(HIGHLAND FUNDS)

 


 

         
(LOGO)   Highland Floating Rate Advantage Fund   (LOGO)
TABLE OF CONTENTS
         
Fund Profile
    1  
Financial Statements
    2  
Investment Portfolio
    3  
Statement of Assets and Liabilities
    12  
Statement of Operations
    13  
Statements of Changes in Net Assets
    14  
Statement of Cash Flows
    16  
Financial Highlights
    17  
Notes to Financial Statements
    21  
Additional Information
    30  
Important Information About This Report
    32  
Economic and market conditions change frequently.
There is no assurance that the trends described in this report will continue or commence.
A prospectus must precede or accompany this report. Please read the prospectus carefully before you invest.

 


 

FUND PROFILE
Highland Floating Rate Advantage Fund
Objective
The Fund seeks to provide a high level of current income, consistent with preservation of capital.
Net Assets as of February 28, 2009
$762.6 million
Portfolio Data as of February 28, 2009
The information below provides a snapshot of the Fund at the end of the reporting period. The Fund is actively managed and the composition of its investment portfolio will change over time.
Quality Breakdown as of 02/28/09 (%)*
         
A
    0.1  
Baa
    0.2  
Ba
    17.1  
B
    41.8  
Caa
    29.5  
Ca
    0.5  
N/R
    10.8  
Top 5 Sectors as of 02/28/09 (%)*
         
Healthcare
    15.5  
Gaming/Leisure
    14.9  
Cable/Wireless Video
    6.9  
Diversified Media
    4.9  
Broadcasting
    4.5  
Top 10 Holdings as of 02/28/09 (%)*
         
Fontainebleau Florida Hotel, LLC (Senior Loans)
    5.3  
Broadstripe, LLC (Senior Loans)
    4.2  
Lake at Las Vegas Joint Venture, Term Loan (DIP) (Senior Loans)
    3.2  
Sacher Funding Ltd. (Foreign Denominated Senior Loan)
    2.7  
CCS Medical, Inc. (Senior Loans)
    2.7  
Talecris Biotherapeutics Holdings Corp. (Senior Loans)
    1.9  
Westgate Investments, LLC (Senior Loans)
    1.7  
Lake at Las Vegas Joint Venture, Term Loan, PIK (Senior Loans)
    1.6  
HCA, Inc. (Senior Loans)
    1.3  
IM US Holdings, LLC (Senior Loans)
    1.3  
*   Quality is calculated as a percentage of total senior loans, notes and bonds. Sectors and holdings are calculated as a percentage of total assets.
Semi-Annual Report  |  1

 


 

FINANCIAL STATEMENTS
     
February 28, 2009   Highland Floating Rate Advantage Fund
     
  A guide to understanding the Fund’s financial statements
 
   
Investment Portfolio
  The Investment Portfolio details all of the Fund’s holdings and their 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.
 
   
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 the Fund’s liabilities (including any unpaid expenses) from the total of the Fund’s investment and non-investment 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.
 
   
Statement of Operations
  This statement details income earned by the Fund and the expenses accrued 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.
 
   
Statements of Changes in Net Assets
  These statements demonstrate how the Fund’s net assets were affected by its operating results, distributions to shareholders and shareholder transactions (e.g., subscriptions, redemptions and distributions reinvestments) during the reporting period. The Statements of Changes in Net Assets also detail changes in the number of shares outstanding.
 
   
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.
 
   
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., class expenses and net investment income as a percentage of average net assets).
 
   
Notes to 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.
2  |  Semi-Annual Report

 


 

INVESTMENT PORTFOLIO (unaudited)
     
February 28, 2009   Highland Floating Rate Advantage Fund
                 
Principal Amount ($)         Value ($)  
Senior Loans (a) - 91.6%        
       
 
       
AEROSPACE - 3.0%        
       
AWAS Capital, Inc.
       
  5,239,034    
Second Lien Term Loan, 7.50%, 03/15/13
    2,051,920  
       
Continental Airlines, Inc.
       
  1,714,286    
Tranche A-1 Term Loan, 5.56%, 06/01/11
    1,037,143  
  4,285,714    
Tranche A-2 Term Loan, 5.56%, 06/01/11
    2,592,857  
       
Delta Air Lines, Inc.
       
  990,000    
Credit-Linked Deposit Loan, 2.33%, 04/30/12
    750,539  
  8,865,000    
Second Lien Term Loan, 3.70%, 04/30/14
    4,454,663  
  4,191,482    
Term Loan Equipment Notes, 4.97%, 09/29/12
    2,389,145  
       
IAP Worldwide Services, Inc.
       
  2,717,456    
First Lien Term Loan, 8.25%, 12/30/12
    1,512,699  
  3,608,978    
Second Lien Term Loan, PIK, 10.50%, 06/28/13
    781,921  
       
US Airways Group, Inc.
       
  15,170,000    
Term Loan, 3.02%, 03/21/14
    6,985,785  
       
 
     
       
 
    22,556,672  
       
 
     
       
 
       
BROADCASTING - 3.7%        
       
All3Media Intermediate Ltd.
       
  4,874,517    
Facility B1, 2.85%, 08/31/14
    3,339,044  
       
ComCorp Broadcasting, Inc.
       
  228,545    
Revolving Loan, 7.75%, 10/03/12 (b) (c)
    111,987  
  2,285,452    
Term Loan, 7.75%, 04/03/13 (b) (c)
    1,119,871  
       
Univision Communications, Inc.
       
  20,081,410    
Initial Term Loan, 2.73%, 09/29/14
    9,267,571  
  4,623,000    
Second Lien Loan, 2.98%, 03/29/09
    4,178,036  
       
Young Broadcasting, Inc.
       
  27,689,047    
Term Loan, 4.75%, 11/03/12 (d)
    10,487,227  
       
 
     
       
 
    28,503,736  
       
 
     
       
 
       
CABLE/WIRELESS VIDEO - 7.3%        
       
Broadstripe, LLC
       
  49,810,348    
First Lien Term Loan PIK, 9.25%, 06/30/11 (b) (d)
    39,404,967  
  1,428,203    
Revolving Loan, 10.34%, 06/30/11 (b) (d) (e)
    1,129,851  
  2,012,918    
Knology, Inc. Term Loan, 2.66%, 06/30/12
    1,690,851  
       
Northland Cable Television, Inc.
       
  4,850,000    
First Lien Term Loan B, 4.45%, 12/22/12
    4,001,250  
  6,000,000    
Second Lien Term Loan, 8.41%, 06/22/13
    4,350,000  
       
Virgin Media Investment Holdings Ltd.
       
  5,880,800    
B4 Facility, 3.13%, 09/03/12
    5,380,932  
       
 
     
       
 
    55,957,851  
       
 
     
       
 
       
CHEMICALS - 1.1%        
       
Brenntag Holding GmbH & Co.
       
  1,000,000    
Second Lien Facility 2, 5.50%, 07/17/15
    615,000  
       
Georgia Gulf Corp.
       
  8,581,097    
Term Loan, 7.91%, 10/03/13
    4,319,209  
       
Tronox Worldwide LLC Revolving Credit Loan,
       
  5,946,055    
5.93%, 11/28/10 (e)
    3,716,284  
       
 
     
       
 
    8,650,493  
       
 
     
       
 
       
CONSUMER DURABLES - 0.3%        
       
Rexair LLC
       
  2,787,485    
First Lien Term Loan, 5.71%, 06/30/10
    2,229,988  
       
 
     
       
 
       
CONSUMER NON-DURABLES - 0.3%        
       
BioTech Research Labs/Philosophy Merger Sub, Inc.
       
  3,898,212    
First Lien Term Loan, 2.48%, 03/16/14
    2,377,909  
       
 
     
       
 
       
DIVERSIFIED MEDIA — 4.3%        
       
Cinemark USA, Inc.
       
  8,714,294    
Term Loan, 2.49%, 10/05/13
    7,812,539  
       
Clarke American Corp.
       
  9,850,000    
Tranche B Term Loan, 3.48%, 06/30/14
    5,926,450  
       
Cydcor, Inc.
       
  5,950,000    
First Lien Tranche B Term Loan, 9.00%, 02/05/13
    4,760,000  
       
DTN, Inc.
       
  6,095,366    
Tranche C Term Loan, 6.70%, 03/10/13
    5,191,179  
       
Endurance Business Media, Inc.
       
  2,742,230    
Term Loan, 4.75%, 07/26/13
    1,796,160  
       
Metro-Goldwyn-Mayer, Inc.
       
  11,624,780    
Tranche B Term Loan, 4.25%, 04/09/12
    5,323,219  
       
Readers Digest Association, Inc.
       
  1,465,000    
Revolving Credit Loan, 2.81%, 03/02/13 (e)
    505,424  
       
Tribune Co.
       
  5,610,682    
Initial Tranche B Advance, 5.25%, 06/04/14 (d)
    1,494,742  
       
 
     
       
 
    32,809,713  
       
 
     
       
 
       
ENERGY - 2.8%        
       
Alon USA Energy, Inc.
       
  196,244    
Edgington Facility, 3.43%, 08/05/13
    78,497  
  1,569,949    
Paramount Facility, 2.90%, 08/05/13
    627,979  
       
Coffeyville Resources, LLC
       
  770,589    
Funded Letter of Credit, 8.75%, 12/28/10
    570,236  
  2,481,900    
Tranche D Term Loan, 8.75%, 12/30/13
    1,836,606  
       
III Exploration II LP
       
  2,000,000    
Second Lien Loan, 6.95%, 04/29/14
    900,000  
       
Monitor US Finco, Inc.
       
  919,772    
Second Lien Term Loan, 17.20%, 01/11/15 (b) (d)
    18,763  
       
Panda Hereford Ethanol, L.P.
       
  5,000,000    
Tranche A Term Loan, 11.00%, 07/28/13 (d)
    3,250,000  
See accompanying Notes to Financial Statements.  |  3

 


 

INVESTMENT PORTFOLIO (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
                 
Principal Amount ($)         Value ($)  
Senior Loans (continued)        
       
 
       
ENERGY (continued)        
       
Resolute Aneth, LLC
       
  10,714,286    
Second Lien Term Loan, 5.68%, 06/26/13
    6,696,429  
       
Value Creation, Inc.
       
  12,745,002    
Term Loan PIK, 12.50%, 02/05/10
    5,735,251  
       
Venoco, Inc.
       
  2,966,913    
Second Lien Term Loan, 5.25%, 05/07/14
    1,405,575  
       
 
     
       
 
    21,119,336  
       
 
     
       
 
       
FINANCIAL - 0.7%        
       
Checksmart Financial Co.
       
  2,500,000    
Second Lien Term Loan, 5.98%, 05/01/13 (d)
    312,500  
       
HUB International Ltd.
       
  1,072,293    
Delayed Draw Term Loan, 3.96%, 06/13/14
    773,842  
  4,764,713    
Initial Term Loan, 3.96%, 06/13/14
    3,438,550  
       
Online Resources Corp.
       
  887,500    
Term Loan, 2.98%, 02/21/12
    714,437  
       
 
     
       
 
    5,239,329  
       
 
     
       
 
       
FOOD/TOBACCO — 2.9%        
       
Aramark Canada Ltd.
       
  4,900,000    
Canadian Term Loan, 3.33%, 01/26/14
    4,116,000  
       
DS Waters of America, Inc.
       
  2,773,333    
Term Loan, 2.71%, 10/29/12
    1,941,333  
       
Sturm Foods, Inc.
       
  4,470,997    
Initial First Lien Term Loan, 3.75%, 01/31/14
    2,626,711  
       
Wm Wrigley Jr. Co.
       
  8,200,000    
Tranche B Term Loan, 6.50%, 10/06/14
    8,131,284  
       
WM.Bolthouse Farms, Inc.
       
  5,813,940    
First Lien Term Loan, 2.69%, 12/16/12
    4,970,919  
       
 
     
       
 
    21,786,247  
       
 
     
       
 
       
FOREST PRODUCTS/CONTAINERS - 0.8%        
       
Boise Paper Holdings, LLC
       
  6,000,000    
Second Lien Term Loan, 9.25%, 02/23/15
    1,989,960  
       
Inuit US Holdings, Inc.
       
  4,504,824    
Facility B2, 2.85%, 06/30/15
    2,151,053  
  4,495,176    
Facility C2, 3.10%, 06/13/16
    2,168,922  
       
 
     
       
 
    6,309,935  
       
 
     
       
 
       
GAMING/LEISURE - 18.0%        
       
Drake Hotel Acquisition
       
  6,041,285    
B Note 1, 8.27% (b) (d)
    3,303,979  
       
Fontainebleau Florida Hotel, LLC
       
  57,500,000    
Tranche C Term Loan, 8.00%, 06/06/12
    48,875,000  
       
Fontainebleau Las Vegas, LLC
       
  4,666,667    
Initial Term Loan, 5.44%, 06/06/14
    1,205,587  
       
Ginn LA Conduit Lender, Inc.
       
  14,595,267    
First Lien Tranche A Credit-Linked Deposit, 8.50%, 06/08/11 (d) (f)
    1,800,034  
  31,288,508    
First Lien Tranche B Term Loan, 9.50%, 06/08/11 (d) (f)
    3,858,812  
  7,000,000    
Second Lien Term Loan, 12.50%, 06/08/12 (d)
    179,340  
       
Green Valley Ranch Gaming LLC
       
  4,560,000    
Second Lien Term Loan, 3.70%, 08/16/14
    478,800  
       
Kuilima Resort Co.
       
