NexPoint Diversified Real Estate Trust (NXDT) N-CSR Certified annual shareholder report (management investment company)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES

Investment Company Act file number 811-21869

Highland Credit Strategies Fund

(Exact name of registrant as specified in charter)

NexBank Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240

(Address of principal executive offices) (Zip code)

R. Joseph Dougherty
Highland Capital Management, L.P.
NexBank Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240

(Name and address of agent for service)

Registrant’s telephone number, including area code: (877) 665-1287

Date of fiscal year end: December 31

Date of reporting period: December 31, 2009

Form N-CSR is to be used by management investment companies to file reports with the Commission not later than 10 days after the transmission to stockholders of any report that is required to be transmitted to stockholders under Rule 30e-1 under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may use the information provided on Form N-CSR in its regulatory, disclosure review, inspection, and policymaking roles.

A registrant is required to disclose the information specified by Form N-CSR, and the Commission will make this information public. A registrant is not required to respond to the collection of information contained in Form N-CSR unless the Form displays a currently valid Office of Management and Budget (“OMB”) control number. Please direct comments concerning the accuracy of the information collection burden estimate and any suggestions for reducing the burden to Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549. The OMB has reviewed this collection of information under the clearance requirements of 44 U.S.C. § 3507.

Item 1. Reports to Stockholders.

The Report to Shareholders is attached herewith.

Highland Credit Strategies Fund

TABLE OF CONTENTS

Portfolio Manager’s Letter	1
Fund Profile	5
Financial Statements	6
Investment Portfolio	7
Statement of Assets and Liabilities	14
Statement of Operations	15
Statements of Changes in Net Assets	16
Statement of Cash Flows	17
Financial Highlights	18
Notes to Financial Statements	19
Report of Independent Registered Public Accounting Firm	29
Additional Information	30
Important Information About This Report	36

Economic and market conditions change frequently.
There is no assurance that the trends described in this report will continue or commence.

Privacy Policy

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

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

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

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

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

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

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

PORTFOLIO MANAGER’S LETTER

Highland Credit Strategies Fund

Dear Shareholders:

We are pleased to provide you with our report for Highland Credit Strategies Fund (the “Fund”) for the year ended December 31, 2009. Below is an overview of the leveraged loan and high yield bond markets, the Fund’s performance and the drivers behind that performance; the Fund’s portfolio data; and our outlook for 2010.

MARKET REVIEW — 2009

The investment environment in the leveraged loan and high yield bond markets in 2009 reversed much of the unprecedented declines experienced in each of these markets during 2008. The leveraged loan market increased 44.8%, as measured by the Credit Suisse Leveraged Loan Index¹ and the high yield bond market increased 54.2%, as measured by the Credit Suisse High Yield Bond Index.² The average bid of leveraged loans was 87.4% of par on December 31, 2009, almost reaching the “pre-Lehman” level of 87.6% of par on August 29, 2008. The average bid of high yield bonds increased from a “pre-Lehman” level of 87.0% of par on August 29, 2008 to 93.3% of par on December 31, 2009. An increase in bids narrowed the discounted spread of leveraged loans from an all-time high of 1842 basis points³ over the London Interbank Offering Rate (“LIBOR”) on December 31, 2008 to 697 basis points over LIBOR on December 31, 2009, which aligns more closely with the trailing 10 year average of 509 basis points over LIBOR.⁴ Similarly, the increased bid of high yield bonds drastically decreased the average yield to worst⁵ of the Credit Suisse High Yield Bond Index from 18.9% on December 31, 2008 to 8.7% on December 31, 2009.⁶

Leveraged Loans

The loan market during 2008 and 2009 was characterized by unprecedented volatility, with a dramatic decrease in prices during 2008 followed by a sharp increase in prices during 2009. The Credit Suisse Leveraged Loan Index fell to a low of 61.6% in December 2008 only to spend the next twelve months rallying back to 87.4% by December 31, 2009. This volatility was primarily driven by the reversal of technical pressures generated by the turmoil in the credit markets during the second half of 2008. September 2008 brought stunning news within the global financial sector including: Fannie Mae and Freddie Mac being put into conservatorship, the collapse of Lehman Brothers, the AIG bailout, Bank of America’s purchase of

1	Credit Suisse Leveraged Loan Index is an index tracked by Credit Suisse designed to mirror the investible universe of the US dollar denominated leveraged loan market.
2	Credit Suisse High Yield Bond Index is an index tracked by Credit Suisse designed to mirror the investible universe of the US dollar denominated high yield debt market.
3	Discounted spread calculation assumes discount to par is amortized evenly over an average three-year remaining life.
4	As measured by the Credit Suisse Leveraged Loan Index.
5	Yield to worst is a measure of yield that takes into effect a bond’s yield to call or yield to maturity, whichever is lowest.
6	As measured by the Credit Suisse High Yield Bond Index.

Annual Report | 1

PORTFOLIO MANAGER’S LETTER

Highland Credit Strategies Fund

Merrill Lynch, volatility in LIBOR and other intrabank rates, and a host of global financial regulators taking monumental efforts to stabilize and restore confidence in the global financial system. This uncertainty and other factors resulted in sellers outnumbering willing buyers and created a systematic deleveraging, particularly in the hedge fund community. This impacted the senior secured bank loan market along with markets for other assets in an unprecedented manner.

During 2009, the technical environment in the leveraged loan market strengthened considerably. Forced selling was significantly lower in 2009 than in 2008, while the level of new issue bank loans decreased from $148.4 billion in 2008 to $66.9 billion in 2009. The volume of new issue loans declined at the same time that leveraged loan investors needed to reinvest capital following debt paydowns from bond refinancings, buy-backs, tenders and other repayments of debt by issuers, resulting in a lower supply but higher demand for loan assets. This increased cash in the market was augmented by new investors finding the depressed trading levels attractive, entering the market and pushing the bid price up. In addition to the improved technical environment, during the summer of 2009, macroeconomic and issuer fundamentals began to show signs of bottoming accompanied by a slight improvement. The increased refinancing activity and improving fundamental outlook combined to significantly decrease default expectations during 2009.

High Yield Bonds

During the year ended December 31, 2009, high yield bond new issuance was active, with over $180.7 billion in new issues in 2009, compared to $52.9 billion in 2008.⁷ The main purpose of new issues during 2009 was refinancing, which benefited the leveraged loan market as well as the high yield bond market. We expect high yield bond issuance to remain active in 2010, primarily for the refinancing of leveraged loans, but also in connection with the refinancing of existing high yield bonds. There is also a demand for high yield bonds given the increase in mutual fund flows into this asset class. This continuing trend is a positive catalyst for leveraged loans and existing high yield bonds. In a refinancing transaction, existing debt holders typically receive a paydown at par resulting in immediate capital appreciation for loans or bonds trading below par. In addition, the proceeds from the paydown need to be reinvested, typically back into leveraged loans or high yield debt. This increased demand for high yield debt caused stronger technicals in the secondary market, which contributed to the market’s impressive performance during 2009.

FUND PERFORMANCE OVERVIEW

On December 31, 2009, the net asset value of the Fund was $7.20 per share, as compared to $6.51 on December 31, 2008. On December 31, 2009, the closing market price of the Fund’s shares on the New York Stock Exchange (ticker symbol “HCF”) was $6.31 per share, as compared to $5.70 on December 31, 2008. During the year ended December 31, 2009, the Fund paid distributions to common shareholders of $0.79 per share. The total return on the Fund’s net assets, assuming reinvestment of distributions, was approximately 27.92% for the twelve months ended December 31, 2009. The Fund’s performance was driven by the overall improvement in the broader leveraged loan and high yield bond market and asset selection within several industries, including broadcasting and healthcare. However, there were positions held during the period that contributed negatively to the portfolio’s return, including positions in the gaming/leisure sector whose value was correlated with the deteriorating domestic real estate market. We are comfortable with the current leverage and positioning of the Fund. We continue to believe that, over the long-term, fundamental factors will outweigh technical factors and diligent credit analysis coupled with proper asset and sector allocation will lead to solid performance.

⁷ J.P. Morgan, Credit Strategy Weekly Update, January 8, 2010.

2 | Annual Report

PORTFOLIO MANAGER’S LETTER

Highland Credit Strategies Fund

FUND DATA

As of December 31, 2009, and December 31, 2008, the Fund’s investment portfolio, exclusive of cash and cash equivalents, was allocated as follows:

December 31, 2009	December 31, 2008

As of December 31, 2009, the Fund’s portfolio was comprised of approximately 62.03% in senior loans, 21.84% in corporate notes and bonds, 10.25% in equity interests and 5.88% in asset-backed securities. As of December 31, 2009, the Fund had leverage from its credit facility in the amount of approximately 18.5%. The Fund may use leverage constituting indebtedness in an aggregate amount up to 25% of the Fund’s total assets (including the proceeds from the leverage), the maximum amount allowable under its credit agreement. The use of financial leverage involves significant risks.

MARKET OUTLOOK — 2010

We believe the financial market collapse during the second half of 2008 and the rally experienced during 2009 were largely technical in nature and that the market has evolved into a fundamentally driven, credit pickers market. We remain constructive on the leveraged loan and high yield bond asset classes and believe good buying opportunities remain for the diligent investor. We expect that further stability in the global economic environment may lead to continued stabilization in the leveraged loan and high yield markets. We believe issuers will continue to bring amendments to lender groups in an effort to stay within covenants, which we believe will improve the economics to the lenders. The high yield market may continue to bifurcate, with well-collateralized debt and debt issued by stable and improving companies continuing to trade well and debt issued by companies facing economic and fundamental headwinds trading poorly. We think that the next fiscal year will continue to be driven more by fundamentals and earnings.

Thank you for your continued participation in Highland Credit Strategies Fund. We look forward to serving your future investment needs.

Brad Means
Portfolio Manager

Brad Means has been a portfolio manager of Highland Credit Strategies Fund since January 1, 2009.

Annual Report | 3

PORTFOLIO MANAGER’S LETTER

Highland Credit Strategies Fund

Past performance does not guarantee future results. Performance during the time period shown is limited and may not reflect the performance in different economic and market cycles. There can be no assurance that similar performance will be experienced. Annualized total return is calculated by PNC Global Investment Servicing (U.S.), Inc. The calculation assumes reinvestment of distributions and other income.

Investing in closed-end funds involve certain risks. The risks involved in a particular fund will depend on the securities held in that fund:

• Market Risk — Refers to general stock market fluctuations. The value of any security can rise or fall and when liquidated, may be worth more or less than the original investment.

• Price Risk — Refers to the fact that shares of closed-end funds frequently trade at a discount from their net asset value.

• Interest Rate Risk — The risk that a rise in interest rates will cause the value of an investment to decline.

• Credit Risk — Refers to an issuer’s ability to meet its obligation to make interest and principal payments.

• Leverage Risk — The risk of higher share price volatility as leverage magnifies both gains and losses.

• Lack of Diversification Risk — A non-diversified fund may be subject to greater price volatility or adversely affected by the performance of the securities in a particular sector. In addition, it may be more susceptible to any single economic, political, or regulatory occurrence than the holdings of an investment company that is more broadly diversified.

4 | Annual Report

FUND PROFILE

Highland Credit Strategies Fund

Objective

The Fund seeks to provide both current income and capital appreciation.

Total Net Assets of Common Shares as of December 31, 2009

$458.8 million

Portfolio Data as of December 31, 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 portfolio will change over time.

Quality Breakdown as of 12/31/09 (%)*
A	0.6
Baa	5.5
Ba	17.5
B	50.6
Caa	11.7
Ca	0.2
C	1.0
NR	12.9

Top 5 Sectors as of 12/31/09 (%)*
Healthcare	22.5
Diversified Media	8.8
Financial	7.1
Gaming/Leisure	6.2
Broadcasting	5.4

Top 10 Holdings as of 12/31/09 (%)*
Genesys Ventures IA, LP (Common Stocks)	6.3
Celtic Pharma Phinco B.V. (Corporate Notes and Bonds)	5.2
ComCorp Broadcasting, Inc. (US Senior Loans)	4.5
SMG H5 Property Ltd. (Foreign Denominated Senior Loans)	3.0
Digicel Group, Ltd. (Corporate Notes and Bonds)	2.4
Lake at Las Vegas Joint Venture (US Senior Loans)	2.3
TCD Pharma (Corporate Notes and Bonds)	2.3
Dfine, Inc. (Preferred Stocks)	2.1
Azithromycin Royalty Sub LLC (Corporate Notes and Bonds)	1.9
Broadstripe, LLC (US Senior Loans)	1.9

* Quality is calculated as a percentage of total senior loans, asset-backed securities, notes and bonds. Sectors and holdings are calculated as a percentage of total assets.

Annual Report | 5

FINANCIAL STATEMENTS

December 31, 2009	Highland Credit Strategies 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 common share price 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 common share is calculated by dividing net assets by the number of common shares outstanding as of the last day of the reporting period.
Statement of Operations	This statement reports 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 applicable to common shareholders.
Statements of Changes in Net Assets	These statements detail how the Fund’s net assets were affected by its operating results, distributions to common shareholders and shareholder transactions from common shares (e.g., subscriptions, redemptions and distribution reinvestments) during the reporting period. The Statements of Changes in Net Assets also detail changes in the number of common 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 common share was affected by the Fund’s operating results. The Financial Highlights also disclose the performance and certain key ratios (e.g., net 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, 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.

