See accompanying notes to financial statements.
See accompanying notes to financial statements.
See accompanying notes to financial statements.
Non-cash financing activities not included herein consist of reinvestment of distributions to unitholders of $3,774,208.
See accompanying notes to financial statements.
See accompanying notes to financial statements.
FSI LOW BETA ABSOLUTE RETURN FUND
NOTES TO FINANCIAL STATEMENTS
February 28, 2015 (Unaudited)
1. Organization
The FSI Low Beta Absolute Return Fund (the “Fund”) is a continuously offered, non-diversified, closed-end management investment company, organized as a Delaware statutory trust on August 3, 2012. The Fund is authorized to issue 1,000,000 units at the net asset value per unit. The Fund’s investment objective is to seek attractive risk-adjusted rates of return, “Alpha,” with a risk profile and volatility similar to that of the Barclays U.S. Aggregate Bond Index. On April 19, 2013, the Fund was initially seeded through the sale of 1,000 units for $100,000 to Gary W. Gould, Managing Principal of Financial Solutions, Inc. and Principal Executive Officer and Trustee of the Fund. The Fund commenced operations on July 1, 2013.
2. Significant Accounting Policies
The following is a summary of the Fund’s significant accounting policies. The policies are in conformity with accounting principles generally accepted in the United States of America (“GAAP”). As an investment company, as defined in Financial Accounting Standards Board (“FASB”) Accounting Standards Update 2013-08, the Fund follows accounting and reporting guidance under FASB Accounting Standards Codification Topic 946, “Financial Services – Investment Companies.”
Security Valuation – The Fund computes its net asset value as of the last business day of each month. In determining its net asset value, the Fund values its investments as of such month-end. The Board of Trustees (the “Board”) has approved procedures pursuant to which the Fund’s Valuation Committee will value the Fund’s investments in Underlying Funds at fair value. As a general matter, the fair value of the Fund’s interest in an Underlying Fund will represent the amount that the Fund could reasonably expect to receive from an Underlying Fund if the Fund’s interest was redeemed at the time of valuation, based on information reasonably available at the time the valuation is made and that the Fund believes to be reliable. In accordance with these procedures, fair value as of each month-end ordinarily will be the value determined as of such month-end for each Underlying Fund in accordance with the Underlying Fund’s valuation policies and reported at the time that the Valuation Committee values the Underlying Fund. In the unlikely event that an Underlying Fund does not report a month-end value to the Fund on a timely basis, the Valuation Committee would determine the fair value of such Underlying Fund based on the most recent value reported by the Underlying Fund, as well as any other relevant information available at the time the Fund values its portfolio. Using the nomenclature of the hedge fund industry, any value reported as “estimated” or “final” values will reasonably reflect market values of securities for which market quotations are available or fair value as of the date the Valuation Committee values the Underlying Fund. Futures contracts which are traded on a commodities exchange are valued at their closing settlement price on the exchange on which they are primarily traded. Over-the-counter futures contracts for which market quotations are readily available are valued based on quotes received from third party pricing services or one or more dealers that make markets in such securities. If quotes are not available from a third party pricing service or one or more dealers, quotes shall be determined based on the fair value of such securities.
GAAP establishes a single authoritative definition of fair value, sets out a framework for measuring fair value and requires additional disclosures about fair value measurement.
FSI LOW BETA ABSOLUTE RETURN FUND
NOTES TO FINANCIAL STATEMENTS (Continued)
Various inputs are used in determining the value of the Fund’s investments. These inputs are summarized in the three broad levels listed below:
| · | Level 1 – quoted prices in active markets for identical assets |
| · | Level 2 – other significant observable inputs (including quoted prices of similar securities, interest rates, prepayment speeds, credit risk, etc.) |
| · | Level 3 – significant unobservable inputs (including the Fund’s own assumptions in determining the fair value of investments) |
The inputs or methodology used for valuing securities are not necessarily an indication of the risks associated with investing in those securities. The inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement falls in its entirety is determined based on the lowest level input that is significant to the fair value measurement.