  6,314,130    
First Lien Term Loan, 9.50%, 09/30/10 (d)
    2,367,799  
       
Lake at Las Vegas Joint Venture
       
  15,790,009    
Revolving Loan Credit-Linked Deposit Account, 14.35%, 06/20/12 (d)
    552,650  
  29,991,997    
Term Loan (DIP), 9.91%, 07/16/09
    29,991,997  
  147,510,120    
Term Loan, PIK, 14.35%, 06/20/12 (d)
    14,549,202  
       
Pivotal Promontory, LLC
       
  6,569,651    
First Lien Term Loan, 10.12%, 08/31/10 (d)
    3,284,826  
       
Revel Entertainment Group, LLC
       
  8,000,000    
First Lien Term Loan, 4.98%, 05/30/09 (b)
    7,363,200  
       
Tamarack Resort, LLC
       
  332,579    
Term Loan, 6.95%, 04/17/09
    332,779  
  3,196,689    
Tranche A Credit-Linked Deposit, 2.60%, 05/19/11 (d)
    1,278,675  
  4,723,108    
Tranche B Term Loan, 11.75%, 05/19/11 (d)
    1,889,243  
       
WAICCS Las Vegas 3 LLC
       
  13,000,000    
First Lien Term Loan, 3.98%, 07/30/09
    9,750,000  
  13,000,000    
Second Lien Term Loan, 9.48%, 07/30/09
    5,200,000  
       
Yellowstone Mountain Club, LLC
       
  3,541,907    
First Lien Term Loan, 5.55%, 09/30/10 (d)
    1,068,487  
       
 
     
       
 
    137,330,410  
       
 
     
       
 
       
HEALTHCARE - 18.0%        
       
Aveta, Inc.
       
  4,054,673    
MMM Original Term Loan, 08/22/11 (g)
    3,248,807  
  602,341    
NAMM New Term Loan, 08/22/11 (g)
    482,626  
  1,085,390    
NAMM Original Term Loan, 08/22/11 (g)
    869,668  
  3,322,897    
PHMC Acquisition Term Loan, 08/22/11 (g)
    2,662,471  
       
CCS Medical, Inc.
       
  43,160,679    
First Lien Term Loan, 4.71%, 09/30/12
    25,119,515  
  4,750,000    
Second Lien Term Loan, 9.46%, 03/30/13
    1,805,000  
       
CHG Cos., Inc./CHG Medical Staffing, Inc.
       
  3,827    
First Lien Term Loan B, 2.98%, 12/20/12
    3,233  
       
Danish Holdco A/S
       
  3,365,689    
Facility B5, 3.58%, 05/29/15
    1,598,702  
4  |  See accompanying Notes to Financial Statements.

 


 

INVESTMENT PORTFOLIO (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
                 
Principal Amount ($)         Value ($)  
Senior Loans (continued)        
       
 
       
HEALTHCARE (continued)        
       
Danish Holdco A/S
       
  2,500,000    
Facility D, 5.21%, 11/30/16
    843,750  
       
Fenwal, Inc.
       
  912,763    
Delayed Draw First Lien Term Loan, 3.51%, 02/28/14
    631,322  
  5,380,740    
Initial First Lien Term Loan, 3.51%, 02/28/14
    3,721,643  
       
Graceway Pharmaceuticals, LLC
       
  6,500,000    
Mezzanine Loan, 9.71%, 11/01/13
    1,625,000  
  2,954,546    
Second Lien Term Loan, 7.96%, 05/03/13
    834,659  
       
HCA, Inc.
       
  895,706    
Tranche A-1 Term Loan, 3.46%, 11/17/12
    785,570  
  14,528,595    
Tranche B-1 Term Loan, 3.71%, 11/18/13
    12,261,553  
       
IM US Holdings, LLC
       
  13,525,000    
First Lien Term Loan, 2.85%, 06/26/14
    12,071,063  
  1,000,000    
Second Lien Term Loan, 4.70%, 06/26/15
    826,660  
       
LifeCare Holdings
       
  11,393,667    
Term Loan, 5.43%, 08/11/12
    6,978,621  
       
Mylan, Inc.
       
  6,888,280    
U.S. Tranche B Term Loan, 10/02/14 (g)
    6,408,588  
       
Nyco Holdings 3 ApS
       
  9,109,858    
Facility B2, 3.73%, 12/29/14
    6,486,948  
  9,109,858    
Facility C2, 4.48%, 12/29/15
    6,551,537  
       
Physiotherapy Associates, Inc./ Benchmark Medical, Inc.
       
  1,500,000    
Second Lien Term Loan, 12.00%, 12/31/13
    675,000  
  4,425,022    
Term Loan, 7.50%, 06/28/13
    2,809,889  
       
Select Medical Corp.
       
  2,947,500    
Additional Tranche B Term Loan, 3.25%, 02/24/12
    2,385,648  
  11,051,167    
Tranche B Term Loan, 3.25%, 02/24/12
    8,944,593  
       
Talecris Biotherapeutics Holdings Corp.
       
  19,529,700    
First Lien Term Loan, 4.74%, 12/06/13
    18,064,973  
  9,500,000    
Second Lien Term Loan, 7.74%, 12/06/14
    8,146,250  
       
Triumph Healthcare Second Holdings LLC
       
  760,042    
First Lien Term Loan, 3.73%, 07/28/13
    606,134  
       
 
     
       
 
    137,449,423  
       
 
     
       
 
       
HOUSING - 4.9%        
       
Atrium Cos., Inc.
       
  7,989,971    
Closing Date Term Loan, PIK, 12.50%, 05/31/12
    2,064,129  
       
Custom Building Products, Inc.
       
  2,364,538    
First Lien Term Loan, 8.00%, 10/29/11
    1,710,365  
       
Giraffe Intermediate, LLC
       
  2,143,382    
Mezzanine Note A-1, 2.21%, 08/09/10 (b)
    1,419,133  
       
Kyle Acquisition Group LLC
       
  1,692,857    
Facility B, 6.00%, 07/20/09 (d)
    186,214  
  1,307,143    
Facility C, 6.00%, 07/20/11 (d)
    120,911  
       
LBREP/L-Suncal Master I, LLC
       
  4,848,813    
First Lien Term Loan, 6.25%, 01/18/10 (d)
    193,952  
       
MPH Mezzanine II, LLC
       
  4,500,000    
Mezzanine 2B, 7.48% (b) (d)
     
       
MPH Mezzanine III, LLC
       
  2,850,000    
Mezanine 3, 8.48% (b) (d)
     
       
MPO Intermediate LLC
       
  606,618    
Mezzanine Note A-1, 2.21%, 08/09/09 (b)
    401,642  
       
November 2005 Land Investors, LLC
       
  1,554,761    
First Lien Term Loan, 6.48%, 05/09/11
    932,856  
       
Pacific Clarion, LLC
       
  10,891,261    
Term Loan, 15.00% (b) (d) (h)
    1,810,128  
       
Roofing Supply Group, LLC
       
  2,842,611    
Term Loan PIK, 9.25%, 08/24/13
    1,606,075  
       
Universal Building Products, Inc.
       
  1,846,498    
Term Loan, 4.55%, 04/28/12
    1,181,759  
       
Westgate Investments, LLC
       
  18,759,189    
Senior Secured Loan, PIK, 13.00%, 09/25/10 (h)
    15,945,311  
  4,873,131    
Third Lien Term Loan, 11.47%, 06/30/15 (e) (h)
    2,680,222  
       
Weststate Land Partners, LLC
       
  4,000,000    
First Lien Term Loan, 6.25% (d)
    2,300,000  
       
Withers Preserve MB-I
       
  4,237,189    
B-Note, 5.95%, 07/01/09 (b)
    3,257,127  
       
Woodlands Commercial Properties Co., LP
       
  400,000    
Secured Term Loan, 2.62%, 08/29/09
    354,000  
       
Woodlands Land Development Co., LP
       
  1,600,000    
Secured Term Loan, 2.62%, 08/29/09
    1,416,000  
       
 
     
       
 
    37,579,824  
       
 
     
       
 
       
INFORMATION TECHNOLOGY - 3.2%        
       
Applied Systems, Inc.
       
  1,376,278    
Term Loan, 3.92%, 09/26/13
    1,039,090  
       
Aspect Software, Inc.
       
  2,545,000    
Second Lien Term Loan, 8.31%, 07/11/12
    827,125  
       
Freescale Semiconductor, Inc.
       
  7,256    
Term Loan, 3.93%, 11/29/13
    3,117  
       
Infor Enterprise Solutions Holdings, Inc.
       
  5,724,627    
Delayed Draw Term Loan, 5.21%, 07/30/12
    3,434,776  
  10,972,202    
Initial U.S. Term Loan, 5.21%, 07/30/12
    6,583,321  
       
SCS Holdings II, Inc.
       
  2,355,858    
First Lien Term Loan, 4.21%, 11/30/12
    1,531,307  
See accompanying Notes to Financial Statements.  |  5

 


 

INVESTMENT PORTFOLIO (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
                 
Principal Amount ($)         Value ($)  
Senior Loans (continued)        
       
 
       
INFORMATION TECHNOLOGY (continued)        
       
SCS Holdings II, Inc.
       
  2,000,000    
Second Lien Term Loan, 7.46%, 05/30/13
    600,000  
       
Serena Software, Inc.
       
  4,779,130    
Term Loan, 3.10%, 03/10/13
    2,604,626  
       
SunGard Data Systems, Inc.
       
  3,990,000    
Incremental Term Loan, 6.75%, 02/28/14
    3,770,550  
       
Verint Systems, Inc.
       
  6,446,154    
Term Loan, 3.71%, 05/25/14
    3,964,385  
       
 
     
       
 
    24,358,297  
       
 
     
       
 
       
MANUFACTURING - 3.0%        
       
Acument Global Technologies, Inc.
       
  1,955,000    
Term Loan, 4.96%, 08/11/13
    928,625  
       
Brand Energy & Infrastructure Services, Inc.
       
  2,947,500    
First Lien Term Loan B, 3.75%, 02/07/14
    1,827,450  
       
FCI International S.A.S.
       
  507,929    
Facility B2A, 4.15%, 11/01/13
    308,567  
  507,929    
Facility B3C, 4.15%, 11/01/13
    368,249  
       
FCI SA
       
  488,995    
Facility B2B, 4.15%, 11/02/13
    354,521  
  488,995    
Facility B4B, 4.15%, 11/02/14
    354,521  
       
FCI USA, Inc.
       
  996,924    
Facility B1, 4.15%, 11/02/13
    722,770  
  996,924    
Facility B5B, 4.15%, 11/02/14
    722,770  
       
Hillman Group, Inc.
       
  4,851,661    
Term Loan B, 4.10%, 03/31/11
    4,123,912  
       
Manitowoc Co., Inc.
       
  3,000,000    
Term Loan B, 6.50%, 08/25/14
    2,277,510  
       
Matinvest 2 SAS / Butterfly Wendal US, Inc.
       
  2,159,172    
B-2 Facility, 2.70%, 06/22/14
    1,543,808  
  2,158,474    
C-2 Facility, 3.20%, 06/22/15
    1,554,101  
       
Ridgefield Acquisition Sarl
       
  4,671,923    
Facility B3, 5.88%, 03/30/15
    2,826,513  
  4,671,923    
Facility C3, 6.38%, 03/28/16
    2,838,193  
       
United Central Industrial Supply Co., LLC
       
  2,890,186    
Term Loan, 3.17%, 03/31/12
    2,398,854  
       
 
     
       
 
    23,150,364  
       
 
     
       
 
       
METALS/MINERALS - 2.0%        
       
Algoma Steel, Inc.
       
  2,111,613    
Term Loan, 2.92%, 06/20/13
    1,293,363  
       
Euramax International Holdings B.V.
       
  1,666,184    
European Second Lien Term Loan, 13.00%, 06/29/13
    291,582  
       
Euramax International, Inc.
       
  4,213,066    
Domestic Second Lien Term Loan, 13.00%, 06/29/13
    716,221  
  3,947,330    
Domestic Term Loan, 8.75%, 06/29/12
    1,480,249  
       
JW Aluminum Co.
       
  3,000,000    
Second Lien Term Loan, 7.23%, 12/16/13
    450,000  
       
Murray Energy Corp.
       
  11,876,780    
First Lien Tranche B Term Loan, 6.94%, 01/28/10
    10,689,102  
       
 
     
       
 
    14,920,517  
       
 
     
       
 
       
RETAIL - 1.8%        
       
Burlington Coat Factory Warehouse Corp.
       
  2,146,881    
Term Loan, 2.73%, 05/28/13
    790,997  
       
Dollar General Corp.
       
  7,000,000    
Tranche B-2 Term Loan, 07/07/14 (g)
    5,811,960  
       
Home Interiors & Gifts, Inc.
       
  35,391,765    
Initial Term Loan, 8.00%, (b) (d) (i)
    668,904  
       
Spirit Finance Corp.
       
  17,500,000    
Term Loan, 4.17%, 08/01/13
    5,643,750  
       
Sports Authority, Inc., The
       
  1,462,500    
Term Loan, 3.71%, 05/03/13
    762,928  
       
 
     
       
 
    13,678,539  
       
 
     
       
 
       
SERVICE - 4.6%        
       
Audio Visual Services Group, Inc.
       
  4,000,000    
Second Lien Loan, 6.96%, 08/28/14
    400,000  
       
First Data Corp.
       
  12,849,373    
Initial Tranche B-1 Term Loan, 3.22%, 09/24/14
    8,514,509  
       
FleetCor Technologies Operating Co., LLC
       
  3,219,667    
Tranche 1 Term Loan, 2.66%, 04/30/13
    2,285,963  
  650,333    
Tranche 2 Term Loan, 2.66%, 04/30/13
    461,737  
       
NES Rentals Holdings, Inc.
       
  9,402,849    
Second Lien Permanent Term Loan, 8.00%, 07/20/13
    4,066,732  
       
Penhall Holding Co.
       
  2,978,045    
Senior Unsecured Term Loan, PIK, 12.29%, 04/01/12
    1,042,316  
       
Sabre, Inc.
       
  8,857,789    
Initial Term Loan, 2.88%, 09/30/14
    4,271,669  
       
Safety-Kleen Systems, Inc.
       
  799,877    
Synthetic Letter of Credit, 2.94%, 08/02/13
    713,226  
  2,997,204    
Term Loan B, 2.94%, 08/02/13
    2,672,517  
       
Total Safety U.S., Inc.
       
  1,000,000    
Second Lien Term Loan, 6.98%, 12/08/13
    550,000  
       
Travelport LLC
       
  15,000,000    
Letter of Credit, 5.05%, 08/23/13
    8,969,550  
       
Valleycrest Cos., LLC
       
  1,851,965    
New Term Loan, 4.20%, 10/04/13
    1,296,375  
       
 
     
       
 
    35,244,594  
       
 
     
6  |  See accompanying Notes to Financial Statements.