6 | Annual Report

INVESTMENT PORTFOLIO

As of December 31, 2009 Highland Credit Strategies Fund

Principal Amount ($)			Value ($)
US Senior Loans (a) — 74.2%
AEROSPACE — 3.0%
		AWAS Capital, Inc.
	1,577,370	Second Lien Priority Term Facility, 6.25%, 03/15/13	1,230,348
		Continental Airlines, Inc.
	571,429	Tranche A-1 Term Loan, 3.63%, 06/01/11	542,857
	1,428,571	Tranche A-2 Term Loan, 3.63%, 06/01/11	1,357,143
		Delta Air Lines, Inc.
	4,189,500	Term Loan, 8.75%, 09/27/13	4,192,118
	5,789,543	Term Loan Equipment Notes, 3.75%, 09/29/12	4,979,007
		IAP Worldwide Services, Inc.
	2,179,701	Second Lien Term Loan, PIK, 6.00%, 06/28/13	1,563,935
			13,865,408
BROADCASTING — 7.1%
		ComCorp Broadcasting, Inc.
	3,584,549	Revolving Loan, PIK, 9.00%, 10/03/12 (b) (c)	2,683,035
	35,860,392	Term Loan, PIK, 9.00%, 04/03/13 (b) (c)	26,841,503
		Cumulus Media, Inc.
	438,726	Replacement Term Loan, 06/11/14 (d)	369,901
		Univision Communications, Inc.
	3,000,000	Initial Term Loan, 2.50%, 09/29/14	2,613,750
			32,508,189
CABLE/WIRELESS VIDEO — 4.4%
		Broadstripe, LLC
	996,668	DIP Revolver, 7.25%, 12/31/09 (c) (e)	993,678
	14,151,375	First Lien Term Loan, PIK, 06/30/11 (c) (f)	11,464,029
	1,428,203	Revolver, 06/30/11 (c) (f)	1,156,987
		Charter Communications Operating, LLC
	6,967,024	New Term Loan, 2.26%, 03/06/14 (d)	6,544,161
			20,158,855
CHEMICALS — 1.6%
		Solutia, Inc.
	1,981,718	Term Loan, 7.25%, 02/28/14	2,016,903
		Texas Petrochemical, LP
	1,321,848	Incremental Term Loan B, 2.88%, 06/27/13	1,192,968
	4,608,344	Term B Loan, 2.88%, 06/27/13	4,159,031
			7,368,902
CONSUMER NON-DURABLES — 1.7%
		Revlon Consumer Products Corp.
	8,125,000	Term Loan, 4.26%, 01/15/12	7,981,350
DIVERSIFIED MEDIA — 6.5%
		Cengage Learning Acquisitions, Inc.
	3,482,188	Term Loan, 2.75%, 07/03/14	3,175,756
		Cydcor, Inc.
	6,829,480	First Lien Tranche B Term Loan, 9.00%, 02/05/13	6,436,785
	3,000,000	Second Lien Tranche B Term Loan, 12.00%, 02/05/14 (c)	2,556,300
		DTN, Inc.
	1,402,365	Tranche C Term Loan, 5.25%, 03/10/13	1,349,776
		Endurance Business Media, Inc.
	3,000,000	Second Lien Term Loan, 11.25%, 01/26/14 (f)	1,050,000
		Harland Clarke Holdings Corp.
	4,932,162	Tranche B Term Loan, 2.75%, 06/30/14	4,116,605
		Metro-Goldwyn-Mayer, Inc.
	14,144,530	Tranche B Term Loan, 04/09/12 (d) (f)	9,144,438
	2,917,500	Tranche B-1 Term Loan, 04/09/12 (f)	1,886,164
			29,715,824
ENERGY — 3.4%
		Alon USA Energy, Inc.
	214,444	Edington Facility, 2.48%, 08/05/13	180,669
	1,715,556	Paramount Facility, 2.49%, 08/05/13	1,445,356
		Calumet Lubricants Co., LP
	197,380	Credit Linked Letter of Credit, 01/03/15 (d)	174,681
	1,465,487	Term Loan, 01/03/15 (d)	1,296,956
		Coffeyville Resources, LLC
	3,979,608	Tranche D Term Loan, 8.50%, 12/30/13	4,003,247
		Venoco, Inc.
	9,340,080	Second Lien Loan, 4.25%, 05/07/14	8,438,155
			15,539,064
FINANCIAL — 1.4%
		HUB International Ltd.
	3,990,000	Additional Term Loan, 6.75%, 06/13/14	3,963,407
	182,588	Delayed Draw Term Loan, 2.75%, 06/13/14	167,981
	812,313	Initial Term Loan, 2.75%, 06/13/14	747,328
		Nuveen Investments, Inc.
	1,500,000	Second Lien Term Loan, 12.50%, 07/31/15 (d) (g)	1,554,750
			6,433,466
FOOD AND DRUG — 0.6%
		Rite Aid Corp.
	994,937	Tranche 2 Term Loan, 1.99%, 06/04/14	883,006
	985,015	Tranche 3 Term Loan, 6.00%, 06/04/14	929,608
	750,000	Tranche 4 Term Loan, 9.50%, 06/10/15	778,204
			2,590,818

See accompanying Notes to Financial Statements. | 7

INVESTMENT PORTFOLIO (continued)

As of December 31, 2009 Highland Credit Strategies Fund

Principal Amount ($)			Value ($)
US Senior Loans (continued)
FOOD/TOBACCO — 3.4%
		DS Waters of America, Inc.
	1,828,889	Term Loan, 2.50%, 10/29/12	1,721,442
		DSW Holdings, Inc.
	5,500,000	Term Loan, 4.25%, 03/02/12 (d)	4,812,501
		PBM Holdings, Inc.
	1,747,962	Term Loan, 2.49%, 09/28/12	1,651,824
		Pierre Foods, Inc.
	950,000	Term Loan, 8.50%, 09/30/14	957,125
		Sturm Foods, Inc.
	1,000,000	First Lien Initial Term Loan, 2.81%, 01/31/14	958,335
	2,562,500	Second Lien Initial Term Loan, 6.31%, 07/31/14	2,250,733
		WM. Bolthouse Farms, Inc.
	1,016,226	First Lien Term Loan, 5.50%, 12/16/12	991,075
	2,500,000	Second Lien Term Loan, 9.00%, 12/16/13	2,380,475
			15,723,510
FOREST PRODUCTS/CONTAINERS — 0.9%
		Consolidated Container Co., LLC
	2,000,000	Second Lien Term Loan, 09/28/14 (d)	1,667,500
		Newark Group, Inc.
	204,186	Credit-Link Letter of Credit, 6.74%, 03/09/13	178,663
	1,638,559	Term Loan, 10.75%, 03/09/13	1,433,739
		Tegrant Corp.
	1,000,000	Second Lien Term Loan, 5.76%, 03/08/15	617,500
			3,897,402
GAMING/LEISURE — 7.7%
		Drake Hotel Acquisition
	6,041,285	B Note 1 (c) (f)	—
		Fontainebleau Florida Hotel, LLC
	18,500,000	Tranche C Term Loan, 06/06/12 (f)	6,105,000
		Ginn LA Conduit Lender, Inc.
	3,937,249	First Lien Tranche A Credit-Linked Deposit, 06/08/11 (f)	280,529
	8,438,203	First Lien Tranche B Term Loan, 06/08/11 (f)	611,770
		Green Valley Ranch Gaming, LLC
	1,000,000	Second Lien Term Loan, 3.50%, 08/16/14	216,250
		Lake at Las Vegas Joint Venture
	159,286	Mezzanine, PIK, 06/20/12 (f)	5,575
	8,162,813	Revolving Loan Credit-Linked Deposit Account, 06/20/12 (f)	163,256
	34,125,359	Term Loan, DIP, 7.73%, 04/30/10	13,650,144
	88,933,097	Term Loan, PIK, 06/20/12 (f)	1,284,507
		Las Vegas Sands, LLC
	1,394,459	Delayed Draw I Term Loan, 2.01%, 05/23/14	1,225,701
	6,901,510	Tranche B Term Loan, 2.01%, 05/23/14	6,066,289
		MGM Mirage, Inc.
	2,000,000	Advance Term Loan, 10/03/11 (d)	1,872,140
	500,000	Revolver, 10/03/11 (d)	437,500
		VML US Finance, LLC
	1,115,135	Term B Delayed Draw Project Loan, 4.76%, 05/25/12	1,060,460
	1,930,590	Term B Funded Project Loan, 4.76%, 05/27/13	1,835,933
		WAICCS Las Vegas 3 LLC
	7,000,000	Second Lien Term Loan, 02/01/10 (f)	700,000
			35,515,054
HEALTHCARE — 2.5%
		Aveta, Inc.
	2,064,687	MMM Original Term Loan, 5.49%, 08/22/11	2,027,275
	306,719	NAMM New Term Loan, 5.49%, 08/22/11	301,161
	552,693	NAMM Original Term Loan, 5.49%, 08/22/11	542,678
	1,692,058	PHMC Acquisition Term Loan, 5.49%, 08/22/11	1,661,398
		LifeCare Holdings
	5,352,637	Term Loan, 4.54%, 08/10/12	4,567,592
		Rehabcare Group, Inc.
	500,000	Term Loan B, 6.00%, 11/24/15	496,095
		Warner Chilcott Co., LLC
	644,068	Term A Loan, 5.50%, 10/30/14	645,775
	322,034	Term B-1 Loan, 5.75%, 04/30/15	322,887
	708,475	Term B-2 Loan, 5.75%, 04/30/15	710,352
			11,275,213
HOUSING — 3.8%
		Custom Building Products, Inc.
	2,814,826	First Lien Term Loan, 8.00%, 10/29/11	2,772,604
	3,981,250	Second Lien Term Loan, 10.75%, 04/20/12	3,817,023
		LBREP/L-Suncal Master I, LLC
	3,190,581	First Lien Term Loan, 01/18/10 (f)	95,717
		Pacific Clarion, LLC
	24,752,866	Term Loan (c) (f) (g)	3,804,515
		Roofing Supply Group, LLC
	3,144,742	Term Loan, PIK, 7.25%, 08/24/13	2,948,196
		Westgate Investments, LLC
	8,144,811	Senior Secured Loan, PIK, 09/25/10 (f) (g)	2,716,737
	2,336,387	Senior Unsecured Loan, PIK, 09/25/12 (f)	558,770
	3,743,195	Third Lien Term Loan, PIK, 06/30/15 (f) (g)	535,839
			17,249,401

8 | See accompanying Notes to Financial Statements.

INVESTMENT PORTFOLIO (continued)

As of December 31, 2009 Highland Credit Strategies Fund

Principal Amount ($)			Value ($)
US Senior Loans (continued)
INFORMATION TECHNOLOGY — 3.2%
		CDW Corp.
	6,906,265	Term Loan, 4.23%, 10/10/14 (d)	5,964,320
		Kronos, Inc.
	2,933,735	First Lien Initial Term Loan, 2.25%, 06/11/14	2,739,375
		Serena Software, Inc.
	1,696,000	Term Loan, 2.26%, 03/11/13	1,561,380
		SunGard Data Systems, Inc.
	1,989,924	Incremental Term Loan, 6.75%, 02/28/14	2,011,485
		Verint Systems, Inc.
	2,483,246	Term Loan, 3.49%, 05/25/14	2,295,972
			14,572,532
MANUFACTURING — 2.4%
		Acument Global Technologies, Inc.
	6,425,243	Term Loan, 10.00%, 08/11/13	4,481,607
		Brand Energy & Infrastructure Services, Inc.
	1,500,000	Second Lien Term Loan, 02/07/15 (d)	1,261,875
		Dana Holding Corp.
	2,763,670	Term Advance, 7.25%, 01/30/15 (d)	2,651,395
		Gentek Holding, LLC
	1,500,000	Tranche B Term Loan, 7.00%, 10/29/14	1,518,188
		United Central Industrial Supply Co., LLC
	1,269,467	Term Loan, 2.48%, 03/31/12	1,215,515
			11,128,580
METALS/MINERALS — 0.4%
		Euramax International, Inc.
	1,454,449	Domestic Term Loan (Cash Pay), 10.00%, 06/29/13	973,026
	1,450,776	Domestic Term Loan, PIK, 3.00%, 06/29/13	970,569
			1,943,595
RETAIL — 3.2%
		Burlington Coat Factory Warehouse Corp.
	5,958,670	Term Loan, 2.51%, 05/28/13 (d)	5,547,165
		Guitar Center, Inc.
	1,474,242	Term Loan, 3.74%, 10/09/14 (d)	1,254,426
		Michaels Stores, Inc.
	1,629,943	B-1 Term Loan, 2.56%, 10/31/13	1,484,601
	2,193,536	B-2 Term Loan, 4.81%, 07/31/16	2,077,695
		Spirit Finance Corp.
	6,500,000	Term Loan, 3.28%, 08/01/13	4,363,125
			14,727,012
SERVICE — 4.4%
		CCS, Inc.
	2,986,924	Term Loan, 3.23%, 11/14/14	2,506,522
		First Data Corp.
	1,488,579	Initial Tranche B-1 Term Loan, 2.98%, 09/24/14	1,326,696
		NES Rentals Holdings, Inc.
	3,224,820	Second Lien Permanent Term Loan, 7.13%, 07/20/13	2,329,932
		Penhall Holding Co.
	9,991,289	Term Loan, PIK, 9.63%, 04/01/12	549,520
		Sabre, Inc.
	7,000,000	Initial Term Loan, 2.49%, 09/30/14	6,347,495
		Safety-Kleen Systems, Inc.
	1,627,119	Synthetic Letter of Credit, 2.75%, 08/02/13	1,509,153
	6,034,576	Term B Loan, 2.75%, 08/02/13	5,597,069
			20,166,387
TELECOMMUNICATIONS — 3.2%
		Avaya, Inc.
	6,974,360	Term Loan, 3.01%, 10/24/14	6,053,187
		Intergra Telecom Holdings, Inc.
	997,449	First Lien Term Loan, 08/31/13 (d)	1,002,745
		Level 3 Financing, Inc.
	6,000,000	Tranche A Term Loan, 2.53%, 03/13/14	5,465,010
		Springboard Finance, LLC
	2,000,000	Dollar Term Loan, 9.00%, 11/19/14	2,057,920
			14,578,862
TRANSPORTATION — AUTOMOTIVE — 2.5%
		BST Safety Textiles Acquisition GMBH
	3,597,929	Second Lien Facility, 06/30/10 (c) (f)	—
		Federal-Mogul Corp.
	1,981,432	Tranche B Term Loan, 2.17%, 12/29/14	1,671,833
	1,010,935	Tranche C Term Loan, 2.17%, 12/28/15	852,976
		Ford Motor Co.
	3,984,637	Tranche B-1 Term Loan, 3.29%, 12/15/13	3,692,901
		Motor Coach Industries International, Inc.
	5,970,085	Second Lien Tranche A, 11.75%, 06/30/12 (c)	3,223,249
	3,678,190	Second Lien Tranche B, 11.75%, 06/30/12 (c)	1,985,855
			11,426,814
TRANSPORTATION — LAND TRANSPORTATION — 0.7%
		New Century Transportation, Inc.
	1,824,061	Term Loan, 7.24%, 08/14/12	1,586,933
		SIRVA Worldwide, Inc.
	746,073	Revolving Credit Loan (Exit Finance), 10.00%, 05/12/12 (e)	376,767
	3,376,227	Second Lien Term Loan, PIK, 12.00%, 05/12/15	506,434
	1,515,969	Term Loan (Exit Finance), 9.50%, 05/12/12	757,985
			3,228,119
UTILITY — 4.1%
		Calpine Corp.
	1,153,533	First Priority Term Loan, 3.14%, 03/29/14	1,095,978

See accompanying Notes to Financial Statements. | 9

INVESTMENT PORTFOLIO (continued)