The following is a summary of the inputs used to value the Fund’s investments by security type, as of February 28, 2015:
| | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| Investments in Securities: | | | | | | | | | | | | |
| Underlying Funds | | | | | | | | | | | | |
| Event Driven Strategies | | $ | - | | | $ | 6,031,949 | | | $ | 870,051 | | | $ | 6,902,000 | |
| Global Macro Strategies | | | - | | | | 1,778,369 | | | | - | | | | 1,778,369 | |
| Long/Short Equity Strategies | | | - | | | | 4,790,437 | | | | 2,294,938 | | | | 7,085,375 | |
| Multi Strategies | | | - | | | | 18,497,011 | | | | 1,081,269 | | | | 19,578,280 | |
| Relative Value Strategies: Fixed Income | | | | | | | | | | | | | | | | |
| Hedge and Fixed Income Arbitrage | | | - | | | | 2,430,222 | | | | 2,290,507 | | | | 4,720,729 | |
| Relative Value Strategies: General | | | - | | | | 3,568,160 | | | | 514,050 | | | | 4,082,210 | |
| Money Market Funds | | | - | | | | 2,360,088 | | | | - | | | | 2,360,088 | |
| | | | | | | | | | | | | | | | | |
| Total | | $ | - | | | $ | 39,456,236 | | | $ | 7,050,815 | | | $ | 46,507,051 | |
It is the Fund’s policy to recognize transfers into and out of any Level at the end of the reporting period. On February 28, 2015, investments in securities having a total value of $9,166,193 transferred from Level 3 to Level 2 due to changes in liquidity.
The following is a reconciliation of Level 3 investments for which significant unobservable inputs were used to determine fair value.
| Balance as of 8/31/14 | | $ | 14,743,542 | |
| Purchases | | | 1,584,567 | |
| Transfers out of Level 3 | | | (9,166,193 | ) |
| Change in unrealized appreciation (depreciation) | | | (111,101 | ) |
| | | | | |
| Balance as of 2/28/2015 | | $ | 7,050,815 | |
FSI LOW BETA ABSOLUTE RETURN FUND
NOTES TO FINANCIAL STATEMENTS (Continued)
Significant unobservable valuation inputs for material Level 3 investments as of February 28, 2015 are as follows:
| | | Value at | | Valuation Technique/ |
| Investment in Securities | | 2/28/2015 | | Unobservable Input |
| Underlying Funds | | | | |
| | | | | |
| BlackGold Opportunity Offshore Fund Ltd., | | | | Unadjusted NAV as practical expedient; |
| Class A - Unrestricted, Series 6/14 | | $ | 907,202 | | subject to a redemption fee if redeemed within 4 months |
| | | | | | |
| BlackGold Opportunity Offshore Fund Ltd., | | | | | Unadjusted NAV as practical expedient; |
| Class A - Unrestricted, Series 2/15 | | | 308,801 | | subject to a redemption fee if redeemed within 12 months |
| | | | | | |
| Eminence Fund, Ltd., | | | | | Unadjusted NAV as practical expedient; |
| Class A, Initial Series | | | 1,081,119 | | cannot be redeemed within 11 months |
| | | | | | |
| Fundamental Credit Opportunities | | | | | Unadjusted NAV as practical expedient; |
| (Offshore), Ltd., Class A, Series FCO-OFF-B2 | | | 873,656 | | subject to a redemption fee if redeemed within 9 months |
| | | | | | |
| Fundamental Credit Opportunities | | | | | Unadjusted NAV as practical expedient; |
| (Offshore), Ltd., Class A, Series FCO-OFF-B4 | | | 200,848 | | subject to a redemption fee if redeemed within 12 months |
| | | | | | |
| Millenium International, Ltd., | | | | | Unadjusted NAV as practical expedient; |
| Class EE Sub Class III, Series 01A | | | 775,831 | | subject to a redemption fee if redeemed within 5 months |
| | | | | | |
| Pine River Fixed Income Fund, Ltd., | | | | | Unadjusted NAV as practical expedient; |
| Class A, Series 60 | | | 514,050 | | subject to a redemption fee if redeemed within 4 months |
| | | | | | |
| Pluscios Offshore Fund, SPC, | | | | | Unadjusted NAV as practical expedient; |
| Class F, Series 0614 | | | 870,051 | | subject to a redemption fee if redeemed within 4 months |
| | | | | | |
| Tide Point Offshore Fund, Ltd. | | | | | Unadjusted NAV as practical expedient; |
| Class 1, Sub-Class A, June 2014 | | | 1,213,819 | | subject to a redemption fee if redeemed within 4 months |
| | | | | | |
| Whitebox Multi-Strategy Fund, Ltd., | | | | | Unadjusted NAV as practical expedient; |
| Class E, Series E-10 | | | 104,176 | | subject to a redemption fee if redeemed within 12 months |
| | | | | | |
| Whitebox Multi-Strategy Fund, Ltd., | | | | | Unadjusted NAV as practical expedient; |
| Class E, Series E-02-15 | | | 201,262 | | subject to a redemption fee if redeemed within 11 months |
Unit Valuation – The net asset value per unit of the Fund is calculated monthly by dividing the total value of the Fund’s assets, less liabilities, by the number of units outstanding. The offering price and redemption price per unit of the Fund is equal to the net asset value per unit.