 


 

INVESTMENT PORTFOLIO (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
                 
Principal Amount ($)         Value ($)  
Senior Loans (continued)        
TELECOMMUNICATIONS - 0.6%        
       
Hargray Acquisition Co.,/DPC Acquisition LLC/HCP Acquisition LLC
       
  2,000,000    
Second Lien Term Loan, 6.74%, 01/29/15
    1,245,000  
       
Knowledgepoint360 Group, LLC
       
  1,000,000    
Second Lien Term Loan, 8.24%, 04/13/15
    650,000  
       
Level 3 Financing, Inc.
       
  3,050,000    
Term Loan, 3.28%, 03/13/14
    2,251,266  
       
NATG Holdings, LLC
       
  111,543    
Term Loan A, 6.75%, 01/23/09 (d)
    8,923  
  82,499    
Term Loan B-1, 7.25%, 01/23/10 (d)
    8,250  
  9,116    
Tranche A Credit-Linked Certificate of Deposit, 6.08% (b) (d)
     
       
 
     
       
 
    4,163,439  
       
 
     
       
 
       
TRANSPORTATION — AUTOMOTIVE - 1.9%        
       
Delphi Corp.
       
  5,626,940    
Initial Tranche C Term Loan DIP, 10.50%, 06/30/09 (d)
    972,673  
  573,060    
Subsequent Tranche C Loan DIP, 10.50%, 06/30/09 (d)
    99,059  
       
Ford Motor Co.
       
  1,831,896    
Term Loan, 5.00%, 12/15/13
    602,749  
       
Key Safety Systems, Inc.
       
  18,820,783    
First Lien Term Loan, 3.44%, 03/08/14
    8,139,989  
  2,000,000    
Second Lien Term Loan, 5.84%, 09/08/14
    390,000  
       
Motor Coach Industries International, Inc.
       
  1,287,444    
Second Lien Term Loan, PIK, 12.75%, 12/01/09
    708,094  
  1,472,652    
Tranche A, DIP, 12.75%, 09/16/09
    1,178,122  
  1,055,544    
Tranche B, DIP, 15.25%, 09/16/09 (b)
    814,669  
       
Remy International, Inc.
       
  2,936,791    
First Lien Tranche B Term Loan, 6.96%, 12/06/13
    1,732,707  
       
 
     
       
 
    14,638,062  
       
 
     
       
 
       
TRANSPORTATION — LAND TRANSPORTATION - 0.2%        
       
JHT Holdings, Inc.
       
  17,491    
Second Lien Term Loan, 12.50%, 10/24/13 (b)
    8,348  
       
SIRVA Worldwide, Inc.
       
  852,143    
Revolving Credit Loan (Exit Finance), 3.55%, 05/12/12 (e)
    387,725  
  3,471,894    
Second Lien Term Loan PIK, 12.00%, 05/12/15
    347,189  
  1,633,838    
Term Loan (Exit Finance), 9.50%, 05/12/12
    825,088  
       
 
     
       
 
    1,568,350  
       
 
     
       
 
       
UTILITY - 5.1%        
       
Bosque Power Co., LLC
       
  9,464,261    
Term Loan, 7.03%, 01/16/15
    6,412,037  
       
Calpine Corp.
       
  5,969,849    
First Priority Term Loan, 4.34%, 03/29/14
    4,328,141  
       
Coleto Creek Power, LP
       
  512,291    
First Lien Synthetic Letter of Credit, 4.21%, 06/28/13
    359,884  
  8,175,900    
First Lien Term Loan, 4.21%, 06/28/13
    5,743,569  
  5,850,000    
Second Lien Term Loan, 5.46%, 06/28/13
    3,656,250  
       
EBG Holdings LLC
       
  3,713,096    
Mezzanine, 7.48%, 12/20/16
    391,954  
       
Entegra TC LLC
       
  5,679,675    
Third Lien Term Loan, 7.46%, 10/19/15
    1,814,656  
       
GBGH, LLC
       
  4,039,797    
Advance First Lien Term Loan PIK, 11.50%, 08/07/13 (b) (d)
    1,924,155  
       
Longview Power, LLC
       
  1,125,000    
Construction Loan, 4.09%, 08/31/11
    810,000  
  2,000,000    
Synthetic Revolving Loan, 3.75%, 02/28/14
    1,358,260  
       
Mach Gen LLC
       
  6,866,799    
Term C Loan, 8.76%, 02/22/15
    4,274,583  
       
Texas Competitive Electric Holdings Co., LLC
       
  7,854,022    
Initial Tranche B-2 Term Loan, 3.95%, 10/10/14
    4,883,788  
       
TPF Generation Holdings, LLC
       
  4,000,000    
Second Lien Term Loan, 5.71%, 12/15/14
    2,726,640  
       
 
     
       
 
    38,683,917  
       
 
     
       
 
       
WIRELESS COMMUNICATIONS - 1.1%        
       
Cricket Communications, Inc.
       
  1,168,864    
Term B Loan, 6.50%, 06/16/13
    1,091,789  
       
DPI Holdings, LLC
       
  1,935,000    
Term Loan, 5.75%, 09/30/10 (b)
    1,396,489  
       
MetroPCS Wireless, Inc.
       
  6,295,695    
Tranche B Term Loan, 3.19%, 11/03/13
    5,496,143  
       
 
     
       
 
    7,984,421  
       
 
     
       
Total Senior Loans (Cost $1,281,280,108)
    698,291,366  
       
 
     
                 
Principal Amount              
Foreign Denominated Senior Loans (a) - 12.4%        
       
 
       
AUSTRALIA - 1.6%        
AUD        
       
PBL Media Group Ltd.
       
  2,790,881    
Facility A Term Loan, 5.25%, 12/31/12
    896,311  
  12,545,336    
Facility B, Tranche 1, 5.50%, 02/07/13
    4,007,300  
       
SMG H5 Pty., Ltd.
       
  19,330,781    
Facility A Term Loan, 8.86%, 12/24/12
    6,946,587  
       
 
     
       
 
    11,850,198  
       
 
     
See accompanying Notes to Financial Statements.  |  7


 

INVESTMENT PORTFOLIO (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
                 
Principal Amount         Value ($)  
Foreign Denominated Senior Loans (continued)        
       
 
       
AUSTRIA - 3.3%        
EUR        
       
Sacher Funding Ltd.
       
  32,946,329    
Euro Term Loan, PIK, 7.33%, 05/14/14
    25,524,544  
       
 
     
       
 
       
DENMARK - 0.2%        
EUR        
       
Nyco Holdings 3 ApS
       
  2,000,000    
Second Lien Facility D, 7.99%, 06/29/16
    1,365,305  
       
 
     
       
 
       
FRANCE - 0.4%        
EUR        
       
Vivarte
       
  1,811,750    
Acquisition Facility, 1.75%, 03/08/16 (e)
    1,003,818  
       
Ypso Holding SA
       
  914,552    
Eur C (Acq) Facility, 4.30%, 12/31/15
    690,400  
  1,717,724    
Eur C (Recap) Facility, 4.30%, 12/31/15
    1,293,513  
       
 
     
       
 
    2,987,731  
       
 
     
       
 
       
GERMANY - 0.7%        
EUR        
       
CBR Fashion GmbH
       
  4,500,000    
Second Lien Facility, 5.55%, 10/19/16
    2,028,906  
       
Kabel Baden Wurttemburg GmbH & Co. KG
       
  1,076,284    
Term B Facility, 5.83%, 06/09/14
    1,039,855  
  1,076,284    
Term C Facility, 6.33%, 06/09/15
    1,045,705  
       
Lavena Holding 3 GmbH
       
  6,781,978    
Facility D, 5.96%, 09/02/16
    538,341  
  6,690,918    
Mezzanine Facility, PIK, 14.93%, 03/06/17
    482,505  
       
Schieder Mobel Holding, GmbH
       
  484,213    
Delayed Draw Term Loan, 15.44%, 07/20/09 (d)
    119,920  
       
 
     
       
 
    5,255,232  
       
 
     
       
 
       
IRELAND - 0.1%        
EUR        
       
BCM Ireland Holdings Ltd.
       
  1,000,000    
Facility D, 5.80%, 03/31/16
    565,173  
       
 
     
       
 
       
NETHERLANDS - 0.3%        
EUR        
       
Amsterdamse Beheer- En Consultingmaatschappij B.V.
       
  1,500,000    
Casema D Term Loan Facility, 5.80%, 03/14/16
    1,400,765  
  1,000,000    
Kabelcom D Term Loan Facility, 5.80%, 03/14/16
    936,663  
       
 
     
       
 
    2,337,428  
       
 
     
       
 
       
SPAIN - 0.7%        
EUR        
       
Grupo Gasmedi, S.L.
       
  1,666,667    
Tranche B Term Loan, 4.46%, 08/11/14
    1,587,564  
  1,666,667    
Tranche C Term Loan, 4.96%, 08/11/15
    1,587,564  
  1,666,667    
Tranche E Second Lien Term Loan, 6.71%, 02/11/16
    1,502,894  
       
Maxi PIX Sarl
       
  2,598,120    
Euro Term Loan, PIK, 9.85%, 05/31/16
    852,456  
       
 
     
       
 
    5,530,478  
       
 
     
       
 
       
UNITED KINGDOM - 4.2%        
GBP        
       
All3Media Intermediate Ltd.
       
  663,243    
Facility B1, 3.79%, 08/31/14
    659,386  
  4,281,270    
Facility C, 4.29%, 08/31/15
    4,286,884  
  3,000,000    
Facility D, 6.16%, 02/29/16
    2,993,243  
  3,948,169    
Mezzanine Loan, PIK, 11.24%, 08/31/16
    3,854,864  
       
Ansco UK Finance Co. Ltd.
       
  796,945    
Tranche B Term Loan, 5.88%, 03/08/12
    806,509  
       
Henson No. 4 Ltd.
       
  1,899,866    
Facility B, 6.20%, 10/30/13
    1,888,817  
  1,899,866    
Facility C, 6.70%, 02/13/15
    1,902,357  
       
Highland Acquisitions Ltd.
       
  1,000,000    
Facility B, 4.19%, 12/31/14
    780,381  
  1,000,000    
Facility C, 4.69%, 12/31/15
    787,508  
  1,121,627    
Mezzanine Facility, PIK, 12.08%, 12/30/16
    727,416  
       
SunGard UK Holdings Ltd.
       
  1,357,589    
U.K. Term Loan, 4.52%, 02/28/14
    1,538,361  
       
Towergate Partnership Ltd.
       
  3,125,000    
Facility A, 3.92%, 10/31/12
    3,452,029  
  3,125,000    
Facility B, 4.42%, 10/31/13
    3,452,029  
       
United Biscuits Holdco Ltd.
       
  3,383,459    
Facility B1, 4.47%, 12/15/14
    3,069,891  
       
Virgin Media Investment Holdings Ltd.
       
  1,750,000    
C Facility, 4.92%, 03/04/13
    1,797,343  
       
 
     
       
 
    31,997,018  
       
 
     
 
UNITED STATES - 0.9%        
EUR        
       
RD German Holdings GmbH
       
  2,479,933    
Euro Term Loan, 3.85%, 03/02/14
    1,023,634  
       
 
     
       
 
       
GBP        
       
Aramark Corp.
       
  1,225,000    
U.K. Term Loan, 5.00%, 01/26/14
    1,501,610  
       
Knowledgepoint360 Group, LLC
       
  1,603,807    
U.K. First Lien Term Loan, 5.32%, 04/13/14
    1,520,186  
8  |  See accompanying Notes to Financial Statements.


 

INVESTMENT PORTFOLIO (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
                 
Principal Amount         Value ($)  
Foreign Denominated Senior Loans (continued)        
 
UNITED STATES (continued)        
GBP        
       
PlayPower, Inc.
       
  2,647,959    
Tranche B Sterling Term Loan, 4.80%, 06/30/12
    3,057,166  
       
 
     
       
 
    6,078,962  
       
 
     
       
 
       
       
Total Foreign Denominated Senior Loans (Cost $200,717,306)
    94,515,703  
       
 
     
                 
Principal Amount ($)              
Asset-Backed Securities (j) - 0.4%        
       
ACA CLO, Ltd.
       
  1,000,000    
Series 2007-1A, Class D, 3.44%, 06/15/22 (k)
    90,000  
       
ACAS CLO, Ltd.
       
  1,500,000    
Series 2007-1A, Class D, 5.39%, 04/20/21 (k)
    93,570  
       
Apidos CDO
       
  1,000,000    
Series 2007-5A, Class C, 2.54%, 04/15/21 (k)
    58,210  
  3,000,000    
Series 2007-CA, Class B, 2.93%, 05/14/20 (k)
    240,000  
       
Babson CLO, Ltd.
       
  1,000,000    
Series 2007-1A, Class C, 2.39%, 01/18/21 (k)
    72,159  
  1,000,000    
Series 2007-2A, Class D, 2.79%, 04/15/21 (k)
    90,000  
  1,000,000    
Series 2007-2A, Class E, 4.74%, 04/15/21
    60,000  
       
Bluemountain CLO, Ltd.
       
  1,000,000    
Series 2007-3A, Class D, 3.27%, 03/17/21 (k)
    116,800  
  1,000,000    
Series 2007-3A, Class E, 5.42%, 03/17/21 (k)
    58,495  
       
Cent CDO, Ltd.
       
  2,000,000    
Series 2007-15A, Class C, 4.41%, 03/11/21 (k)
    181,542  
       
Commercial Industrial Finance Corp.
       
  1,000,000    
Series 2006-2A, Class B2L, 6.20%, 03/01/21 (k)
    78,092  
       
Goldman Sachs Asset Management CLO, PLC,
       
  2,030,043    
Series 2007-1A, Class D, PIK 3.92%, 08/01/22 (k)
    223,305  
  1,020,709    
Series 2007-1A, Class E, PIK 6.17%, 08/02/22 (k)
    132,692  
       
Greywolf CLO, Ltd
       
  1,000,000    
Series 2007-1A, Class E, 6.19%, 02/18/21 (k)
    160,000  
       
GSC Partners CDO Fund, Ltd.,
       
  1,000,000    
Series 2007-8A, Class C, 2.62%, 04/17/21 (k)
    67,849  
       
ING Investment Management
       
  6,000,000    
Series 2007-5A, Class B, 2.27%, 05/01/22 (k)
    480,000  
       
Inwood Park CDO, Ltd.
       