As of December 31, 2009 Highland Credit Strategies Fund

Principal Amount ($)			Value ($)
UTILITY (continued)
		Coleto Creek Power, LP
	184,651	First Lien Synthetic Letter of Credit, 3.00%, 06/28/13	166,186
	2,525,391	First Lien Term Loan, 3.00%, 06/28/13	2,290,214
	4,825,000	Second Lien Term Loan, 4.23%, 06/28/13	3,552,406
		Entegra TC LLC
	10,178,952	Third Lien Term Loan, PIK, 6.25%, 10/19/15	4,509,276
		GBGH, LLC
	2,202,643	First Lien Term Loan, 4.00%, 06/09/13 (c)	1,758,811
	706,213	Second Lien Term Loan, 12.00%, 06/09/14 (c)	486,581
		Texas Competitive Electric Holdings Co., LLC
	5,964,415	Initial Tranche B-2 Term Loan, 3.73%, 10/10/14	4,859,150
			18,718,602
WIRELESS COMMUNICATIONS — 2.1%
		Digicel International Finance Ltd.
	3,500,000	Tranche A — T&T, 09/30/12 (d)	3,368,750
	3,750,075	Tranche A Term Loan, 2.81%, 03/30/12	3,609,447
		MetroPCS Wireless, Inc.
	2,984,576	Tranche B Term Loan, 2.54%, 11/03/13	2,862,208
			9,840,405
		Total US Senior Loans (Cost $533,618,705)	340,153,364
Principal Amount
Foreign Denominated Senior Loans (a) — 3.9%
AUSTRALIA — 3.9%
AUD
		SMG H5 Property Ltd.
	22,870,278	Facility A Term Loan, 6.21%, 12/24/12	17,997,397
		Total Foreign Denominated Senior Loans (Cost $18,570,363)	17,997,397
Principal Amount ($)
Asset-Backed Securities (h) — 6.9%
		AB CLO, Ltd.
	2,000,000	Series 2007-1A, Class C, 2.13%, 04/15/21 (c) (i)	1,385,232
		ACA CLO, Ltd.
	4,000,000	Series 2006-2A, Class B, 1.00%, 01/20/21 (i)	2,120,000
	2,000,000	Series 2007-1A, Class D, 2.63%, 06/15/22 (i)	850,000
		Babson CLO, Ltd.
	1,000,000	Series 2007-2A, Class D, 1.98%, 04/15/21 (i)	450,000
		Bluemountain CLO, Ltd.
	1,000,000	Series 2007-3A, Class D, 1.65%, 03/17/21 (c) (i)	524,766
		Cent CDO, Ltd.
	2,000,000	Series 2007-15A, Class C, 2.51%, 03/11/21 (i)	902,800
		Columbus Nova CLO, Ltd.
	2,000,000	Series 2007- 1A, Class D, 1.62%, 05/16/19 (i)	1,085,000
		Commercial Industrial Finance Corp.
	1,000,000	Series 2006-1BA, Class B2L, 4.25%, 12/22/20	388,100
	962,970	Series 2006-2A, Class B2L, 4.26%, 03/01/21 (i)	319,514
		Cornerstone CLO, Ltd.
	2,500,000	Series 2007-1A, Class C, 2.68%, 07/15/21 (i)	1,287,500
		Goldman Sachs Asset Management CLO PLC
	4,000,000	Series 2007-1A, Class D, 3.03%, 08/01/22 (i)	1,820,000
	1,066,984	Series 2007-1A, Class E, 08/01/22 (f) (i)	234,736
		Greywolf CLO, Ltd
	1,000,000	Series 2007-1A, Class D, 1.77%, 02/18/21 (i)	430,000
	814,466	Series 2007-1A, Class E, 4.22%, 02/18/21 (i)	358,365
		GSC Partners CDO Fund, Ltd.
	3,000,000	Series 2007-8A, Class C, 1.76%, 04/17/21 (i)	712,200
		Gulf Stream Sextant CLO, Ltd.
	1,013,186	Series 2007-1A, Class D, 2.65%, 06/17/21 (i)	486,329
		Hillmark Funding
	2,000,000	Series 2006-1A, Class C, 1.97%, 05/21/21 (i)	942,500
	612,103	Series 2006-1A, Class D, 3.87%, 05/21/21 (i)	244,841
		Inwood Park CDO, Ltd.
	1,000,000	Series 2006-1A, Class C, 0.98%, 01/20/21 (i)	780,000
	1,000,000	Series 2006-1A, Class D, 1.68%, 01/20/21 (i)	700,000
		Limerock CLO
	2,000,000	Series 2007-1A, Class D, 3.63%, 04/24/23 (i)	600,000
		Madison Park Funding Ltd.
	2,000,000	Series 2007-5A, Class C, 1.71%, 02/26/21 (i)	833,400
	1,500,000	Series 2007-5A, Class D, 3.76%, 02/26/21 (i)	514,500
		Marquette US/European CLO, PLC
	1,000,000	Series 2006-1A, Class D1, 2.03%, 07/15/20 (i)	275,000
		Navigator CDO, Ltd.
	1,005,684	Series 2006-2A, Class D, 09/20/20 (f) (i)	553,126
		Ocean Trails CLO
	1,000,000	Series 2006-1A, Class D, 4.03%, 10/12/20 (i)	369,950
	2,500,000	Series 2007-2A, Class C, 2.63%, 06/27/22 (i)	1,275,000
		PPM Grayhawk CLO, Ltd.
	1,000,000	Series 2007-1A, Class C, 1.68%, 04/18/21 (i)	419,000
	826,734	Series 2007-1A, Class D, 04/18/21 (f) (i)	287,042

10 | See accompanying Notes to Financial Statements.

INVESTMENT PORTFOLIO (continued)

As of December 31, 2009 Highland Credit Strategies Fund

Principal Amount ($)			Value ($)
		Primus CLO, Ltd.
	5,126,536	Series 2007-2A, Class D, 07/15/21 (f) (i)	1,999,349
	2,087,069	Series 2007-2A, Class E, 07/15/21 (f) (i)	521,767
		Rampart CLO, Ltd.
	4,000,000	Series 2006-1A, Class C, 1.73%, 04/18/21 (i)	2,006,400
		St. James River CLO, Ltd.
	2,391,870	Series 2007-1A, Class E, 4.56%, 06/11/21 (i)	837,155
		Stanfield Daytona CLO, Ltd.
	1,200,000	Series 2007-1A, Class B1L, 1.63%, 04/27/21 (i)	576,000
		Stanfield McLaren CLO, Ltd.
	4,000,000	Series 2007-1A, Class B1L, 2.66%, 02/27/21 (i)	1,840,000
		Stone Tower CLO, Ltd.
	2,000,000	Series 2007-6A, Class C, 1.63%, 04/17/21 (i)	960,000
		Venture CDO, Ltd.
	2,000,000	Series 2007-9A, Class D, 4.43%, 10/12/21 (i)	1,012,500
		Westbrook CLO, Ltd.
	1,000,000	Series 2006-1A, Class D, 1.95%, 12/20/20 (i)	510,000
		Total Asset-Backed Securities (Cost $49,548,858)	31,412,072
Foreign Asset-Backed Securities (h) — 0.5%
Principal Amount
IRELAND — 0.5%
EUR
		Static Loan Funding
	2,000,000	Series 2007-1X, Class D, 5.65%, 07/31/17 (i)	1,334,309
	2,000,000	Series 2007-1X, Class E, 8.15%, 07/31/17 (i)	1,076,056
		Total Foreign Asset-Backed Securities (Cost $5,669,662)	2,410,365
Principal Amount ($)
Corporate Notes and Bonds — 27.5%
AEROSPACE — 0.6%
		Delta Air Lines, Inc.
	5,000,000	06/30/23 (f)	73,000
	7,000,000	12/15/29 (f)	115,500
	1,000,000	9.50%, 09/15/14 (i)	1,043,750
		Northwest Airlines Corp.
	2,500,000	12/30/27 (f)	19,000
		Northwest Airlines, Inc.
	1,498,064	9.06%, 05/20/12	1,318,297
			2,569,547
BROADCASTING — 0.0%
		Young Broadcasting, Inc.
	3,065,000	03/01/11 (f) (j)	10,727
CHEMICALS — 0.6%
		Berry Plastics Holding Corp.
	3,000,000	8.88%, 09/15/14	2,932,500
DIVERSIFIED MEDIA — 1.0%
		Baker & Taylor, Inc.
	8,300,000	11.50%, 07/01/13 (i)	4,513,125
FINANCIAL — 0.5%
		Penhall International Corp.
	3,500,000	12.00%, 08/01/14 (i)	2,213,750
FOOD AND DRUG — 0.5%
		Rite Aid Corp.
	2,000,000	10.38%, 07/15/16	2,130,000
FOOD/TOBACCO — 0.4%
		Dole Foods Company, Inc.
	2,000,000	8.00%, 10/01/16 (i)	2,040,000
FOREST PRODUCTS/CONTAINERS — 0.0%
		NewPage Holding Corp., PIK
	341,479	7.56%, 11/01/13 (h)	104,578
GAMING/LEISURE — 0.4%
		MGM Mirage, Inc.
	2,000,000	6.75%, 04/01/13	1,735,000
HEALTHCARE — 16.0%
		Argatroban Royalty Sub LLC
	9,041,634	18.50%, 09/21/14 (i)	8,137,471
		Azithromycin Royalty Sub LLC
	15,000,000	16.00%, 05/15/19 (i)	11,550,000
		Celtic Pharma Phinco B.V., PIK
	52,617,143	17.00%, 06/15/12 (i)	31,570,286
		Cinacalcet Royalty Sub LLC
	270,520	8.00%, 03/30/17 (i)	286,751
		Fosamprenavir Pharma
	3,863,129	15.50%, 06/15/18 (i)	3,554,079
		Molecular Insight Pharmaceuticals, Inc., PIK
	3,954,541	8.48%, 11/01/12 (i) (h)	1,779,543
		Pharma IV (Eszopiclone)
	2,237,922	12.00%, 06/30/14 (i)	1,946,992
		Pharma V (Duloxetine)
	800,000	13.00%, 10/15/13 (i)	768,000
		TCD Pharma
	15,500,000	16.00%, 04/15/24 (i)	13,640,000
			73,233,122
INFORMATION TECHNOLOGY — 0.1%
		Charys Holding Co., Inc.
	5,000,000	02/16/12 (c) (f)	—
		Magnachip Semiconductor
	385,679	12/15/11 (f) (h) (j)	194,999
		New Holding, Inc.
	477,689	03/12/13 (c) (f)	173,401
			368,400
MANUFACTURING — 0.9%
		Polypore, Inc.
	4,000,000	8.75%, 05/15/12	4,000,000

See accompanying Notes to Financial Statements. | 11

INVESTMENT PORTFOLIO (continued)

As of December 31, 2009 Highland Credit Strategies Fund

Principal Amount ($)			Value ($)
Corporate Notes and Bonds (continued)
RETAIL — 0.3%
		Burlington Coat Factory
	500,000	11.13%, 04/15/14 (j)		518,750
		Nebraska Book Co., Inc.
	1,000,000	10.00%, 12/01/11 (i)		1,017,500
				1,536,250
TRANSPORTATION — AUTOMOTIVE — 2.1%
		American Tire Distributors Holdings, Inc.
	11,500,000	6.54%, 04/01/12 (h)		9,602,500
		Delphi Corp.
	3,750,000	05/01/10 (f)		56,250
	3,933,000	06/15/10 (f)		58,995
	8,334,000	05/01/29 (f) (j)		125,010
				9,842,755
UTILITY — 1.0%
		Calpine Corp.
	2,795,000	7.25%, 10/15/17 (i)		2,697,175
		Kiowa Power
	2,000,000	5.74%, 03/30/21 (i)		1,890,236
				4,587,411
WIRELESS COMMUNICATIONS — 3.1%
		Digicel Group, Ltd., PIK
	14,492,000	9.13%, 01/15/15 (i)		14,347,080
		Total Corporate Notes and Bonds (Cost $179,894,490)		126,164,245
Claims (k) — 0.1%
FINANCIAL — 0.1%
		Lehman Brothers Holding, Inc.
	1,198,046	Trade Claims LBSF		431,297
RETAIL — 0.0%
		Home Interiors & Gifts, Inc.
	6,933,961	Proof of Claims (c)		10,401
		Total Claims (Cost $5,595,198)		441,698
Shares
Common Stocks (k) — 9.8%
AEROSPACE — 0.0%
	3,948	Delta Air Lines, Inc.		44,928
BROADCASTING — 0.0%
	2,010,616	Communications Corp. of America (b) (c)		—
	57,757	Gray Television, Inc., Class A		87,791
				87,791
DIVERSIFIED MEDIA — 0.2%
	46,601	American Banknote Corp. (c)		765,188
HEALTHCARE — 8.4%
	395,838	Dfine, Inc. (c)		395,838
	24,000,000	Genesys Ventures IA, LP (b) (c)		38,160,000
				38,555,838
HOUSING — 0.0%
	8	Westgate Investments LLC, Class B-1 (c)		—
INFORMATION TECHNOLOGY — 0.0%
	9,342	New Holding, Inc. (c)		—
METALS/MINERALS — 0.1%
	7,579	Euramax International, Inc. (c)		454,361
RETAIL — 0.2%
	105,092	Sally Beauty Holdings, Inc.		803,954
SERVICE — 0.3%
	200,964	Safety-Kleen Systems, Inc. (c)		1,406,750
TELECOMMUNICATIONS — 0.0%
	1	Viatel Holding (Bermuda) Ltd.		10
TRANSPORTATION — AUTOMOTIVE — 0.0%
	1,544,148	Delphi Corp. (c)		—
TRANSPORTATION — LAND TRANSPORTATION — 0.2%
	18,022	SIRVA Worldwide, Inc. (c)		937,144
UTILITY — 0.0%
	81,194	Entegra TC LLC		182,687
	4,365	GBGH LLC (c)		—
				182,687
WIRELESS COMMUNICATIONS — 0.4%
	1,772,064	ICO Global Communications Holding Ltd.		1,913,829
		Total Common Stocks (Cost $63,057,446)		45,152,480
Preferred Stocks (k) — 2.8%
	1,000,000	Adelphia Recovery Trust (c)		5,000
	2,150,537	Dfine, Inc., Series D (c)		12,774,190
		Total Preferred Stocks (Cost $10,934,997)		12,779,190
Units
Warrants (k) — 0.2%
	20,000	Clearwire Corp., expires 08/15/10		700
	1,271	GBGH LLC, expires 06/09/14 (c)		—
	1,000	Grande Communications, expires 04/01/11 (c)		—
	49,317	IAP Worldwide Services, Inc., Series A, expires 06/12/15 (c)		—
	14,444	IAP Worldwide Services, Inc., Series B, expires 06/12/15 (c)		—
	7,312	IAP Worldwide Services, Inc., Series C, expires 06/12/15 (c)		—

12 | See accompanying Notes to Financial Statements.

INVESTMENT PORTFOLIO (continued)

As of December 31, 2009 Highland Credit Strategies Fund

Units			Value ($)
Warrants (k) (continued)
	643,777	Microvision, Inc., expires 07/23/13		907,726
		Total Warrants (Cost $10)
				908,426
Total Investments — 125.9%
(Cost of $866,889,729) (l)				577,419,237
Other Assets & Liabilities, Net — (25.9)%				(118,655,392	)
Net Assets applicable to Common Shareholders — 100.0%				458,763,845

The amount of $1,250,615 in cash was segregated with the brokers and/or custodian to cover investments sold short outstanding as of December 31, 2009 and is included in “Other Assets & Liabilities, Net”:

Short Sales — 0.3%

EQUITY SECURITY — 0.3%

Shares
RETAIL — 0.3%
	87,311	Ethan Allen Interiors, Inc.	1,171,714
		Total Investments sold short (Proceeds $1,178,072)	1,171,714

(a)	Senior loans (also called bank loans, leveraged loans, or floating rate loans) in which the Fund invests, generally pay interest at rates which are periodically determined by reference to a base lending rate plus a spread. (Unless otherwise identified by footnote (g), all senior loans carry a variable rate 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. Rate shown represents the weighted average rate at December 31, 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 a contractual requirement or at their election, cannot be predicted with accuracy. As a result, the actual maturity may be substantially less than the stated maturity shown.
(b)	Affiliated issuers. See Note 10.
(c)	Represents fair value as determined by the Fund’s Board of Trustees (the “Board”) or its designee in good faith, pursuant to the policies and procedures approved by the Board. Securities with a total aggregate market value of $113,946,814, or 24.8% of net assets, were fair valued under the fair value procedures as of December 31, 2009.
(d)	All or a portion of this position has not settled. Full contract rates do not take effect until settlement date.
(e)	Senior Loan assets had additional unfunded loan commitments. See Note 9.
(f)	The issuer is in default of its payment obligation. Income is not being accrued.
(g)	Fixed rate senior loan.
(h)	Floating rate asset. The interest rate shown reflects the rate in effect at December 31, 2009.
(i)	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 December 31, 2009, these securities amounted to $136,430,075 or 29.7% of net assets.
(j)	Securities (or a portion of securities) on loan. See Note 8.
(k)	Non-income producing security.
(l)	Cost for U.S. federal income tax purposes is $874,196,213.
AUD	Australian Dollar
EUR	Euro Currency
GBP	Great Britain Pound
CDO	Collateralized Debt Obligation
CLO	Collateralized Loan Obligation
DIP	Debtor-in-Possession
PIK	Payment-in-Kind

Foreign Denominated Senior Loans &
Asset Backed Securities
Industry Concentration Table:
(% of Net Assets)

Diversified Media	3.9	%
Financial	0.5	%
Total	4.4	%

Forward foreign currency contracts outstanding as of December 31, 2009 were as follows:

		Principal
Contracts		Amount				Net
to Buy or		Covered by				Unrealized
to Sell	Currency	Contracts		Expiration		Appreciation
Sell	EUR		35,000		02/03/10	$	204
Sell	EUR		1,665,000		05/14/10		107,340
Sell	GBP		384,000		02/03/10		28,789
Sell	GBP		2,583,500		05/14/10		145,562
						$	281,895

See accompanying Notes to Financial Statements. | 13

STATEMENT OF ASSETS AND LIABILITIES

As of December 31, 2009 Highland Credit Strategies Fund

	($)
Assets:
Unaffiliated issuers, at value (cost $792,338,651)		509,734,699
Affiliated issuers, at value (cost $74,551,078) (Note 10)		67,684,538
Total investments, at value (cost $866,889,729)		577,419,237
Cash and foreign currency*		9,497,085
Restricted cash (Note 2)		1,250,615
Cash held as collateral for securities loaned (Note 8)		753,763
Net unrealized appreciation on forward foreign currency contracts		281,895
Receivable for:
Investments sold		4,566,080
Dividends and interest receivable		7,876,544
Prepaid commitment fee (Note 7)		1,243,645
Other assets		84,450
Total assets		602,973,314
Liabilities:
Notes payable (Note 7)		112,000,000
Securities sold short, at value (proceeds $1,178,072)		1,171,714
Net discount and unrealized depreciation on unfunded transactions (Note 9)		5,939,043
Payable upon receipt of securities loaned (Note 8)		753,763
Payables for:
Investments purchased		23,225,077
Investment advisory fee payable (Note 4)		413,742
Administration fee (Note 4)		62,521
Trustees’ fees (Note 4)		36,570
Interest expense (Note 7)		130,010
Accrued expenses and other liabilities		477,029
Total liabilities		144,209,469
Net Assets Applicable To Common Shares		458,763,845
Composition of Net Assets:
Par value of common shares (Note 1)		63,699
Paid-in capital in excess of par value of common shares		1,156,135,046
Undistributed net investment income		7,570,774
Accumulated net realized gain/(loss) from investments, short positions, credit default swap and foreign currency transactions		(412,073,293	)
Net unrealized appreciation/(depreciation) on investments, unfunded transactions, short positions, forward foreign currency contracts, credit default swap, senior loan based derivatives and translation of assets and liabilities denominated in foreign currency		(292,932,381	)
Net Assets Applicable to Common Shares		458,763,845
Common Shares
Net assets		458,763,845
Shares outstanding (unlimited authorization)		63,699,429
Net asset value per share (Net assets/shares outstanding)		7.20

* Foreign currency held at cost is $(135,064).

