The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
40 | 86 Strategic Income Fund | Semi-Annual Report |
Notes to Financial Statements (unaudited) | December 31, 2005 |
The 40|86 Strategic Income Fund (formerly, the Conseco Strategic Income Fund) (the “Fund”) was organized as a business trust under the laws of the Commonwealth of Massachusetts on June 2, 1998 and commenced operations on July 31, 1998. The Fund is registered with the Securities and Exchange Commission (“SEC”) under the Investment Company Act of 1940 (the “1940 Act”), as amended, as a closed-end, non-diversified management investment company. At December 31, 2005, Conseco, Inc. (“Conseco”) owned 14,516 shares of the Fund’s common stock.
2. SIGNIFICANT ACCOUNTING POLICIES
Security Valuation, Transactions and Related Investment Income
Investment transactions are accounted for on the trade date. The cost of investments sold is determined by use of the specific identification method for both financial reporting and income tax reporting purposes. Interest income is recorded on an accrual basis; dividend income is recorded on the ex-dividend date. The Fund holds investments that are restricted as to resale with a cost of $18,845,163 and a market value of $19,068,063 under Rule 144A of the Securities Act of 1933. These securities represent 25.93% of the net assets of the Fund. These securities may be resold to qualified institutional buyers in transactions exempt from registration.
Investments are stated at market value in the accompanying financial statements. Values for fixed income and other securities are provided by third-party pricing services. Securities traded in the over-the-counter market are valued at the mean between the closing bid and asked prices or, if such data is not available, at the most recently available prices or under policies adopted by the Board of Trustees. Securities traded on stock exchanges are valued at the last sale price as of the close of business on the date of determination or, lacking any sales, at the mean between the closing bid and asked prices. Fund securities, which are traded both in the over-the-counter market and on an exchange, are valued according to the broadest and most representative market, and it is expected that for debt securities this ordinarily will be the over-the-counter market. Securities for which market quotations are not readily available are valued at fair value as determined in good faith by or under the supervision of the Board of Trustees. Debt securities purchased with maturities of sixty days or less are valued at amortized cost.
Investments held by the Fund may be purchased with accrued interest, and the investments owned by the Fund may accrue interest during the period the investment is owned by the Fund. If an investment owned by the Fund experiences a default and has accrued interest from purchase or has recorded accrued interest during the period it is owned, the Fund’s policy is to cease interest accruals from the time the investments are traded as “flat” in the market. The Fund evaluates the collectibility of purchased accrued interest and previously recorded interest on an investment-by-investment basis.
Distribution of Income and Gains
The Fund intends to distribute monthly to shareholders substantially all of its net investment income and to distribute, at least annually, any net realized capital gains in excess of net realized capital losses (including any capital loss carryovers). However, the Board of Trustees may decide to declare dividends at other intervals.
Federal Income Taxes
For federal income tax purposes, the Fund intends to qualify as a regulated investment company under Subchapter M of the Internal Revenue Code by distributing substantially all of its taxable income and net capital gains to its shareholders annually and otherwise complying with the requirements for regulated investment companies. Therefore, no provision has been made for federal income taxes.
Income and Capital Gain distributions are determined in accordance with federal income tax regulations, which may differ from GAAP. The tax character of distributions paid during the year ended June 30, 2005 and June 30, 2004 were as follows:
| Ordinary income (2005) | $ | 5,787,722 | |
| Ordinary income (2004) | | 6,371,292 | |
| At June 30, 2005, the components of net assets (excluding paid in capital) on a tax basis were as follows: | | | |
| Undistributed Ordinary Income | $ | 109,361 | |
| Capital Loss and other loss carryovers | | (26,761,787 | ) |
| Accumulated Earning | | (26,652,426 | ) |
| Unrealized Appreciation — Tax | | 2,277,349 | |
| Total Accumulated Earnings (Deficit) | $ | (24,375,077 | ) |
The differences between book and tax basis net unrealized appreciation are primarily attributable to wash sales. The cumulative timing difference for ordinary income is due to the timing of distributions. The cumulative timing difference for the capital loss carryover is due to Wash Sales.
| Net Asset Value | $ | 76,834,729 | |
| Paid in Capital | | (101,209,806 | ) |
| Net assets (excluding paid in capital) | $ | (24,375,077 | ) |
During the year ended June 30, 2005, the Fund used capital loss carryforwards of $4,513,347. As of June 30, 2005, the Fund had a total capital loss carryover of $26,761,787, which is available to offset future net realized gains on securities transactions to the extent provided for in the Internal Revenue Code. The capital loss of $16,920,009 will expire in 2008, $5,367,863 in 2009, and $4,473,915 in 2010.
