LIBOR USD 3 Month+3.250%, 11/14/22

    9,954,898  
  5,960,081    

EnergySolutions, LLC (aka Envirocare of Utah, LLC), Initial Term Loan, 1st Lien, VAR LIBOR USD 3 Month+3.750%, 05/09/25

    5,649,055  
   

 

 

 
      36,429,089  
   

 

 

 
  TRANSPORTATION - 1.2%  
  11,669,365    

Gruden Acquisition, Inc.,
Incremental Term Loan, 1st Lien, VAR LIBOR USD 3 Month+5.500%, 08/18/22

    11,698,539  
   

 

 

 
  UTILITIES - 2.5%  
  11,397,995    

Eastern Power, LLC (Eastern Covert Midco, LLC), Term Loan, VAR LIBOR USD 3 Month+3.750%, 10/02/23

    11,445,182  
  2,319,304    

Granite Acquisition, Inc.,
Term Loan B, 2nd Lien, VAR LIBOR USD 3 Month+7.250%, 12/19/22

    2,327,027  
  11,780,034    

Lightstone Holdco LLC,
Refinancing Term Loan B, VAR LIBOR USD 3 Month+3.750%, 01/30/24

    10,861,191  
  664,412    

Lightstone Holdco LLC,
Refinancing Term Loan C, VAR LIBOR USD 3 Month+3.750%, 01/30/24

    612,588  
  59,127,210    

Texas Competitive Electric Holdings Co., LLC, Extended Escrow Loan (f) .

    53,215  
   

 

 

 
      25,299,203  
   

 

 

 
 

Total U.S. Senior Loans (Cost $633,689,739)

    523,437,730  
   

 

 

 

    Shares    

 
 

Preferred Stock - 30.1%

 
  ENERGY - 1.7%  
  1,790,983    

Crestwood Equity Partners 9.25% (g)

    16,530,773  
   

 

 

 
  FINANCIAL - 3.6%  
  516,666    

Creative Science Properties, Inc. (h)

    7,749,990  
  3,980    

Eastland Ltd. 1.00%, 05/01/2022

    1,657,935  
  85,000    

Federal Home Loan Mortgage 5.57% (g)(r)

    844,050  
  162,000    

Federal Home Loan Mortgage (g)(h)(r)

    2,886,340  
  525,000    

Federal Home Loan Mortgage 5.30% (g)

    9,660,000  
  225,315    

Federal Home Loan Mortgage 5.90% (g)(r)

    2,253,150  
 

 

See Glossary on page 13 for abbreviations along with accompanying Notes to Consolidated Financial  Statements.       5


CONSOLIDATED INVESTMENT PORTFOLIO (continued)

 

 

 

As of December 31, 2019   Highland Income Fund

 

    Shares    

 

    Value ($)    

 
 

Preferred Stock (continued)

 
  FINANCIAL (continued)  
  50,000    

Federal National Mortgage Association 8.25% (g)(r)

    566,500  
  100,000    

Federal National Mortgage Association 7.63% (g)(r)

    1,090,000  
  302,000    

Federal National Mortgage Association (g)(h)(r)

    5,199,500  
  30,000    

Federal National Mortgage Association 5.13% (g)(r)

    596,700  
  59,449    

Federal National Mortgage Association 5.38% (g)(r)

    3,803,855  
  3,840    

Federal National Mortgage Association 4.75% (g)(r)

    75,994  
   

 

 

 
      36,384,014  
   

 

 

 
  REAL ESTATE - 24.8%  
  645,161    

Braemar Hotels & Resorts, Inc., REIT 5.50% (g)(r)

    12,258,059  
  180,008    

Creek Pine Holdings, LLC, REIT 10.25% (b)(d)(g)

    208,435,249  
  24,415    

Jernigan Capital, Inc., REIT 7.00% (b)(d)(g)

    24,590,048  
  83,300    

Wheeler Real Estate Investment Trust, REIT 9.00% (g)

    915,467  
  74,600    

Wheeler Real Estate Investment Trust, REIT 8.75%, 10.75%, 09/21/23 (g)(j) .

    1,112,286  
   

 

 

 
      247,311,109  
   

 

 

 
 

Total Preferred Stock (Cost $273,945,468)

    300,225,896  
   

 

 

 

    Principal Amount ($)    

 
 

Collateralized Loan Obligations - 20.6%

 
  750,000    

Acis CLO, Ltd.,
Series 2014-4A, Class D VAR LIBOR USD 3 Month+3.100%, 5.01%, 5/1/2026 (k)(l)

    744,075  
  4,000,000    

Acis CLO, Ltd.,
Series 2014-3A, Class E VAR ICE LIBOR USD 3 Month+4.750%, 6.66%, 2/1/2026 (k)(l)(m)

    3,444,400  
  1,000,000    

Acis CLO, Ltd.,
Series 2015-6A, Class D VAR LIBOR USD 3 Month+3.770%, 5.68%, 5/1/2027 (k)(l)(m)

    997,500  
  7,000,000    

Acis CLO, Ltd.,
Series 2014-5A, Class D VAR LIBOR USD 3 Month+4.340%, 6.25%, 11/1/2026 (k)(l)(m)

    6,885,900  
  7,500,000    

Acis CLO, Ltd.,
Series 2015-6A, Class E VAR LIBOR USD 3 Month+5.490%, 7.40%, 5/1/2027 (k)(l)(m)

    6,543,750  
  14,750,000    

Acis CLO, Ltd.,
Series 2014-4A, Class E VAR ICE LIBOR USD 3 Month+4.800%, 6.71%, 5/1/2026 (k)(l)(m)

    12,611,250  
  1,750,000    

AMMC CLO XIV,
Series 2017-14A, Class B2L2 VAR ICE LIBOR USD 3 Month+6.530%, 8.47%, 7/25/2029 (k)(l)

    1,653,750  

    Principal Amount ($)    

 

    Value ($)    

 
  3,000,000    

Apidos CLO XXII,
Series 2015-22A, Class D VAR ICE LIBOR USD 3 Month+6.000%, 7.97%, 10/20/2027 (k)(l)

    2,940,000  
  2,300,000    

Atrium IX,
Series 2017-9A, Class ER VAR ICE LIBOR USD 3 Month+6.450%, 8.36%, 5/28/2030 (k)(l)

    2,277,000  
  2,000,000    

Benefit Street Partners CLO XI,
Series 2017-11A, Class E VAR ICE LIBOR USD 3 Month+7.200%, 9.20%, 4/15/2029 (k)(l)

    1,640,000  
  3,500,000    

BlueMountain CLO, Ltd.,
Series 2015- 3A, Class ER VAR LIBOR USD 3 Month+8.080%, 10.05%, 4/20/2031 (k)(l)(m)

    2,658,250  
  3,000,000    

BlueMountain CLO, Ltd.,
Series 2018- 1A, Class E VAR ICE LIBOR USD 3 Month+5.950%, 7.89%, 7/30/2030 (k)(l)

    2,810,533  
  1,500,000    

Bristol Park CLO,
Series 2016-1A, Class E VAR ICE LIBOR USD 3 Month+7.250%, 9.25%, 4/15/2029 (k)(l)

    1,501,842  
  3,500,000    

California Street CLO IX,
Series 2019- 9A, Class FR2 VAR ICE LIBOR USD 3 Month+8.520%, 10.80%, 7/16/2032 (k)(l)

    3,237,500  
  3,875,000    

Carlyle Global Market Strategies CLO,
Series 2018-1A, Class ER VAR ICE LIBOR USD 3 Month+5.400%, 7.40%, 4/17/2031 (k)(l)

    3,332,500  
  5,382,500    

Carlyle Global Market Strategies CLO,
Series 2019-1A, Class ER VAR ICE LIBOR USD 3 Month+6.940%, 8.91%, 7/20/2031 (k)(l)

    5,113,375  
  2,250,000    

Catamaran CLO, Ltd.,
Series 2015-1A, Class E VAR LIBOR USD 3 Month+5.150%, 7.10%, 4/22/2027 (k)(l)

    2,075,625  
  3,000,000    

Catamaran CLO, Ltd.,
Series 2014-2A, Class D VAR LIBOR USD 3 Month+4.850%, 6.85%, 10/18/2026 (k)(l)(m)

    2,784,600  
  1,250,000    

Cathedral Lake CLO,
Series 2013-1A, Class DR 9.25%, 10/15/2029 (l)

    1,154,000  
  4,000,000    

Cathedral Lake CLO,
Series 2016-4A, Class E2R VAR ICE LIBOR USD 3 Month+7.830%, 9.80%, 10/20/2028 (k)(l)(m)

    3,840,000  
  1,750,000    

CIFC Funding, Ltd.,
Series 2018-3A, Class FR VAR ICE LIBOR USD 3 Month+6.800%, 8.77%, 4/19/2029 (k)(l)

    1,400,000  
  1,000,000    

CIFC Funding, Ltd.,
Series 2018-1A, Class ER2 VAR LIBOR USD 3 Month+5.850%, 7.85%, 1/18/2031 (k)(l)

    945,000  
 

 

6       See Glossary on page 13 for abbreviations along with accompanying Notes to Consolidated Financial  Statements.


CONSOLIDATED INVESTMENT PORTFOLIO (continued)

 

 

 

As of December 31, 2019   Highland Income Fund

 

    Principal Amount ($)    

 

    Value ($)    

 
 

Collateralized Loan Obligations (continued)

 
  1,225,000    

CIFC Funding, Ltd.,
Series 2017-3A, Class D VAR ICE LIBOR USD 3 Month+6.000%, 7.97%, 7/20/2030 (k)(l)

    1,189,720  
  5,000,000    

CIFC Funding, Ltd.,
Series 2014-3A, Class FR2 VAR ICE LIBOR USD 3 Month+8.250%, 10.20%, 10/22/2031 (k)(l)(m)

    4,100,000  
  4,000,000    

Covenant Credit Partners CLO III,
Series 2017-1A, Class F VAR LIBOR USD 3 Month+7.950%, 9.95%, 10/15/2029 (k)(l)