14 | See accompanying Notes to Financial Statements.

STATEMENT OF OPERATIONS

For the Year Ended December 31, 2009 Highland Credit Strategies Fund

	($)
Investment Income:
Interest from unaffiliated issuers		53,083,998
Interest from affiliated issuers (Note 10)		4,755,228
Securities lending income		23,180
Total investment income		57,862,406
Expenses:
Investment advisory fees (Note 4)		4,922,321
Administration fees (Note 4)		984,464
Accounting service fees		313,610
Transfer agent fee		87,909
Trustees’ fees (Note 4)		137,061
Custodian fees		63,722
Registration fees		74,312
Reports to shareholders		192,872
Merger expenses (Note 13)		672,322
Audit fees		127,650
Legal fees		1,578,393
Insurance expense		119,923
Interest expense (Note 7)		4,974,015
Commitment fee expense (Note 7)		898,355
Other expenses		242,023
Total operating expenses		15,388,952
Fees and expenses waived or reimbursed by Investment Adviser (Note 4)		(1,232,025	)
Net operating expenses		14,156,927
Dividends paid on securities sold short		12,689
Net expenses		14,169,616
Net investment income		43,692,790
Net Realized and Unrealized Gain/(Loss) on Investments:
Net realized gain/(loss) on investments from unaffiliated issuers		(159,140,098	)
Net realized gain/(loss) on credit default swap (1)		238,001
Net realized gain/(loss) on forward foreign currency contracts (2)		4,678,395
Net realized gain/(loss) on foreign currency transactions		(85,046	)
Net change in unrealized appreciation/(depreciation) on investments *		206,225,996
Net change in unrealized appreciation/(depreciation) on unfunded transactions (Note 9)		2,770,296
Net change in unrealized appreciation/(depreciation) on short positions		6,358
Net change in unrealized appreciation/(depreciation) on forward foreign currency contracts (2)		(4,839,756	)
Net change in unrealized appreciation/(depreciation) on credit default swap and senior loan based derivatives (1)		(282,543	)
Net change in unrealized appreciation/(depreciation) on translation of assets and liabilities denominated in foreign currency		(901,372	)
Net realized and unrealized gain/(loss) on investments		48,670,231
Net increase in net assets from operations		92,363,021

*	Change in unrealized appreciation (depreciation) does not include unrealized depreciation of $86,923,196 in connection with the reorganization of HCD into the Fund on June 12, 2009 (See Notes 1 and 13).
(1)	The primary risk exposure is credit contracts (See Notes 1 and 12).
(2)	The primary risk exposure is foreign exchange contracts (See Notes 1 and 12).

See accompanying Notes to Financial Statements. | 15

STATEMENTS OF CHANGES IN NET ASSETS

Highland Credit Strategies Fund

	Year Ended			Year Ended
	December 31, 2009			December 31, 2008
	($)			($)
From Operations
Net investment income		43,692,790			73,076,096
Net realized gain/(loss) on investments, short positions, credit default swap and foreign currency transactions		(154,308,748	)		(205,020,852	)
Net change in unrealized appreciation/(depreciation) on investments, unfunded transactions, short positions, forward foreign currency contracts, credit default swap, senior loan based derivatives and translation of assets and liabilities denominated in foreign currency (a)		202,978,979			(319,230,361	)
Net change in net assets from operations		92,363,021			(451,175,117	)
Distributions Declared to Common Shareholders
From net investment income		(46,162,639	)		(74,715,148	)
From capital gains		—			(10,782,212	)
Total distributions declared to common shareholders		(46,162,639	)		(85,497,360	)
Share Transactions from Common Shares
Subscriptions from rights offering		—			143,506,876
Subscriptions from reorganizations (Notes 1 and 13)		51,353,210			133,321,183
Redemptions from reorganizations (Notes 1 and 13) (b)		(252	)		(23,238	)
Net increase from share transactions from common shares		51,352,958			276,804,821
Total increase (decrease) in net assets from common shares		97,553,340			(259,867,656	)
Net Assets Applicable to Common Shares
Beginning of year		361,210,505			621,078,161
End of year (including undistributed net investment income of $7,570,774 and $4,907,190, respectively)		458,763,845			361,210,505
Change in Common Shares
Subscriptions from rights offering		—			11,535,615
Subscriptions from reorganizations		8,173,278			9,471,694
Redemptions from reorganizations(b)		(39	)		(1,669	)
Net increase in common shares		8,173,239			21,005,640

(a)	Does not include unrealized depreciation of $86,923,196 and $33,787,604, respectively, in connection with the reorganizations of PHY and CNN into the Fund on July 18, 2008 and the reorganization of HCD into the Fund on June 12, 2009 (the “Reorganizations”). (See Notes 1 and 13).
(b)	Fractional shares in the Reorganizations were redeemed. Only whole shares were issued.

16 | See accompanying Notes to Financial Statements.

STATEMENT OF CASH FLOWS

For the Year Ended December 31, 2009) Highland Credit Strategies Fund

	($)
Cash Flows Provided by Operating Activities
Net investment income		43,692,790
Adjustments to Reconcile Net Investment Income to Net Cash and Foreign Currency Provided by Operating Activities
Purchase of investment securities		(431,611,930	)
Proceeds from disposition of investment securities		427,060,416
Purchase of securities sold short		1,178,072
Decrease in receivable for investments sold		27,522,539
Decrease in receivable for credit default swap (a)		966,803
Decrease in interest and fees receivable		11,305,689
Increase in restricted cash		(1,250,615	)
Decrease in receivable for securities lending		4,524,475
Increase in other assets		(1,269,119	)
Net amortization/(accretion) of premium/(discount)		(5,578,622	)
Mark-to-market on realized and unrealized gain/(loss) on foreign currency		3,691,977
Increase in payable for investments purchased		12,164,559
Decrease in payable		(2,190,175	)
Decrease in payables to related parties		(247,993	)
Decrease in interest payable		(507,807	)
Decrease in payable upon receipt of securities loaned		(4,524,475	)
Decrease in dividends payable on securities sold short		(1,849	)
Decrease in excise tax payable		(353,670	)
Decrease in other expenses and liabilities		(705,569	)
Net cash and foreign currency provided by operating activities		83,865,496
Cash Flows Used by Financing Activities
Decrease in notes payable		(29,000,000	)
Net purchase of short-term securities as a result of reorganizations (Notes 1 and 13)		505,826
Payment of shares redeemed as a result of reorganizations (Notes 1 and 13)		(252	)
Distributions paid in cash		(46,162,639	)
Net cash flow used by financing activities		(74,657,065	)
Net increase in cash and foreign currency		9,208,431
Cash and Foreign Currency
Beginning of the year		288,654
End of the year		9,497,085
Supplemental disclosure of cash flow information:
Cash paid during the year for interest		5,481,425

(a) Includes realized gain/(loss) on credit default swap.

See accompanying Notes to Financial Statements. | 17

FINANCIAL HIGHLIGHTS

Highland Credit Strategies Fund

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

	For the			For the			For the			For the
	Year Ended			Year Ended			Year Ended			Period Ended
	December 31,			December 31,			December 31,			December 31,
Common Shares Per Share Operating Performance:	2009			2008			2007			2006(a)
Net Asset Value, Beginning of Year	$	6.51		$	17.99		$	20.08		$	19.06
Income from Investment Operations:
Net investment income		0.74			1.35			1.71			0.71
Net realized and unrealized gain/(loss) on investments		0.74			(9.79	)		(1.85	)		0.91
Total from investment operations		1.48			(8.44	)		(0.14	)		1.62
Less Distributions Declared to Common Shareholders:
From net investment income		(0.79	)		(1.46	)		(1.65	)		(0.60	)
From net realized gains		—			(0.26	)		(0.30	)		—
Total distributions declared to common shareholders		(0.79	)		(1.72	)		(1.95	)		(0.60	)
Dilutive impact of rights offering		—			(1.32	)		—			—
Net Asset Value, End of Year	$	7.20		$	6.51		$	17.99		$	20.08
Market Value, End of Year	$	6.31		$	5.70		$	15.82		$	21.16
Market Value Total Return (c)		27.69	%		(57.84	)%		(17.05	)%		9.06	% (b)
Ratios and Supplemental Data:
Net assets, end of period (in 000’ s)	$	458,764		$	361,211		$	621,078		$	692,964
Common Share Information at End of Year:
Ratios based on average net assets of common shares:
Gross operating expenses (including interest and commitment fee expense)		3.90	%		3.78	%		4.03	%		2.56	%
Interest and commitment fee expense		1.49	%		1.63	%		2.16	%		1.03	%
Dividend expense from short positions		—	(d)		0.17	%		0.03	%		N/A
Fees and expenses waived		(0.31	)%		(0.09	)%		—			—
Net expenses		3.59	%		3.86	%		4.06	%		2.56	%
Net investment income		11.09	%		11.36	%		8.64	%		7.37	%
Ratios based on managed net assets of common shares:
Gross operating expenses (including interest and commitment fee expense)		3.12	%		2.69	%		2.94	%		2.20	%
Interest and commitment fee expense		1.19	%		1.16	%		1.58	%		0.89	%
Dividend expense from short positions		—	(d)		0.12	%		0.02	%		N/A
Fees and expenses waived		(0.25	)%		(0.06	)%		—			—
Net expenses		2.87			2.75	%		2.96	%		2.20	%
Net investment income		8.88	%		8.12	%		6.31	%		6.33	%
Portfolio turnover rate		88	%		78	%		66	%		46	% (b)

(a)	Highland Credit Strategies Fund commenced investment operations on June 29, 2006. (b) Not annualized.
(b)	Not annualized.
(c)	Based on market value per share. Distributions, if any, are assumed for purposes of this calculation to be reinvested at prices obtained under the Fund’s Dividend Reinvestment Plan.
(d)	Less than 0.005%.

18 | See accompanying Notes to Financial Statements.

NOTES TO FINANCIAL STATEMENTS

December 31, 2009 Highland Credit Strategies Fund

Note 1. Organization and Operations

Highland Credit Strategies Fund (the “Fund”) is a Delaware statutory trust 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 non-diversified, closed-end management investment company. The Fund may issue an unlimited number of common shares, par value $0.001 per share (“Common Shares”). The Fund commenced operations on June 29, 2006.

On July 18, 2008, the Fund issued 5,805,987 shares, in exchange for 30,874,699 shares of Prospect Street High Income Portfolio Inc. (“PHY”) and 3,665,707 shares in exchange for 9,947,104 shares of Prospect Street Income Shares Inc. (“CNN”) to acquire PHY and CNN in a tax-free exchange approved by the Board of Directors and stockholders of each acquired fund. The net assets on such date of the Fund, PHY, and CNN were $641,375,543, $80,852,458, and $51,047,990, respectively.

On June 12, 2009, the Fund issued 8,173,238 shares, in exchange for 17,716,771 shares of Highland Distressed Opportunities, Inc. (“HCD”). The net assets on such date of the Fund and HCD were $348,872,330 and $51,353,210, respectively (See Note 13).

Investment Objective

The Fund seeks to provide both current income and capital appreciation.

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 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 common shares is calculated as of the last business day of each month, in connection with each issuance of common shares by the Fund, as of each distribution date (after giving effect to the relevant declaration) and on such other dates as determined by the Fund’s Board of Trustees (the “Board” or “Trustees”), or its designee, in accordance with procedures approved by the Board. The NAV is calculated by dividing the value of the Fund’s net assets attributable to common shares by the numbers of common shares outstanding.

Valuation of Investments

In computing the Fund’s net assets attributable to common shares, 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 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 and bond positions are not traded on exchanges and consequently are valued based on a mean of the bid and ask price from the third-party pricing services or broker-dealer sources that Highland Capital Management, L.P. (the “Investment Adviser”) has determined generally has the capability to provide appropriate pricing services and has been approved by the Trustees.

Securities for which market quotations are not readily available, for which the Fund has determined the price received from a pricing service or broker-dealer is “stale” or otherwise do 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 net asset value), 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 NAV. 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 cost adjusted for amortization of premiums and accretion of discounts. 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.

Annual Report | 19

NOTES TO FINANCIAL STATEMENTS (continued)

December 31, 2009 Highland Credit Strategies Fund

Fair Value Measurements:

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. The levels of fair value inputs used to measure the Fund’s investments are characterized into a fair value hierarchy. Where inputs for an asset or liability fall into more than one level in the fair value hierarchy, the investment is classified in its entirety based on the lowest level input that is significant to that investment’s valuation. The three levels of the fair value hierarchy are described below:

Level 1 —	Quoted unadjusted prices for identical instruments in active markets to which the Fund has access at the date of measurement;
Level 2 —	Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active, but are valued based on executed trades; broker quotations that constitute an executable price; and alternative pricing sources supported by observable inputs are classified within Level 2. Level 2 inputs are either directly or indirectly observable for the asset in connection with market data at the measurement date; and
Level 3 —	Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. In certain cases, investments classified within Level 3 may include securities for which the Fund has obtained indicative quotes from broker-dealers that do not necessarily represent prices the broker may be willing to trade on, as such quotes can be subject to material management judgment. Unobservable inputs are those inputs that reflect the Fund’s own assumptions that market participants would use to price the asset or liability based on the best available information.