Investment Income – Dividend income is recorded on the ex-dividend date.
Security Transactions – Investment transactions are accounted for on the trade date. Gains and losses on securities sold are determined on a specific identification basis.
FSI LOW BETA ABSOLUTE RETURN FUND
NOTES TO FINANCIAL STATEMENTS (Continued)
Distributions to Unitholders – Distributions to unitholders arising from net investment income and net realized capital gains, if any, are declared and paid at least annually. The amount of distributions from net investment income and net realized gains are determined in accordance with federal income tax regulations, which may differ from GAAP. These differences are due primarily to differing treatments of income and gains on various investment securities held by the Fund, timing differences and differing characterizations of distributions made by the Fund. Dividends and distributions to unitholders are recorded on the ex-dividend date. The tax character of distributions paid to unitholders during the periods ended February 28, 2015 and August 31, 2014 was as follows:
| Periods Ended | | | Ordinary
Income | | | Long-Term
Capital Gains | | | Total | |
| February 28, 2015 | | | $ | 2,631,168 | | | $ | 1,143,040 | | | $ | 3,774,208 | |
| August 31, 2014 | | | $ | 663,788 | | | $ | - | | | $ | 663,788 | |
Futures Contracts – The Fund may enter into futures contracts as part of its investment strategy and for hedging purposes. When the Fund purchases or sells a futures contract, no price is paid to or received by the Fund. Instead, the Fund is required to deposit with the futures commission merchant an amount of cash or qualifying securities currently ranging from 5% to 10% of the contract amount. This is called the “initial margin deposit.” Subsequent payments, known as “variation margin,” are made or received by the Fund, depending on the fluctuations in the fair value of the futures contract. The Fund recognizes an unrealized gain or loss equal to the variation margin. If market conditions move unexpectedly, the Fund may not achieve the anticipated benefits of the futures contracts and may realize a loss. The initial margin deposits for futures contracts and the variation margin receivable or payable are reported on the Statement of Assets and Liabilities. Additionally, the Fund is required to maintain, on a daily basis, cash or liquid securities in an amount equal to the current market value of the futures in which it invests minus any amounts paid to brokers toward such position.
Estimates – The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.
Federal Income Tax – The Fund has qualified and intends to continue to qualify as a “regulated investment company” under Subchapter M of the Internal Revenue Code of 1986 (the “Code”). Qualification generally will relieve the Fund of liability for federal income taxes to the extent 100% of its net investment income and net realized gains are distributed in accordance with the Code. Accordingly, no provision for income tax has been made.
In order to avoid imposition of the excise tax applicable to regulated investment companies, it is also the Fund's intention to declare as dividends in each calendar year at least 98% of its net investment income (earned during the calendar year) and 98.2% of its net realized capital gains (earned during the twelve months ended October 31) plus undistributed amounts from prior years.