40 | 86 Strategic Income Fund | Semi-Annual Report |
Notes to Financial Statements (unaudited) | December 31, 2005 |
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, as of the date of the financial statements, and the reported amount of increases and decreases in net assets from operations during the reporting period. Actual results could differ from those estimates.
3. OTHER EXPENSES
The Fund pays expenses of Trustees who are not affiliated persons of the Fund or 40|86 Advisors, Inc. (the “Adviser” and “Administrator”), a wholly-owned subsidiary of Conseco. The Fund pays each of its Trustees who is not a Trustee, officer or employee of the Adviser, the Administrator or any affiliate thereof an annual fee of $7,500 plus $1,500 for each Board of Trustees meeting attended. Additionally, each Trustee receives a fee of $500 for Board meetings and separate committee meetings attended that are conducted by telephone. The Board Chairman receives an additional $375 for each meeting attended. The Fund reimburses all Trustees for travel and out-of-pocket expenses incurred in connection with Board of Trustees meetings.
4. TRANSACTIONS WITH AFFILIATES
Investment Advisory Agreement
The Adviser serves as the Investment Manager and Administrator to the Fund under the terms of the Investment Management and Administration Agreement. The Adviser supervises the Fund’s management and investment program, performs a variety of services in connection with management and operation of the Fund and pays all compensation of officers and Trustees of the Fund who are affiliated persons of the Adviser or the Fund. As compensation for its services to the Fund, the Fund has agreed to pay the Adviser a monthly advisory fee equal to an annual rate of 0.90 percent of the value of the average weekly value of the total assets of the Fund less the sum of accrued liabilities (other than the aggregate indebtedness constituting financial leverage) (the “Managed Assets”). The total fees incurred for such services for the six months ended December 31, 2005 were $502,006.
Shareholder Servicing Agreement
Conseco Services, LLC, a wholly-owned subsidiary of Conseco, acts as the Shareholder Servicing Agent to the Fund under the Shareholder Service Agreement. As compensation for its services, the Fund has agreed to pay Conseco Services, LLC a monthly shareholder servicing fee equal to an annual rate of 0.10 percent of the Managed Assets. The Administrator has contractually agreed to waive its shareholder servicing fee to an annual rate of 0.02 percent of Managed Assets through June 30, 2006. The Administrator may discontinue this limit any time after June 30, 2006. The total fees incurred for such services for the six months ended December 31, 2005 were $11,244.
5. ADMINISTRATION AGREEMENT
The Fund contracted for certain administration services with PFPC, Inc. (“PFPC”). For its services, PFPC receives a monthly fee equal to an annual rate of 0.105 percent of the first $250 million of average weekly net assets; 0.080 percent of the next $250 million of average weekly net assets; 0.055 percent of the next $250 million of average weekly net assets; and 0.035 percent of average weekly net assets in excess of $750 million, subject to a minimum monthly charge of $7,500. The total fees incurred for such services for the six months ended December 31, 2005 were $50,386.
6. PORTFOLIO ACTIVITY
Purchases and sales of securities other than short-term obligations aggregated $23,506,638 and $29,123,381, respectively, for six months ended December 31, 2005.
7. INDEBTEDNESS
The Fund expects to utilize financial leverage through borrowings, including the issuance of debt securities, preferred shares or through other transactions, such as reverse repurchase agreements, which have the effect of financial leverage. There can be no assurance that a leveraging strategy will be successful during any period in which it is used. The Fund intends to utilize leverage to provide the shareholders with a potentially higher return. Leverage creates risks for the shareholders, including the likelihood of greater volatility of net asset value and market price of the shares, and the risk of fluctuations in interest rates on borrowings.
Loan Agreement
The Fund entered into a secured Loan and Pledge Agreement with Custodial Trust Company (the “Agreement”) on October 4, 2000. The Agreement is callable on demand. Under the Agreement, the aggregate amount of the loans outstanding may not exceed 33 1/3 percent of total assets (including the amount obtained through leverage). Borrowings bear interest at the Federal Funds Rate plus a margin of 0.75 percent. Interest payments are made monthly. Advances made under the Agreement are due and payable on demand. The Fund shall maintain a pledge account which gives the Custodial Trust Company as pledgee effective control over the Fund assets with a collateral value greater than the sum of the outstanding aggregate principal amount of the loans and the interest accrued thereon. The Fund is required to maintain asset coverage, as defined in the Agreement, of at least 3:1. Portfolio securities with an aggregate value of $71,010,304 were included in the pledge account at December 31, 2005. The Fund was in compliance with the terms of the agreement at December 31, 2005.