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 December 31, 2009 as follows:

						Level 2			Level 3
				Level 1		Significant			Significant
	Total Value at			Quoted		Observable			Unobservable
Investment in Securities	December 31, 2009			Price		Input			Input
Common Stocks
Aerospace	$	44,928		$	—	$	44,928		$	—
Broadcasting		87,791			87,791		—			—
Diversified Media		765,188			—		—			765,188
Healthcare		38,555,838			—		—			38,555,838
Metals/Minerals		454,361			—		—			454,361
Retail		803,954			803,954		—			—
Service		1,406,750			—		—			1,406,750
Telecommunications		10			10		—			—
Transportation — Land Transportation		937,144			—		—			937,144
Utility		182,687			—		—			182,687
Wireless Communication		1,913,829			1,913,829		—			—
Preferred Stocks		12,779,190			—		5,000			12,774,190
Warrants		908,426			907,726		—			700
Debt
Senior Loans		358,150,761			—		202,395,514			155,755,247
Asset-Backed Securities		33,822,437			—		—			33,822,437
Corporate Debt		126,164,245			—		52,562,723			73,601,522
Claims		441,698			—		—			441,698
Total Investments	$	577,419,237		$	3,713,310	$	255,008,165		$	318,697,762
Other Financial Instruments*
Short Sales
Retail	$	(1,171,714	)	$	—	$	(1,171,714	)	$	—
Assets		281,895			—		281,895			—
Total Other Financial Instruments	$	(889,819	)	$	—	$	(889,819	)	$	—

* 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.

20 | Annual Report

NOTES TO FINANCIAL STATEMENTS (continued)

December 31, 2009 Highland Credit Strategies Fund

The Fund did not have any liabilities that were measured at fair value or Level 3 on a recurring basis at December 31, 2009.

The tables below set 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 year ended December 31, 2009.

						Level 3		Net
						securities		amortization/
Assets at Fair Value	Balance as of		Transfers			Acquired from		(accretion) of					Net			Net
using unobservable	December 31,		in/(out)			Reorganization		premium/		Net realized			unrealized			purchase/			Balance as of
inputs (Level 3)	2008		of Level 3			(Note 13)		(discount)		gains/(losses)			gains/(losses)			(sales)*			December 31, 2009
Common Stocks
Diversified Media	$	489,310	$	—		$	—	$	—	$	—		$	275,878		$	—		$	765,188
Healthcare		10,157,000		—			14,880,000		—		—			8,123,000			5,395,838			38,555,838
Information Technology		—		—			—		—		—			(1,214,460	)		1,214,460			—
Metals/Minerals		—		—			—		—		—			(28,039	)		482,400			454,361
Service		502,411		—			—		—		—			904,339			—			1,406,750
Transportation — Land Transportation		585,073		—			—		—		—			352,071			—			937,144
Utility		324,776		—			—		—		—			(142,089	)		—			182,687
Preferred Stocks		9,999,997		—			—		—		—			2,774,193			—			12,774,190
Warrants		309,073		—			—		—		—			(308,373	)		—			700
Debt
Senior Loans		210,106,203		1,451,431			18,895,689		2,392,933		(85,264,703	)		58,053,483			(49,879,789	)		155,755,247
Asset-Backed Securities		9,437,152		—			—		319,033		700,309			24,898,421			(1,532,478	)		33,822,437
Corporate Debt		118,919,586		(15,140,088	)		14,718,377		185,971		(23,348,057	)		15,773,071			(37,507,338	)		73,601,522
Claims		1,306,894		—			17,469		—		(4,836,655	)		5,135,944			(1,181,954	)		441,698
Total	$	362,137,475	$	(13,688,657	)	$	48,511,535	$	2,897,937	$	(112,749,106	)	$	114,597,439		$	(83,008,861	)	$	318,697,762

* Includes any applicable borrowings and/or pay downs made on revolving credit facilities held in the Fund’s investment portfolio.

The net unrealized losses presented in the tables above relate to investments that are still held at December 31, 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 year ended December 31, 2009, a net amount of $13,688,657 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.

Security Transactions

Security transactions are accounted for on the trade date. Cost is determined and gains/(losses) are based upon the specific identification method for both financial statement and 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 security 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.

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. With forwards, there is counterparty credit risk to the Fund because the forwards are not exchange traded, and there is no clearinghouse to guarantee the forwards against default.

Short Equity and Bond Sales

A short sale is a transaction in which the Fund sells a security it does not own in anticipation that the market price of that security will decline. When the Fund makes a short sale, it must borrow the security sold short from a broker-dealer and deliver it to the buyer upon settlement of the sale.

Annual Report | 21

NOTES TO FINANCIAL STATEMENTS (continued)

December 31, 2009 Highland Credit Strategies Fund

The Fund may have to pay a fee to borrow particular securities and is often obligated to pay over any payments received on such borrowed securities. Cash of $1,250,615 held as collateral for short sales is included in restricted cash on the Statement of Assets and Liabilities.

When short sales are employed, the Fund intends to attempt to limit exposure to a possible market decline in the value of its portfolio securities through short sales of securities that the Investment Adviser believes possess volatility characteristics similar to those being hedged. In addition, the Fund may use short sales for non-hedging purposes to pursue its investment objective. Subject to the requirements of the 1940 Act and the Internal Revenue Code of 1986, as amended (the “Code”), the Fund will not make a short sale if, after giving effect to such sale, the market value of all securities sold short by the Fund exceeds 25% of the value of its total assets.

Credit Default Swaps

To the extent consistent with the Fund’s prospectus, the Fund may enter into credit default swap agreements. The “buyer” in a credit default contract is obligated to pay the “seller” a periodic stream of payments over the term of the contract provided that no event of default on an underlying reference obligation has occurred. If an event of default occurs, the seller typically pays the buyer the “par value” (full notional value) of the reference obligation in exchange for the reference obligation. The Fund may be either the buyer or seller in the transaction. If the Fund is a buyer and no event of default occurs, the Fund loses its investment and recovers nothing. However, if an event of default occurs, the buyer receives full notional value for a reference obligation that may have little or no value. As a seller, the Fund receives income throughout the term of the contract, which typically is between six months and five years, provided that there is no default event.

Credit default swaps involve greater risks than if the Fund had invested in the reference obligation directly. In addition to general market risks, credit default swaps are subject to illiquidity risk, counterparty risk and credit risks. If an event of default were to occur, the value of the reference obligation received by the seller, coupled with the periodic payments previously received, may be less than the full notional value it pays to the buyer, resulting in a loss of value to the seller. When the Fund acts as a seller of a credit default swap agreement it is exposed to many of the same risks of leverage as certain other leveraged transactions, since if an event of default occurs the seller must pay the buyer the full notional value of the reference obligation. As of December 31, 2009, there were no credit default swap trades outstanding.

Income Recognition

Interest income is recorded on the accrual basis and includes accretion of discounts and amortization of premiums. Dividend income is recorded on the ex-dividend date.

U.S. Federal Income Tax Status

The Fund intends to qualify each year as a “regulated investment company” under Subchapter M of the Code, 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.

Management has analyzed the Fund’s tax positions taken on federal income tax returns for all open tax years (current and prior three tax years), and has concluded that no provision for federal income tax is required in the Fund’s financial statements. The Fund’s federal and state income and federal excise tax returns for tax years for which the applicable statutes of limitations have not expired are subject to examination by the Internal Revenue Service and state departments of revenue.

Distributions to Shareholders

The Fund plans to pay distributions monthly and capital gain distributions annually to common shareholders. To permit the Fund to maintain more stable monthly distributions and annual distributions, the Fund may from time to time distribute less than the entire amount of income and gains earned in the relevant month or year, respectively. The undistributed income and gains would be available to supplement future distributions. Shareholders of the Fund will automatically have all distributions reinvested in Common Shares of the Fund issued by the Fund or purchased in the open market in accordance with the Fund’s Dividend Reinvestment Plan (the “Plan”) unless an election is made to receive cash. Each participant in the Plan will pay a pro rata share of brokerage commissions incurred in connection with open market purchases, and participants requesting a sale of securities through the plan agent of the Plan are subject to a sales fee and a brokerage commission.

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 purchase investments. Cash and cash equivalents are valued at cost plus accrued interest, which approximates market value. The value of cash equivalents denominated in foreign currencies is determined by converting to U.S. dollars on the date of the statement of assets and liabilities. At December 31, 2009, the Fund had $131,401 of cash and cash equivalents denominated in foreign currencies, with a cost of $135,064.

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

22 |  Annual Report

NOTES TO FINANCIAL STATEMENTS (continued)

December 31, 2009 Highland Credit Strategies Fund

Liabilities and includes cash and foreign currency on hand at its custodian bank.

Additional Accounting Standards

In June 2009, the Financial Accounting Standards Board (“FASB”) issued the FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (“Codification”) which identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements that are presented in conformity with U.S. GAAP. It established the Codification as the single source of authoritative accounting principles recognized by the FASB in the preparation of financial statements in conformity with U.S. GAAP. Codification does not create new accounting and reporting guidance, rather it reorganizes U.S. GAAP pronouncements into approximately 90 topics within a consistent structure. All guidance contained in the Codification carries equal level of authority. The Codification became effective for financial statements issued for interim and annual periods ending after Sept. 15, 2009. The Codification did not have a material effect on the Fund’s financial statements.

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.

Reclassifications are made to the Fund’s capital accounts for permanent tax differences to reflect income and gains available for distribution (or available capital loss carryforwards) under income tax regulations.

For the year ended December 31, 2009, permanent differences resulting primarily from foreign bond bifurcation, realized swap gain/(loss) reclass and Section 988 gain/(loss) reclass were identified and reclassified among the components of the Fund’s net assets as follows:

Undistributed		Accumulated
Net Investment		Net Realized			Paid-In
Income		Loss			Capital
$	5,133,433	$	(11,372,531	)	$	6,239,098

The tax character of distributions paid during the years ended December 31, 2009 and December 31, 2008, the past two tax years ends, were as follows:

Distributions paid from:	2009		2008
Ordinary income*	$	46,162,639	$	84,472,625
Long-term capital gains		—		1,024,735

* For tax purposes, short-term capital gains distributions, if any, are considered ordinary income distributions.

As of December 31, 2009, the most recent tax year end, the components of distributable earnings on a tax basis were as follows:

Undistributed		Undistributed					Accumulated
Ordinary		Long-Term		Net Unrealized			Capital and
Income		Capital Gains		(Depreciation)*			Other Losses
$	7,982,245	$	—	$	(300,238,865	)	$	(404,896,385	)

* Any differences between book-basis and tax-basis net unrealized appreciation/(depreciation) are primarily due to deferral of losses from wash sales.

As of December 31, 2008, the most recent year end, for federal income tax purposes, the Fund had capital loss carry-forwards, which will expire in the indicated years:

Capital Loss				Expiration
Carryforwards				Date
$	3,196,740	*		2010
	11,115,101	*		2011
	3,279,930	*		2012
	8,679,337	*		2014
	6,437,279	*		2015
	90,161,614	* **		2016
	282,026,384			2017
$	404,896,385		Total

*	These capital loss carryforward amounts were acquired in the reorganizations of PHY and CNN into the Fund on July 18, 2008. The Fund’s ability to utilize the capital loss carryforwards is limited under Internal Revenue Service regulations.
**	This capital loss carryforward amount includes $17,875,363 acquired in the reorganization of HCD into the Fund on June 12, 2009, and is available to offset future capital gains of the Fund. The Fund’s ability to utilize the capital loss carryforwards is limited under Internal Revenue Service regulations.

Unrealized appreciation and depreciation at December 31, 2009, based on cost of investments for U.S. federal income tax purposes was:

Unrealized appreciation	$	26,848,343
Unrealized depreciation		(323,625,319	)
Net unrealized depreciation	$	(296,776,976	)

Note 4. Investment Advisory, Administration, and Trustee Fees

Investment Advisory Fee

The Investment Adviser to the Fund receives an annual fee, paid monthly, in an amount equal to 1.00% of the average weekly value of the Fund’s Managed Assets. The Fund’s “Managed Assets” is an amount equal to the total assets of the Fund, including any form of leverage, minus all accrued expenses incurred in the normal course of operations, but not

Annual Report | 23

NOTES TO FINANCIAL STATEMENTS (continued)

December 31, 2009 Highland Credit Strategies Fund

excluding any liabilities or obligations attributable to investment leverage obtained through (i) indebtedness of any type (including, without limitation, borrowing through a credit facility or the issuance of debt securities), (ii) the issuance of preferred stock or other preference securities, (iii) the reinvestment of collateral received for securities loaned in accordance with the Fund’s investment objectives and policies, and/or (iv) any other means.

In connection with the reorganizations of PHY and CNN into the Fund on July 18, 2008, the Investment Adviser agreed to waive certain advisory fees for a period of two years until July 17, 2010. Over the period of two years, the Investment Adviser agreed to waive advisory fees of $1,656,448. For the year ended December 31, 2009, the Investment Adviser waived advisory fees of $828,225.

Administration Fee

The Investment Adviser provides administrative services to the Fund. For its services, the Investment Adviser receives an annual fee, payable monthly, in an amount equal to 0.20% of the average weekly value of the Fund’s 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”). The Investment Adviser pays PNC directly for these sub-administration services.

In connection with the reorganizations of PHY and CNN into the Fund on July 18, 2008, the Investment Adviser agreed to waive certain administration fees for a period of two years until July 17, 2010. Over the period of two years, the Investment Adviser agreed to waive administration fees of $807,602. For the year ended December 31, 2009, the Investment Adviser waived administration fees of $403,800.

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 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 year ended December 31, 2009, the cost of purchases and proceeds from sales of securities, excluding short-term obligations, were $431,611,930 and $427,060,416, respectively. The cost of purchases excludes securities received from the reorganization of HCD into the Fund on June 12, 2009.

Note 6. Senior Loan Participation Commitments

The Fund may invest its 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 December 31, 2009, the Fund held no loans on participation.

Note 7. Credit Agreement

Effective September 16, 2009, the Fund entered into a $170,000,000 Credit Agreement (the “Credit Agreement”) with The Bank of Nova Scotia. The Credit Agreement replaced a prior credit agreement and has a maturity date of September 15, 2010. Concurrent with the entering into the Credit Agreement the Fund agreed to pay a $1,700,000 upfront fee. This fee is amortized over the remaining term of the Credit Agreement and $498,355 of upfront fee expense is included in commitment fee expense on the Statement of Operations.

At December 31, 2009, the Fund had outstanding borrowings under the Credit Agreement, totaling $112,000,000, secured by substantially all of the assets in the Company’s portfolio, including cash and cash equivalents. As of December 31, 2009, interest is charged at a rate equal to the Adjusted LIBO Rate plus 2.50% per annum based on the outstanding borrowings. In addition, the Fund has agreed to pay a commitment fee on the unutilized commitment amount of 2.00% per annum. The average daily loan balance was $97,865,753 at a weighted average interest rate of 1.25%, excluding any commitment fee, for the year ended December 31, 2009. With respect to these borrowings, interest and commitment fees of $5,872,370 is included in the Statement of Operations.

24 |  Annual Report

NOTES TO FINANCIAL STATEMENTS (continued)

December 31, 2009 Highland Credit Strategies Fund

The Fund is required to maintain 400% asset coverage with respect to amounts outstanding under the Credit Agreement. Prior to entering into the Credit Agreement, the Fund was required to maintain 300% asset coverage 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
	Total Amount		per $1,000 of
Date	Outstanding		Indebtedness
12/31/2009	$	112,000,000	$	5,096
12/31/2008		141,000,000		3,562
12/31/2007		248,000,000		3,504
12/31/2006		285,000,000		3,429

Note 8. Securities Loans

The Fund may make secured loans of its portfolio securities amounting to not more than one-third of the value of its total assets, thereby realizing additional income. The risks in lending portfolio securities, as with other extensions of credit, consist of possible delays in recovery of the securities or possible loss of rights in the collateral should the borrower fail financially and possible investment losses in the investment of collateral. As a matter of policy, securities loans are made to unaffiliated broker-dealers pursuant to agreements requiring that loans be continuously secured by collateral in cash or short-term debt obligations at least equal at all times to the bid value of the securities subject to the loan. The borrower pays to the Fund an amount equal to any interest or dividends received on securities subject to the loan. The Fund retains all or a portion of the interest received on investment of the cash collateral and receives a fee from the borrower. As of December 31, 2009, the market value of securities loaned by the Fund was $705,084. The loaned securities were secured with cash collateral of $753,763, which was invested in the BlackRock Institutional Money Market Trust.