  1,000,000    
Series 2006-1A, Class E, 4.64%, 01/20/21 (k)
    80,000  
       
Landmark CDO
       
  1,000,000    
Series 2007-9A, Class E, 4.59%, 04/15/21 (k)
    93,400  
       
Madison Park Funding I Ltd.
       
  1,000,000    
Series 2007-5A, Class D, 4.75%, 02/26/21 (k)
    88,734  
       
Ocean Trails CLO
       
  2,500,000    
Series 2007-2A, Class C, 3.61%, 06/27/22 (k)
    125,000  
       
PPM Grayhawk CLO, Ltd.
       
  1,150,000    
Series 2007-1A, Class D, 4.69%, 04/18/21 (k)
    99,694  
       
Stanfield Daytona CLO, Ltd.
       
  1,000,000    
Series 2007-1A, Class B1L, 2.52%, 04/27/21 (k)
    57,790  
       
Stanfield McLaren CLO, Ltd.
       
  3,000,000    
Series 2007-1A, Class B1L, 4.58%, 02/27/21 (k)
    222,609  
  1,000,000    
Series 2007-1A, Class B2L, 6.68%, 02/27/21 (k)
    98,283  
       
Stone Tower CLO, Ltd.
       
  4,000,000    
Series 2007-6A, Class C, 1.71%, 04/17/21 (k)
    200,000  
       
 
     
 
       
Total Asset-Backed Securities (Cost $29,142,942)
    3,268,224  
       
 
     
       
 
       
Claims (I) - 0.1%        
 
AEROSPACE - 0.0%        
       
Delta Air Lines, Inc.
       
  310,290    
Comair ALPA Claim, 12/31/10
    7,757  
  879,660    
Delta ALPA Claim, 12/31/10
    83,568  
       
Northwest Airlines, Inc.
       
  5,400,000    
ALPA Trade Claim, 08/21/13
    10,152  
  2,914,735    
Bell Atlantic Trade Claim, 08/21/13
    5,480  
  3,000,000    
CIT Leasing Corp Trade Claim, 08/21/13
    5,640  
  5,000,000    
EDC Trade Claims, 08/21/13
    9,400  
  9,587,700    
Flight Attendant Claim, 05/17/14
    18,025  
  3,250,000    
GE Trade Claim, 08/21/13
    6,110  
  5,690,250    
IAM Trade Claim, 08/21/13
    10,698  
  6,250,000    
Mesaba Trade Claim, 08/15/13
    11,750  
  6,322,050    
Retiree Claim, 08/21/13
    11,885  
       
 
     
       
 
    180,465  
       
 
     
       
 
       
UTILITY - 0.1%        
       
Mirant Corp.
       
  20,500,000    
01/01/20
    205,000  
       
 
     
       
Total Claims (Cost $8,099,863)
    385,465  
       
 
     
See accompanying Notes to Financial Statements.  |  9


 

INVESTMENT PORTFOLIO (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
                 
Shares              
Common Stocks (I) - 0.1%        
 
AEROSPACE - 0.0%        
  26,999    
Delta Air Lines, Inc.
    135,807  
       
 
     
       
 
       
BROADCASTING - 0.0%        
  152,363    
Communications Corp. of America (b) (c)
     
       
 
     
       
 
       
TRANSPORTATION — LAND TRANSPORTATION - 0.0%        
  2,023    
JHT Holdings, Inc (b)
     
  20,347    
SIRVA Worldwide, Inc. (b)
    187,396  
       
 
     
       
 
    187,396  
       
 
     
       
 
       
UTILITY - 0.1%        
  139,846    
Entegra TC, LLC
    489,461  
       
 
     
       
Total Common Stocks (Cost $3,256,980)
    812,664  
       
 
     
                 
Units              
 
Warrants (I) - 0.0%        
 
AEROSPACE - 0.0%        
       
IAP Worldwide Services, Inc.
       
  86,304    
Series A, expires 06/12/15,
     
       
IAP Worldwide Services, Inc.
       
  25,276    
Series B, expires 06/12/15,
     
       
IAP Worldwide Services, Inc.
       
       
 
     
  12,797    
Series C, expires 06/12/15,
     
       
 
     
       
 
       
ENERGY - 0.0%        
       
Value Creation, Inc.,
       
  345,538    
expires 01/28/14
     
       
Value Creation, Inc.,
       
       
 
     
  345,538    
expires 01/28/14
     
       
 
     
       
 
     
       
 
     
       
Total Warrants (Cost $—)
     
Total Investments - 104.6%     797,273,422  
       
 
     
     (Cost of $1,522,497,199) (m)        
Other Assets & Liabilities, Net — (4.6)%     (34,698,585 )
       
 
     
Net Assets - 100.0%     762,574,837  
       
 
     
(a)   Senior loans (also called bank loans, leveraged loans, or floating rate loans) in which the Highland Floating Rate Advantage Fund (“Fund”) invests generally pay interest at rates which are periodically determined by reference to a base lending rate plus a premium. (Unless otherwise identified by footnote (h), 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. The rate shown represents the weighted average rate at February 28, 2009. Senior loans, while exempt from registration under the Securities Act of 1933, (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 may be substantially less than the stated maturity shown.
 
(b)   Represents fair value as determined by the Fund’s Board of Trustees (the “Board”) or its designees in good faith, pursuant to the policies and procedures approved by the Board. Securities with a total aggregate market value of $64,340,609, or 8.4% of net assets, were fair valued as of February 28, 2009.
 
(c)   Affiliated issuer. See Note 10.
 
(d)   The issuer is in default of its payment obligation. Income is not being accrued.
 
(e)   Senior Loan assets have additional unfunded loan commitments. See Note 9.
 
(f)   Loans held on participation. See Note 7.
 
(g)   All or a portion of this position has not settled. Contract rates do not take effect until settlement date.
 
(h)   Fixed rate senior loan.
 
(i)   The issuer is in liquidation.
 
(j)   Floating rate asset. The interest rate shown reflects the rate in effect at February 28, 2009.
 
(k)   Securities exempt from registration under Rule 144A of the 1933 Act. These securities may only be resold, in transactions exempt from registration, to qualified institutional buyers. At February 28, 2009, these securities amounted to $3,208,224 or 0.4% of net assets.
 
(l)   Non-income producing security.
 
(m)   Cost for U.S. Federal income tax purposes is $1,522,980,565.
 
AUD   Australian Dollar
 
CDO   Collateralized Debt Obligation
 
CLO   Collateralized Loan Obligation
 
DIP   Debtor-in-Possession
 
EUR   Euro Currency
 
GBP   Great Britain Pound
 
PIK   Payment-in-Kind
 
SEK   Swedish Kronor
10  |  See accompanying Notes to Financial Statements.


 

INVESTMENT PORTFOLIO (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
Forward foreign currency contracts outstanding as of February 28, 2009 were as follows:
                                 
            Principal                
Contracts           Amount             Net  
to Buy or           Covered by             Unrealized  
to Sell   Currency     Contracts     Expiration     Appreciation  
 
Sell
  EUR     18,000,000       05/05/09     $ 472,203  
Sell
  EUR     28,500,000       08/03/09       709,854  
Sell
  GBP     15,000,000       05/05/09       65,277  
Sell
  GBP     12,500,000       08/03/09       (47,850 )
 
                             
 
                          $ 1,199,484  
 
                             
Foreign Denominated Senior Loans
Industry Concentration Table:

(% of Total Net Assets)
         
Financial
    4.2 %
Broadcasting
    1.7 %
Diversified Media
    1.7 %
Retail
    1.2 %
Cable/Wireless Video
    1.1 %
Healthcare
    0.8 %
Food/Tobacco
    0.7 %
Consumer Durables
    0.4 %
Telecommunications
    0.3 %
Information Technology
    0.2 %
Gaming/Leisure
    0.1 %
 
       
Total
    12.4 %
 
       
See accompanying Notes to Financial Statements.  |  11

 


 

STATEMENT OF ASSETS AND LIABILITIES
     
February 28, 2009 (unaudited)   Highland Floating Rate Advantage Fund
         
    ($)
 
Assets:
       
Unaffiliated issuers, at value (cost $1,520,020,716)
    796,041,564  
Affiliated issuers, at value (cost $2,476,483) (Note 10)
    1,231,858  
 
       
Total investments, at value (cost $1,522,497,199)
    797,273,422  
Cash
    41,452,036  
Foreign currency (cost $2,167,606)
    1,987,276  
Net unrealized appreciation on forward foreign currency contracts
    1,247,334  
Receivable for:
       
Investments sold
    69,205,305  
Dividends and interest receivable
    17,048,843  
Fund shares sold
    655,021  
Other assets
    482,693  
 
       
Total assets
    929,351,930  
 
       
 
       
Liabilities:
       
Notes payable (Note 8)
    136,000,000  
Net unrealized depreciation on forward foreign currency contracts
    47,850  
Net discount and unrealized appreciation/(depreciation) on unfunded transactions (Note 9)
    13,766,157  
Payables for:
       
Distributions
    1,753,379  
Investments purchased
    13,426,654  
Investment advisory fee payable (Note 4)
    465,128  
Administration fee (Note 4)
    143,142  
Fund shares redeemed
    51,140  
Trustees’ fees (Note 4)
    4,186  
Service and distribution fees (Note 4)
    370,660  
Transfer agent fees
    143,113  
Interest expense (Note 8)
    486,235  
Accrued expenses and other liabilities
    119,449  
 
       
Total liabilities
    166,777,093  
 
       
Net Assets
    762,574,837  
 
       
 
       
Composition of Net Assets:
       
Par Value (Note 1)
    1,351,095  
Paid-in capital
    1,958,492,409  
Overdistributed net investment income (Note 2)
    (50,885,283 )
Accumulated net realized gain/(loss) from investments and foreign currency transactions
    (411,018,122 )
Net unrealized appreciation/(depreciation) on investments, unfunded transactions, forward currency contracts, and translation of assets and liabilities denominated in foreign currency
    (735,365,262 )
 
       
Net Assets
    762,574,837  
 
       
 
       
Class A
       
Net assets
    270,360,304  
Shares outstanding (unlimited authorization)
    47,900,145  
Net asset value per share (Net assets/shares outstanding)
    5.64 (a)
Maximum offering price per share (100 / 96.50 of $5.64)
    5.84 (b)
 
       
Class B
       
Net assets
    27,135,686  
Shares outstanding (unlimited authorization)
    4,808,035  
Net asset value and offering price per share (Net assets/shares outstanding)
    5.64 (a)
 
       
Class C
       
Net assets
    397,862,574  
Shares outstanding (unlimited authorization)
    70,491,214  
Net asset value and offering price per share (Net assets/shares outstanding)
    5.64 (a)
 
       
Class Z
       
Net assets
    67,216,273  
Shares outstanding (unlimited authorization)
    11,910,095  
Net asset value, offering and redemption price per share (Net assets/shares outstanding)
    5.64  
(a)   Redemption price per share is equal to net asset value less any applicable contingent deferred sales charge.
 
(b)   On sales of $100,000 or more, the offering price is reduced.
12  |  See accompanying Notes to Financial Statements.

 


 

STATEMENT OF OPERATIONS
     
For the Six Months Ended February 28, 2009 (unaudited)   Highland Floating Rate Advantage Fund
         
    ($)
 
Investment Income:
       
Interest from unaffiliated issuers
    68,238,599  
Interest from affiliated issuers (Note 10)
    129,957  
 
       
Total investment income
    68,368,556  
 
       
 
       
Expenses:
       
Investment advisory fees (Note 4)
    4,427,913  
Administration fees (Note 4)
    1,395,056  
Accounting service fees
    215,020  
Distribution fee: (Note 4)
       
Class A
    192,187  
Class B
    89,404  
Class C
    1,608,809  
Service fee: (Note 4)
       
Class A
    480,467  
Class B
    49,669  
Class C
    670,337  
Transfer agent fee
    681,380  
Professional fees
    239,106  
Trustees’ fees (Note 4)
    131,059  
Custodian fees
    100,073  
Registration fees
    57,028  
Reports to shareholders
    220,742  
Insurance expense
    55,518  
Interest expense (Note 8)
    4,859,090  
Commitment fee expense (Note 8)
    2,566,987  
Other expenses
    72,386  
 
       
Total operating expenses
    18,112,231  
 
       
Fees and expenses waived or reimbursed by Investment Adviser (Note 4)
    (92,370 )
 
       
Net expenses
    18,019,861  
 
       
Net investment income
    50,348,695  
 
       
 
       
Net Realized and Unrealized Gain/(Loss) on Investments:
       
Net realized gain/(loss) on investments from unaffiliated issuers
    (332,289,924 )
Net realized gain/(loss) on foreign currency transactions
    48,509,483  
Net change in unrealized appreciation/(depreciation) on investments
    (303,673,893 )
Net change in unrealized appreciation/(depreciation) on unfunded transactions (Note 9)
    (8,954,593 )
Net change in unrealized appreciation/(depreciation) on forward foreign currency contracts
    (19,266,667 )
Net change in unrealized appreciation/(depreciation) on translation of assets and liabilities denominated in foreign currency
    1,224,216  
 
       
Net realized and unrealized gain/(loss) on investments
    (614,451,378 )
 
       
Net decrease in net assets from operations
    (564,102,683 )
 
       
See accompanying Notes to Financial Statements.  |  13

 


 

STATEMENTS OF CHANGES IN NET ASSETS
Highland Floating Rate Advantage Fund
                 
    Six Months Ended    
    February 28, 2009   Year Ended
    (unaudited)   August 31, 2008
    ($)   ($)
Increase/(Decrease) in Net Assets:
               
 
               
From Operations
               
Net investment income
    50,348,695       172,604,154  
Net realized gain/(loss) on investments, swaps and foreign currency transactions
    (283,780,441 )     (140,556,628 )
Net change in unrealized appreciation/(depreciation) on investments, unfunded transactions, forward foreign currency contracts and translation of assets and liabilities denominated in foreign currency
    (330,670,937 )     (266,353,346 )
 
               
Net change in net assets from operations
    (564,102,683 )     (234,305,820 )
 
               
 