    2,230,000  
  2,050,000    

Dryden 36 Senior Loan Fund,
Series 2019-36A, Class ER2 VAR ICE LIBOR USD 3 Month+6.880%, 8.88%, 4/15/2029 (k)(l)

    2,029,500  
  4,250,000    

Dryden 41 Senior Loan Fund,
Series 2018-41A, Class FR VAR ICE LIBOR USD 3 Month+7.200%, 9.19%, 4/15/2031 (k)(l)

    3,156,217  
  3,500,000    

Dryden 64 CLO,
Series 2018-64A, Class F VAR ICE LIBOR USD 3 Month+7.150%, 9.15%, 4/18/2031 (k)(l)(m)

    2,905,000  
  2,000,000    

Eaton Vance CLO,
Series 2019-1A, Class DRR VAR ICE LIBOR USD 3 Month+7.100%, 9.10%, 1/15/2028 (k)(l)

    2,000,000  
  8,000,000    

Eaton Vance CLO,
Series 2019-1A, Class F VAR ICE LIBOR USD 3 Month+8.250%, 10.25%, 4/15/2031 (k)(l)(m)

    7,520,000  
  1,000,000    

Galaxy XXIV CLO,
Series 2017-24A, Class E VAR ICE LIBOR USD 3 Month+5.500%, 7.50%, 1/15/2031 (k)(l)

    948,398  
  5,450,000    

Galaxy XXVI CLO, Series 2018-26A, Class F VAR LIBOR USD 3 Month+8.000%, 9.90%, 11/22/2031 (k)(l)

    4,796,000  
  3,000,000    

GoldenTree Loan Management US CLO 3,
Series 2018-3A, Class F VAR ICE LIBOR USD 3 Month+6.500%, 8.47%, 4/20/2030 (k)(l)

    2,516,550  
  3,500,000    

GoldenTree Loan Management US CLO 4,
Series 2014-4A, Class F VAR ICE LIBOR USD 3 Month+6.400%, 8.34%, 4/24/2031 (k)(l)

    2,992,500  
  3,500,000    

GoldenTree Loan Opportunities IX, Ltd.,
Series 2018-9A, Class FR2 VAR LIBOR USD 3 Month+7.640%, 9.57%, 10/29/2029 (k)(l)(m)

    3,080,000  
  2,000,000    

Greywolf CLO IV,
Series 2019-1A, Class D VAR ICE LIBOR USD 3 Month+6.940%,
8.94%, 4/17/2030 (k)(l)

    2,002,599  
  5,500,000    

Jamestown CLO IX,
Series 2019-9A, Class DR VAR ICE LIBOR USD 3 Month+6.940%, 8.91%, 10/20/2028 (k)(l)(m)

    5,498,517  

    Principal Amount ($)    

 

    Value ($)    

 
  6,000,000    

Jay Park CLO, Ltd.,
Series 2016-1A, Class ER VAR LIBOR USD 3 Month+7.350%, 9.32%, 10/20/2027 (k)(l)(m)

    5,250,000  
  3,000,000    

JFIN CLO, Ltd.,
Series 2013-1I, Class E VAR LIBOR USD 3 Month+6.000%, 7.97%, 1/20/2025 (k)

    3,000,000  
  3,000,000    

LCM XIII, Ltd., Series 2016-13A, Class ER VAR ICE LIBOR USD 3 Month+7.300%, 9.27%, 7/19/2027 (k)(l)(m)

    2,940,000  
  1,000,000    

LCM XXIII, Ltd.,
Series 2016-23A, Class D VAR LIBOR USD 3 Month+7.050%, 9.02%, 10/20/2029 (k)(l)(m)

    915,000  
  1,400,000    

Madison Park Funding XX,
Series 2018- 20A, Class ER VAR ICE LIBOR USD 3 Month+5.300%, 7.24%, 7/27/2030 (k)(l)

    1,295,000  
  5,000,000    

Madison Park Funding XXIV,
Series 2019-24A, Class ER VAR ICE LIBOR USD 3 Month+7.200%, 9.17%, 10/20/2029 (k)(l)

    5,000,000  
  1,000,000    

Madison Park Funding XXX,
Series 2018-30A, Class F VAR ICE LIBOR USD 3 Month+6.850%, 8.85%, 4/15/2029 (k)(l)

    900,000  
  490,000    

Magnetite VII, Ltd.,
Series 2018-7A, Class ER2 VAR LIBOR USD 3 Month+6.500%, 8.50%, 1/15/2028 (k)(l)

    448,350  
  4,500,000    

Man GLG US CLO,
Series 2018-1A, Class DR VAR LIBOR USD 3 Month+5.900%, 7.87%, 4/22/2030 (k)(l)

    3,771,150  
  500,000    

Mountain View CLO XIV,
Series 2019- 1A, Class F VAR ICE LIBOR USD 3 Month+8.700%, 10.70%, 4/15/2029 (k)(l)

    490,400  
  5,800,000    

MP CLO VII,
Series 2018-1A, Class FRR VAR ICE LIBOR USD 3 Month+7.910%, 9.91%, 10/18/2028 (k)(l)

    4,497,707  
  1,575,000    

Nassau, Ltd.,
Series 2017-IA, Class D VAR LIBOR USD 3 Month+6.180%, 8.18%, 10/15/2029 (k)(l)

    1,417,500  
  3,000,000    

Neuberger Berman CLO XX, Ltd.,
Series 2017-20A, Class FR VAR ICE LIBOR USD 3 Month+7.450%, 9.45%, 1/15/2028 (k)(l)(m)

    2,802,385  
  4,000,000    

Northwoods Capital XII-B, Ltd.,
Series 2018-12BA, Class F VAR LIBOR USD 3 Month+8.170%, 10.06%, 6/15/2031 (k)(l)

    3,000,000  
  1,000,000    

OZLM Funding III,
Series 2016-3A, Class DR VAR ICE LIBOR USD 3 Month+7.770%, 9.72%, 1/22/2029 (k)(l)

    995,000  
  3,110,000    

OZLM XXII, Ltd.,
Series 2018-22A, Class E VAR LIBOR USD 3 Month+7.390%, 9.39%, 1/17/2031 (k)(l)

    2,550,200  
 

 

See Glossary on page 13 for abbreviations along with accompanying Notes to Consolidated Financial  Statements.       7


CONSOLIDATED INVESTMENT PORTFOLIO (continued)

 

 

 

As of December 31, 2019   Highland Income Fund

 

    Principal Amount ($)    

 

    Value ($)    

 
 

Collateralized Loan Obligations (continued)

 
  1,750,000    

Palmer Square CLO, Ltd.,
Series 2019- 1A, Class DR2 VAR ICE LIBOR USD 3 Month+6.250%, 8.14%, 5/21/2029 (k)(l)

    1,731,450  
  4,000,000    

Regatta VII Funding,
Series 2016-1A, Class ER 6.86%, 12/20/2028 (m)

    3,780,000  
  3,150,000    

Saranac CLO III, Ltd.,
Series 2018-3A, Class ER VAR LIBOR USD 3 Month+7.500%, 9.43%, 6/22/2030 (k)(l)

    2,929,500  
  5,000,000    

Saranac CLO VI, Ltd.,
Series 2018-6A, Class E VAR LIBOR USD 3 Month+6.400%, 8.29%, 8/13/2031 (k)(l)

    4,284,350  
  3,000,000    

Shackleton CLO IX, Ltd.,
Series 2016- 9A, Class E VAR ICE LIBOR USD 3 Month+6.760%, 8.73%, 10/20/2028 (k)(l)(m)

    2,855,700  
  1,500,000    

Symphony CLO XXI,
Series 2019-21A, Class E VAR ICE LIBOR USD 3 Month+6.750%, 9.11%, 7/15/2032 (k)(l)

    1,502,550  
  2,000,000    

TCI-Flatiron CLO,
Series 2019-1A, Class ER VAR ICE LIBOR USD 3 Month+6.900%, 8.90%,7/17/2028 (k)(l)

    2,000,000  
  1,000,000    

TCW CLO,
Series 2019-1A, Class F VAR ICE LIBOR USD 3 Month+8.670%, 10.58%, 2/15/2029 (k)(l)

    960,000  
  2,200,000    

TICP CLO I-2,
Series 2018-IA, Class E VAR ICE LIBOR USD 3 Month+8.000%, 9.94%, 4/26/2028 (k)(l)

    1,915,430  
  4,150,000    

TICP CLO III-2, Ltd.,
Series 2018-3R, Class F VAR LIBOR USD 3 Month+7.980%, 9.95%, 4/20/2028 (k)(l)

    3,484,340  
  2,000,000    

Trinitas CLO III, Ltd.,
Series 2015-3A, Class E VAR LIBOR USD 3 Month+5.250%, 7.25%, 7/15/2027 (k)(l)

    1,380,000  
  9,000,000    

Trinitas CLO X,
Series 2019-10A, Class F VAR LIBOR USD 3 Month+7.785%, 9.79%, 4/15/2032 (k)(l)

    7,965,000  
  5,580,000    

Voya CLO, Ltd.,
Series 2019-2A, Class DR VAR ICE LIBOR USD 3 Month+7.110%, 9.08%, 7/19/2028 (k)(l)

    5,496,300  
  3,200,000    

Voya CLO, Ltd.,
Series 2018-4A, Class ER VAR LIBOR USD 3 Month+9.050%, 11.05%, 7/14/2031 (k)(l)

    3,186,854  
  3,000,000    

Zais CLO 3, Ltd.,
Series 2018-3A, Class DR VAR LIBOR USD 3 Month+6.910%, 8.91%, 7/15/2031 (k)(l)

    2,167,500  

    Principal Amount ($)    

 

    Value ($)    

 
  3,300,000    

Zais CLO 8, Ltd.,
Series 2018-1A, Class E VAR LIBOR USD 3 Month+5.250%, 7.25%, 4/15/2029 (k)(l)

    2,516,250  
   

 

 

 
 

Total Collateralized Loan Obligations
(Cost $220,149,033)

    204,983,767  
   

 

 

 

    Shares    

 
 