Note 9. Unfunded Loan Commitments

As of December 31, 2009, the Fund had unfunded loan commitments of $4,935,735 and GBP 5,000,000, which could be extended at the option of the borrower, as detailed below:

	Unfunded
	Loan
Borrower	Commitment
Broadstripe, LLC	$	1,321,970
Sirva Worldwide, Inc.		1,613,765
Sorenson Communications, Inc.		2,000,000
Mobileserv Ltd	GBP	5,000,000

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 December 31, 2009, the Fund recognized net discount and unrealized depreciation on unfunded transactions of $5,939,043. The net change in unrealized appreciation on unfunded transactions of $2,770,296 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 as of December 31, 2009:

	Par Value at		Shares at		Market Value
	December 31,		December 31,		December 31,		December 31,
	2009		2009		2008		2009
CornCorp Broadcasting, Inc.* (a) (Senior Loans)	$	39,444,941		—	$	5,807,308	$	29,524,538
Communication Corp of America (b) (Common Stock)		—		2,010,616		—		—
Genesys Ltd. (c) (Common Stock)		—		24,000,000		10,157,000		38,160,000
	$	39,444,941		26,010,616	$	15,964,308	$	67,684,538

*	Company is a wholly owned subsidiary of Communications Corporation of America.
(a)	On June 12, 2009, $18,849,521 par value of the security was acquired through the HCD reorganization (See Notes 1 and 13).
(b)	On June 12, 2009, 1,256,635 shares of the security were acquired through the HCD reorganization (See Notes 1 and 13).
(c)	On June 12, 2009 12,000,000 shares of the security were acquired through the HCD reorganization (See Notes 1 and 13).

Note 11. Indemnification

The Fund has a variety of indemnification obligations under contracts with its service providers and certain counterparties. The Fund’s maximum exposure under these arrangements is unknown. The Board has approved the advancement of certain expenses to a service provider in connection with pending litigation subject to appropriate documentation and safeguards.

Note 12. Disclosure of Significant Risks and Contingencies

Concentration Risk

The Fund may focus its investments in instruments of only a few companies. The concentration of the Fund’s portfolio in any one obligor would subject the Fund to a greater degree

Annual Report | 25

NOTES TO FINANCIAL STATEMENTS (continued)

December 31, 2009 Highland Credit Strategies Fund

of risk with respect to defaults by such obligor, and the concentration of the portfolio in any one industry would subject the Fund to a greater degree of risk with respect to economic downturns relating to such industry.

Non-Payment Risk

Corporate debt obligations, including Senior Loans, 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 net asset value 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 Senior Loans may result in greater net asset value fluctuation than if the Fund did not make such investments.

Illiquidity of Investments Risk

The investments made by the Fund may be illiquid, and consequently the Fund may not be able to sell such investments at prices that reflect the Investment Adviser’s assessment of their value or the amount originally paid for such investments by the Fund. Illiquidity may result from the absence of an established market for the investments as well as legal, contractual or other restrictions on their resale and other factors. Furthermore, the nature of the Fund’s investments, especially those in financially distressed companies, may require a long holding period prior to profitability.

Troubled, Distressed or Bankrupt Companies Risk

The Fund invests in companies that are troubled, in distress or bankrupt. As such, they are subject to a multitude of legal, industry, market, environment and governmental forces that make analysis of these companies inherently difficult. Further, the Investment Adviser relies on company management, outside experts, market participants and personal experience to analyze potential investments for the Fund. There can be no assurance that any of these sources will prove credible, or that the resulting analysis will produce accurate conclusions.

Leverage Risk

The Fund currently uses leverage through borrowings from a credit facility, and may also use leverage through the issuances of preferred shares. The use of leverage, which can be described as exposure to changes in price at a ratio greater than the amount of equity invested, either through the issuance of preferred shares, borrowing or other forms of market exposure, magnifies both the favorable and unfavorable effects of price movements in the investments made by the Fund. Insofar as the Fund employs leverage in its investment operations, the Fund will be subject to substantial risks of loss.

Foreign Securities Risk

Investments in foreign securities involve certain factors not typically associated with investing in U.S. securities, such as risks relating to (i) currency exchange matters, including fluctuations in the rate of exchange between the U.S. dollar (the currency in which the books of the Fund are maintained) and the various foreign currencies in which the Fund’s portfolio securities will be denominated and costs associated with conversion of investment principal and income from one currency into another; (ii) differences between the U.S. and foreign securities markets, including the absence of uniform accounting, auditing and financial reporting standards and practices and disclosure requirements, and less government supervision and regulation; (iii) political, social or economic instability; and (iv) the extension of credit, especially in the case of sovereign debt.

Forward Currency Contracts Risk

The Fund is subject to foreign currency exchange rate risk in the normal course of pursuing its investment objectives. The Fund may use futures contracts to gain exposure to, or hedge against changes in the value of foreign currencies. A forward contract represents a commitment for the future purchase or sale of an asset at a specified price on a specified date. Upon entering into such contracts daily fluctuations in the value of the contract are recorded for financial statement purposes as unrealized gains or losses by the Fund. At the expiration of the contracts the Fund realizes the gain or loss. Upon entering into such contracts, the Fund bears the risk of exchange rates moving unexpectedly, in which case, the Fund may not achieve the anticipated benefits of the forward contracts and may realize a loss. With forwards, there is counterparty credit risk to the Fund because the forwards are not exchange traded, and there is no clearinghouse to guarantee the forwards against default.

Emerging Markets Risk

Investing in securities of issuers based in underdeveloped emerging markets entails all of the risks of investing in foreign securities to a heightened degree. These heightened risks include: (i) greater risks of expropriation, confiscatory taxation, nationalization, and less social, political and economic stability; (ii) the smaller size of the markets for such securities and a lower volume of trading, resulting in lack of liquidity and in price volatility; and (iii) certain national policies which may restrict the Fund’s investment opportunities, including restrictions on investing in issuers or industries deemed sensitive to relevant national interest.

Derivatives Risk

Derivative transactions in which the Fund may engage for hedging or speculative purposes 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

26 | Annual Report

NOTES TO FINANCIAL STATEMENTS (continued)

December 31, 2009 Highland Credit Strategies Fund

the other party to the transaction or illiquidity of the derivative instruments. Furthermore, the ability to successfully use derivative transactions depends on the Investment Adviser’s ability to predict pertinent market movements, which can not be assured. Thus, 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.

Investments in Swaps Risk

Investments in swaps involve the exchange with another party of commitment to pay a stream of payments. Use of swaps subjects the Fund to risk of default by the counter party. 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 in the event 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 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 payment 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 may enter into over-the-counter forwards, options, swaps and other derivatives 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.

Short Equity and Bond Sales Risk

Short selling involves selling securities which may or may not be owned and borrowing the same securities for delivery to the purchaser, with an obligation to replace the borrowed securities at a later date. The Fund will profit from declines in the market prices of securities sold short to the extent such decline exceeds the transaction costs and the costs of borrowing the securities. However, since the borrowed securities must be replaced by purchases at market prices in order to close out the short position, any appreciation in the price of the borrowed securities would result in a loss. There can be no assurance that the securities necessary to cover a short position will be available for purchase.

Note 13. Reorganization — Merger of Highland Distressed Opportunities, Inc. into the Fund

On December 19, 2008, the Board of Trustees approved an agreement and plan of merger and liquidation (“Agreement”) which provided for the transfer of all of the assets and liabilities of HCD for shares of the Fund. Shareholders of HCD approved the merger at a meeting on May 27, 2009. The merger was completed by a tax-free exchange of shares on June 12, 2009. For financial reporting purposes, assets received and shares issued by the Fund were recorded at fair value; however, the cost basis of the investments received from HCD was carried forward to align ongoing reporting of the Fund’s realized and unrealized gains and losses with amounts distributable to shareholders for tax purposes.

The shares outstanding of HCD immediately before the merger and shares of the Fund issued to HCD shareholders were:

Merged Fund	Shares Exchanged		Acquiring Fund	Shares Issued		Net Asset Value		Conversion Ratio
Highland Distressed			Highland Credit
Opportunities, Inc.		17,716,771	Strategies Fund		8,173,238	$	6.28		0.4613

The net assets and net unrealized appreciation/(depreciation) of HCD and the net assets of the Fund immediately before the merger were as follows:

			Unrealized
			Appreciation/
Merged Fund	Net Assets		(Depreciation)			Acquiring Fund	Net Assets
Highland Distressed						Highland Credit
Opportunities, Inc	$	51,353,210	$	(86,923,196	)	Strategies Fund	$	348,872,330

Annual Report | 27

NOTES TO FINANCIAL STATEMENTS (continued)

December 31, 2009 Highland Credit Strategies Fund

Assuming the acquisition had been completed on January 1, 2009, the Fund’s results of operations for the year ended December 31, 2009 would have been as follows:

Net investment income/(loss)	$	44,575,801
Net realized and unrealized gain/(loss) on investments	$	40,774,176
Net increase in assets from operations	$	85,349,977

Because the combined investment portfolios have been managed as a single portfolio since the acquisition was completed, it is not practicable to separate the amounts of revenue and earnings of HCD that have been included in the Fund’s Statement of Operations since June 12, 2009.

Note 14. Subsequent Events

Management has evaluated the impact of all subsequent events on the Fund through February 19, 2010, the date the financial statements were issued, and has determined that there were no subsequent events requiring disclosure.

28 | Annual Report

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Trustees and Shareholders of Highland Credit Strategies Fund:

In our opinion, the accompanying statement of assets and liabilities, including the investment portfolio, and the related statements of operations and of changes in net assets and of cash flows and the financial highlights present fairly, in all material respects, the financial position of Highland Credit Strategies Fund (the “Fund”) at December 31, 2009, and the results of its operations and its cash flows for the year then ended, the changes in its net assets and the financial highlights for the periods indicated in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as “financial statements”) are the responsibility of the Fund’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of investments at December 31, 2009 by correspondence with the custodian and the banks with whom the Fund owns participations in loans, provide a reasonable basis for our opinion.

PricewaterhouseCoopers, LLP
Dallas, Texas
February 19, 2010

Semi-Annual Report | 29

ADDITIONAL INFORMATION (unaudited)

December 31, 2009 Highland Credit Strategies 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 contrary provisions 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.

Tax Information

The Fund hereby designates as qualified interest income distributions 92.18% of ordinary income distributions, for the fiscal year ended December 31, 2009.

Dividend Reinvestment Plan

Unless the registered owner of Common Shares elects to receive cash by contacting PNC (the “Plan Agent”), agent for shareholders in administering the Fund’s Dividend Reinvestment Plan (the “Plan”), all dividends declared for your Common Shares of the Fund will be automatically reinvested by PNC in additional Common Shares of the Fund. If a registered owner of Common Shares elects not to participate in the Plan, you will receive all dividends in cash paid by check mailed directly to you (or, if the shares are held in street or other nominee name, then to such nominee) by PNC, as dividend disbursing agent. You may elect not to participate in the Plan and to receive all dividends in cash by sending written instructions or by contacting PNC, as dividend disbursing agent, at the address set forth below. Participation in the Plan is completely voluntary and may be terminated or resumed at any time without penalty by contacting the Plan Agent before the dividend record date; otherwise such termination or resumption will be effective with respect to any subsequently declared dividend or other distribution. Some brokers may automatically elect to receive cash on your behalf and may reinvest that cash in additional Common Shares of the Fund for you.

The Plan Agent will open an account for each shareholder under the Plan in the same name in which such shareholder’s Common Shares are registered. Whenever the Fund declares a dividend or other distribution (together, a “dividend”) payable in cash, non-participants in the Plan will receive cash and participants in the Plan will receive the equivalent in Common Shares. The Common Shares will be acquired by the Plan Agent for the participants’ accounts, depending upon the circumstances described below, either (i) through receipt of additional unissued but authorized Common Shares from the Fund (“newly issued Common Shares”) or (ii) by purchase of outstanding Common Shares on the open market (“open-market purchases”) on the New York Stock Exchange or elsewhere.

If, on the payment date for any dividend, the market price per Common Share plus estimated brokerage commissions is greater than the net asset value per Common Share (such condition being referred to herein as “market premium”), the Plan Agent will invest the dividend amount in newly issued Common Shares, including fractions, on behalf of the participants. The number of newly issued Common 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 Common Share on the payment date; provided that, if the net asset value per Common Share is less than 95% of the market price per Common Share on the payment date, the dollar amount of the dividend will be divided by 95% of the market price per Common Share on the payment date.

If, on the payment date for any dividend, the net asset value per Common Share is greater than the market value per common share plus estimated brokerage commissions (such condition being referred to herein as “market discount”), the Plan Agent will invest the dividend amount in Common Shares acquired on behalf of the participants in open-market purchases.

In the event of a market discount on the payment date for any dividend, the Plan Agent will have until the last business day before the next date on which the Common Shares trade on an “ex-dividend” basis or 120 days after the payment date for such dividend, whichever is sooner (the “last purchase date”), to invest the dividend amount in Common Shares acquired in open-market purchases. It is contemplated that the Fund will pay monthly dividends. Therefore, the period during which open-market purchases can be made will exist only from the payment date of each dividend through the date before the “ex-dividend” date of the third month of the quarter. If, before the Plan Agent has completed its open-market purchases, the market price of a Common Share exceeds the net asset value per Common Share, the average per Common Share purchase price paid by the Plan Agent may exceed the

30 | Annual Report

ADDITIONAL INFORMATION (unaudited) (continued)

December 31, 2009 Highland Credit Strategies Fund

net asset value of the Common Shares, resulting in the acquisition of fewer common shares than if the dividend had been paid in newly issued Common Shares on the dividend payment date. Because of the foregoing difficulty with respect to open market purchases, if the Plan 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 Plan Agent may cease making open-market purchases and may invest the uninvested portion of the dividend amount in newly issued Common Shares at the net asset value per Common Share at the close of business on the last purchase date; provided that, if the net asset value per Common Share is less than 95% of the market price per Common Share on the payment date, the dollar amount of the dividend will be divided by 95% of the market price per Common Share on the payment date.

The Plan Agent maintains all shareholders’ accounts in the Plan and furnishes written confirmation of all transactions in the accounts, including information needed by shareholders for tax records. Common Shares in the account of each Plan participant will be held by the Plan Agent on behalf of the Plan participant, and each shareholder proxy will include those shares purchased or received pursuant to the Plan. The Plan Agent will forward all proxy solicitation materials to participants and vote proxies for shares held under the Plan in accordance with the instructions of the participants.

In the case of shareholders such as banks, brokers or nominees which hold shares for others who are the beneficial owners, the Plan Agent will administer the Plan on the basis of the number of Common Shares certified from time to time by the record shareholder’s name and held for the account of beneficial owners who participate in the Plan.

There will be no brokerage charges with respect to Common Shares issued directly by the Fund. However, each participant will pay a pro rata share of brokerage commissions incurred in connection with open-market purchases. 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 such dividends. Accordingly, any taxable dividend received by a participant that is reinvested in additional Common Shares will be subject to federal (and possibly state and local) income tax even though such participant will not receive a corresponding amount of cash with which to pay such taxes. Participants who request a sale of shares through the Plan Agent are subject to a $2.50 sales fee and pay a brokerage commission of $0.05 per share sold.

The Fund reserves the right to amend or terminate the Plan. There is no direct service charge to participants in the Plan; however, the Fund reserves the right to amend the Plan to include a service charge payable by the participants.

All correspondence concerning the Plan should be directed to the Plan Agent at PNC, 301 Bellevue Parkway, Wilmington, Delaware 19809; telephone (877) 665-1287.