               
Distributions Declared to Shareholders
               
From net investment income
               
Class A
    (30,810,715 )     (66,858,129 )
Class B
    (3,140,726 )     (6,306,525 )
Class C
    (41,938,923 )     (81,955,858 )
Class Z
    (8,813,646 )     (18,988,774 )
 
               
Total distributions from net investment income
    (84,704,010 )     (174,109,286 )
From capital gains
               
Class A
          (709,297 )
Class B
          (74,228 )
Class C
          (948,645 )
Class Z
          (192,326 )
 
               
Total distributions from capital gains
          (1,924,496 )
 
               
Total distributions declared to shareholders
    (84,704,010 )     (176,033,782 )
 
               
 
               
Share Transactions
               
Class A
               
Subscriptions
    17,890,380       143,667,826  
Distributions reinvested
    17,901,743       40,921,710  
Redemptions
    (98,818,143 )     (516,535,311 )
 
               
Net decrease
    (63,026,020 )     (331,945,775 )
 
               
Class B
               
Subscriptions
    47,396       356  
Distributions reinvested
    1,905,311       3,909,321  
Redemptions
    (9,263,265 )     (25,435,593 )
 
               
Net decrease
    (7,310,558 )     (21,525,916 )
 
               
Class C
               
Subscriptions
    6,412,369       109,094,141  
Distributions reinvested
    24,815,433       51,939,527  
Redemptions
    (95,038,008 )     (444,187,742 )
 
               
Net decrease
    (63,810,206 )     (283,154,074 )
 
               
Class Z
               
Subscriptions
    3,090,144       32,128,836  
Distributions reinvested
    4,052,439       10,049,186  
Redemptions
    (41,892,938 )     (111,027,504 )
 
               
Net decrease
    (34,750,355 )     (68,849,482 )
 
               
Net decrease from share transactions
    (168,897,139 )     (705,475,247 )
 
               
Total decrease in net assets
    (817,703,832 )     (1,115,814,849 )
 
               
 
               
Net Assets
               
Beginning of period
    1,580,278,669       2,696,093,518  
 
               
End of period (including overdistributed net investment income of $(50,885,283) and $(16,529,968), respectively)
    762,574,837       1,580,278,669  
 
               
14  |  See accompanying Notes to Financial Statements.

 


 

STATEMENTS OF CHANGES IN NET ASSETS (continued)
Highland Floating Rate Advantage Fund
                 
    Six Months Ended    
    February 28, 2009   Year Ended
    (unaudited)   August 31, 2008
    ($)   ($)
Change in Shares
               
Class A
               
Subscriptions
    2,510,606       13,098,507  
Issued for distributions reinvested
    2,949,964       3,792,699  
Redemptions
    (16,003,122 )     (47,863,735 )
 
               
Net decrease
    (10,542,552 )     (30,972,529 )
 
               
Class B
               
Subscriptions
    4,989       36  
Issued for distributions reinvested
    315,554       364,258  
Redemptions
    (1,540,595 )     (2,430,986 )
 
               
Net decrease
    (1,220,052 )     (2,066,692 )
 
               
Class C
               
Subscriptions
    934,339       9,860,415  
Issued for distributions reinvested
    4,110,412       4,828,665  
Redemptions
    (15,417,039 )     (41,873,048 )
 
               
Net decrease
    (10,372,288 )     (27,183,968 )
 
               
Class Z
               
Subscriptions
    425,975       2,970,390  
Issued for distributions reinvested
    660,551       931,170  
Redemptions
    (6,714,033 )     (10,225,487 )
 
               
Net decrease
    (5,627,507 )     (6,323,927 )
See accompanying Notes to Financial Statements.  |  15

 


 

STATEMENT OF CASH FLOWS
     
For the Six Months Ended February 28, 2009 (unaudited)   Highland Floating Rate Advantage Fund
         
    ($)
 
Cash Flows Provided by Operating Activities
       
Net investment income
    50,348,695  
 
       
Adjustments to Reconcile Net Investment Income to Net Cash and Foreign Currency Provided by Operating Activities
       
Purchase of investment securities
    (65,608,894 )
Proceeds from disposition of investment securities
    736,778,100  
Increase in receivable for investments sold
    (14,949,519 )
Decrease in interest and fees receivable
    5,145,589  
Increase in other assets
    (380,246 )
Net amortization/(accretion) of premium/(discount)
    (3,538,516 )
Mark-to-market on realized and unrealized gain/(loss) on foreign currency
    49,733,699  
Decrease in payable for investments purchased
    (87,523,406 )
Decrease in payables to related parties
    (1,353,713 )
Decrease in interest payable
    (965,273 )
Decrease in other expenses and liabilities
    (740,876 )
 
       
Net cash and foreign currency provided by operating activities
    666,945,640  
 
       
 
       
Cash Flows Used by Financing Activities
       
Decrease in notes payable
    (375,000,000 )
Proceeds from shares sold
    27,569,018  
Payment of shares redeemed
    (244,961,214 )
Distributions paid in cash
    (38,658,252 )
 
       
Net cash flow used by financing activities
    (631,050,448 )
 
       
Net increase in cash and foreign currency
    35,895,192  
 
       
 
       
Cash and Foreign Currency
       
Beginning of the period
    7,544,120  
 
       
End of the period
    43,439,312  
 
       
 
       
Supplemental disclosure of cash flow information:
       
Cash paid during the year for interest
    5,824,363  
 
       
16  |  See accompanying Notes to Financial Statements.

 


 

FINANCIAL HIGHLIGHTS
Highland Floating Rate Advantage Fund
Selected data for a share outstanding throughout each period is as follows:
                                                 
               
    Six Months Ended                                
    February 28, 2009     Years Ended August 31,
Class A Shares   (unaudited)     2008     2007     2006     2005     2004  
Net Asset Value, Beginning of Period
  $ 9.70     $ 11.75     $ 12.43     $ 12.19     $ 12.08     $ 11.22  
 
Income from Investment Operations:
                                               
Net investment income(a)
    0.33       0.90       1.00       0.96       0.67       0.56  
Net realized and unrealized gain/(loss)(a)
    (3.83 )     (2.05 )     (0.60 )     0.22       0.11       0.89  
 
                                   
Total from investment operations
    (3.50 )     (1.15 )     0.40       1.18       0.78       1.45  
 
Less Distributions Declared to Shareholders:
                                               
From net investment income
    (0.56 )     (0.89 )     (1.01 )     (0.94 )     (0.67 )     (0.59 )
From net realized gains
          (0.01 )     (0.07 )                  
 
                                   
Total distributions declared to shareholders
    (0.56 )     (0.90 )     (1.08 )     (0.94 )     (0.67 )     (0.59 )
 
Net Asset Value, End of Period
  $ 5.64     $ 9.70     $ 11.75     $ 12.43     $ 12.19     $ 12.08  
Total return(b)
    (36.21 )%(c)     (10.28 )%     3.10 %     10.08 %     6.56 %(d)     13.14 %
 
Ratios to Average Net Assets/ Supplemental Data:
                                               
Net assets, end of period (000’s)
  $ 270,360     $ 567,048     $ 1,050,738     $ 729,845     $ 351,557     $ 212,205  
Total expenses excluding interest and commitment fee expenses
    1.77 %     1.58 %     1.33 %     1.16 %     1.38 %     1.47 %(f)
Interest and commitment fee expenses
    1.39 %     1.47 %     1.06 %     1.04 %     0.72 %     0.40 %
Waiver/reimbursement
    0.02 %     0.02 %           0.04 %     0.10 %     0.18 %
Net expenses including interest and commitment fee expenses(e)
    3.14 %     3.03 %     2.39 %     2.16 %     2.00 %     1.69 %(f)
Net investment income
    9.64 %     8.28 %     8.05 %     7.78 %     5.60 %     4.73 %(f)
Portfolio turnover rate
    5 %(c)     22 %     70 %     61 %     85 %     110 %
(a)   Per share data was calculated using average shares outstanding during the period.
 
(b)   Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or contingent deferred sales charge (“CDSC”). For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced.
 
(c)   Not annualized.
 
(d)   A late audit adjustment was made to NAV, however, performance was not recalculated using the adjusted NAV. Rather total return is calculated using the net asset value used for trading at the close of business on August 31, 2005.
 
(e)   Net expense ratio has been calculated after applying any waiver/reimbursement, if applicable.
 
(f)   The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%.
See accompanying Notes to Financial Statements.  |  17

 


 

FINANCIAL HIGHLIGHTS
Highland Floating Rate Advantage Fund
Selected data for a share outstanding throughout each period is as follows:
                                                 
               
    Six Months Ended                                
    February 28, 2009     Years Ended August 31,
Class B Shares   (unaudited)     2008     2007     2006     2005     2004  
 
Net Asset Value, Beginning of Period
  $ 9.70     $ 11.75     $ 12.43     $ 12.19     $ 12.08     $ 11.22  
 
Income from Investment Operations:
                                               
Net investment income(a)
    0.32       0.86       0.96       0.92       0.63       0.53  
Net realized and unrealized gain/(loss) (a)
    (3.83 )     (2.05 )     (0.60 )     0.22       0.11       0.88  
 
                                   
Total from investment operations
    (3.51 )     (1.19 )     0.36       1.14       0.74       1.41  
 
Less Distributions Declared to Shareholders:
                                               
From net investment income
    (0.55 )     (0.85 )     (0.97 )     (0.90 )     (0.63 )     (0.55 )
From net realized gains
          (0.01 )     (0.07 )                  
 
                                   
Total distributions declared to shareholders
    (0.55 )     (0.86 )     (1.04 )     (0.90 )     (0.63 )     (0.55 )
 
Net Asset Value, End of Period
  $ 5.64     $ 9.70     $ 11.75     $ 12.43     $ 12.19     $ 12.08  
Total return(b)
    (36.32 )%(c)     (10.60 )%     2.74 %     9.70 %     6.19 %(d)     12.75 %
 
Ratios to Average Net Assets/ Supplemental Data:
                                               
Net assets, end of period (000’s)
  $ 27,136     $ 58,486     $ 95,122     $ 115,651     $ 124,500     $ 124,589  
Total expenses excluding interest and commitment fee expenses
    2.12 %     1.93 %     1.68 %     1.51 %     1.73 %     1.82 %(f)
Interest and commitment fee expenses
    1.39 %     1.47 %     1.06 %     1.04 %     0.72 %     0.40 %
Waiver/reimbursement
    0.02 %     0.02 %           0.04 %     0.10 %     0.18 %
Net expenses including interest and commitment fee expenses(e)
    3.49 %     3.38 %     2.74 %     2.51 %     2.35 %     2.04 %(f)
Net investment income
    9.29 %     7.93 %     7.70 %     7.43 %     5.25 %     4.50 %(f)
Portfolio turnover rate
    5 %(c)     22 %     70 %     61 %     85 %     110 %
(a)   Per share data was calculated using average shares outstanding during the period.
 
(b)   Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced.
 
(c)   Not annualized.
 
(d)   A late audit adjustment was made to NAV, however, performance was not recalculated using the adjusted NAV. Rather total return is calculated using the net asset value used for trading at the close of business on August 31, 2005.
 
(e)   Net expense ratio has been calculated after applying any waiver/reimbursement, if applicable.
 
(f)   The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%.
18  |  See accompanying Notes to Financial Statements.

 


 

FINANCIAL HIGHLIGHTS
Highland Floating Rate Advantage Fund
Selected data for a share outstanding throughout each period is as follows:
                                                 
               
    Six Months Ended                                
    February 28, 2009     Years Ended August 31,
Class C Shares   (unaudited)     2008     2007     2006     2005     2004  
 
Net Asset Value, Beginning of Period
  $ 9.70     $ 11.75     $ 12.43     $ 12.19     $ 12.08     $ 11.22  
 
Income from Investment Operations:
                                               
Net investment income(a)
    0.31       0.84       0.93       0.90       0.61       0.50  
Net realized and unrealized gain/(loss) (a)
    (3.83 )     (2.04 )     (0.59 )     0.22       0.11       0.89  
 
                                   
Total from investment operations
    (3.52 )     (1.20 )     0.34       1.12       0.72       1.39  
 
Less Distributions Declared to Shareholders:
                                               
From net investment income
    (0.54 )     (0.84 )     (0.95 )     (0.88 )     (0.61 )     (0.53 )
From net realized gains
          (0.01 )     (0.07 )                  
 
                                   
Total distributions declared to shareholders
    (0.54 )     (0.85 )     (1.02 )     (0.88 )     (0.61 )     (0.53 )
 
Net Asset Value, End of Period
  $ 5.64     $ 9.70     $ 11.75     $ 12.43     $ 12.19     $ 12.08  
Total return(b)
    (36.37 )%(c)     (10.73 )%     2.50 %     9.62 %     6.03 %(d)     12.57 %
 
Ratios to Average Net Assets/ Supplemental Data:
                                               
Net assets, end of period (000’s)
  $ 397,863     $ 784,597     $ 1,269,850     $ 816,720     $ 391,455     $ 278,731  
Total expenses excluding interest and commitment fee expenses
    2.27 %     2.08 %     1.83 %     1.66 %     1.88 %     1.97 %(f)
Interest and commitment fee expenses
    1.39 %     1.47 %     1.06 %     1.04 %     0.72 %     0.40 %
Waiver/reimbursement
    0.02 %     0.02 %           0.04 %     0.10 %     0.18 %
Net expenses including interest and commitment fee expenses(e)
    3.64 %     3.53 %     2.89 %     2.66 %     2.50 %     2.19 %(f)
Net investment income
    9.14 %     7.78 %     7.55 %     7.28 %     5.10 %     4.19 %(f)
Portfolio turnover rate
    5 %(c)     22 %     70 %     61 %     85 %     110 %
(a)   Per share data was calculated using average shares outstanding during the period.
 
(b)   Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced.
 
(c)   Not annualized.
 
(d)   A late audit adjustment was made to NAV, however, performance was not recalculated using the adjusted NAV. Rather total return is calculated using the net asset value used for trading at the close of business on August 31, 2005.
 
(e)   Net expense ratio has been calculated after applying any waiver/reimbursement, if applicable.
 