FSI LOW BETA ABSOLUTE RETURN FUND
NOTES TO FINANCIAL STATEMENTS (Continued)
The following information is computed on a tax basis for each item as of February 28, 2015:
| Tax cost of portfolio investments | $ | 46,742,597 |
| Gross unrealized appreciation | $ | - |
| Gross unrealized depreciation | | (235,546) |
| Net unrealized depreciation | | (235,546) |
| Other gains | | 545,820 |
| Distributable earnings | $ | 310,274 |
The difference between the federal income tax cost of portfolio investments and the financial statement cost is due to certain timing differences in the recognition of capital gains or losses under income tax regulations and GAAP. These “book/tax” differences are temporary in nature and are primarily due to holdings classified as passive foreign investment companies (“PFICs”).
For the six months ended February 28, 2015, the Fund reclassified $58,030 of realized gains from security transactions against paid-in capital on the Statement of Assets and Liabilities. Such reclassification, the result of permanent differences between the financial statement and income tax reporting requirements, had no effect on the Fund’s net assets or net asset value per share and are due to gains recognized on holdings classified as PFICs.
The Fund recognizes the tax benefits or expenses of uncertain tax positions only when the position is “more likely than not” to be sustained assuming examination by tax authorities. Management has reviewed the Fund’s tax positions for the current tax year and all open tax years (tax years ended August 31, 2013 and August 31, 2014) and has concluded that no provision for unrecognized tax benefits or expenses is required in these financial statements.
3. Investment Transactions
During the six months ended February 28, 2015, cost of purchases and proceeds from sales of investment securities, other than short-term investments, were $1,880,000 and $1,933,058 respectively.
4. Transactions with Related Parties and Other Service Providers
INVESTMENT ADVISORY AGREEMENT
The Fund’s investments are managed by Financial Solutions, Inc. (the “Adviser”) pursuant to the terms of an Investment Advisory Agreement. Under the Investment Advisory Agreement, the Adviser receives an advisory fee from the Fund at an annual rate of 1.11% of the Fund’s average monthly net assets and pays any sub-advisory fees out of the fees it receives.
The Adviser has contractually agreed, until April 30, 2015, to reduce its advisory fees and to reimburse the Fund’s operating expenses to the extent necessary so that the Fund’s annual operating expenses (after fee reductions and/or expense reimbursements, and exclusive of taxes, interest, portfolio transaction expenses, acquired fund fees and expenses and extraordinary expenses not incurred in the ordinary course of business) do not exceed an amount equal to 1.60% of the Fund’s average monthly net assets. During the six months ended February 28, 2015, there were no advisory fee reductions or other fee waivers.
FSI LOW BETA ABSOLUTE RETURN FUND
NOTES TO FINANCIAL STATEMENTS (Continued)
Advisory fee reductions and Fund operating expenses reimbursed by the Adviser are subject to repayment by the Fund for a period of three fiscal years following the end of the fiscal year in which such reduction or reimbursement was incurred, provided that the repayments do not cause the Fund’s current expenses to exceed the expense limit in effect at the time of the reduction or reimbursement. This Adviser Waiver Agreement (“Adviser Wavier”) may be terminated by the Board upon sixty (60) days’ written notice, and without payment of any penalty. No such termination shall affect the obligation (including the amount of the obligation) of the Fund to repay fee reductions and/or expense reimbursements with respect to periods prior to such termination. As of February 28, 2015, the Adviser may in the future recover advisory fee reductions totaling $68,397. The Adviser may recover a portion of this amount no later than the dates as stated below:
August 31, 2016 | | August 31, 2017 |
$15,222 | | $53,175 |
SUB-ADVISERS
Meritage Capital, LLC (“Meritage”) and Pluscios Management LLC (“Pluscios”) serve as sub-advisers to the Fund. The Adviser pays Meritage and Pluscios any sub-advisory fees out of the fees it receives pursuant to the Investment Advisory Agreement. Meritage and Pluscios have each executed an agreement with the Adviser under which each agrees under certain circumstances to waive a portion of its sub-advisory fees payable to it by the Adviser (each a “Sub-Advisory Waiver Agreement”). Each Sub-Advisory Waiver Agreement provides that the applicable sub-adviser will waive its annual contractual fee in an amount equal to the value of annual advisory fee reductions and/or Fund expense reimbursements by the Adviser (as a percentage of the annual advisory fee) under the Adviser Waiver up to a maximum of 50% of the sub-adviser’s annual contractual fee through April 30, 2015 (each a “Sub-Adviser Waiver”). Pursuant to each Sub-Advisory Waiver Agreement, if the Adviser recoups all of the Adviser Waiver for any period permitted under the Adviser Waiver (the “Recoupment Period”), the Adviser shall use that recoupment to reimburse a Sub-Adviser in an amount equal to its Sub-Adviser Waiver for the Recoupment Period. If the amount of the recoupment paid by the Fund is less than the Adviser Waiver for the Recoupment Period, the Adviser shall reimburse the Sub-Adviser in an amount equal to the Sub-Advisory Waiver for the Recoupment Period multiplied by the ratio of the recoupment amount to the Adviser Waiver.