40 | 86 Strategic Income Fund | Semi-Annual Report |
Notes to Financial Statements (unaudited) | December 31, 2005 |
Borrowings at December 31, 2005 totaled $31.0 million, and the interest rate on such borrowings was 4.75 percent.
| Average daily balance of loans outstanding during the six months ended December 31, 2005 | $ | 35,095,390 | |
| Weighted average interest rate for the period | | 4.49% | |
| Maximum amount of loans outstanding at any month-end during the six months ended December 31, 2005 | $ | 36,549,195 | |
| Maximum percentage of total assets at any month-end during the six months ended December 31, 2005 | | 31.85% | |
| Amount of loans outstanding at December 31, 2005 | $ | 31,049,195 | |
| Percentage of total assets at December 31, 2005 | | 29.39% | |
8. INDEMNIFICATIONS
Under the Fund’s organizational documents, its officers and trustees are indemnified against certain liabilities arising out of the performance of their duties to the Fund. In addition, in the normal course of business, the Fund enters into contracts with its vendors and others that provide for general indemnifications. The Fund’s maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Fund. However, based on experience, the Fund expects the risk of loss to be remote.
40 | 86 Strategic Income Fund | Semi-Annual Report |
Automatic Dividend Reinvestment Plan (unaudited) | |
Pursuant to the Fund’s Automatic Dividend Reinvestment Plan (the “DRIP”), unless a shareholder otherwise elects, all dividends and capital gain distributions will be automatically reinvested in additional shares by PFPC, Inc. (“PFPC”), as agent for shareholders in administering the DRIP (the “DRIP Agent”). Shareholders who elect not to participate in the DRIP will receive all dividends and other distributions in cash paid by check mailed directly to the shareholder of record (or, if the shares are held in street or other nominee name, then to such nominee) by PFPC as dividend disbursing agent. DRIP participants may elect not to participate in the DRIP and to receive all dividends and capital gain distributions in cash by sending written instructions to PFPC, as dividend disbursing agent, at the address set forth below. Participation in the DRIP is completely voluntary and may be terminated or resumed at any time without penalty by written notice if received by the DRIP Agent not less than ten days prior to any distribution record date; otherwise such termination will be effective with respect to any subsequently declared dividend or other distribution.
Whenever the Fund declares an income dividend or a capital gain distribution (collectively referred to in this section as “dividends”) payable either in shares or in cash, non-participants in the DRIP will receive cash and participants in the DRIP will receive the equivalent in shares. The shares will be acquired by the DRIP Agent or an independent broker-dealer for the participants’ accounts, depending upon the circumstances described below, either: (i) through receipt of additional unissued but authorized shares from the Fund (“newly issued shares”); or (ii) by purchase of outstanding shares on the open market (“open market purchases”) on the NYSE or elsewhere. If on the payment date for the dividend, the net asset value per share is equal to or less than the market price per share plus estimated brokerage commissions (such condition being referred to herein as “market premium”), the DRIP Agent will invest the dividend amount in newly issued shares on behalf of the participants. The number of newly issued shares to be credited to each participant’s account will be determined by dividing the dollar amount of the dividend by the net asset value per share on the date the shares are issued, provided that the maximum discount from the then current market price per share on the date of issuance may not exceed 5%. If on the dividend payment date, the net asset value per share is greater than the market value thereof (such condition being referred to herein as “market discount”), the DRIP Agent will invest the dividend amount in shares acquired on behalf of the participants in open-market purchases.
In the event of a market discount on the dividend payment date, the DRIP Agent will have until the last business day before the next date on which the shares trade on an “ex-dividend” basis, but no more than 30 days after the dividend payment date, to invest the dividend amount in shares acquired in open-market purchases. It is contemplated that the Fund will pay monthly income dividends. Therefore, the period during which open-market purchases can be made will exist only from the payment date of the dividend through the date before the next “ex-dividend” date, which typically will be approximately ten days. If, before the DRIP Agent has completed its open-market purchases, the market price of a share exceeds the net asset value per share, the average per share purchase price paid by the DRIP Agent may exceed the net asset value per share, resulting in the acquisition of fewer shares than if the dividend had been paid in newly issued shares on the dividend payment date. Because of the foregoing difficulty with respect to open-market purchases, the DRIP provides that if the DRIP Agent is unable to invest the full dividend amount in open-market purchases during the purchase period or if the market discount shifts to a market premium during the purchase period, the DRIP Agent will cease making open-market purchases and will invest the uninvested portion of the dividend amount in newly issued shares at the close of business on the earlier of the last day of the purchase period or the first day during the purchase period on which the market discount shifts to a market premium.