(f)   The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%.
See accompanying Notes to Financial Statements.  |  19

 


 

FINANCIAL HIGHLIGHTS
Highland Floating Rate Advantage Fund
Selected data for a share outstanding throughout each period is as follows:
                                                 
               
    Six Months Ended                                
    February 28, 2009     Years Ended August 31,
Class Z Shares   (unaudited)     2008     2007     2006     2005     2004  
 
Net Asset Value, Beginning of Period
  $ 9.70     $ 11.75     $ 12.43     $ 12.19     $ 12.08     $ 11.22  
 
Income from Investment Operations:
                                               
Net investment income(a)
    0.35       0.94       1.04       1.00       0.71       0.59  
Net realized and unrealized gain/(loss) (a)
    (3.84 )     (2.05 )     (0.60 )     0.22       0.11       0.90  
 
                                   
Total from investment operations
    (3.49 )     (1.11 )     0.44       1.22       0.82       1.49  
 
Less Distributions Declared to Shareholders:
                                               
From net investment income
    (0.57 )     (0.93 )     (1.05 )     (0.98 )     (0.71 )     (0.63 )
From net realized gains
          (0.01 )     (0.07 )                  
 
                                   
Total distributions declared to shareholders
    (0.57 )     (0.94 )     (1.12 )     (0.98 )     (0.71 )     (0.63 )
 
Net Asset Value, End of Period
  $ 5.64     $ 9.70     $ 11.75     $ 12.43     $ 12.19     $ 12.08  
Total return(b)
    (36.09 )%(c)     (9.97 )%     3.46 %     10.47 %     6.93 %(d)     13.52 %
 
Ratios to Average Net Assets/ Supplemental Data:
                                               
Net assets, end of period (000’s)
  $ 67,216     $ 170,147     $ 280,383     $ 161,996     $ 75,293     $ 53,049  
Total expenses excluding interest and commitment fee expenses
    1.42 %     1.23 %     0.98 %     0.81 %     1.03 %     1.12 %(f)
Interest and commitment fee expenses
    1.39 %     1.47 %     1.06 %     1.04 %     0.72 %     0.40 %
Waiver/reimbursement
    0.02 %     0.02 %           0.04 %     0.10 %     0.18 %
Net expenses including interest and commitment fee expenses(e)
    2.79 %     2.68 %     2.04 %     1.81 %     1.65 %     1.34 %(f)
Net investment income
    9.99 %     8.63 %     8.40 %     8.13 %     5.95 %     4.93 %(f)
Portfolio turnover rate
    5 %(c)     22 %     70 %     61 %     85 %     110 %
(a)   Per share data was calculated using average shares outstanding during the period.
 
(b)   Total return is at net asset value assuming all distributions are reinvested and no initial sales charge or CDSC. For periods with waivers/reimbursements, had the Fund’s investment adviser not waived or reimbursed a portion of expenses, total return would have been reduced.
 
(c)   Not annualized.
 
(d)   A late audit adjustment was made to NAV, however, performance was not recalculated using the adjusted NAV. Rather total return is calculated using the net asset value used for trading at the close of business on August 31, 2005.
 
(e)   Net expense ratio has been calculated after applying any waiver/reimbursement if applicable.
 
(f)   The benefits derived from custody credits and directed brokerage arrangements, if applicable, had an impact of less than 0.01%.
20  |  See accompanying Notes to Financial Statements.

 


 

NOTES TO FINANCIAL STATEMENTS (unaudited)
     
February 28, 2009   Highland Floating Rate Advantage Fund
Note 1. Organization
Highland Floating Rate Advantage Fund (the “Fund”) is a Delaware statutory trust that is successor in interest to a Massachusetts business trust of the same name and is registered with the Securities and Exchange Commission (the “SEC”) under the Investment Company Act of 1940, as amended (the “1940 Act”), as a continuously offered, non-diversified, closed-end management investment company.
Investment Objective
The Fund seeks to provide a high level of current income, consistent with preservation of capital.
Fund Shares
The Fund may issue an unlimited number of shares, with par value $0.001 per share and continuously offers three classes of shares: Class A, Class C and Class Z. The Fund has discontinued selling Class B Shares to new and existing investors, although existing investors may still reinvest distributions in Class B Shares. Class A shares are sold with a front-end sales charge. Class A, B and C shares may be subject to a contingent deferred sales charge (“CDSC”), Class Z shares are sold only to certain eligible investors. Certain share classes have their own sales charge and bear class-specific expenses, which include distribution fees and service fees.
Note 2. Significant Accounting Policies
The following is a summary of significant accounting policies consistently followed by the Fund in the preparation of its financial statements.
Use of Estimates
The Fund’s financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), which require management to make estimates and assumptions that may affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ materially.
Fund Valuation
The net asset value (“NAV”) of the Fund’s Shares is calculated daily in accordance with procedures approved by the Board of Trustees (the “Board” or “Trustees”). The NAV per share of each class of the Fund’s shares is calculated by dividing the value of the Fund’s net assets attributable to the class of shares by the total number of Shares of the class outstanding.
Valuation of Investments
In computing the Fund’s net assets, securities with readily available market quotations use those quotations for valuation. When portfolio securities are traded on the relevant day of valuation, the valuation will generally be the last reported sale price on that day. If there are no such sales on that day, the security will be valued at the mean between the most recently quoted bid and asked 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 positions are not traded on exchanges and consequently are valued based on a mean of the bid and ask price from the third-party pricing services or broker-dealer sources that Highland Capital Management, L.P. (the “Investment Adviser”) has determined generally has the capability to provide appropriate pricing services and is approved by the Fund’s Board.
Securities for which market quotations are not readily available and for which the Fund has determined the price received from a pricing service or broker-dealer is “stale” or otherwise does not represent fair value (including when events materially affect the value of securities that occur between the time when market price is determined and calculation of the Fund’s 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: (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 not easily substantiated by auditing procedures.
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. Short-term investments, that is, those with a remaining maturity of 60 days or less, are valued at amortized cost, a method of valuation which approximates market value. Repurchase agreements are valued at cost plus accrued interest. Foreign price quotations are converted to U.S. dollar equivalents using the 4:00 PM London Time Spot Rate.
Semi-Annual Report  |  21

 


 

NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
Adoption of Statement of Financial Accounting Standards No. 157 “Fair Value Measurement” (“FAS 157”):
In September 2006, the Financial Accounting Standards Board (“FASB”) issued FAS 157, “Fair Value Measurement,” which is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. FAS 157 defines how fair value should be determined for financial reporting purposes, establishes a framework for measuring fair value under GAAP, and requires additional disclosures about the use of fair value measurements in interim and annual periods subsequent to initial recognition, expanded information about the assets and liabilities measured at fair value and the potential effect of these fair valuations on net assets, but is not expected to result in any changes to the fair value measurements of the Fund’s investments. Adoption of FAS 157 requires the Fund to assume that the portfolio investment is sold in a principal market to a market participant, or in the absence of a principal market, the most advantageous market, which may be a hypothetical market.
The Fund has adopted FAS 157 as of September 1, 2008. The Fund has performed an analysis of all existing investments and derivative instruments to determine the significance and character of all inputs to their fair value determination. Based on this assessment, the adoption of FAS 157 did not have any material effect on the Fund’s NAV. However, the adoption of FAS 157 does require the Fund to provide additional disclosures about the inputs used to develop the measurements and the effect of certain measurements on changes in net assets for the reportable periods as contained in the Fund’s periodic filings. The levels of fair value inputs used to measure the Fund’s investments are characterized in accordance with the fair value hierarchy established by FAS 157. 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 established under FAS 157 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.
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. A summary of the inputs used to value the Fund’s assets as of February 28, 2009 is as follows:
                                 
Investments in Securities
                       
(Market Value)
  Total     Level 1     Level 2     Level 3  
Portfolio Investments
  $ 797,273,422     $ 135,807     $ 267,653,177     $ 529,484,438  
 
                       
Total
  $ 797,273,422     $ 135,807     $ 267,653,177     $ 529,484,438  
 
                       
 
                               
Other Financial Instruments (Unrealized Appreciation/(Depreciation)) *
                               
Forward Foreign Currency Contracts
  $ 1,199,484     $     $ 1,199,484     $  
 
                       
Total
  $ 1,199,484     $     $ 1,199,484     $  
 
                       
*   Other financial instruments are derivative instruments not reflected in the Investment Portfolio, such as, forwards and swaps, which are valued at the unrealized appreciation/(depreciation) on the investment.
The Fund did not have any liabilities that were measured at fair value on a recurring basis at February 28, 2009.
22  |  Semi-Annual Report

 


 

NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
The table below sets forth a summary of changes in the Fund’s assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended February 28, 2009.
         
Assets at Fair Value using unobservable inputs (Level 3)   Portfolio Investments  
Balance as of August 31, 2008
  $ 456,148,750  
Transfers in/(out) of Level 3
    479,708,604  
Net amortization/(accretion) of premium/(discount)
    1,797,021  
Net realized gains/(losses)
    (36,386,575 )
Net unrealized gains/(losses)
    (292,377,677 )
Net purchases and sales*
    (79,405,685 )
 
     
Balance as of February 28, 2009
  $ 529,484,438  
 
     
*   Includes any applicable borrowings and/or paydowns made on revolving credit facilities held in the Fund’s investment portfolio.
The net unrealized losses presented in the table above relate to investments that are still held at February 28, 2009, and the Fund presents these unrealized losses on the Statement of Operations as net change in unrealized appreciation/(depreciation) on investments.
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. As a result, for the six months ended February 28, 2009, $479,708,604 of the Fund’s portfolio investments was transferred to/from Level 2 to Level 3. Determination of fair values is uncertain because it involves subjective judgments and estimates not easily substantiated by auditing procedures.
New Accounting Pronouncements
In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“FAS 161”). FAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. FAS 161 requires enhanced disclosures about Fund’s derivative and hedging activities. Management is currently evaluating the impact the adoption of FAS 161 will have on the Fund’s financial statement disclosures.
In April 2009, FASB Staff Position No. 157-4 — Determining Fair Value when the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP 157-4”) was issued. FSP 157-4 clarifies the process for measuring the fair value of financial instruments when the markets become inactive and quoted prices may reflect distressed transactions. FSP 157-4 provides a non-exclusive list of factors a reporting entity should consider when determining whether there has been a significant decrease in the volume and level of activity for an asset or liability when compared with normal market activity.
Under FSP 157-4, if a reporting entity concludes there has been a significant decrease in volume and level of activity for the asset or liability (or similar assets or liabilities), transactions or quoted prices may not be determinative of fair value. Further analysis of the transactions or quoted prices is needed, and a significant adjustment to the transactions or quoted prices may be necessary to estimate fair value in accordance with FASB Statement No. 157 — Fair Value Measurements. FSP 157-4 is effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively. Early adoption is permitted for periods ending after March 15, 2009. Earlier adoption for periods ending before March 15, 2009, is not permitted. At this time, Management is evaluating the impact of FSP 157-4 on the Fund’s financial statements.
Security Transactions
Security transactions are accounted for on the trade date. Costs and gains/(losses) are determined based upon the specific identification method for both financial statement and U.S. federal income tax purposes.
Foreign Currency
Foreign currencies, investments and other assets and liabilities are translated into U.S. dollars at the exchange rates using the current 4:00 PM London Time Spot Rate. Fluctuations in the value of the foreign currencies and other assets and liabilities resulting from changes in exchange rates, between trade and settlement dates on securities transactions and between the accrual and payment dates on dividends, interest income and foreign withholding taxes, are recorded as unrealized foreign currency gains/(losses). Realized gains/(losses) and unrealized appreciation/(depreciation) on investment securities and income and expenses are translated on the respective dates of such transactions. The effect of changes in foreign currency exchange rates on investments in securities are not segregated in the Statement of Operations from the effects of changes in market prices of those securities, but are included with the net realized and unrealized gain or loss on investment securities.
Semi-Annual Report  |  23

 


 

NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
February 28, 2009
Highland Floating Rate Advantage Fund
Forward Foreign Currency Contracts
In order to minimize the movement in NAV resulting from a decline or appreciation in the value of a particular foreign currency against the U.S. dollar or another foreign currency or for other reasons, the Fund is authorized to enter into forward currency exchange contracts. These contracts involve an obligation to purchase or sell a specified currency at a future date at a price set at the time of the contract. Forward currency contracts do not eliminate fluctuations in the values of portfolio securities but rather allow the Fund to establish a rate of exchange for a future point in time.
Income Recognition
Interest income is recorded on an accrual basis and includes accretion of discounts and amortization of premiums, if any. Facility fees received are recorded as a reduction of cost to the loan and amortized through the maturity of the loan. Dividend income is recorded on the ex-dividend date.
Determination of Class Net Asset Values
All income, expenses (other than distribution fees and service fees, which are class-specific expenses, as shown on the Statement of Operations) and realized and unrealized gains/(losses) are allocated to each class of shares of the Fund on a daily basis for purposes of determining the NAV of each class. Income and expenses are allocated to each class based on the settled shares method, while realized and unrealized gains/(losses) are allocated based on the relative net assets of each class.
U.S. Federal Income Tax Status
The Fund intends to qualify each year as a “regulated investment company” under Subchapter M of the Internal Revenue Code of 1986, as amended, and will distribute substantially all of its taxable income and gains, if any, for its tax year, and as such will not be subject to U.S. federal income taxes. In addition, the Fund intends to distribute, in each calendar year, substantially all of its net investment income, capital gains and certain other amounts, if any, such that the Fund should not be subject to federal excise tax. Therefore, no U.S. federal income or excise tax provisions are recorded.
The accumulated capital losses to offset future gains (capital loss carryforward) for the Fund are $8,394,093, which will expire on August 31, 2016.
On July 13, 2006, the FASB released FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 provides guidance on how uncertain tax positions should be recognized, measured, presented, and disclosed in the financial statements. FIN 48 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Fund’s tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authorities. Tax positions not deemed to satisfy the “more-likely-than-not” threshold would be recorded as a tax benefit or expense in the current year. The Fund adopted FIN 48 as of September 1, 2007 for all subsequent reporting periods and management has determined that there has been no material impact on the financial statements.
Distributions to Shareholders
Distributions from net investment income are declared daily and paid monthly. Net realized capital gains, if any, are distributed at least annually.
Distributions made by regulated investment companies may differ from aggregate GAAP-basis undistributed net investment income and accumulated net realized gains (total GAAP-basis net realized gains). The principal cause is that required minimum fund distributions are based on income tax regulations, rather than GAAP. The differences created can be temporary, meaning they will reverse in the future, or they can be permanent. Permanent differences between book and tax accounting relating to distributions are reclassified to paid-in-capital at year-end. For the six months ended February 28, 2009, the difference between distributions made and GAAP net investment income was primarily attributable to differences in the treatment of gains on foreign currency transactions.
Cash and Cash Equivalents
The Fund considers liquid assets deposited with a bank, money market funds, and certain short term debt instruments with maturities of 3 months or less to be cash equivalents. These investments represent amounts held with financial institutions that are readily accessible to pay Fund expenses or investments. Cash and cash equivalents are valued at cost plus accrued interest, which approximates market value. The value of cash equivalents denominated in foreign currencies is determined by converting to U.S. dollars on the date of the statement of assets and liabilities. At February 28, 2009, the Fund had $1,987,276 of cash and cash equivalents denominated in foreign currencies, with a cost of $2,167,606.
Statement of Cash Flows
Information on financial transactions which have been settled through the receipt or disbursement of cash is presented in the Statement of Cash Flows. The cash and foreign currency amount shown in the Statement of Cash Flows is the amount included within the Fund’s Statement of Assets and Liabilities and includes cash and foreign currency on hand at its custodian bank and sub-custodian bank, respectively, and does not include any short-term investments.
24  |  Semi-Annual Report