Common Stocks - 16.6%

 
  COMMUNICATION SERVICES - 4.8%  
  49,600    

Loral Space & Communications, Inc. (i)(r)

    1,603,072  
  502,161    

Metro-Goldwyn-Mayer, Inc. (i)(n)

    38,582,787  
  27,134    

TerreStar Corporation (b)(d)(n)

    7,520,731  
   

 

 

 
      47,706,590  
   

 

 

 
  CONSUMER DISCRETIONARY - 0.7%  
  1,450    

Toys ‘R’ Us (i)

    362,542  
  1,450    

Tru Kids, Inc. (i)

    6,888,308  
   

 

 

 
      7,250,850  
   

 

 

 
  ENERGY - 0.3%  
  167,419    

Fieldwood Energy LLC (i)

    3,376,339  
  1,118,286    

Value Creation, Inc. (b)(d)(i)

    1  
   

 

 

 
      3,376,340  
   

 

 

 
  GAMING/LEISURE - 0.0%  
  34,512    

LLV Holdco LLC - Series A, Membership Interest (b)(d)(e)(i)

     
  436    

LLV Holdco LLC - Series B, Membership Interest (b)(d)(e)(i)

     
   

 

 

 
       
   

 

 

 
  HEALTHCARE - 0.1%  
  207,031    

CCS Medical Inc. (b)(d)(e)(i)

    72,254  
  18,750    

Portola Pharmaceuticals, Inc. (i)

    447,750  
   

 

 

 
      520,004  
   

 

 

 
  HOUSING - 0.0%  
  1,648,350    

Westgate Investments LLC (b)(d)(i)

     
   

 

 

 
  INDUSTRIALS - 0.0%  
  250,627    

Remington Outdoor Co., Inc. (i)

    175,439  
   

 

 

 
  MATERIALS - 0.2%  
  299,032    

MPM Holdings, Inc. (i)

    1,495,160  
  14,621    

Omnimax International, Inc. (b)(d)(e)(i)

    45,617  
   

 

 

 
      1,540,777  
   

 

 

 
  REAL ESTATE - 10.5%  
  1,393,678    

Allenby (b)(d)(e)(i)

    1  
  15,790    

Alpine Income Property Trust

    300,484  
  571,700    

City Office, REIT (r)

    7,729,384  
  9,370,190    

Claymore (b)(d)(e)(i)

    9  
  31,232    

Jernigan Capital, Inc., REIT

    597,781  
  4,328,483    

NFRO REIT SUB, LLC (b)(d)(e)(i)

    95,747,521  
   

 

 

 
      104,375,180  
   

 

 

 
 

Total Common Stocks (Cost $444,029,340)

    164,945,180  
   

 

 

 
 

 

8       See Glossary on page 13 for abbreviations along with accompanying Notes to Consolidated Financial  Statements.


CONSOLIDATED INVESTMENT PORTFOLIO (continued)

 

 

 

As of December 31, 2019   Highland Income Fund

 

    Principal Amount ($)    

 

    Value ($)    

 
 

Agency Collateralized Mortgage Obligations (l) - 14.2%

 
  60,608,606    

FREMF Mortgage Trust,
Series 2019- KF60, Class C VAR LIBOR USD 1 Month+6.000%, 7.70%, 2/25/2026 (m)

    60,487,389  
  114,251,407    

FREMF Mortgage Trust,
Series 2019- K99, Class D 0.00%, 11/25/2029

    50,727,625  
  54,160,055    

FREMF Mortgage Trust,
Series 2019- K97, Class D 0.00%, 1/25/2030 (m)

    24,088,768  
  588,459,986    

FREMF Mortgage Trust,
Series 2019- K97, Class X2A 0.10%, 7/25/2029 (o)

    4,719,449  
  133,593,827    

FREMF Mortgage Trust,
Series 2019- K97, Class X2B 0.10%, 1/25/2030 (o)

    1,047,375  
   

 

 

 
 

Total Agency Collateralized Mortgage Obligations
(Cost $141,185,124)

    141,070,606  
   

 

 

 
 

LLC Interest (b)(d)(e) - 8.9%

 
  11,854,986    

SFR WLIF I, LLC

    11,680,955  
  52,666,032    

SFR WLIF II, LLC

    52,169,918  
  25,478,982    

SFR WLIF III, LLC

    24,926,597  
   

 

 

 
 

Total LLC Interest
(Cost $90,000,000)

    88,777,470  
   

 

 

 
 

Corporate Bonds & Notes - 3.1%

 
  ENERGY - 0.1%  
  15,600,000    

Ocean Rig UDW, Inc. 7.25%, 04/01/19 (b)(c)(d)(l)

    1,076,400  
  5,000,000    

Rex Energy Corp.
8.00%, 10/03/19 (c)

    50,000  
   

 

 

 
      1,126,400  
   

 

 

 
  INDUSTRIALS - 0.0%  
  7,500,000    

American Airlines (c)

    190,395  
   

 

 

 
  REAL ESTATE - 0.2%  
  2,000,000    

CBL & Associates
5.95%, 12/15/26 (r)

    1,204,645  
   

 

 

 
  UTILITIES - 2.8%  
  13,753,863    

Bruce Mansfield Unit 1 2007 Pass- Through Trust
6.85% (c)(r)

    12,079,259  
  5,958,000    

Pacific Gas & Electric 6.05%, 03/01/34 (c)(r)

    6,252,027  
  4,000,000    

6.25%, 03/01/39 (c)(r)

    4,223,740  
  5,000,000    

6.35%, 02/15/38 (c)(r)

    5,307,825  
  8,000,000    

Texas Competitive Electric Holdings Co., LLC (c)(f)

    26,000  
  20,000,000    

Texas Competitive Electric Holdings Co., LLC
10.25%, 11/01/15 (c)(f)

    96,000  
   

 

 

 
      27,984,851  
   

 

 

 
 

Total Corporate Bonds & Notes (Cost $41,529,648)

    30,506,291  
   

 

 

 

    Principal Amount ($)    

 

    Value ($)    

 
 

Purchased Call Options (i) - 1.8%

 
 

Total Purchased Call Options (Cost $9,735,246)

    18,359,600  
   

 

 

 

    Shares    

 
 

Registered Investment Company - 1.8%

 
  989,143    

NexPoint Strategic Opportunities Fund (e)(r)

    17,517,723  
   

 

 

 
 

Total Registered Investment Companies (Cost $17,788,175)

    17,517,723  
   

 

 

 

    Units    

 
 

Rights (i) - 0.1%

 
  Utilities - 0.1%  
  1,117,866    

Texas Competitive Electric Holdings Co., LLC

    1,175,995  
   

 

 

 
 

Total Rights
(Cost $3,878,018)

    1,175,995  
   

 

 

 
 

Warrants (i) - 0.0%

 
  ENERGY - 0.0%  
  5,801    

Arch Coal, Inc., Expires 10/08/2023

    175,480  
   

 

 

 
  INDUSTRIALS - 0.0%  
  453    

Omnimax Holdings, Inc., Expires 12/31/2049(b)(d)(e)

    1,412  
  178,140    

Remington Outdoor Co., Inc.

     
   

 

 

 
      1,412  
   

 

 

 
 

Total Warrants
(Cost $264,794)

    176,892  
   

 

 

 

    Principal Amount ($)    

 
 

Claims (b)(c)(d)(i)(p) - 0.0%

 
  Communication Services - 0.0%  
  3,791,858    

Lehman Brothers Commercial Paper LCPI Claim Facility

    52,138  
   

 

 

 
 

Total Claims
(Cost $1,814,883)

    52,138  
   

 

 

 

    Shares    

 
 

Cash Equivalent (q) - 3.4%

 
  MONEY MARKET FUND - 3.4%  
  33,588,954    

Dreyfus Treasury & Agency Cash Management, Institutional Class 1.490%

    33,588,954  
   

 

 

 
 

Total Cash Equivalent
(Cost $33,588,954)

    33,588,954  
   

 

 

 
 

Total Investments - 153.2%

    1,524,818,242  
   

 

 

 
 

(Cost $1,911,598,422)

 
 

 

See Glossary on page 13 for abbreviations along with accompanying Notes to Consolidated Financial  Statements.       9


CONSOLIDATED INVESTMENT PORTFOLIO (continued)

 

 

 

As of December 31, 2019   Highland Income Fund

 

    Shares    

 

    Value ($)    

 
 

Securities Sold Short - (0.9)%

 
 

Common Stock - (0.9)%

 
  INFORMATION TECHNOLOGY - (0.9)%  
  (70,750)    

Texas Instruments, Inc.

    (9,076,517
   

 

 

 
 

Total Common Stocks
(Proceeds $8,472,623)

    (9,076,517
   

 

 

 
 

Total Securities Sold Short - (0.9)% (Proceeds $8,472,623)

    (9,076,517
   

 

 

 
 

Other Assets & Liabilities, Net - (52.3)%

    (520,336,800
   

 

 

 
 

Net Assets - 100.0%

    995,404,925  
   

 

 

 

 

(a)

Senior loans (also called bank loans, leveraged loans, or floating rate loans) in which the Fund invests generally pay interest at rates which are periodically determined by reference to a base lending rate plus a spread (unless otherwise identified, all senior loans carry a variable rate of interest). These base lending rates are generally (i) the Prime Rate offered by one or more major United States banks, (ii) the lending rate offered by one or more European banks such as the London Interbank Offered Rate (“LIBOR”) or (iii) the Certificate of Deposit rate. As of December 31, 2019, the LIBOR USD 3 Month rate was 1.91%. Senior loans, while exempt from registration under the Securities Act of 1933, as amended (the “1933 Act”), contain certain restrictions on resale and cannot be sold publicly. Senior secured floating rate loans often require prepayments from excess cash flow or permit the borrower to repay at its election. The degree to which borrowers repay, whether as a contractual requirement or at their election, cannot be predicted with accuracy. As a result, the actual remaining maturity maybe substantially less than the stated maturity shown.

(b)

Securities with a total aggregate value of $555,848,016, or 55.8% of net assets, were classified as Level 3 within the three-tier fair value hierarchy. Please see Notes to Investment Portfolio for an explanation of this hierarchy, as well as a list of unobservable inputs used in the valuation of these instruments.