The DRIP Agent maintains all shareholders’ accounts in the DRIP and furnishes written confirmation of all transactions in the accounts, including information needed by shareholders for tax records. Shares in the account of each DRIP participant will be held on his or her behalf by the DRIP Agent on behalf of the DRIP participant, and each shareholder proxy will include those shares purchased or received pursuant to the DRIP. The DRIP Agent will forward all proxy solicitation materials to participants and vote proxies for shares held pursuant to the DRIP in accordance with the instructions of the participants.
In the case of shareholders such as banks, brokers or nominees that hold shares for others who are the beneficial owners, the DRIP Agent will administer the DRIP on the basis of the number of shares certified from time to time by the record shareholder’s name and held for the account of beneficial owners who participate in the DRIP.
There will be no brokerage charges with respect to shares issued directly by the Fund as a result of dividends payable either in shares or in cash. However, each participant will pay a pro rata share of brokerage commissions incurred with respect to the DRIP Agents open-market purchases in connection with the reinvestment of dividends.
The automatic reinvestment of dividends will not relieve participants of any federal, state or local income tax that may be payable (or required to be withheld) on the dividends.
Shareholders participating in the DRIP may receive benefits not available to shareholders not participating in the DRIP.
If the market price (plus commissions) of the Fund’s shares is above their net asset value, participants of the DRIP will receive
40 | 86 Strategic Income Fund | Semi-Annual Report |
Automatic Dividend Reinvestment Plan (unaudited) (continued) | |
shares of the Fund at less than they could otherwise purchase them and will have shares with a cash value greater than the value of any cash distribution they would have received on their shares. If the market price (plus commissions) is below the net asset value, participants will receive distributions in shares with a net asset value greater than the value of any cash distribution they would have received on their shares. However, there may be insufficient shares available in the market to make distributions in shares at prices below the net asset value. Also, because the Fund does not redeem its shares, the price on resale may be more or less than the net asset value.
Experience under the DRIP may indicate that changes are desirable. Accordingly, the Fund reserves the right to amend or terminate the DRIP. There is no direct service charge to participants in the DRIP, however, the Fund reserves the right to amend the DRIP to include a service charge payable by the participants.
All correspondence concerning the DRIP should be directed to the DRIP Agent at PFPC, Inc., PO Box 43027, Providence, RI 02940-3027.
Meeting of Shareholders - December 15, 2005 (unaudited)
Proposal 1 -
Election two trustees to the Board of Trustees
Class II Trustee: Audrey L. Kurzawa | Shares Voted | | Percent of Shares Outstanding | | Percent of Shares Voted | |
| Voted | 5,121,663.303 | | 74.882% | | 99.974% | |
| Unvoted | 1,323.000 | | 0.019% | | 0.026% | |
| Total | 5,122,986.303 | | 74.901% | | 100.000% | |
| | | | | | | |
Class III Trustee: Vincent J. Otto | |
| Voted | 5,120,663.303 | | 74.867% | | 99.955% | |
| Unvoted | 2,323.000 | | 0.034% | | 0.045% | |
| Total | 5,122,986.303 | | 74.901% | | 100.000% | |
Federal Tax Information (unaudited)
For the year ended June 30, 2005, 1% of ordinary income distributions paid by the Fund may be subject to a maximum tax rate of 15%, as provided by the Jobs and Growth Tax Relief and Reconciliation Act of 2003. The Fund intends to designate the maximum amount allowable as taxed at a maximum rate of 15%. Complete information will be reported in conjunction with your 2005 Form 1099-DIV. For corporate shareholders, 1% of ordinary income distributions paid by the Fund qualifies for the dividend received deduction.