 


 

NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
Note 3. U.S. Federal Tax Information
The timing and character of income and capital gain distributions are determined in accordance with income tax regulations, which may differ from GAAP. As a result, net investment income/(loss) and net realized gain/(loss) on investment transactions for a reporting period may differ significantly from distributions during such period. These differences are primarily attributable to reclassification of foreign currency transactions.
Reclassifications are made to the Fund’s capital accounts at fiscal year end for permanent tax differences to reflect income and gains available for distribution (or available capital loss carryforwards) under income tax regulations.
The tax character of distributions paid during the past two tax years ended August 31, 2008 and August 31, 2007, were as follows:
                 
Distributions paid from:   2008   2007
 
Ordinary income*
  $ 174,109,322     $ 210,015,075  
 
Long-term capital gains
    1,924,460       194,634  
*   For tax purposes, short-term capital gain distributions, if any, are considered ordinary income distributions.
As of August 31, 2008, the most recent tax year end, the components of distributable earnings on a tax basis were as follows:
                         
Accumulated
  Undistributed   Undistributed    
Capital and
  Ordinary   Long-Term   Net Unrealized
Other Losses
  Income   Capital Gains   Depreciation*
$(126,304,926)
  $ 9,034,384     $     $ (426,808,885 )
*   The differences between book-basis and tax-basis net unrealized appreciation/(depreciation) are primarily due to deferral of losses from wash sales and premium amortization adjustments.
Unrealized appreciation and depreciation at February 28, 2009, based on cost of investments for U.S. federal income tax purposes, and excluding any unrealized appreciation and depreciation from changes in the value of other assets and liabilities resulting from changes in exchange rates was:
         
Unrealized appreciation
  $ 2,897,106  
Unrealized depreciation
    (728,604,249 )
 
     
Net unrealized depreciation
  $ (725,707,143 )
 
     
Note 4. Advisory, Administration, Service and Distribution and Trustee Fees
Investment Advisory Fee
The Investment Adviser receives a monthly investment advisory fee based on the Fund’s average daily managed assets at the following annual rates:
         
Average Daily Managed Assets   Annual Fee Rate
First $1 billion
    0.65 %
 
Next $1 billion
    0.60 %
 
Over $2 billion
    0.55 %
 
Average daily managed assets of the Fund means the average daily value of the total assets of the Fund less all accrued liabilities of the Fund (other than the aggregate amount of any outstanding borrowings constituting financial leverage).
For the six months ended February 28, 2009, the Fund’s effective investment advisory fee rate was 0.63%.
Administration Fees
The Investment Adviser provides administrative services to the Fund for a monthly administration fee at the annual rate of 0.20% of the Fund’s average daily managed assets. Under a separate sub-administration agreement, the Investment Adviser has delegated certain administrative functions to PNC Global Investment Servicing (U.S.) Inc. (“PNC”), formerly known as PFPC Inc. The Investment Adviser pays PNC directly for these services.
Service and Distribution Fees
PFPC Distributors, Inc. (the “Underwriter”) serves as the principal underwriter and distributor of the Fund’s shares. The Underwriter receives the front end sales charge imposed on the sale of Class A Shares and the CDSC imposed on certain redemptions of Class A, Class B and Class C Shares. For the six months ended February 28, 2009, the Underwriter received $5,478 of front end sales charges on Class A Shares and $21,178, $17,051, and $23,543 of CDSC on Class A, Class B and Class C Share redemptions, respectively.
The Fund has adopted a plan pursuant to Rule 12b-1 under the 1940 Act (the “Plan”), which requires the payment of a monthly service fee to the Underwriter at an annual rate of 0.25% of the average daily net assets attributable to Class A, Class B and Class C Shares of the Fund. The Plan also requires the payment of a monthly distribution fee to the Underwriter at an annual rate of 0.10%, 0.45% and 0.60% of the average daily net assets attributable to Class A, Class B and Class C Shares, respectively.
Expense Limits and Fee Reimbursements
Effective December 18, 2006, the Investment Adviser had voluntarily agreed to waive management fees (including both advisory fees and administration fees) so that the Fund’s annual operating expenses (exclusive of advisory fees, administration
Semi-Annual Report  |  25

 


 

NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
fees, brokerage commissions, taxes, distribution and service fees, leverage expenses and extraordinary expenses, if any) would not exceed 0.15% of the average daily net assets of the Fund for each share class. For the six months ended February 28, 2009, the Investment Adviser waived fees in an amount equal to 0.02% of the average daily net assets of the Fund. This waiver was discontinued by the Investment Adviser effective October 1, 2008.
Fees Paid to Officers and Trustees
Each Trustee who is not an “interested person” of the Fund as defined in the 1940 Act (the “Independent Trustees”) receives an annual retainer of $150,000 payable in quarterly installments and allocated among each portfolio in the Highland Fund Complex based on relative net assets. The “Highland Fund Complex” consists of all of the registered investment companies and a business development company advised by the Investment Adviser as of the date of this annual report.
The Fund pays no compensation to its one interested Trustee or any of its officers, all of whom are employees of the Investment Adviser.
Note 5. Fund Information
For the six months ended February 28, 2009, the cost of purchases and proceeds from sales of securities, excluding short-term obligations, were $65,608,894 and $736,778,100, respectively.
Note 6. Periodic Repurchase Offers
The Fund has adopted a policy to offer each fiscal quarter to repurchase a specified percentage (between 5% and 25%) of the shares then outstanding at the Fund’s NAV (“Repurchase Offers”). Repurchase Offers are scheduled to occur on or about the 15th day (or the next business day if the 15th is not a business day) in the months of February, May, August, and November. It is anticipated that the date on which the repurchase price of shares will be determined (the “Repurchase Pricing Date”) will be the same date as the deadline for shareholders to provide their repurchase requests to the Distributor (the “Repurchase Request Deadline”), and if so, the Repurchase Request Deadline will be set for a time no later than the close of regular trading on the New York Stock Exchange on such date. The Repurchase Pricing Date will occur no later than the 14th day after the Repurchase Request Deadline, or the next business day if the 14th day is not a business day. Repurchase proceeds will be paid to shareholders no later than seven days after the Repurchase Pricing Date. If shareholders tender for repurchase more than the Repurchase Offer amount for a given Repurchase Offer, the Fund may repurchase an additional amount of shares of up to 2% of the shares outstanding on the Repurchase Request Deadline.
For the six months ended February 28, 2009, there were two Repurchase Offers. In the November 2008 and February 2009 Repurchase Offers, the Fund offered to repurchase 10% and 15%, respectively, of its shares. In the November 2008 and February 2009 Repurchase Offers, 12.0% and 12.6%, respectively, of shares outstanding were repurchased. In connection with the November 2008 Repurchase Offer, the Fund repurchased an additional 2% of its shares outstanding on the Repurchase Request Deadline to accommodate the Shareholder Repurchase Request.
Note 7. Senior Loan Participation Commitments
The Fund invests, under normal conditions, at least 80% of its net assets (plus any borrowings for investment purposes) in adjustable rate senior loans (“Senior Loans”), the interest rates of which float or vary periodically based upon a benchmark indicator of prevailing interest rates to domestic or foreign corporations, partnerships and other entities that operate in a variety of industries or geographic regions (“Borrowers”). If the lead lender in a typical lending syndicate becomes insolvent, enters Federal Deposit Insurance Corporation (“FDIC”) receivership or, if not FDIC insured enters into bankruptcy, the Fund may incur certain costs and delays in receiving payment or may suffer a loss of principal and/or interest. When the Fund purchases a participation of a Senior Loan interest, the Fund typically enters into a contractual agreement with the lender or other third party selling the participation, not with the Borrower directly.
As such, the Fund assumes the credit risk of the Borrowers, as well as of the selling participants or other persons interpositioned between the Fund and the Borrowers. The ability of Borrowers, selling participants or other persons interpositioned between the Fund and the Borrowers to meet their obligations may be affected by a number of factors, including economic developments in a specific industry.
At February 28, 2009, the following sets forth the selling participants with respect to interests in Senior Loans purchased by the Fund on a participation basis.
                 
    Principal        
Selling Participant   Amount     Value  
Credit Suisse, Cayman Island Branch:
               
Ginn LA Conduit Lender, Inc.,
               
First Lien Tranche A Credit-Linked Deposit
  $ 3,948,880     $ 1,800,034  
First Lien Tranche B Term Loan
    8,464,963       3,858,812  
 
             
 
          $ 5,658,846  
 
             
26  |  Semi-Annual Report

 


 

NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
Note 8. Credit Agreement
Effective October 7, 2008, the Fund entered into a Revolving Credit and Security Agreement, as amended, with The Bank of Nova Scotia (the “Credit Agreement”) pursuant to which the Fund could borrow up to $625,000,000. Interest is charged at a rate equal to         .30% per annum plus the applicable rate based on the outstanding borrowings. In addition, the Fund has agreed to pay commitment fee expenses on the commitment unit of each lender group of .70% per annum.
At February 28, 2009, the Fund had outstanding borrowings under the Credit Agreement totaling $136,000,000. The interest rate charged at February 28, 2009 was 1.49%. The average daily loan balance was $327,872,928 at a weighted average interest rate of 2.75%. With respect to these borrowings, interest and facility expense of $7,426,077 is included on the Statement of Operations.
The Fund is required to maintain 300% asset coverage with respect to amounts outstanding under the Credit Agreement under Section 18(a) of the 1940 Act. Asset coverage is calculated by subtracting the Fund’s total liabilities, not including any amount representing bank loans and senior securities, from the Fund’s total assets and dividing the result by the principal amount of the borrowings outstanding. As of the dates indicated below, the Fund’s debt outstanding and asset coverage was as follows:
                 
            Asset
            Coverage per
    Total Amount   $1,000 of
     Date   Outstanding   Indebtedness
 
02/28/2009
  $ 136,000,000     $ 6,607  
 
08/31/2008
    511,000,000       4,093  
 
08/31/2007
    960,000,000       4,005  
 
08/31/2006
    335,000,000       7,292  
 
08/31/2005
    250,000,000       5,129  
 
08/31/2004
    95,000,000       8,038  
Note 9. Unfunded Loan Commitments
As of February 28, 2009, the Fund had unfunded loan commitments of $32,896,642, which could be extended at the option of the borrower, pursuant to loan agreements with the following borrowers:
         
    Unfunded
    Loan
Borrower   Commitment
 
Broadstripe, LLC
  $ 6,828,248  
 
Cricket Communications, Inc.
    6,500,000  
 
Fontainebleau Las Vegas, LLC
    2,333,333  
 
Mobileserv Ltd.
    2,500,000  
 
Readers Digest Association, Inc.
    35,000  
 
SIRVA Worldwide, Inc.
    1,665,551  
         
    Unfunded  
    Loan  
    Commitment  
Borrower   (continued)  
Sorrenson Communications, Inc.
  $ 2,000,000  
 
Tronox Worldwide LLC
    4,092,991  
 
Vivarte
    3,164,000  
 
Water PIK, Inc.
    1,000,000  
 
Westgate Investments, LLC
    2,777,519  
 
 
  $ 32,896,642  
 
     
Unfunded loan commitments are marked to market on the relevant day of valuation in accordance with the Fund’s valuation policies. Any applicable unrealized gain/(loss) and unrealized appreciation/(depreciation) on unfunded loan commitments are recorded on the Statement of Assets and Liabilities and the Statement of Operations, respectively. As of February 28, 2009, the Fund recognized net discount and unrealized depreciation on unfunded transactions of $13,766,157. The net change in unrealized depreciation on unfunded transactions of $8,954,593 is recorded in the Statement of Operations.
Note 10. Affiliated Issuers
Under Section 2(a)(3) of the 1940 Act, a portfolio company is defined as “affiliated” if a Fund owns five percent or more of its voting stock. The Fund held at least five percent of the outstanding voting stock of the following companies during the six months ended February 28, 2009:
                                 
    Par Value at     Shares at     Market Value
    February 28,     February 28,     August 31,     February 28,  
    2009     2009     2008     2009  
ComCorp Broadcasting, Inc.*
                               
(Senior Loans)
  $ 2,513,997           $ 2,309,752     $ 1,231,858  
Communications Corp. of America
                               
(Common Stock)
          152,263       668,681        
 
                       
 
  $ 2,513,997       152,263     $ 2,978,433     $ 1,231,858  
 
                       
*   Company is a wholly owned subsidiary of Communications Corp of America.
Note 11. Indemnification
The Fund has a variety of indemnification obligations under contracts with its service providers. The Fund’s maximum exposure under these arrangements is unknown. However, the Fund has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote.
Semi-Annual Report  |  27

 


 

NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
Note 12. Disclosure of Significant Risks and Contingencies