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 Trustees who are not “interested persons” (as defined in the 1940 Act) of the Fund (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 the 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 17-18, 2009, the Board, as requested through Fund counsel and the Independent Trustees’ independent legal counsel, received from the Investment Adviser written and oral information, including: (1) information confirming the financial condition of the Investment Adviser; (2) information on the advisory and compliance personnel of the Investment Adviser, including compensation arrangements; (3) information on the internal compliance procedures of the Investment Adviser; (4) information regarding brokerage and portfolio transactions; (5) information on any legal proceedings or regulatory audits or investigations affecting the Investment Adviser; and (6) comparative information showing (i) the fees payable under the Advisory Agreement versus the investment advisory fees of (a) certain registered investment companies that follow investment strategies similar to those of the Fund and (b) certain private pooled investment vehicles managed by the Investment Adviser, (ii) the Fund’s expense ratio versus (a) other registered investment companies that follow investment strategies similar to those of the Fund and (b) certain unaffiliated private pooled investment vehicles, (iii) the Fund’s performance versus (a) other registered investment companies that follow investment strategies similar to those of the Fund, (b) a private pooled investment vehicle managed by Highland and (c) a benchmark index and (iv) the Fund’s profitability versus certain private pooled investment vehicles managed by 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 Trustees’ conclusion as to the continuation of the Advisory Agreement was based on a comprehensive consideration of all information provided to the Trustees and not the result of any single factor. Some of the factors that figured particularly in the Trustees’ deliberations are described below, although individual Trustees may have evaluated the information presented differently from one another, giving

Annual Report | 31

ADDITIONAL INFORMATION (unaudited) (continued)

December 31, 2009 Highland Credit Strategies Fund

different weights to various factors. The fee arrangements for the Fund 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 Trustees’ conclusions may be based, in part, on their 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 Trustees 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. They 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 Trustees reviewed the management structure, assets under management and investment philosophies and processes of the Investment Adviser. They also reviewed and discussed the Investment Adviser’s compliance policies and procedures. The Trustees concluded that the Investment Adviser has the quality and depth of personnel and investment methods essential to performing its duties 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 Trustees 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 their meetings throughout the year. The Trustees discussed relative performance and contrasted the Fund’s performance versus that of the Fund’s peers, as represented by certain other registered investment companies that follow investment strategies similar to the Fund, Highland Credit Opportunities Fund (“Credit Opportunities Fund”), a private pooled investment vehicle managed by the Investment Adviser, and the Credit Suisse Leveraged Loan 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 Trustees also gave substantial consideration to the fees payable under the Advisory Agreement, including: (1) the annual fee as a portion of the Fund’s Managed Assets paid to the Investment Adviser under the Advisory Agreement and the administration agreement between the Fund and the Investment Adviser; (2) the expenses the Investment Adviser incurs in providing advisory services; (3) the profitability of the Fund as compared to the profitability of Credit Opportunities Fund; and (4) a comparison of the fees payable to the Investment Adviser under the Advisory Agreement to fees payable to (i) other investment advisers serving other registered investment companies that follow investment strategies similar to those of the Fund and (ii) the Investment Adviser by Credit Opportunities Fund. After reviewing these and related factors, the Trustees 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 Trustees considered the asset level of the Fund, the information provided by the Investment Adviser relating to its costs and information comparing the fee rate charged by the Investment Adviser with fee rates charged by other unaffiliated investment advisers to their clients. The Trustees also considered that, due to its nature as a closed-end fund, the Fund’s asset level is not expected to increase significantly as a result of new capital contributions. As a result, the Trustees did not view the potential for realization of economies of scale as the Fund’s assets grow to be a material factor in their deliberations. The Trustees noted that they would consider economies of scale in the future in the event the Fund experiences significant asset growth through a merger, rights offering, material increase in the market value of the Fund’s portfolio securities or otherwise. The Trustees considered whether breakpoints in the fee under the Advisory Agreement would be appropriate in light of the Fund’s assets and current fee structure, including any waivers, and determined not to recommend any breakpoints for the Fund at this time.

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 of 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, 2009, of the Advisory Agreement.

32 | Annual Report

ADDITIONAL INFORMATION (unaudited)

December 31, 2009 Highland Credit Strategies Fund

Trustees and Officers

The Board is responsible for the overall management of the Fund, including supervision of the duties performed by the Investment Adviser. The names and ages of the Trustees and officers of the Fund, the year each was first elected or appointed to office, their principal business occupations during the last five years, the number of funds overseen by each Trustee and other directorships they hold are shown below. The business address for each Trustee and officer of the Fund is c/o Highland Capital Management, L.P., Two Galleria Tower, 13455 Noel Road, Suite 800, Dallas, TX 75240.

		Term of	Principal	Number of Portfolios
		Office and	Occupation(s)	in Highland Funds		Other
	Positions	Length of	During Past	Complex Overseen		Directorships/
Name and Age	with Funds	Time Served	Five Years	by Trustee1		Trusteeships Held
INDEPENDENT TRUSTEES
Timothy K. Hui (Age 61)	Trustee	3 years; Trustee since 2006 (inception)	Vice President since February 2008, Dean of Educational Resources from July 2006 to January 2008, Assistant Provost for Graduate Education from July 2004 to June 2006, and Assistant Provost for Educational Resources, July 2001 to June 2004 at Philadelphia Biblical University.		6	None
Scott F. Kavanaugh (Age 48)	Trustee	3 years; Trustee since 2006 (inception)	Vice-Chairman, President and Chief Operating Officer at Keller Financial Group since September 2007; Chairman and Chief Executive Officer at First Foundation Bank since September 2007; Vice Chairman, President and Chief Operating Officer of First Foundation, Inc. (holding company) since September 2007; Private investor since February 2004; Sales Representative at Round Hill Securities from March 2003 to January 2004; Executive at Provident Funding Mortgage Corporation from February 2003 to July 2003; Executive Vice President, Director and Treasurer at Commercial Capital Bank from January 2000 to February 2003; Managing Principal and Chief Operating Officer at Financial Institutional Partners Mortgage Company and Managing Principal and President of Financial Institutional Partners, LLC (an investment banking firm) from April 1998 to February 2003.		6	None

Annual Report | 33

ADDITIONAL INFORMATION (unaudited) (continued)

December 31, 2009 Highland Credit Strategies Fund

Trustees and Officers

		Year First	Principal	Number of Portfolios
		Elected or	Occupation(s)	in Highland Funds		Other
Name, Address,	Position	Appointed	During Past	Complex Overseen		Directorships
and Age	with Fund	to Office	Five Years	by Trustee1		Held
INDEPENDENT TRUSTEES
James F. Leary (Age 79)	Trustee	3 years; Trustee since 2006 (inception)	Managing Director, Benefit Capital Southwest, Inc. (a financial consulting firm) since January 1999.		6	Board Member of Capstone Group Of Funds (7 portfolios)
Bryan A. Ward (Age 54)	Trustee	3 years; Trustee since 2006 (inception)	Senior Manager, Accenture, LLP (a consulting firm) since January 2002.		6	None
INTERESTED TRUSTEE2
R. Joseph Dougherty2 (Age 39)	Trustee and Chairman of the Board	3 years; Trustee and Chairman of the Board since 2006 (inception)	Team Leader of the Investment Adviser since 2000, Trustee of the funds in the Highland Fund Complex since 2004 and President and Chief Executive Officer of the funds in the Highland Fund Complex since December 2008; Director of NexBank Securities, Inc. since June 2009; Senior Vice President of Highland Distressed Opportunities, Inc. from September 2006 to June 2009; Senior Vice President of the funds in the Highland Fund Complex from 2004 to December 2008.		6	None

1	The Highland Fund Complex consists of all of the registered investment companies advised by the Investment Adviser as of the date of this report.
2	Mr. Dougherty is deemed to be an “interested person” of the Fund under the 1940 Act because of his position with the Investment Adviser.

34 | Annual Report

ADDITIONAL INFORMATION (unaudited) (continued)

December 31, 2009 Highland Credit Strategies Fund

Trustees and Officers

		Year First
		Elected or
Name, Address,	Position	Appointed
and Age	with Fund	to Office	Principal Occupation(s) During Past Five Years
OFFICERS
R. Joseph Dougherty1 (Age 39)	Chairman of the Board, President and Chief Executive Officer	Indefinite Term; President and Chief Executive Officer since December 2008	Team Leader of the Investment Adviser since 2000, Trustee of the funds in the Highland Fund Complex since 2004 and President and Chief Executive Officer of the funds in the Highland Fund Complex since December 2008; Director of NexBank Securities, Inc. since June 2009; Senior Vice President of Highland Distressed Opportunities, Inc. from September 2006 to June 2009; Senior Vice President of the funds in the Highland Fund Complex from 2004 to December 2008.
M. Jason Blackburn (Age 33)	Treasurer (Principal Accounting Officer) and Secretary	Indefinite Term; Treasurer and Secretary since 2006 (inception)	Assistant Controller of the Investment Adviser since November 2001 and Treasurer and Secretary of the funds in the Highland Fund Complex.
Michael Colvin (Age 40)	Chief Compliance Officer	Indefinite Term; Chief Compliance Officer since July 2007	General Counsel and Chief Compliance Officer of the Investment Adviser since June 2007 and Chief Compliance Officer of the funds in the Highland Fund Complex since July 2007; Shareholder in the Corporate and Securities Group at Greenberg Traurig, LLP, from January 2007 to June 2007; Partner from January 2003 to January 2007 in the Private Equity Practice Group at Weil, Gotshal & Manges, LLP.

1 Mr. Dougherty is deemed to be an “interested person” of the Fund under the 1940 Act because of his position with the Investment Adviser.

Annual Report | 35

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

This report has been prepared for shareholders of Highland Credit Strategies Fund (the “Fund”). The Fund mails one shareholder report to each shareholder address. If you would like more than one report, please call shareholder services at 1-877-665-1287 and additional reports will 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 Securities and Exchange Commission’s (“SEC”) website at http://www.sec.gov.

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

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 SEC’s Public Reference Room in Washington, DC. Information on the Public Reference Room may be obtained by calling 1-800-SEC-0330. On June 22, 2009, the Fund submitted a CEO annual certification to the New York Stock Exchange (“NYSE”) on which the Fund’s principal executive officer certified that he was not aware, as of the date, of any violation by the Fund of the NYSE’s Corporate Governance listing standards. In addition, as required by Section 302 of the Sarbanes-Oxley Act of 2002 and related SEC rules, the Fund’s principal executive officer and principal financial officer made quarterly certifications, included in filings with the SEC on Forms N-CSR and N-Q relating to, among other things, the Fund’s disclosure controls and procedures and internal controls over financial reporting, as applicable.

36 | Annual Report

Item 2. Code of Ethics.

(a)	The registrant, as of the end of the period covered by this report, has adopted a code of ethics that applies to the registrant’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the registrant or a third party.
(b)	Not applicable.
(c)	There have been no amendments, during the period covered by this report, to a provision of the code of ethics that applies to the registrant’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the registrant or a third party, and that relates to any element of the code of ethics description.
(d)	The registrant has not granted any waivers, including an implicit waiver, from a provision of the code of ethics that applies to the registrant’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the registrant or a third party, that relates to one or more of the items set forth in paragraph (b) of this item’s instructions.
(e)	Not applicable.
(f)	The registrant’s code of ethics is incorporated by reference to Exhibit (a)(1) to the registrant’s Form N CSR filed with the Securities and Exchange Commission on March 9, 2007 (Accession No. 0000935069-07-000565)

Item 3. Audit Committee Financial Expert.

As of the end of the period covered by the report, the registrant’s board of trustees has determined that James Leary is qualified to serve as an audit committee financial expert serving on its audit committee and that he is “independent,” as defined by Item 3 of Form N-CSR.

Item 4. Principal Accountant Fees and Services.

The information required by this item will be contained in the Registrant’s definitive Proxy Statement for its 2010 Annual Stockholder Meeting, to be filed with the Securities and Exchange Commission within 120 days after December 31, 2009, and is incorporated by reference herein.

Item 5. Audit Committee of Listed registrants.

The Registrant has a separately-designated standing audit committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. It is composed of the following Directors, each of who is not an “interested person” as defined in the 1940 Act:

Timothy K. Hui
Scott F. Kavanaugh
James F. Leary
Bryan A. Ward

Item 6. Investments.

(a) Schedule of Investments in securities of unaffiliated issuers as of the close of the reporting period is included as part of the report to shareholders filed under Item 1 of this form.

(b) Not applicable.

Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies.

The Proxy Voting Policies are attached herewith

APPENDIX E

HIGHLAND CAPITAL MANAGEMENT, L.P.

PROXY VOTING POLICY

1. Application; General Principles

     1.1 This proxy voting policy (the “Policy”) applies to securities held in Client accounts (including registered investment companies and other pooled investment vehicles) as to which the above-captioned investment adviser (the “Company”) has voting authority, directly or indirectly. Indirect voting authority exists where the Company’s voting authority is implied by a general delegation of investment authority without reservation of proxy voting authority.

     1.2 The Company shall vote proxies in respect of securities owned by or on behalf of a Client in the Client’s best economic interests and without regard to the interests of the Company or any other Client of the Company.

2. Voting; Procedures

     2.1 Monitoring. A member of the settlement group (the “settlement designee”) of the Company shall have responsibility for monitoring portfolios managed by the Company for securities subject to a proxy vote. Upon the receipt of a proxy notice related to a security held in a portfolio managed by the Company, the settlement designee shall forward all relevant information to the portfolio manager(s) with responsibility for the security. The portfolio manager(s) may consult a member of the settlement group as necessary.

     2.2 Voting. Upon receipt of notice from the settlement designee, the portfolio manager(s) of the fund(s) in which the security subject to a proxy vote shall evaluate the subject matter of the proxy and cause the proxy to be voted on behalf of the Client in accordance with the Guidelines set forth below.

     2.3 Guideline. In determining how to vote a particular proxy, the portfolio manager(s) shall consider, among other things, the interests of each Client account as it relates to the subject matter of the proxy, any potential conflict of interest the Company may have in voting the proxy on behalf of the Client and the procedures set forth in this Policy. This Policy is designed to be implemented in a manner reasonably expected to ensure that voting rights are exercised in the best interests of the Company’s clients. Each proxy is voted on a case-by-case basis taking into consideration any relevant contractual obligations as well as other relevant facts and circumstances. In general, the Company reviews and considers corporate governance issues related to proxy matters and generally supports proposals that foster good corporate governance practices. Portfolio manager(s) may vote proxies as recommended by the security issuers management on routine matters related to the operation of the issuer and on matters not expected to have a significant impact on the issuer and/or its shareholders, because the Company believes that recommendations by the issuer are generally in shareholders’ best interests, and therefore in the best economic interest of the Company’s clients.

     2.4 Conflicts of Interest. If the portfolio manager(s) determine that the Company may have a potential material conflict of interest (as defined in Section 3 of this Policy) in voting a particular proxy, the portfolio manager(s) shall contact the Company’s compliance department prior to causing the proxy to be voted.

     2.4.1. For a security held by a an investment company, the Company shall disclose the conflict and its reasoning for voting as it did to the Retail Fund’s Board of Trustees at the next regularly scheduled quarterly meeting. In voting proxies for securities held by an investment company, the Company may consider only the interests of the Fund. It is the responsibility of the compliance department to document the basis for the decision and furnish the documentation to the Board of Trustees. The Company may resolve the conflict of interest by following the proxy voting recommendation of a disinterested third party (such as ISS, Glass Lewis, or another institutional proxy research firm).

     2.5 Non-Votes. The Company may determine not to vote proxies in respect of securities of any issuer if it determines it would be in its Client’s overall best interests not to vote. Such determination may apply in respect of all Client holdings of the securities or only certain specified Clients, as the Company deems appropriate under the circumstances. As examples, the portfolio manager(s) may determine: (a) not to recall securities on loan if, in its judgment, the matters being voted upon are not material events affecting the securities and the negative consequences to Clients of disrupting the securities lending program would outweigh the benefits of voting in the particular instance or (b) not to vote certain foreign securities positions if, in its judgment, the expense and administrative inconvenience outweighs the benefits to Clients of voting the securities.