40 | 86 Strategic Income Fund | Semi-Annual Report |
Board of Trustees and Officers (unaudited) | |
Name (Age) Address | Position Held With Trust | Principal Occupation(s) During Past 5 Years |
Audrey L. Kurzawa* (38) 11815 N. Pennsylvania St. Carmel, IN 46032 | President and Trustee Since June 2005 and Formerly Treasurer Since October 2002 | Certified Public Accountant. Controller, Adviser. President and Trustee of one other mutual fund managed by the Adviser. |
| | | |
Diana H. Hamilton (48) 11815 N. Pennsylvania St. Carmel, IN 46032 | Trustee Since December 2004 | President, Sycamore Advisors, LLC, a municipal finance advisory firm; Formerly, State of Indiana Director of Public Finance. Trustee of one other mutual fund managed by the Adviser. |
| | | |
R. Matthew Neff (49) 11815 N. Pennsylvania St. Carmel, IN 46032 | Trustee Since December 2004 | Chairman and Co-Chief Executive Officer of Senex Financial Corp., a financial services company engaged in the healthcare finance field. Trustee of one other mutual fund managed by the Adviser. |
| | | |
Vincent J. Otto (46) 11815 N. Pennsylvania St. Carmel, IN 46032 | Trustee Since December 2005 | Executive Vice President and Chief Financial Officer, Waterfield Mortgage Company and Union Federal Bank. Director, Federal Home Loan Bank of Indianapolis. |
| | | |
William T. Devanney (49) 11815 N. Pennsylvania St. Carmel, IN 46032 | Vice President Since July 1998 | Senior Vice President, Corporate Taxes of Conseco Services, LLC and various affiliates. Vice President of one other mutual fund managed by the Adviser. |
| | | |
Daniel Murphy (49) 11815 N. Pennsylvania St. Carmel, IN 46032 | Treasurer Since June 2005 | Senior Vice President and Treasurer, Conseco, Inc. Treasurer of one other mutual fund managed by the Adviser. |
| | | |
Jeffrey M. Stautz (47) 11815 N. Pennsylvania St. Carmel, IN 46032 | Chief Legal Officer and Secretary Since May 2005 | Vice President, General Counsel, Secretary and Chief Compliance Officer, Adviser. Chief Legal Officer and Secretary of one other mutual fund managed by the Adviser. |
| | | |
Sarah L. Bertrand (37) 11815 N. Pennsylvania St. Carmel, IN 46032 | Chief Compliance Officer and Assistant Secretary Since December 2004 | Assistant Vice President, Legal and Compliance, Adviser. Chief Compliance Officer and Assistant Secretary of one other mutual fund managed by the Adviser. |
__________
* The Trustee so indicated is an ”interested person,” as defined in the 1940 Act, of the Trust due to the positions indicated with the Adviser and its affiliates.
Each Trustee serves until the expiration of the term of his designated class and until his successor is elected and qualified, or until his death or resignation, or removal as provided in the Fund’s by—laws or charter or statute.
All Trustees oversee the seven portfolios that make up the total fund complex including 40|86 Strategic Income Fund (1) and 40|86 Series Trust (6).
INVESTMENT ADVISER 40|86 Advisors, Inc. Carmel, IN | INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM PricewaterhouseCoopers LLP Indianapolis, IN | LEGAL COUNSEL Kirkpatrick & Lockhart Nicholson Graham LLP Washington, DC |
TRANSFER AGENT PFPC, Inc. Providence, RI | | CUSTODIAN PFPC Trust Company Philadelphia, PA |
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that the Fund uses to determine how to vote proxies relating to portfolio securities is available without charge, upon request, by calling (800) 852-4750. Furthermore, you can obtain the description on the SEC’s website at http://www.sec.gov.
PROXY VOTING RECORDS FOR THE 12-MONTH PERIOD ENDED JUNE 30, 2005
Information regarding how the Fund voted proxies relating to portfolio securities during the most recent 12-month period ended June 30 is available without charge, upon request, by calling (800) 852-4750. Furthermore, you can obtain the Fund’s proxy voting records on the SEC’s website at http://www.sec.gov.
AVAILABILITY OF QUARTERLY PORTFOLIO SCHEDULE
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 filing for the most recent quarter is available without charge, upon request, by calling (800) 852-4750. Furthermore, you can obtain the Fund’s quarterly portfolio schedule on the SEC’s website at http://www.sec.gov. The Fund’s Forms N-Q may also be reviewed and copied at the SEC’s Public Reference Room in Washington, DC, and information on the operation of the Public Reference Room may be obtained by calling (800) SEC-0330.
40|86 STRATEGIC INCOME FUND
11815 N. Pennsylvania Street
Carmel, IN 46032
800-852-4750
40|86 STRATEGIC INCOME FUND
11815 N. Pennsylvania Street
Carmel, IN 46032