Meritage and Pluscios serve as investment managers of Centennial Global Macro Fund Segregated Portfolio, Series D and Pluscios Offshore Fund, SPC, Class F, respectively. During the six months ended February 28, 2015 the Fund’s purchases of hedge funds managed by Meritage and Pluscios were as follows:
| Centennial Global Macro Fund Segregated Portfolio, Series D 0215 | $ | 305,000 |
TRUSTEE COMPENSATION
During the six months ended February 28, 2015, the Trustees who are not considered “interested persons” of the Fund (“Independent Trustee”), voted to increase the annual compensation paid by the Fund to each Independent Trustee from $10,000 to $15,000. Each Independent Trustee is also reimbursed for travel and related expenses incurred in attending Board meetings. No officer of the Fund is compensated by the Fund.
FSI LOW BETA ABSOLUTE RETURN FUND
NOTES TO FINANCIAL STATEMENTS (Continued)
FUND SERVICES
Ultimus Fund Solutions, LLC (“Ultimus”) provides fund administration, fund accounting, compliance and transfer agency services to the Fund. Ultimus also provides a Principal Financial Officer, a Chief Compliance Officer and an Anti-Money Laundering Compliance Officer to the Fund, as well as certain additional compliance support functions. The Fund pays Ultimus fees in accordance with a Services Agreement for such services. In addition, the Fund pays out-of-pocket expenses including, but not limited to, postage and supplies.
DISTRIBUTION AGREEMENT
Foreside Fund Services, LLC (the “Distributor”) serves as the Fund’s principal underwriter. The Distributor is not affiliated with the Adviser or with Ultimus.
5. Derivatives Risk and Transactions
In seeking risk adjusted rates of return, the Fund may invest in U.S. Treasury futures to provide exposure to the market value change of a high quality fixed income portfolio. The price of a futures contract may change rapidly in response to changes in the markets and the general economic environment as well as in response to changes in the value of the underlying U.S. Treasury securities. Futures may entail investment exposures that are greater than their cost would suggest, meaning that a small investment in futures could have a large potential effect on the performance of the Fund. Changes in the liquidity of U.S. Treasury futures (i.e., due to, among other things, price fluctuation or position limitations imposed by U.S. commodity exchanges) and rising interest rates may cause the value of U.S. Treasury futures to decline.
If the Fund invests in U.S. Treasury futures at inopportune times or the Adviser misjudges market conditions, the Fund’s investment in the U.S. Treasury futures may lower the Fund’s return or result in a loss to the Fund. The Fund could also experience losses if the U.S. Treasury futures do not offset losses incurred by the Fund on its investment in the Underlying Funds or if the Fund is not able to timely liquidate its position in U.S. Treasury futures due to an illiquid secondary market. Changes in the liquidity of U.S. Treasury futures (i.e. due to, among other things, price fluctuation or position limitations imposed by U.S. commodity exchanges) may result in significant, rapid and unpredictable changes in the value of the U.S. Treasury futures. It is also possible that the U.S. Commodity Futures Trading Commission may suspend trading in a particular contract, order immediate liquidation and settlement of a particular contract or order that trading in a particular contract be conducted for liquidation only.
The Fund had no outstanding derivative instruments as of February 28, 2015.