Industry Concentration Risk
The Fund will concentrate its investments in the financial services industry, subjecting it to greater risk than a fund that is more diversified.
Non-Payment Risk
Senior Loans, like other corporate debt obligations, are subject to the risk of non-payment of scheduled interest and/or principal. Non-payment would result in a reduction of income to the Fund, a reduction in the value of the Senior Loan experiencing non-payment and a potential decrease in the NAV of the Fund.
Credit Risk
Investments rated below investment grade are commonly referred to as high-yield, high risk or “junk debt.” They are regarded as predominantly speculative with respect to the issuing company’s continuing ability to meet principal and/or interest payments. Investments in high-yield securities may result in greater NAV fluctuation than if the Fund did not make such investments.
Leverage Risk
The Fund currently uses leverage through borrowings from a credit facility. The use of leverage for investment purposes creates opportunities for greater total returns, but at the same time involves risks. Any investment income or gains earned with respect to the amounts borrowed that is in excess of the interest that is due on the borrowing will augment the Fund’s income. Conversely, if the investment performance with respect to the amounts borrowed fails to cover the interest on such borrowings, the value of the Fund’s shares may decrease more quickly than would otherwise be the case, and dividends on the shares could be reduced or eliminated. Interest payments and fees incurred in connection with such borrowings will reduce the amount of net income available for payment to shareholders.
Currency Risk
A portion of the Fund’s assets may be quoted or denominated in non-U.S. currencies. These securities may be adversely affected by fluctuations in relative currency exchange rates and by exchange control regulations. The Fund’s investment performance may be negatively affected by a devaluation of a currency in which the Fund’s investments are quoted or denominated. Further, the Fund’s investment performance may be significantly affected, either positively or negatively, by currency exchange rates because the U.S. dollar value of securities quoted or denominated in another currency will increase or decrease in response to changes in the value of such currency in relation to the U.S. dollar.
Non-U.S. Securities Risk
Investment in securities of non-U.S. issuers may involve special risks compared to investing in securities of U.S. issuers. These risks are more pronounced to the extent that the Fund invests a significant portion of its non-U.S. investments in one region or in the securities of emerging market issuers. These risks may include: (i) non-U.S. issuers may be subject to less rigorous disclosure, accounting standards and regulatory requirements; (ii) many non-U.S. markets are smaller, less liquid and more volatile and the Adviser may not be able to sell the Fund’s investments at times, in amounts and at prices it considers reasonable; and (iii) the economies of non-U.S. issuers may grow at slower rates than expected or may experience more severe downturns or recessions. Additionally, certain investments in non-U.S. issuers also may be subject to foreign withholding or other taxes on dividends, interest or capital gain.
Derivatives Risk
Derivative transactions in which the Fund may engage for hedging and speculative purposes or to enhance total return, including engaging in transactions such as options, futures, swaps, foreign currency transactions (including forward foreign currency contracts, currency swaps or options on currency and currency futures) and other derivative transactions, involve certain risks and considerations. These risks include the imperfect correlation between the value of such instruments and the underlying assets, the possible default of the other party to the transaction or illiquidity of the derivative instruments. The use of derivative transactions may result in losses greater than if they had not been used, may require the Fund to sell or purchase portfolio securities at inopportune times or for prices other than current market value, may limit the amount of appreciation the Fund can realize on an investment or may cause the Fund to hold a security that it might otherwise sell. The successful use of derivative transactions depends on the Adviser’s ability to predict correctly the direction and extent of movements in interest rates.
Swaps Risk
Investments in swaps involve the exchange with another party of their respective commitments. Use of swaps subjects the Fund to risk of default by the counterparty. If there is a default by the counterparty to such a transaction, there may be contractual remedies pursuant to the agreements related to the transaction although contractual remedies may not be sufficient, especially if the counterparty is insolvent. However, the swap market has grown substantially in recent years with a large number of banks and investment banking firms acting both as principals and agents utilizing standardized swap documentation. As a result, the swap market has become relatively liquid in comparison with the markets for other similar instruments which are traded in the interbank market. The Fund may enter into total return swaps, credit
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NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
default swaps, currency swaps or other swaps which may be surrogates for other instruments such as currency forwards or options.
Counterparty Credit Risk
Counterparty credit risk is the potential loss the Fund may incur as a result of the failure of a counterparty or an issuer to make payments according to the terms of a contract. Counterparty credit risk is measured as the loss the Fund would record if its counterparties failed to perform pursuant to the terms of their obligations to the Fund. Because the Fund enters into over-the-counter forwards, options, swaps and other derivative financial instruments, the Fund is exposed to the credit risk of its counterparties. To limit the counterparty credit risk associated with such transactions, the Fund conducts business only with financial institutions judged by the Investment Adviser to present acceptable credit risk.
Note 13: Market Conditions
Recent events in the financial sector have resulted in an unusually high degree of volatility in the financial markets and the net asset value of many mutual funds, including the Funds. Events contributing to this volatility include, but are not limited to, the seizure of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation by U.S. banking regulators, the bankruptcy filing of Lehman Brothers and sale of Merrill Lynch to Bank of America, and the government bailout of AIG. The potential investment in the financial sector in general, as reflected in each Fund’s investment portfolios, exposes investors to the negative (or positive) performance resulting from these and other events.
Note 14: Subsequent Events
Effective March 27, 2009, the Fund entered into Amendment to the Revolving Credit and Security Agreement, which reduced the amount the Fund could borrow from $625,000,000 to $450,000,000.
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ADDITIONAL INFORMATION (unaudited)
     
February 28, 2009   Highland Floating Rate Advantage Fund
Additional Portfolio Information
The Investment Adviser and its affiliates manage other accounts, including registered and private funds and individual accounts. Although investment decisions for the Fund are made independently from those of such other accounts, the Investment Adviser may, consistent with applicable law, make investment recommendations to other clients or accounts that may be the same or different from those made to the Fund, including investments in different levels of the capital structure of a company, such as equity versus senior loans, or that take positions in multiple levels of the capital structure. The Investment Adviser has adopted policies and procedures that address the allocation of investment opportunities, execution of portfolio transactions, personal trading by employees and other potential conflicts of interest that are designed to ensure that all client accounts are treated equitably over time. Nevertheless, this may create situations where a client could be disadvantaged because of the investment activities conducted by the Investment Adviser for other client accounts. When the Fund and one or more of such other accounts is prepared to invest in, or desires to dispose of, the same security, available investments or opportunities for each will be allocated in a manner believed by the Investment Adviser to be equitable to the Fund and such other accounts. The Investment Adviser also may aggregate orders to purchase and sell securities for the Fund and such other accounts. Although the Investment Adviser believes that, over time, the potential benefits of participating in volume transactions and negotiating lower transaction costs should benefit all accounts including the Fund, in some cases these activities may adversely affect the price paid or received by the Fund or the size of the position obtained or disposed of by the Fund.
Approval of Investment Advisory Agreement
The Fund has retained the Investment Adviser to manage its assets pursuant to an Investment Advisory Agreement with the Investment Adviser (the “Advisory Agreement”), which has been approved by the Fund’s Board of Trustees, including a majority of the Independent Trustees.
Following an initial term of two years, the Advisory Agreement continues in effect from year-to-year provided such continuance is specifically approved at least annually by the vote of holders of at least a majority of the outstanding shares of the Fund, or by the Board of Trustees, and, in either event, by a majority of the Independent Trustees of the Fund casting votes in person at a meeting called for such purpose.
At a meeting held on December 18-19, 2008, the Board, as requested by Fund counsel and the Independent Trustees’ independent legal counsel, from the Investment Adviser received written and oral information, including: (i) information confirming the financial soundness of the Investment Adviser; (ii) information on the advisory and compliance personnel of the Investment Adviser, including compensation arrangements; (iii) information on the internal compliance procedures of the Investment Adviser; (iv) comparative information showing (a) the fees payable under the Advisory Agreement versus the investment advisory fees of (1) certain registered investment companies that follow investment strategies similar to those of the Fund, (b) the expense ratios of the Fund versus other registered investment companies that follow investment strategies similar to those of the Fund and (2) certain private pooled investment vehicles managed by the Investment Adviser, and (c) the performance of the Fund versus (1) certain other registered investment companies that follow investment strategies similar to those of the Fund and (2) certain indices; (v) information regarding brokerage and portfolio transactions; and (vi) information on any legal proceedings or regulatory audits or investigations affecting the Investment Adviser. The Trustees reviewed and considered various factors discussed in the legal memorandum from the Independent Trustees’ independent legal counsel, the detailed information provided by the Investment Adviser and other relevant information and factors.
The Board’s conclusion as to the continuation of the Advisory Agreement was based on a comprehensive consideration of all information provided to the Board and not the result of any single factor. Some of the factors that figured particularly in the Board’s deliberations are described below, although individual Trustees may have evaluated the information presented differently from one another, giving different weights to various factors. The fee arrangements for the Funds and other funds managed by the Investment Adviser are the result of review and discussion between the Independent Trustees and the Investment Adviser since the Fund’s inception. Certain aspects of such arrangements may receive greater scrutiny in some years than in others, and the Board’s conclusions may be based, in part, on its consideration of these same arrangements during the course of the year and in prior years.
The nature, extent, and quality of the services provided by the Investment Adviser
The Board considered the portfolio management services provided by the Investment Adviser and the activities related to portfolio management, including use of technology, research capabilities and investment management staff. The Board discussed the relevant experience and qualifications of the personnel providing advisory services, including the background and experience of the members of the Fund’s portfolio management team. The Board reviewed the management structure, assets under management and investment philosophies and processes of the Investment Adviser. It also reviewed and discussed the Investment Adviser’s compliance policies and procedures. The Board concluded that the Investment Adviser has the quality and depth of personnel and investment methods essential to performing its duties
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ADDITIONAL INFORMATION (unaudited) (continued)
     
February 28, 2009   Highland Floating Rate Advantage Fund
under the Advisory Agreement and that the nature and quality of such advisory services are satisfactory.
The Investment Adviser’s Historical Performance in Managing the Fund
The Board reviewed the Investment Adviser’s historical performance in managing the Fund over various time periods and reflected on previous discussions regarding matters bearing on the Investment Adviser’s performance at its meetings throughout the year. The Board discussed relative performance and contrasted the performance of the Fund versus that of the Fund’s peers, as represented by certain other registered investment companies that follow investment strategies similar to the Fund, the Credit Suisse Leveraged Loan Index and the S&P/LSTA All Loans Index. After reviewing these and related factors, the Trustees concluded that they were satisfied with the Investment Adviser’s responses and efforts relating to performance.
The Costs of the Services to be Provided by the Investment Adviser and the Profits Realized by the Investment Adviser and its Affiliates from the Relationship with the Fund
The Board also gave substantial consideration to the fees payable under the Advisory Agreement, including: (i) the annual fee as a portion of the Fund’s Average Daily Managed Assets paid to the Investment Adviser under the Fund’s Advisory Agreement and the administration agreement between the Fund and the Investment Adviser; (ii) the expenses the Investment Adviser incurs in providing advisory services; (iii) the profitability of the Fund and such profitability as compared to the profitability of the other registered investment companies managed by the Investment Adviser, including Highland Floating Rate Fund; and (iv) a comparison of the fees payable to the Investment Adviser under the Advisory Agreement to fees payable to (a) other investment advisers serving other registered investment companies that follow investment strategies similar to those of the Fund and (b) the Investment Adviser by Highland Floating Rate Fund. After reviewing these and related factors, the Board determined that the fees payable to the Investment Adviser under the Advisory Agreement represent reasonable compensation in light of the services being provided by the Investment Adviser to the Fund.
The Extent to which Economies of Scale would be Realized as the Fund Grows and Whether Fee Levels Reflect these Economies of Scale for the Benefit of Shareholders
The Board considered the asset level of the Fund the various breakpoints in the Fund’s fees, the information provided by the Investment Adviser relating to its costs and information comparing the fee rates charged by the Investment Adviser with fee rates charged by other unaffiliated investment advisers to their clients. The Trustees concluded that the fee structure of the Fund is reasonable and appropriately should result in a sharing of economies of scale in view of the information provided by the Investment Adviser.
Following a further discussion of the factors deemed material, including those described above, and the merits of the Advisory Agreement and its various provisions, the Board of Trustees, including all the Independent Trustees, determined that the Advisory Agreement, including the advisory fee paid to the Investment Adviser under the Advisory Agreement, is fair and reasonable to the Fund and approved the continuation, for a period of one year commencing December 31, 2008, of the Advisory Agreement.
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IMPORTANT INFORMATION ABOUT THIS REPORT
Investment Adviser
Highland Capital Management, L.P.
NexBank Tower
13455 Noel Road, Suite 800
Dallas, TX 75240
Transfer Agent
PNC Global Investment Servicing (U.S.) Inc.
101 Sabin Street
Pawtucket, RI 02860
Underwriter
PFPC Distributors, Inc.
760 Moore Road
King of Prussia, PA 19406
Custodian
PFPC Trust Company
8800 Tinicum Boulevard
Philadelphia, PA 19153
Independent Registered Public
Accounting Firm

PricewaterhouseCoopers LLP
2001 Ross Avenue, Suite 1800
Dallas, TX 75201
Fund Counsel
Ropes & Gray LLP
One International Place
Boston, MA 02110-2624
This report has been prepared for shareholders of Highland Floating Rate Advantage Fund.
The Fund mails one shareholder report to each shareholder address. If you would like more than one report, please call shareholder services at 1-877-665-1287 to request that additional reports be sent to you.
A description of the policies and procedures that the Fund uses to determine how to vote proxies relating to its portfolio securities, and the Fund’s proxy voting record for the most recent 12-month period ended June 30, are available (i) without charge, upon request, by calling 1-877-665-1287 and (ii) on the SEC’s website at http://www.sec.gov.
The Fund files its complete schedule of portfolio holdings with the SEC for the first and third quarters of each fiscal year on Form N-Q. The Fund’s Forms N-Q are available on the SEC’s website at http://www.sec.gov and also may be reviewed and copied at the Commission’s Public Reference Room in Washington, DC. Information on the Public Reference Room may be obtained by calling 1-800-SEC-0330. Shareholders may obtain the Form N-Q by visiting the Fund’s website at www.hcmlp.com.
The Statement of Additional Information includes information about Fund Trustees and is available upon request without charge by calling 1-877-665-1287.
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