(c)

The issuer is, or is in danger of being, in default of its payment obligation.

(d)

Represents fair value as determined by the Fund’s Board of Trustees (the “Board”), or its designee in good faith, pursuant to the policies and procedures approved by the Board. The Board considers fair valued securities to be securities for which market quotations are not readily available and these securities may be valued using a combination of observable and unobservable inputs. Securities with a total aggregate value of $555,848,016, or 55.8% of net assets, were fair valued under the Fund’s valuation procedures as of December 31, 2019. Please see Notes to Investment Portfolio.

(e)

Affiliated issuer. Assets with a total aggregate market value of $325,583,765, or 31.9% of net assets, were affiliated with the Fund as of December 31, 2019.

(f)

Represents value held in escrow pending future events. No interest is being accrued.

(g)

Perpetual security with no stated maturity date.

(h)

There is currently no rate available.

(i)

Non-income producing security.

(j)

Step Bonds - Represents the current rate, the step rate and the step date.

(k)

Variable or floating rate security. The base lending rates are generally the lending rate offered by one or more European banks such as the LIBOR. The interest rate shown reflects the rate in effect December 31, 2019. LIBOR, otherwise known as London Interbank Offered Rate, is the benchmark interest rate that banks charge each other for short-term loans. Current LIBOR rates include 3 months equal to 1.91%.

(l)

Securities exempt from registration under Rule 144A of the 1933 Act. These securities may only be resold in transaction exempt from registration to qualified institutional buyers. At December 31, 2019, these securities amounted to $340,350,773 or 34.2% of net assets.

 

(m)

As of December 31, 2019, investments with a total aggregate value of $165,988,409 were fully or partially segregated with broker(s)/custodian as collateral for reverse repurchase agreements.

(n)

Restricted Securities. These securities are not registered and may not be sold to the public. There are legal and/or contractual restrictions on resale. The Fund does not have the right to demand that such securities be registered. The values of these securities are determined by valuations provided by pricing services, brokers, dealers, market makers, or in good faith under the procedures established by the Fund’s Board of Trustees. Additional Information regarding such securities follows:

 

Restricted
Security
  Security
Type
    Acquisition
Date
    Cost of
Security
    Market Value
at Year End
    Percent
of Net
Assets
 

Metro-Goldwyn- Mayer, Inc.

    Common Stocks       12/20/2010     $ 21,845,688     $ 38,582,787       3.9

TerreStar Corporation

    Common Stocks       3/16/2018     $ 3,093,276     $ 7,520,731       0.8

 

(o)

Interest only security (“IO”). These types of securities represent the right to receive the monthly interest payments on an underlying pool of mortgages. Payments of principal on the pool reduce the value of the “interest only” holding.

(p)

These positions represent claims that have been filed with the United States Bankruptcy Court Southern District of New York against Lehman Commercial Paper, Inc. UK Branch.

(q)

Rate shown is 7 day effective yield.

(r)

All or part of this security is pledged as collateral for short sales. The market value of the securities pledged as collateral was $37,810,949.

 

 

10       See Glossary on page 13 for abbreviations along with accompanying Notes to Consolidated Financial  Statements.


CONSOLIDATED INVESTMENT PORTFOLIO (continued)

 

 

 

As of December 31, 2019   Highland Income Fund

 

Futures contracts outstanding as of December 31, 2019 were as follows:

 

Description    Expiration
Date
     Number of
Contracts
    Notional
Value
    Unrealized
Depreciation
    Value  

Short Futures:

           

Russell 2000 Index E-MINI

     March 2020        (1,350   $ (110,476,136   $ (2,289,364   $ (112,765,500

These are exchange traded future contracts, therefore, a Level 1 fair value security.

Purchased options contracts outstanding as of December 31, 2019 were as follows:

 

Description    Exercise
price
     Counterparty      Expiration
Date
   Number of
Contracts
     Notional
Value
     Premium      Value  

PURCHASED CALL OPTIONS:

                    

USD Call/CNH Put

   $ 7.45        BNP      February 2020      300,000,000      $ 2,088,000,000      $ 699,000      $ 40,500  

USD Call/CNH Put

     7.70        BNP      October 2020      200,000,000        1,392,000,000        1,300,000        557,600  

USD Call/HKD Put

     7.85        BNP      January 2020      250,000,000        1,947,500,000        325,000        55,000  

USD Call/HKD Put

     7.80        BNP      June 2020      125,000,000        973,750,000        558,250        381,500  

iShares MSCI Brazil ETF

     45.00        Jefferies      March 2020      45,000        212,400,000        6,852,996        17,325,000  
                 

 

 

    

 

 

 
                  $ 9,735,246      $ 18,359,600  
                 

 

 

    

 

 

 

 

Description    Exercise
price
     Counterparty      Expiration
Date
     Number of
Contracts
    Notional
Value
    Premium     Value  

WRITTEN PUT OPTION:

                 

iShares MSCI Brazil ETF

   $ 42.00        Jefferies        March 2020        (22,000   $ (103,840,000   $ (5,955,523   $ (1,518,000

The average amount of borrowing by the Fund on reverse repurchase agreements outstanding during the year ended December 31, 2019 was $50,171,540 at a weighted average interest rate of 3.78% for BNP Securities and $34,233,551 at a weighted average interest rate of 3.51% for Mizuho Securities.

Reverse Repurchase Agreements outstanding as of December 31, 2019 were as follows:

 

Counterparty    Collateral Pledged    Interest
Rate
     Trade
Date
     Maturity
Date
     Repurchase
Amount
    Principal
Amount
    Value  

BNP

   Acis CLO, Ltd., Series 2014-3A, Class E, VAR ICE LIBOR USD 3 Month+4.750%, 6.66%, 02/01/26      3.235        12/20/2019        1/17/2020      $ (2,120,121   $ (4,000,000   $ (2,114,800

BNP

   Acis CLO, Ltd., Series 2014-4A, Class E, VAR ICE LIBOR USD 3 Month+4.800%, 6.71%, 05/01/26      3.235        12/20/2019        1/17/2020        (9,005,352     (14,750,000     (8,982,750

BNP

   Acis CLO, Ltd., Series 2014-5A, Class D, VAR ICE LIBOR USD 3 Month+4.340%, 6.25%, 11/01/26      2.785        12/20/2019        1/21/2020        (5,415,005     (7,000,000     (5,403,300

BNP

   Acis CLO, Ltd., Series 2015-6A, Class E, VAR ICE LIBOR USD 3 Month+5.490%, 7.40%, 05/01/27      3.235        12/20/2019        1/17/2020        (4,766,964     (7,500,000     (4,755,000

BNP

   Acis CLO, Ltd., Series 2015-6A, Class D, VAR ICE LIBOR USD 3 Month+3.770%, 5.68%, 05/01/27      2.785        12/20/2019        1/17/2020        (769,363     (1,000,000     (767,700

BNP

   BlueMountain CLO, Ltd., Series 2015-3A, Class ER, VAR ICE LIBOR USD 3 Month+8.080%, 10.05%, 04/20/31      3.727        10/7/2019        1/6/2020        (2,037,208     (3,500,000     (2,018,800

BNP

   Catamaran CLO, Ltd., Series 2014-2A, Class D, VAR ICE LIBOR USD 3 Month+4.850%, 6.85%, 10/18/26      3.750        10/15/2019        1/15/2020        (2,033,198     (3,000,000     (2,013,900

BNP

   Cathedral Lake CLO, Series 2016-4A, Class E2R, VAR ICE LIBOR USD 3 Month+7.830%, 9.80%, 10/20/28      3.163        12/5/2019        1/3/2020        (2,949,496     (4,000,000     (2,942,000

BNP

   CIFC Funding, Ltd., Series 2014-3A, Class FR2, VAR ICE LIBOR USD 3 Month+8.250%, 10.20%, 10/22/31      3.727        10/7/2019        1/6/2020        (2,887,449     (5,000,000     (2,860,500

BNP

   Dryden 64 CLO, Series 2018-64A, Class F, VAR ICE LIBOR USD 3 Month+7.150%, 9.15%, 04/18/31      3.727        10/7/2019        1/6/2020        (1,919,465     (3,500,000     (1,901,550

BNP

   Eaton Vance CLO, Series 2019-1A, Class F, VAR ICE LIBOR USD 3 Month+8.250%, 10.25%, 04/15/31      3.727        12/16/2019        1/6/2020        (1,624,364     (3,000,000     (1,615,500

BNP

   Eaton Vance CLO, Series 2019-1A, Class F, VAR ICE LIBOR USD 3 Month+8.250%, 10.25%, 04/15/31      3.727        12/16/2019        1/6/2020        (2,725,412     (5,000,000     (2,719,500

Mizuho

   FREMF Mortgage Trust, Series 2019-K97, Class D, 0.00%, 1/25/30      3.100        10/25/2019        1/25/2020        (18,068,000     (54,160,055     (18,068,000

Mizuho

   FREMF Mortgage Trust, Series 2019-KF60, Class C, VAR ICE LIBOR USD 1 Month+6.000% 7.70%, 2/25/26      3.080        10/30/2019        1/30/2020        (45,824,876     (60,608,606     (45,467,000

BNP

   GoldenTree Loan Opportunities IX, Ltd., Series 2014-9A, Class FR2, VAR ICE LIBOR USD 3 Month+7.640%, 9.57%, 10/29/29      3.255        12/27/2019        1/27/2020        (1,962,686     (3,500,000     (1,957,200

 

See Glossary on page 13 for abbreviations along with accompanying Notes to Consolidated Financial  Statements.       11


CONSOLIDATED INVESTMENT PORTFOLIO (concluded)

 

 

 

As of December 31, 2019   Highland Income Fund

 

Counterparty    Collateral Pledged    Interest
Rate
     Trade
Date
     Maturity
Date
     Repurchase
Amount
    Principal
Amount
    Value  