     2.6 Recordkeeping. Following the submission of a proxy vote, the applicable portfolio manager(s) shall submit a report of the vote to a settlement designee of the Company. Records of proxy votes by the Company shall be maintained in accordance with Section 4 of this Policy.

3. Conflicts of Interest

     3.1 Voting the securities of an issuer where the following relationships or circumstances exist are deemed to give rise to a material conflict of interest for purposes of this Policy:

     3.1.1 The issuer is a Client of the Company, or of an affiliate, accounting for more than 5% of the Company’s or affiliate’s annual revenues.

     3.1.2 The issuer is an entity that reasonably could be expected to pay the Company or its affiliates more than $1 million through the end of the Company’s next two full fiscal years.

     3.1.3 The issuer is an entity in which a “Covered Person” (as defined in the Company’s Policies and Procedures Designed to Detect and Prevent Insider Trading and to Comply with Rule 17j-1 of the Investment Company Act of 1940, as amended (the “Code of Ethics”)) has a beneficial interest contrary to the position held by the Company on behalf of Clients.

     3.1.4 The issuer is an entity in which an officer or partner of the Company or a relative¹ of any such person is or was an officer, director or employee, or such person or relative otherwise has received more than $150,000 in fees, compensation and other payment from the issuer during the Company’s last three fiscal years; provided, however, that the Compliance Department may deem such a relationship not to be a material conflict of interest if the Company representative serves as an officer or director of the issuer at the direction of the Company for purposes of seeking control over the issuer.

     3.1.5 The matter under consideration could reasonably be expected to result in a material financial benefit to the Company or its affiliates through the end of the Company’s next two full fiscal years (for example, a vote to increase an investment advisory fee for a Fund advised by the Company or an affiliate).

     3.1.6 Another Client or prospective Client of the Company, directly or indirectly, conditions future engagement of the Company on voting proxies in respect of any Client’s securities on a particular matter in a particular way.

     3.1.7 The Company holds various classes and types of equity and debt securities of the same issuer contemporaneously in different Client portfolios.

     3.1.8 Any other circumstance where the Company’s duty to serve its Clients’ interests, typically referred to as its “duty of loyalty,” could be compromised.

     3.2 Notwithstanding the foregoing, a conflict of interest described in Section 3.1 shall not be considered material for the purposes of this Policy in respect of a specific vote or circumstance if:

     3.2.1 The securities in respect of which the Company has the power to vote account for less than 1% of the issuer’s outstanding voting securities, but only if: (i) such securities do not represent one of the 10 largest holdings of such issuer’s outstanding voting securities and (ii) such securities do not represent more than 2% of the Client’s holdings with the Company.

¹ For the purposes of this Policy, “relative” includes the following family members: spouse, minor children or stepchildren or children or stepchildren sharing the person’s home.

     3.2.2 The matter to be voted on relates to a restructuring of the terms of existing securities or the issuance of new securities or a similar matter arising out of the holding of securities, other than common equity, in the context of a bankruptcy or threatened bankruptcy of the issuer.

4. Recordkeeping, Retention and Compliance Oversight

     4.1 The Company shall retain records relating to the voting of proxies, including:

     4.1.1 Copies of this Policy and any amendments thereto.

     4.1.2 A copy of each proxy statement that the Company receives regarding Client securities.

     4.1.3 Records of each vote cast by the Company on behalf of Clients.

     4.1.4 A copy of any documents created by the Company that were material to making a decision how to vote or that memorializes the basis for that decision.

     4.1.5 A copy of each written request for information on how the Company voted proxies on behalf of the Client, and a copy of any written response by the Company to any (oral or written) request for information on how the Company voted.

     4.2 These records shall be maintained and preserved in an easily accessible place for a period of not less than five years from the end of the Company’s fiscal year during which the last entry was made in the records, the first two years in an appropriate office of the Company.

     4.3 The Company may rely on proxy statements filed on the SEC’s EDGAR system or on proxy statements and records of votes cast by the Company maintained by a third party, such as a proxy voting service (provided the Company had obtained an undertaking from the third party to provide a copy of the proxy statement or record promptly on request).

     4.4 Records relating to the voting of proxies for securities held by investment company clients will be reported periodically, as requested, to the investment company’s Board of Trustees and, to the SEC on an annual basis pursuant to Form N-PX.

     4.5 Compliance oversees the implementation of this procedure, including oversight over voting and the retention of proxy ballots voted. The CCO may review proxy voting pursuant to the firm’s compliance program.

Adopted by the Company’s Compliance Committee: March 24, 2009, amended June 17, 2009.

Approved by the Highland Funds Board of Trustees for all Funds (except Highland Long/Short Equity Fund): June 5, 2009.

Item 8. Portfolio Managers of Closed-End Management Investment Companies.

(a)(1) Identification of Portfolio Manager(s) or Management Team Members and Description of Role of Portfolio Manager(s) or Management Team Members

          The Fund’s portfolio manager, who is primarily responsible for the day-to-day management of the Fund’s portfolio, is Brad Means.

          Brad Means — Mr. Means is a Senior Portfolio Manager at Highland. Prior to joining Highland in May 2004, Mr. Means was a Managing Director in FTI Consulting’s Corporate Finance group where he worked on corporate turnaround, restructuring and bankruptcy advisory engagements. From 1998 to 2001, he was a Director in PricewaterhouseCoopers LLP’s Chairman’s Office and focused on enterprise strategy, venture capital, business development and divestiture initiatives. Prior to his role in the Chairman’s Office, Mr. Means worked in the Strategic Change Consulting and the Assurance & Business Advisory groups of Price Waterhouse serving clients across a broad range of industries including Automotive, Energy, Financials and Industrials. He holds an MBA from the Stanford Graduate School of Business and a BSBA in Finance and Accounting from Creighton University. Mr. Means has earned the right to use the Chartered Financial Analyst designation.

(a)(2) Other Accounts Managed by Portfolio Manager(s) or Management Team Member and Potential Conflicts of Interest

          Other Accounts Managed by Portfolio Manager(s) or Management Team Member

          The following table provides information about funds and accounts, other than the Fund, for which the Fund’s portfolio manager is primarily responsible for the day-to-day portfolio management as of December 31, 2009.

Brad Means

					# of Accounts		Total Assets with
	Total				Managed with		Performance-Based
	# of Accounts		Total Assets		Performance-Based		Advisory Fee
Type of Accounts	Managed		(millions)		Advisory Fee		(millions)
Registered Investment Companies:		3		1,531		—		—
Other Pooled Investment Vehicles:		—		—		—		—
Other Accounts:		—		—		—		—

          Potential Conflicts of Interests

          Highland and/or its general partner, limited partners, officers, affiliates and employees provide investment advice to other parties and manage other accounts and private investment vehicles similar to the Fund. In connection with such other investment management activities, the Adviser and/or its general partner, limited partners, officers, affiliates and employees may decide to invest the funds of one or more other accounts or recommend the investment of funds by other parties, rather than the Fund’s monies, in a particular security or strategy. In addition, the Adviser and such other persons will determine the allocation of funds from the Fund and such other accounts to investment strategies and techniques on whatever basis they consider appropriate or desirable in their sole and absolute discretion.

          The Adviser has built a professional working environment, a firm-wide compliance culture and compliance procedures and systems designed to protect against potential incentives that may favor one account over another. The 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, the

Adviser furnishes advisory services to numerous clients in addition to the Fund, and the Adviser may, consistent with applicable law, make investment recommendations to other clients or accounts (including accounts that are hedge funds or have performance or higher fees paid to the Adviser or in which portfolio managers have a personal interest in the receipt of such fees) that may be the same as or different from those made to the Fund. In addition, the Adviser, its affiliates and any of their partners, directors, officers, stockholders or employees may or may not have an interest in the securities whose purchase and sale the Adviser recommends to the Fund. Actions with respect to securities of the same kind may be the same as or different from the action that the Adviser, or any of its affiliates, or any of their partners, directors, officers, stockholders or employees or any member of their families may take with respect to the same securities. Moreover, the Adviser may refrain from rendering any advice or services concerning securities of companies of which any of the Adviser’s (or its affiliates’) partners, directors, officers or employees are directors or officers, or companies as to which the Adviser or any of its affiliates or partners, directors, officers and employees of any of them has any substantial economic interest or possesses material non-public information. In addition to its various policies and procedures designed to address these issues, the Adviser includes disclosure regarding these matters to its clients in both its Form ADV and investment advisory agreements.

          The Adviser, its affiliates or their partners, directors, officers and employees similarly serve or may serve other entities that operate in the same or related lines of business. Accordingly, these individuals may have obligations to investors in those entities or funds or to other clients, the fulfillment of which might not be in the best interests of the Fund. As a result, the Adviser will face conflicts in the allocation of investment opportunities to the Fund and other funds and clients. In order to enable such affiliates to fulfill their fiduciary duties to each of the clients for which they have responsibility, the Adviser will endeavor to allocate investment opportunities in a fair and equitable manner which may, subject to applicable regulatory constraints, involve pro rata co-investment by the Fund and such other clients or may involve a rotation of opportunities among the Fund and such other clients.

          While the Adviser does not believe there will be frequent conflicts of interest, if any, the Adviser and its affiliates have both subjective and objective procedures and policies in place designed to manage the potential conflicts of interest between the Adviser’s fiduciary obligations to the Fund and their similar fiduciary obligations to other clients so that, for example, investment opportunities are allocated in a fair and equitable manner among the Fund and such other clients. An investment opportunity that is suitable for multiple clients of the Adviser and its affiliates may not be capable of being shared among some or all of such clients due to the limited scale of the opportunity or other factors, including regulatory restrictions imposed by the 1940 Act. There can be no assurance that the Adviser’s or its affiliates’ efforts to allocate any particular investment opportunity fairly among all clients for whom such opportunity is appropriate will result in an allocation of all or part of such opportunity to the Fund. Not all conflicts of interest can be expected to be resolved in favor of the Fund.

(a)(3) Compensation Structure of Portfolio Manager(s) or Management Team Members

          Highland’s financial arrangements with its portfolio managers, its competitive compensation and its career path emphasis at all levels reflect the value senior management places on key resources. Compensation may include a variety of components and may vary from year to year based on a number of factors, including the pre-tax relative performance of a portfolio manager’s underlying account, the pre-tax combined performance of the portfolio managers’ underlying accounts, and the pre-tax relative performance of the portfolio managers’ underlying accounts measured against other employees. The principal components of compensation include a base salary, a discretionary bonus, various retirement benefits and one or more of the incentive compensation programs established by Highland, such as its “Short-Term Incentive Plan” and its “Long-Term Incentive Plan,” described below.

          Base compensation. Generally, portfolio managers receive base compensation based on their seniority and/or their position with Highland, which may include the amount of assets supervised and other management roles within Highland. Base compensation is determined by taking into account current industry norms and market data to ensure that Highland pays a competitive base compensation.

          Discretionary compensation. In addition to base compensation, portfolio managers may receive discretionary compensation, which can be a substantial portion of total compensation. Discretionary compensation can include a discretionary cash bonus paid to recognize specific business contributions and to ensure that the total level of compensation is competitive with the market, as well as participation in incentive plans, including one or more of the following:

Short-Term Incentive Plan. The purpose of this plan is to attract and retain the highest quality employees for positions of substantial responsibility, and to provide additional incentives to a select group of management or highly-compensated employees of Highland in order to promote the success of Highland.

Long Term Incentive Plan. The purpose of this plan is to create positive morale and teamwork, to attract and retain key talent and to encourage the achievement of common goals. This plan seeks to reward participating employees based on the increased value of Highland.

Because each person’s compensation is based on his or her individual performance, Highland does not have a typical percentage split among base salary, bonus and other compensation. Senior portfolio managers who perform additional management functions may receive additional compensation in these other capacities. Compensation is structured such that key professionals benefit from remaining with Highland.

(a)(4) Disclosure of Securities Ownership

          The following table sets forth the dollar range of equity securities beneficially owned by the portfolio manager in the Fund as of December 31, 2009.

	Dollar Ranges of Equity Securities Beneficially Owned by
Name of Portfolio Manager	Portfolio Manager
Brad Means	—

(b) Not applicable.

Item 9. Purchases of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers.

REGISTRANT PURCHASES OF EQUITY SECURITIES

							(d) Maximum Number (or
					(c) Total Number of Shares		Approximate Dollar Value) of
	(a) Total Number		(b) Average		(or Units) Purchased as Part		Shares (or Units) that May Yet Be
	of Shares (or		Price Paid per		of Publicly Announced		Purchased Under the Plans or
Period	Units) Purchased		Share (or Unit)		Plans or Programs		Programs
July 1, 2009 to July 31, 2009		51,497	$	5.484298		51,497		63,699,468
August 1, 2009 to August 31, 2009		50,777	$	5.681200		50,777		63,699,468
September 1, 2009 to September 30, 2009		43,516	$	6.337800		43,516		63,699,468

							(d) Maximum Number (or
					(c) Total Number of Shares		Approximate Dollar Value) of
	(a) Total Number		(b) Average		(or Units) Purchased as Part		Shares (or Units) that May Yet Be
	of Shares (or		Price Paid per		of Publicly Announced		Purchased Under the Plans or
Period	Units) Purchased		Share (or Unit)		Plans or Programs		Programs
October 1, 2009 to October 31, 2009		43,396	$	6.194101		43,396		63,699,468
November 1, 2009 to November 30, 2009		42,484	$	6.400600		42,484		63,699,468
December 1, 2009 to December 31, 2009		41,864	$	6.393357		41,864		63,699,468
Total		273,534				273,534

Footnote columns (c) and (d) of the table, by disclosing the following information in the aggregate for all plans or programs publicly announced:

a.	The date each plan or program was announced: Purchases were made pursuant to an Automatic Dividend Reinvestment Plan that was last filed with the SEC on June 21, 2006
b.	The dollar amount (or share or unit amount) approved: NONE
c.	The expiration date (if any) of each plan or program: NONE
d.	Each plan or program that has expired during the period covered by the table: NONE

Item 10. Submission of Matters to a Vote of Security Holders.

There have been no material changes to the procedures by which the shareholders may recommend nominees to the registrant’s board of directors.

Item 11. Controls and Procedures.

(a) The registrant’s principal executive and principal financial officers, or persons performing similar functions, have concluded that the registrant’s disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940, as amended (the “1940 Act”) (17 CFR 270.30a-3(c))) are effective, as of a date within 90 days of the filing date of the report that includes the disclosure required by this paragraph, based on their evaluation of these controls and procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or 240.15d-15(b)).

(b) There were no changes in the registrant’s internal control over financial reporting (as defined in Rule 30a-3(d) under the 1940 Act (17 CFR 270.30a-3(d)) that occurred during the registrant’s second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

Item 12. Exhibits.

(a)(1)	The registrant’s code of ethics is incorporated by reference to Exhibit (a)(1) to the registrant’s Form N-CSR filed with the Securities and Exchange Commission on March 9, 2007 (Accession No. 0000935069-07-000565).
(a)(2)	Certifications pursuant to Rule 30a-2(a) under the 1940 Act and Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.
(a)(3)	Not applicable.
(b)	Certifications pursuant to Rule 30a-2(b) under the 1940 Act and Section 906 of the Sarbanes- Oxley Act of 2002 are attached hereto.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

(registrant)	Highland Credit Strategies Fund
By (Signature and Title)*	/s/ R. Joseph DoughertyR. Joseph Dougherty, Chief Executive Officer and President (principal executive officer)

Date 3/10/10

Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

By (Signature and Title)* /s/ R. Joseph Dougherty   R. Joseph Dougherty, Chief Executive Officer and President
(principal executive officer)

Date 3/10/10

By (Signature and Title)* /s/ M. Jason Blackburn   M. Jason Blackburn, Treasurer and Secretary
(principal financial officer)

Date 3/10/10

^* Print the name and title of each signing officer under his or her signature.