The average monthly notional amount of futures contracts purchased during the six months ended February 28, 2015 was $7,471,643.
FSI LOW BETA ABSOLUTE RETURN FUND
NOTES TO FINANCIAL STATEMENTS (Continued)
The Fund’s transactions in derivative instruments during the six months ended February 28, 2015 are recorded in the following locations in the Statement of Operations:
| Type of Derivative | | Location | | | | Location | | Net Change
in Unrealized Appreciation/
Depreciation | |
Interest rate contracts –
Futures contracts | | Net realized gains from futures contracts | | $ | 685,319 | | Net change in unrealized appreciation/depreciation on futures contracts | | $ | (45,900 | ) |
6. Offering of Fund Units; Repurchase Offers
Fund units may be purchased by investors who meet certain eligibility requirements set forth in the Fund’s current prospectus as of the first business day of each calendar month; however, Fund units may be offered more or less frequently as determined by the Board in its sole discretion. Fund units are sold at the current net asset value per unit. Generally, the minimum initial investment in the Fund is $50,000 and the minimum additional investment is $5,000. The Fund may accept investments for lesser amounts under certain circumstances, including where a unitholder has significant assets under the management of the Adviser or an affiliate and other special circumstances that may arise. There are no initial or subsequent investment minimums for accounts maintained by financial institutions for the benefit of their clients who purchase units through investment programs such as employee benefit plans. Certain selling broker-dealers and financial advisers may impose higher minimums.
Distributions to unitholders arising from net investment income and net realized gains, if any, are reinvested in full and fractional units at the NAV per unit next determined on the payable of such distributions unless a unitholder elects to receive the distributions in the form of cash.
Because the Fund is a closed-end fund, unitholders do not have the right to require the Fund to redeem any or all of their Units. To provide a limited degree of liquidity to unitholders, the Fund may from time to time offer to repurchase Units pursuant to written repurchase offers, but is not obligated to do so. Repurchases will be made at such times, in such amounts and on such terms as may be determined by the Board, in its sole discretion, pursuant to written repurchase offers. In determining whether the Fund should offer to repurchase units, the Board will consider a variety of operational, business and economic factors. The Board convenes quarterly to consider whether or not to authorize a repurchase offer. The Board expects that repurchase offers, if authorized, will be made no more frequently than on a quarterly basis and will typically have a valuation date as of March 31, June 30, September 30 or December 31 (or, if any such date is not a Business Day, on the last Business Day of such calendar quarter). During the six months ended February 28, 2015, no units were repurchased by the Fund.
7. Principal Investment Risks
An investment in the Fund should be considered a speculative investment that entails a high degree of risk and units of the Fund are only available for purchase by certain eligible investors. It is possible that an investor may lose some or all of its investment and that the Fund may not achieve its investment objective.
The Fund is non-diversified and the Fund’s investment in the securities of a limited number of issuers exposes the Fund to greater market risk and potentially greater market losses than if its investments were diversified in securities issued by a greater number of issuers.
FSI LOW BETA ABSOLUTE RETURN FUND
NOTES TO FINANCIAL STATEMENTS (Continued)
The Underlying Funds invest in a variety of different assets and employ a number of different strategies which in turn subject their investors, including the Fund, to certain risks including those associated with: (1) investing in equities, fixed income securities and convertible securities of U.S. and foreign issuers, derivatives, commodities and currencies; (2) participating in short sale transactions; and (3) employing arbitrage and leverage. The Fund may also implement leverage and invest directly in derivatives which will directly expose the Fund to the risks associated with the employment of leverage and investments in derivatives.
The Fund may not be able to withdraw its investment in an Underlying Fund promptly after it has made a decision to do so. Fund unitholders do not have the right to require the Fund to redeem or repurchase its units and may not have access to the money they invest for an indefinite period of time. Repurchases will be made at such times, and in such amounts, and on such terms as may be determined by the Board, in its sole discretion.