BNP

   Jamestown CLO IX, Series 2019-9A, Class DR, VAR ICE LIBOR USD 3 Month+6.940%, 8.91%, 10/20/28      3.255        12/30/2019        1/29/2020      $ (3,973,499   $ (5,500,000   $ (3,962,750

BNP

   Jay Park CLO, Ltd., Series 2016-1A, Class ER, VAR ICE LIBOR USD 3 Month+7.350%, 9.32%, 10/20/27      3.255        12/27/2019        1/27/2020        (3,350,766     (6,000,000     (3,341,400

BNP

   LCM XIII, Ltd., Series 2016-13A, Class ER, VAR ICE LIBOR USD 3 Month+7.300%, 9.27%, 07/19/27      3.255        12/27/2019        1/27/2020        (2,079,412     (3,000,000     (2,073,600

BNP

   LCM XXIII, Ltd., Series 2016-23A, Class D, VAR ICE LIBOR USD 3 Month+7.050%, 9.02%, 10/20/29      3.255        12/27/2019        1/27/2020        (691,433     (1,000,000     (689,500

BNP

   Neuberger Berman CLO XX, Ltd., Series 2017-20A, Class FR, VAR ICE LIBOR USD 3 Month+7.450%, 9.45%, 01/15/28      3.255        12/27/2019        1/27/2020        (1,688,018     (3,000,000     (1,683,300

BNP

   Regatta VII Funding, Series 2016-1A, Class ER, 6.86%, 12/20/28      3.255        12/27/2019        1/27/2020        (1,409,740     (2,000,000     (1,405,800

BNP

   Regatta VII Funding, Series 2016-1A, Class ER, 6.86%, 12/20/28      3.163        12/5/2019        1/3/2020        (869,460     (1,250,000     (867,250

BNP

   Shackleton CLO IX, Ltd., Series 2016-9A, Class E, VAR ICE LIBOR USD 3 Month+6.760%, 8.73%, 10/20/28      3.477        10/7/2019        1/6/2020        (2,204,709     (3,000,000     (2,185,500
                  

 

 

 

Total Reverse Repurchase Agreements

                $ (119,796,600
                  

 

 

 

 

12       See Glossary on page 13 for abbreviations along with accompanying Notes to Consolidated Financial  Statements.


GLOSSARY: (abbreviations that may be used in the preceding statements)(unaudited)

 

 

 

Other Abbreviations:
CLO   Collateralized Loan Obligation
FREMF   Freddie Mac Multi-Family
ICE   Intercontinental Exchange
LIBOR   London Interbank Offered Rate
PIK   Payment In-Kind
REIT   Real Estate Investment Trust
USD   United States Dollar
VAR   Variable

 

Annual Report       13


CONSOLIDATED STATEMENT OF ASSETS AND LIABILITIES

 

 

 

As of December 31, 2019   Highland Income Fund

 

      $  

Assets

  

Investments from unaffiliated issuers, at value(a)

     1,165,645,523  

Affiliated investments, at value (Note 10)

     325,583,765  
  

 

 

 

Total Investments, at value

     1,491,229,288  

Cash equivalents (Note 2)

     33,588,954  

Cash

     4,362,660  

Restricted Cash — Securities Sold Short and Written Options (Notes 2)

     9,100,343  

Restricted Cash — Futures (Note 3)

     4,455,000  

Receivable for:

  

Variation margin

     783,337  

Investments sold and principal paydowns

     9,378,485  

Dividends and interest

     13,122,475  

Fund shares sold

     101,566  

Due from broker

     4,624,535  

Prepaid expenses and other assets

     935,987  
  

 

 

 

Total assets

     1,571,682,630  
  

 

 

 

Liabilities:

  

Line of credit (Note 6)

     300,000,000  

Securities sold short, at value (Notes 2 and 8)

     9,076,517  

Reverse repurchase agreements (Note 3)

     119,796,600  

Written options contracts, at value (Note 3)

     1,518,000  

Payable for:

  

Due to broker

     3,324,533  

Investment advisory and administration fees (Note 7)

     1,135,768  

Interest expense and commitment fee payable (Note 6)

     1,009,760  

Custody fees

     123,375  

Investments purchased

     15,110  

Accrued expenses and other liabilities

     521,793  
  

 

 

 

Total liabilities

     436,521,456  
  

 

 

 

Mezzanine Equity:

  

Cumulative preferred shares (Series A), net of deferred financing costs (Note 1 and 2)

     139,756,249  
  

 

 

 

Net Assets

     995,404,925  
  

 

 

 

Net Assets Consist of:

  

Paid-in capital

     1,618,711,203  

Total accumulated losses

     (623,306,278
  

 

 

 

Net Assets

     995,404,925  
  

 

 

 

Investments, at cost

     1,252,964,878  

Affiliated investments, at cost (Note 10)

     625,044,590  

Cash equivalents, at cost (Note 2)

     33,588,954  

Proceeds from securities sold short

     8,472,623  

Written options premiums received

     5,955,523  

Common Shares

  

Shares outstanding ($0.001 par value; unlimited authorization)

     71,736,075  

Net asset value per share (Net assets/shares outstanding)

     13.88  

 

14       See accompanying Notes to Consolidated Financial Statements.


CONSOLIDATED STATEMENT OF OPERATIONS

 

 

 

For the Year Ended December 31, 2019   Highland Income Fund

 

      $  

Investment Income

  

Income:

  

Dividends from unaffiliated issuers

     4,633,926  

Dividends from affiliated issuers (Note 10)

     4,710,997  

Interest from unaffiliated issuers

     70,961,832  

Interest from affiliated issuers

     6,106,190  

Interest paid in kind from unaffiliated issuers

     1,406,601  

Interest paid in kind from affiliated issuers (Note 10)

     7,601,478  
  

 

 

 

Total income

     95,421,024  
  

 

 

 

Expenses:

  

Investment advisory (Note 7)

     9,558,928  

Administration fees (Note 7)

     3,081,656  

Interest expense, commitment fees, and financing costs (Note 6)

     16,131,844  

Legal fees

     1,324,419  

Accounting services fees

     768,680  

Audit fees

     609,271  

Custodian/wire agent fees

     389,830  

Reports to shareholders

     388,665  

Transfer agent fees

     298,385  

Trustees fees (Note 6)

     220,002  

Insurance

     167,468  

Dividends and fees on securities sold short (Note 2)

     127,970  

Expedited settlement facility (Note 7)

     81,544  

Other

     1,596,713  
  

 

 

 

Total operating expenses

     34,745,375  
  

 

 

 

Net investment income

     60,675,649  
  

 

 

 

Preferred dividend expenses

     (3,285,411

Net Realized and Unrealized Gain (Loss) on Investments

  

Realized gain (loss) on:

  

Investments from unaffiliated issuers

     (61,622,104

Investments in affiliated issuers

     (1,743,503

Securities sold short (Note 2)

     16,648  

Written options contracts (Note 3)

     (1,395,070

Futures contracts (Note 3)

     (9,294,349

Foreign currency related transactions

     34  

Net Change in Unrealized Appreciation (Depreciation) on:

  

Investments

     32,662,284  

Investments in affiliated issuers

     19,721,570  

Securities sold short (Note 2)

     (603,894

Written options contracts (Note 3)

     4,437,523  

Futures contracts (Note 3)

     (2,289,364

Foreign currency related translations

     124  
  

 

 

 

Net realized and unrealized gain (loss) on investments

     (20,110,101
  

 

 

 

Total increase in net assets resulting from operations

     37,280,137  
  

 

 

 

 

See accompanying Notes to Consolidated Financial Statements.       15


CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

 

 

 

       Highland Income Fund

 

     Year Ended
December 31, 2019
($)
     Period Ended
December 31, 2018‡
($)
     Year Ended
June 30, 2018
($)
 

Increase (Decrease) in Net Assets

        

Operations:

        

Net investment income

     60,675,649        29,883,997        50,700,522  

Preferred dividend expense

     (3,285,411              

Net realized (loss) on investments, securities sold short, written options, futures contracts and foreign currency transactions

     (74,038,344      (388,852      (28,313,816

Net increase (decrease) in unrealized appreciation (depreciation) on investments, securities sold short, written options, futures contracts and foreign currency transactions

     53,928,243        (56,562,382      41,408,816  
  

 

 

    

 

 

    

 

 

 

Net increase (decrease) from operations

     37,280,137        (27,067,237      63,795,522  
  

 

 

    

 

 

    

 

 

 

Distributions

        

Class A

                   (3,380,302

Class C

                   (2,697,014

Class Z

                   (6,360,145

Shares of closed-end fund

     (58,214,363      (32,468,254      (37,207,965

Return of capital:

        

Shares of closed-end fund

     (8,201,030      (720,948      (6,936,337
  

 

 

    

 

 

    

 

 

 

Total distributions

     (66,415,393      (33,189,202      (56,581,763
  

 

 

    

 

 

    

 

 

 

Increase (decrease) in net assets from operations and distributions

     (29,135,256      (60,256,439      7,213,759  
  

 

 

    

 

 

    

 

 

 

Share transactions*:

        

Proceeds from sale of shares

        

Class A

                   75,507,963  

Class C

                   49,282,371  

Class Z

                   252,257,435  

Value of distributions reinvested

        

Class A

                   3,008,894  

Class C

                   2,470,570  

Class Z

                   5,841,184  

Shares of closed-end fund

     1,291,961        1,121,049        1,244,740  

Cost of shares redeemed

        

Class A

                   (61,916,334

Class C

                   (26,700,962

Class Z

                   (109,971,065

Shares repurchased of closed-end fund (Note 1)

     (3,163,298              
  

 

 

    

 

 

    

 

 

 

Net increase (decrease) from shares transactions

     (1,871,337      1,121,049        191,024,796  
  

 

 

    

 

 

    

 

 

 

Total increase (decrease) in net assets

     (31,006,593      (59,135,390      198,238,555  
  

 

 

    

 

 

    

 

 

 

Net Assets

        

Beginning of year

     1,026,411,518        1,085,546,908        887,308,353  
  

 

 

    

 

 

    

 

 

 

End of year

     995,404,925        1,026,411,518        1,085,546,908  
  

 

 

    

 

 

    

 

 

 

 

For the six month period ended December 31, 2018. Effective April 11, 2019, the Fund had a fiscal year change from June 30 to December 31 (Note 1).