The units are not, and are not expected to be, listed for trading on any securities exchange and, to the Fund’s knowledge, there is no, nor will there be, a secondary trading market for the units. Units are subject to substantial restrictions on transferability and resale, and may not be transferred or resold except as permitted under the Fund’s Agreement and Declaration of Trust, as may be amended from time to time. A unitholder should not expect to be able to sell its units regardless of how the Fund performs. Because a unitholder may be unable to sell its units, the unitholder will be unable to reduce its exposure on any market downturn.
For a complete description of the principal risks involved and the eligibility criteria for investors, please refer to the Fund’s current prospectus.
8. Contingencies and Commitments
The Fund indemnifies its officers and Trustees for certain liabilities that might arise from their performance of their duties to the Fund. Additionally, in the normal course of business the Fund enters into contracts that contain a variety of representations and warranties and which provide general indemnifications. The Fund’s maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Fund that have not yet occurred. However, based on experience, the Fund expects the risk of loss to be remote.
9. Subsequent Events
The Fund is required to recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed as of the date of the Statement of Assets and Liabilities. For non-recognized subsequent events that must be disclosed to keep the financial statements from being misleading, the Fund is required to disclose the nature of the event as well as an estimate of its financial effect, or a statement that such an estimate cannot be made. Management has evaluated subsequent events through the issuance of these financial statements and has noted no such events.
FSI LOW BETA ABSOLUTE RETURN FUND (THE “FUND”)
APPROVAL OF INVESTMENT ADVISORY AND SUB-ADVISORY AGREEMENTS (Unaudited)
The Board of Trustees (the “Board”), including the Trustees who are not “interested persons” (as that terms is defined in Section 2(a)(19) of the Investment Company Act of 1940, as amended) (the “Independent Trustees”) voting separately, has reviewed and approved the continuance of the Investment Advisory Agreement between Financial Solutions, Inc. (“FSI”) and the Fund (the “FSI Agreement”); (2) the Sub-Advisory Agreement between Meritage Capital, LLC (“Meritage”), FSI and the Fund (the “Meritage Agreement”); and (3) the Sub-Advisory Agreement between Pluscios Management, LLC (“Pluscios”), FSI and the Fund (the “Pluscios Agreement” and collectively with the FSI Agreement and the Meritage Agreement, the “Advisory Agreements”), each for an additional annual term. Approval took place at an in-person meeting held on November 7, 2014, at which a majority of the Trustees, including a majority of the Independent Trustees, were present.
Prior to the meeting, the Board requested from, and received and reviewed a substantial amount of information provided by, the Adviser, Meritage and Pluscios. The Board also received a memorandum from counsel to the Fund and the Independent Trustees (“Counsel”) outlining the Board’s duties and legal standards applicable to the consideration and approval of advisory agreements. During the meeting and prior to approving the continuance of the Advisory Agreements for an additional annual term, the Board met with representatives of each of FSI, Meritage and Pluscios and the Independent Trustees convened in executive session with Counsel to further discuss the proposed continuance of the Advisory Agreements.
In considering the Advisory Agreements for the Fund and reaching its conclusion with respect thereto, the Board reviewed and analyzed various factors that it determined were relevant, including the factors described below. In their deliberations, the Board did not identify any particular information that was all-important or controlling.
Financial Solutions, Inc.
Nature, Extent and Quality of Services
The Trustees reviewed the services being provided by the Adviser to the Fund including, without limitation: (1) allocating Fund assets among the Alpha Engine (as defined in the Prospectus), the Beta Wrapper and the Buffer Account (as defined in the Prospectus); (2) allocating assets dedicated to the Alpha Engine amongst the Adviser and each of Meritage and Pluscios (each a “Sub-Adviser”); (3) managing a portion of the Alpha Engine, the Beta Wrapper and the Buffer Account; (4) overseeing the Sub-Advisers’ management of a portion of the Alpha Engine; and (5) providing Board reporting regarding the Fund’s assets and the management thereof. The Trustees also considered the experience of the Adviser’s personnel servicing the Fund, the Adviser’s compliance environment as well as the Fund’s performance. The Trustees also noted the Adviser’s clean regulatory history, the absence of the Adviser’s involvement in litigation, the Fund’s increase in assets and the Adviser’s plan to further increase Fund assets in the future. The Trustees concluded that they are satisfied with the quality, extent, and nature of the services provided by the Adviser.