*

Capital stock activity prior to November 3, 2017 has been adjusted to give effect to an approximately 2 to 1 reverse stock split as part of the conversion to a closed-end fund. (Note 1) Distribution activity related to the A, C, and Z share classes relates to the period from July 1, 2017 through November 3, 2017.

 

16       See accompanying Notes to Consolidated Financial Statements.


CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS (continued)

 

 

 

  Highland Income Fund

 

     Year Ended
December 31, 2019
     Period Ended
December 31, 2018‡
     Year Ended
June 30, 2018
 

CAPITAL STOCK ACTIVITY - SHARES*

        

Class A:

        

Shares sold

                   5,028,824  

Issued for distribution reinvested

                   200,393  

Shares redeemed

                   (4,126,129

Shares converted in conversion (Note 1)

                   (19,014,516
  

 

 

    

 

 

    

 

 

 

Net Decrease in fund shares

                   (17,911,428
  

 

 

    

 

 

    

 

 

 

Class C:

        

Shares sold

                   3,282,455  

Issued for distribution reinvested

                   164,623  

Shares redeemed

                   (1,779,278

Shares converted in conversion (Note 1)

                   (16,925,308
  

 

 

    

 

 

    

 

 

 

Net Decrease in fund shares

                   (15,257,508
  

 

 

    

 

 

    

 

 

 

Class Z:

        

Shares sold

                   16,798,932  

Issued for distribution reinvested

                   389,052  

Shares redeemed

                   (7,323,136

Shares converted in conversion (Note 1)

                   (35,789,642
  

 

 

    

 

 

    

 

 

 

Net Decrease in fund shares

                   (25,924,794
  

 

 

    

 

 

    

 

 

 

Shares of closed-end fund:

        

Shares converted in conversion (Note 1)

                   71,729,466  

Issued for distribution reinvested

     98,540        75,364        67,754  

Shares redeemed (Note 1)

     (235,049              
  

 

 

    

 

 

    

 

 

 

Net Increase (Decrease) in fund shares

     (136,509      75,364        71,797,220  
  

 

 

    

 

 

    

 

 

 

 

For the six month period ended December 31, 2018. Effective April 11, 2019, the Fund had a fiscal year change from June 30 to December 31 (Note 1).

*

Capital stock activity prior to November 3, 2017 has been adjusted to give effect to an approximately 2 to 1 reverse stock split as part of the conversion to a closed-end fund. (Note 1) Distribution activity related to the A, C, and Z share classes relates to the period from July 1, 2017 through November 3, 2017.

 

See accompanying Notes to Consolidated Financial Statements.       17


CONSOLIDATED STATEMENT OF CASH FLOWS

 

 

 

For the Year Ended December 31, 2019   Highland Income Fund

 

      $  

Cash Flows Provided by Operating Activities:

  

Net increase in net assets resulting from operations

     37,280,137  

Adjustments to Reconcile Net Investment Gain to Net Cash Provided by Operating Activities:

  

Purchases of investment securities from unaffiliated issuers

     (758,662,641

Purchases of investment securities from affiliated issuers

     (180,162,062

Interest paid in kind from unaffiliated issuers

     (1,406,601

Interest paid in kind from affiliated issuers

     (7,601,478

Proceeds from disposition of investment securities from unaffiliated issuers

     851,757,234  

Proceeds from disposition of investment securities from affiliated issuers

     9,743,771  

Purchases to cover securities sold short

     (1,510,918

Proceeds from securities sold short

     10,000,189  

Purchases to cover written options

     (15,341,765

Proceeds from written options

     19,902,218  

Paydowns at cost

     85,851,683  

Net accretion of discount

     (2,742,953

Net realized loss on Investments from unaffiliated issuers

     61,622,104  

Net realized loss on Investments from affiliated issuers

     1,743,503  

Net realized gain on securities sold short, written options contracts, futures, and foreign currency transactions

     1,378,388  

Net change in unrealized appreciation/(depreciation) on investments, securities sold short, and foreign currency related transactions

     (56,217,607

Decrease in receivable for investments sold and principal paydowns

     697,024  

Increase in receivable for dividends and interest

     (6,344,659

Increase in receivable for variation margin

     (783,337

Decrease due from broker

     2,773,329  

Increase in prepaid expenses and other assets

     (770,053

Decrease in payable for investments purchased

     (16,046,351

Decrease in payable to investment advisory

     (92,682

Increase due to broker

     3,324,533  

Increase in payable to custody

     123,375  

Decrease in payable for commitment fees and interest expense

     (820,922

Decrease in accrued expenses and other liabilities

     (304,007
  

 

 

 

Net cash flow provided by operating activities

     37,389,452  
  

 

 

 

Cash Flows Used In Financing Activities:

  

Increase in cumulative preferred shares

     139,756,249  

Distributions paid in cash, net of receivable

     (65,123,432

Shares repurchased of closed-end fund

     (3,163,298

Decrease in notes payable

     (150,000,000

Proceeds from shares sold

     85,322  

Proceeds from reverse repurchase agreements, net

     73,655,500  
  

 

 

 

Net cash flow used by financing activities

     (4,789,659
  

 

 

 

Effect of exchange rate changes on cash

     158  
  

 

 

 

Net increase in cash

     32,599,951  
  

 

 

 

Cash, Cash Equivalents, and Restricted Cash:

  

Beginning of year

     18,907,006  
  

 

 

 

End of year

     51,506,957  
  

 

 

 

Supplemental disclosure of cash flow information:

  

Reinvestment of distributions

     1,291,961  

Cash paid during the period for interest expense and commitment fees

     (16,952,766

 

18       See accompanying Notes to Consolidated Financial Statements.


CONSOLIDATED FINANCIAL HIGHLIGHTS

 

 

 

  Highland Income Fund

 

Selected data for a share outstanding throughout each period is as follows:

 

    For the
Year Ended
December 31,
2019
    For the
Period Ended
December 31,
2018**
    For the Years Ended June 30,  
  2018*‡     2017*‡     2016*‡     2015*‡  

Net Asset Value, Beginning of Year/Period

  $ 14.28     $ 15.12     $ 15.01     $ 14.33     $ 16.17     $ 16.91  

Income from Investment Operations:

           

Net investment income(a)

    0.85       0.42       0.75       0.68       0.89       0.74  

Preferred dividend expense

    (0.05                              

Net realized and unrealized gain (loss)

    (0.28     (0.80     0.18       0.74       (1.84     (0.74
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Income from Investment Operations

    0.52       (0.38     0.93       1.42       (0.95     (b)   

Less Distributions Declared to shareholders:

 

       

From net investment income

    (0.81     (0.45     (0.72     (0.74     (0.89     (0.74

From return of capital

    (0.11     (0.01     (0.10                  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total distributions declared to shareholders

    (0.92     (0.46     (0.82     (0.74     (0.89     (0.74

Net Asset Value, End of Year/Period(c)

  $ 13.88     $ 14.28     $ 15.12     $ 15.01     $ 14.33     $ 16.17  

Market Value, End of Year/Period

  $ 12.43     $ 12.80     $ 15.62     $     $     $  

Total Return(d)

    4.30     (15.44 )%(e)       9.77     10.05     (5.77 )%      0.11

Ratios to Average Net Assets / Supplemental Data:(f)(g)

 

Net Assets, End of Year/Period (000’s)

  $ 995,405     $ 1,026,412     $ 1,085,547     $ 389,278     $ 241,197     $ 283,673  

Gross operating expenses(h)(i)

    3.39     3.10     1.79     1.20 %(j)       1.38     1.03

Net investment income(i)

    5.93     5.48     4.98     4.61     5.65     4.55

Portfolio turnover rate

    18     27 %(e)       177     63     53     55

Average commission rate paid(k)

  $ 0.0032     $ 0.0243     $ 0.0300        

 

*

Per share data prior to November 3, 2017 has been adjusted to give effect to an approximately 2 to 1 reverse stock split as part of the conversion to a closed-end fund. (Note 1)

**

For the six month period ended December 31, 2018. Effective April 11, 2019, the Fund had a fiscal year change from June 30 to December 31 (Note 1).

Reflects the financial highlights of Class Z of the open-end fund prior to the conversion.

(a)

Per share data was calculated using average shares outstanding during the period.

(b)

Represents less than $0.005 per share.

(c)

The Net Asset Value per share and total return have been calculated based on net assets which include adjustments made in accordance with U.S. Generally Accepted Accounting Principles required at period end for financial reporting purposes. These figures do not necessarily reflect the Net Asset Value per share or total return experienced by the shareholder at period end

(d)

Total return is based on market value per share for periods after November 3, 2017. Distributions are assumed for purposes of this calculation to be reinvested at prices obtained under the Fund’s Dividend Reinvestment Plan. Prior to November 3, 2017, total return is at net asset value assuming all distributions are reinvested. For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been lower.

(e)

Not annualized.

(f)

All ratios for the period have been annualized, unless otherwise indicated.

(g)

Supplemental expense ratios are shown below.

(h)

Includes dividends and fees on securities sold short.

(i)

Excludes 12b-1 fees from partial period operating as an open-end fund. Following the conversion on November 3, 2017, the Fund is no longer subject to 12b-1fees.

(j)

Refer to Note 7 in the Notes to the Financial Statements for discussion of prior period custodian out-of-pocket expenses that were communicated to the Fund in the current period. The amount of the reimbursement was immaterial on a per share basis and did not impact the total return of the Fund. The Ratios of Gross Operating Expenses and Net Operating Expenses to Average Net Assets would be unchanged as the reimbursement of custodian fees was offset against current period expense waivers/ reimbursements with no impact to net expenses or net investment income.

(k)

Represents the total dollar amount of commissions paid on portfolio transactions divided by total number of portfolio shares purchased and sold for which commissions were charged. The period prior to the Conversion Date is not presented.

 

See accompanying Notes to Consolidated Financial Statements.       19


CONSOLIDATED FINANCIAL HIGHLIGHTS (continued)

 

 

 

  Highland Income Fund

 

Supplemental Expense Ratios:

 

     For the
Year Ended
December  31,
2019
     For the
Period Ended
December 31,
2018**
    For the Years Ended June 30,  
  2018     2017      2016      2015  

Net operating expenses (net of waiver/reimbursement, if applicable, but gross of all other operating expenses)

     3.39      3.10     1.79     1.12      1.11      1.04

Interest expense, commitment fees, and preferred dividend expense

     1.90      1.63     0.49     0.01      0.15      0.04

Dividends and fees on securities sold short

     0.01      %(l)      %(l)      0.01      0.01      0.05

 

(l)

Represents less than 0.005%.

 

20       See accompanying Notes to Consolidated Financial Statements.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

December 31, 2019   Highland Income Fund

 

Note 1. Organization

Highland Income Fund (the “Fund”) is organized as an unincorporated business trust under the laws of The Commonwealth of Massachusetts. The Fund is registered with the U.S. Securities and Exchange Commission (the “SEC”) under the Investment Company Act of 1940, as amended (the “1940 Act”), as a non-diversified, closed-end management investment company. On September 25, 2017, the Fund acquired the assets of Highland Floating Rate Opportunities Fund (the “Predecessor Fund”), a series of Highland Funds I, a Delaware statutory trust. The Fund is the successor to the accounting and performance information of the Predecessor Fund.

Effective April 11, 2019, the Fund changed its fiscal year end to December 31. The previous fiscal year end was June 30.

On May 20, 2019, the Fund changed its name from Highland Floating Rate Opportunities Fund to Highland Income Fund.

On November 3, 2017, shareholders of the Fund approved a proposal authorizing the Board of Trustees (the “Board”) of the Fund to convert the fund from an open-end fund to a closed-end fund at a special meeting of shareholders. The Board took action to convert the Fund to a closed-end fund effective shortly after 4:00 p.m. Eastern Time on November 3, 2017 (the “Conversion Date”). The Fund also effected an approximately 1-for-2 reverse stock split of the Fund’s issued and outstanding shares on November 3, 2017, thereby reducing the number of shares outstanding. Shareholders were paid cash for any fractional shares resulting from the reverse stock split. The Fund began listing its shares for trading on the New York Stock Exchange (the “NYSE”) on November 6, 2017 under the ticker symbol “HFRO”. The Fund may issue an unlimited number of common shares, par value $0.001 per share (“Common Shares”). Prior to the Conversion Date, the Fund issued Class A, Class C, and Class Z shares. The Fund incurred $1,076,274 in Conversion costs related to the fund conversion to a closed-end fund.

On October 29, 2019, the Board of the Fund authorized the repurchase of up to $25 million of the Fund’s shares. Under this program, the Fund repurchased 235,049 shares through December 2019. Upon retirement of the repurchased shares, the net asset value (“NAV”) was $3.2mm, or $13.46 per share.

On July 29, 2019, the Fund issued 5.4 million 5.375% Series A Cumulative Preferred shares (NYSE: HFRO.PR.A) with an aggregate liquidation value of $135mm. Subsequently on August 9, 2019, the underwriters exercised their option to purchase additional overallotment shares of $10mm, resulting in a total Preferred outstanding offering of $145mm.

The Series A Preferred shares are perpetual, non-callable for five years, and have a liquidation preference of $25.00 per share. Distributions are scheduled quarterly, with payments

beginning on September 30, 2019. Series A Preferred shares trade on the NYSE. Moody’s Investors Service has assigned an A1 rating to the preferred shares.

On October 14, 2019, the Board of the Fund approved an amendment to the Third Amended and Restated Agreement and Declaration of Trust of the Fund to require the affirmative vote or consent of the holders of 75% of each class of shares outstanding (with each such class voting separately thereon) for certain transactions involving a Principal Shareholder. For purposes of this requirement, Principal Shareholder is defined any person which is the beneficial owner, directly or indirectly, of more than 5% of the outstanding shares of the Fund or of any class and shall include any “affiliate” or “associate”, as such terms are defined in Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as amended. The certain transactions covered by this requirement include: (i) a merger or consolidation of the Fund or any subsidiary of the Fund with or into any Principal Shareholder; (ii) the issuance of any securities of the Fund to any Principal Shareholder for cash; (iii) the sale, lease or exchange of all or any substantial part of the assets of the Fund to any Principal Shareholder (except assets determined by the Board to have an aggregate fair market value of less than $1,000,000, aggregating for the purpose of such computation all assets sold, leased or exchanged in any series of similar transactions within a twelve-month period or assets sold in the ordinary course of business); and (iv) the sale, lease or exchange to or with the Fund or any subsidiary thereof, in exchange for securities of the Fund, of any assets of any Principal Shareholder (except assets determined by the Board to have an aggregate fair market value of less than $1,000,000 aggregating for the purpose of such computation all assets sold, leased or exchanged in any series of similar transactions within a twelve-month period).

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 applies the accounting and reporting guidance of Accounting Standards Codification Topic 946 applicable to investment companies. The Fund’s consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), which require Highland Capital Management Fund Advisors, L.P., the Fund’s investment adviser (“HCMFA” or the “Investment Adviser”), 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 consolidated financial

 

 

Annual Report       21


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

 

 

December 31, 2019   Highland Income Fund

 

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.

Basis of Consolidation

The Fund consolidates HFRO Sub, LLC (“HFRO Sub”), a Delaware wholly owned subsidiary, for financial reporting, and the holdings of HFRO Sub, LLC are included within the Consolidated Financial Statements for the Fund. HFRO Sub is a bankruptcy remote financing vehicle used to obtain leverage with the portfolio of bank loans serving as collateral. All inter-company accounts and transactions have been eliminated in the consolidation.

Fund Valuation

The NAV of the Fund’s common shares is calculated daily on each day that the NYSE is open for business as of the close of the regular trading session on the NYSE, usually 4:00 PM, Eastern Time. The NAV is calculated by dividing the value of the Fund’s net assets attributable to common shares by the numbers of common shares outstanding.

Valuation of Investments

In computing the Fund’s net assets attributable to shares, securities with readily available market quotations on the NYSE, National Association of Securities Dealers Automated Quotation (“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 quotations will be valued pursuant to policies adopted by the Fund’s 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. Generally, the Fund’s 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 the Investment Adviser has determined to have the capability to provide appropriate pricing services which have been approved by the Board.

Securities for which market quotations are not readily available, or for which the Fund has determined that 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 between the time when market price is determined and calculation of the Fund’s net asset value (“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, but not limited to: (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 Fund’s 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. Using a fair value pricing methodology to value securities may result in a value that is different from a security’s most recent sale price and from the prices used by other investment companies to calculate their NAVs. Determination of fair value is uncertain because it involves subjective judgments and estimates.

There can be no assurance that the Fund’s 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 to the Fund. The NAV shown in the Fund’s consolidated financial statements may vary from the NAV published by the Fund as of its period end because portfolio securities transactions are accounted for on the trade date (rather than the day following the trade date) for financial statement purposes.

Deferred Financing Costs on the Preferred Stock

Deferred financing costs on the preferred shares consist of fees and expenses incurred in connection with the closing of the preferred stock offerings, and are capitalized at the time of payment. Based on ASC 480-10-S99, preferred stock that, by its terms, is contingently redeemable upon the occurrence of an event that is outside of the issuer’s control should be classified as mezzanine equity; therefore, these costs are only amortized once it is probable the shares will become redeemable. As of December 31, 2019, the Fund is compliant with all contingent redemption provisions of the preferred offering, therefore the financing costs are

 

 

22       Annual Report


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

 

 

December 31, 2019   Highland Income Fund

 

currently unamortized until probable. Deferred financing costs of $5.2 million are presented net with the mezzanine equity on the Consolidated Statement of Assets and Liabilities.

 

Issuance   Shares at
December 31,
2018
    Beginning
Value as of
December 31,
2018
    Issuance Net
Liquidation
Value
    Deferred
Issuance
Costs
    Paydowns     Balance net of
Deferred Financing
Costs at December 31,
2019
    Shares at
December 31,
2019
 

Cumulative preferred shares (Series A)

        $     $ 145,000,000.00     $ 5,243,751.00     $     $ 139,756,249.00       5,800,000.00  

 

Fair Value Measurements

The Fund has performed an analysis of all existing investments and derivative instruments to determine the significance and character of inputs to their fair value determination. The levels of fair value inputs used to measure the Fund’s 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 investment’s valuation. The three levels of the fair value hierarchy are described below:

 

Level 1 

Quoted unadjusted prices for identical instruments in active markets to which the Fund has access at the date of measurement;

 

Level 2 —

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

 

Level 3 

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 Fund’s own assumptions that market participants would use to price the asset or liability based on the best available information.

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 and its affiliates. 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 Fund’s investments consisted of senior loans, foreign denominated or domiciled senior loans, collateralized loan obligations, corporate bonds and notes, U.S. asset-backed securities, non-U.S. asset-backed securities, claims, common stocks, registered investment companies, cash equivalents, rights, warrants, preferred stock, agency collateralized mortgage obligations, LLC interests, purchased call options, and registered investment companies. The fair value of the Fund’s senior loans and bonds are generally based on quotes received from brokers or independent pricing services. Loans, bonds and asset-backed securities 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 and bonds 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.

The fair value of the Fund’s common stocks, registered investment companies, rights and warrants that are not actively traded on national exchanges are generally priced using quotes derived from implied values, indicative bids, or a limited amount of actual trades and are classified as Level 3 assets because the inputs used by the brokers and pricing services to derive the values are not readily observable. Exchange-traded options are valued based on the last trade price on the primary exchange on which they trade. If an option does not trade, the mid-price, which is the mean of the bid and ask price, is utilized to value the option.

At the end of each calendar quarter, the Investment Adviser 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, the Investment Adviser evaluates the Level 1 and 2 assets and liabilities on a quarterly basis for changes in listings or delistings on national exchanges.

 

 

Annual Report       23


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

 

 

December 31, 2019   Highland Income Fund

 

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 Fund’s investments may fluctuate from period to period. Additionally, the fair value of investments may differ significantly from the values that would

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 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 at the end of the period. A summary of the inputs used to value the Fund’s assets as of December 31, 2019 is as follows:

 

        Total value at
December 31, 2019
$
       Level 1
Quoted
Price
$
       Level 2
Significant
Observable
Inputs
$
       Level 3
Significant
Unobservable
Inputs
$
 

Highland Income Fund

                   

Assets

                   

U.S. Senior Loans

                   

Commercial Services

       25,574,694                   25,574,694           

Communication Services

       11,406,790                   5,299,383          6,107,407  

Consumer Discretionary

       29,060,626                   29,060,626           

Consumer Products

       12,855,251                   12,855,251           

Energy

       24,607,186                   24,607,186           

Financial

       24,228,052                   24,228,052           

Gaming/Leisure

       10,753,914                            10,753,914  

Healthcare

       81,842,022                   34,108,365          47,733,657  

Industrials

       33,324,221                   25,219,034          8,105,187  

Information Technology

       110,450,576                   53,621,576          56,829,000  

Manufacturing

       3,534,756                   3,534,756           

Oil & Gas

       9,164,263                   9,164,263           

Real Estate

       21,096,400                   21,096,400           

Retail

       52,112,148                   52,112,148           

Service

       36,429,089                   36,429,089           

Transportation

       11,698,539                   11,698,539           

Utilities

       25,299,203                   25,299,203           

Preferred Stock

                   

Energy

       16,530,773          16,530,773                    

Financial

       36,384,014                   36,384,014           

Real Estate

       247,311,109          12,258,059          2,027,753          233,025,297  

Collateralized Loan Obligations

       204,983,767                   204,983,767           

Common Stocks

                   

Communication Services

       47,706,590          1,603,072          38,582,787          7,520,731  

Consumer Discretionary

       7,250,850                   7,250,850           

Energy

       3,376,340                   3,376,339          1  

Gaming/Leisure(1)

                                   

Healthcare

       520,004          447,750                   72,254  

Housing(1)

                                   

Industrials

       175,439                   175,439           

Materials

       1,540,777                   1,495,160          45,617  

Real Estate

       104,375,180          8,627,649                   95,747,531  

Agency Collateralized Mortgage Obligations

       141,070,606                   141,070,606           

LLC Interest

       88,777,470                            88,777,470  

Corporate Bonds & Notes

                   

Energy

       1,126,400                   50,000          1,076,400  

Industrials

       190,395                   190,395           

 

24       Annual Report


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

 

 

December 31, 2019   Highland Income Fund

 

        Total value at
December 31, 2019
$
       Level 1
Quoted
Price
$
       Level 2
Significant
Observable
Inputs
$
       Level 3
Significant
Unobservable
Inputs
$
 

Real Estate

       1,204,645                   1,204,645           

Utilities

       27,984,851                   27,984,851           

Purchased Call Options

       18,359,600          17,325,000          1,034,600           

Registered Investment Company

       17,517,723          17,517,723                    

Rights

                   

Utilities

       1,175,995                   1,175,995           

Warrants

                   

Energy

       175,480          175,480                    

Industrials

       1,412                            1,412  

Claims

       52,138                            52,138  

Cash Equivalent

       33,588,954          33,588,954                    
    

 

 

      

 

 

      

 

 

      

 

 

 

Total Assets

       1,524,818,242          108,074,460          860,895,766          555,848,016  
    

 

 

      

 

 

      

 

 

      

 

 

 

Liabilities

                   

Securities Sold Short(2)

       (9,076,517        (9,076,517                  
    

 

 

      

 

 

      

 

 

      

 

 

 

Total Liabilities

       (9,076,517        (9,076,517                  
    

 

 

      

 

 

      

 

 

      

 

 

 

Total

       1,515,741,725          98,997,943          860,895,766          555,848,016  
    

 

 

      

 

 

      

 

 

      

 

 

 

 

(1) 

This category includes securities with a value of zero.

(2) 

See Investment Portfolio detail for industry breakout.

The table below sets forth a summary of changes in the Fund’s assets measured at fair value using significant unobservable inputs (Level 3) for the year ended December 31, 2019.

 

     Balance
as of
December 31,
2018
$
    Transfers
into
Level 3
$
    Transfers
Out
of Level 3
$
    Net
Amortization
(Accretion)
of Premium/
(Discount)
$
    Net
Realized
Gains/
(Losses)
$
    Net
Unrealized
Gains/
(Losses)
$
    Net
Purchases
$
    Net
(Sales)
$
    Distribution
to Return
Capital
$
    Balance
as of
December 31,
2019
$
   

Change in
Unrealized
Appreciation
(Depreciation)
from
Investments
at of
December 31,
2019

$

 

Common Stock

                     

Communication Services

    7,566,587                               (45,856                       7,520,731       (507,948

Energy

    1                                                       1        

Healthcare

                                  72,254                         72,254       72,254  

Housing

                                                                (323,754

Information Technology

                                                                 

Materials

    2,844,759                               (2,799,142                       45,617       (711,006

Media

    1,258,086                               6,598,465             (7,856,551                 6,598,465  

Real Estate

    17,207,035                               556,728       77,983,768                   95,747,531       570,387  

Utilities

                                  661,135             (661,135                 635,190  

Corporate Bonds & Notes

                     

Energy

    1,076,400                                       1,076,400        

LLC Interest

                                  (1,222,530     90,000,000                   88,777,470       (1,222,530

Preferred Stock

    214,305,563                               16,804,734       1,915,000                   233,025,297       5,007,504  

U.S.

Senior Loan

                     

Communication Services

    5,472,828                   548             (6,570     640,601                   6,107,407       (11,448

Gaming/Leisure

    10,002,768                   58,674       28,475       147,182       938,933       (422,118           10,753,914       259,855  

Healthcare

    24,398,513                               16,674,566       6,660,578                   47,733,657       19,576,293  

 

Annual Report       25


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

 

 

December 31, 2019   Highland Income Fund

 

     Balance
as of
December 31,
2018
$
    Transfers
into
Level 3
$
    Transfers
Out
of Level 3
$
    Net
Amortization
(Accretion)
of Premium/
(Discount)
$
    Net
Realized
Gains/
(Losses)
$
    Net
Unrealized
Gains/
(Losses)
$
    Net
Purchases
$
    Net
(Sales)
$
    Distribution
to Return
Capital
$
    Balance
as of
December 31,
2019
$
   

Change in
Unrealized
Appreciation
(Depreciation)
from
Investments
at of
December 31,
2019

$

 

Housing

                            (1,743,503     1,743,503                               1,743,503  

Industrials

    8,269,728                   363,695             (1,764,280     1,236,044                   8,105,187       (1,518,633

Information Technology

    57,000,000                               (171,000                       56,829,000       (171,000

Real Estate

    1,228,016                   (6,343     8,756       33,403             (1,263,832                 70,643  

Warrant

                     

Industrials

    88,054                               (86,642                   1,412       (22,007

Information Technology

    51,729                         3,287       (25,564           (29,452                 (10,558

Claims

    52,138                                                       52,138        
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    350,822,205           —           —       416,574       (1,702,985     37,170,386       179,374,924       (10,233,088         —       555,848,016       30,035,210  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Investments designated as Level 3 may include assets valued using quotes or indications furnished by brokers which are based on models or estimates and may not be executable prices. In light of the developing market conditions, the Investment Adviser continues to search for observable data

points and evaluate broker quotes and indications received for portfolio investments. For the year ended December 31, 2019, there were no transfers between levels. Determination of fair values is uncertain because it involves subjective judgments and estimates that are unobservable.

 

 

The following is a summary of significant unobservable inputs used in the fair valuations of assets and liabilities categorized within Level 3 of the fair value hierarchy:

 

Category   Market
Value at
12/31/2019
    Valuation Technique   Unobservable Inputs   Input Value(s)

Preferred Stock

    233,025,297     Net Asset Value   N/A   N/A
    Discounted Cash Flow   Discount Rate   11.0%

U.S. Senior Loans

    129,529,165     Adjusted Appraisal   Liquidity Discount   10%
      Asset Specific Discount   10%
    Multiples Analysis   Multiple of EBITDA less CAPEX   6.25x - 11.00x
    Transaction Analysis   Multiple of EBITDA less CAPEX   10.0x - 12.0x
    Transaction Indication of Value   % of Par   30.0% - 35.0%
    Black-Scholes Model   Volatility Assumption   25% - 40%
    Discounted Cash Flow   Discount Rate   7.75% - 11.10%
      Spread Adjustment   0.10%

Common Stocks

    103,386,134     Multiples Analysis   Multiple of EBITDA less CAPEX   6.25x - 11.00x
      Multiple of EBITDA   7.0x - 8.75x
      Unadjusted Price/MHz-PoP   $0.12 - $0.95
      Risk Discount   55.2% - 59.8%
    Discounted Cash Flow   Discount Rate   7.75% - 20.0%
      Capitalization Rate   10.5%
    Transaction Analysis   Multiple of EBITDA   8.25x - 8.75x
      Multiple of EBITDA less CAPEX   10.0x - 12.0x
    Transaction Indication of Value   % of Par   30.0% - 35.0%
      Enterprise Value ($mm)   $365.0 - $771.0
    Black-Scholes Model   Volatility Assumption   25% - 40%
    Net Asset Value   N/A   N/A

LLC Interest

    88,777,470     Discounted Cash Flow   Discount Rate   2.59% - 9.45%

Corporate Bonds & Notes

    1,076,400     Liquidation Analysis   Claim Amount: Percent of Par   6.9%

Claims

    52,138     Pricing Feed   Indication of Value   1.375

 

26       Annual Report


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

 

 

 

December 31, 2019   Highland Income Fund

 

Category   Market
Value at
12/31/2019
    Valuation Technique   Unobservable Inputs   Input Value(s)

Warrants

    1,412     Discounted Cash Flow   Discount Rate   20%
    Multiples Analysis   Multiple of EBITDA   7.0x - 8.75x
    Transaction Analysis   Multiple of EBITDA   8.25x - 8.75x