FSI LOW BETA ABSOLUTE RETURN FUND (THE “FUND”)
APPROVAL OF INVESTMENT ADVISORY AND SUB-ADVISORY AGREEMENTS (Unaudited) (Continued)
Performance of the Fund
The Trustees compared the performance of the Fund with the performance of its benchmark index, the HRFI Fund of Funds Diversified Index (the “HFRI Index”), and comparable funds managed by other investment advisers noting that each of the year-to-date and inception to date performance of the Fund (as of July 31, 2014) is the best of its peer group. The Trustees considered that the Fund outperformed the HFRI Index, during both performance periods, and the consistency of the Fund’s volatility with that of the Barclays U.S. Aggregate Bond Index. The Trustees also noted that the Adviser does not manage any other accounts similar to the Fund. The Board concluded that they were satisfied with the Fund’s performance.
Cost of Advisory Services and Profitability
The Trustees considered the advisory fees paid to Adviser during a twelve month period and the Adviser’s expenses incurred over that period including payments to the Sub-Advisers as well as an estimation of the Adviser’s operational overhead allocable to the Advisory Services. The Trustees also considered the amount of advisory fee waived by the Adviser over the period, the expiration of the Expense Limitation Agreement on April 30, 2015 and the Adviser’s decision to not seek renewal of the Expense Limitation Agreement for periods subsequent to April 30, 2015. The Trustees noted that, at current Fund asset levels, the Fund will naturally run at the net expense ratio required under the Expense Limitation Agreement. The Trustees also reviewed the Adviser’s financial statements and insurance arrangements. The Trustees concluded that the Adviser’s profitability was reasonable and that the Adviser’s assets, coupled with its insurance coverage, were sufficient to cover potential liabilities incurred under the FSI Agreement.
Comparative Fee and Expense Data; Economies of Scale
The Trustees considered that the fee arrangement of the Fund with the Adviser currently involves both an advisory fee and an Expense Limitation Agreement that expires on April 30, 2015. The Trustees noted that, at current Fund asset levels, the Fund will naturally run at the net expense ratio required under the Expense Limitation Agreement. The Trustees compared the fees and expenses of the Fund (including the Fund’s advisory fee) to a peer group of comparable funds, noting that the Fund’s advisory fee is lower than the median and average of its peer group and that the Fund’s gross and net expenses are within the range of gross and net expenses reported by the comparable funds. The Trustees also noted that management fees paid by the funds comprising the peer group do not include breakpoints. The Trustees considered the standard fee schedule utilized by the Adviser which includes breakpoints for certain asset levels and distinguished the higher advisory fees (without breakpoints) paid by the Fund based on the following factors: (1) the Adviser does not manage any other account similar to the Fund; and (2) the Adviser is responsible for supervising the Fund’s Sub-Advisers and periodic Board reporting. The Trustees concluded that the fees paid to the Adviser under the FSI Agreement and the Fund’s overall expenses are reasonable.
FSI LOW BETA ABSOLUTE RETURN FUND (THE “FUND”)
APPROVAL OF INVESTMENT ADVISORY AND SUB-ADVISORY AGREEMENTS (Unaudited) (Continued)
Other Benefits
The Trustees considered the Adviser’s representation that it does not derive any other benefits from its relationship with the Fund and concluded that Adviser does not receive any additional financial or other benefits from its relationship with the Fund.
Meritage Capital, LLC
Nature, Extent and Quality of Services
The Trustees reviewed the services being provided by Meritage to the Fund including, without limitation, the management of the Fund assets allocated to Meritage for management (the “Meritage Assets”). The Trustees also considered the experience of Meritage’s personnel servicing the Fund, Meritage’s compliance environment as well as the performance of the Meritage Assets. The Trustees also noted Meritage’s clean regulatory history and the absence of Meritage’s involvement in litigation. The Trustees concluded that they are satisfied with the quality, extent, and nature of the services provided by Meritage.
Performance of the Meritage Assets
The Trustees compared the performance of the Meritage Assets with the performance of the HFRI Index and another similarly managed pooled investment vehicle (“Meritage Private Fund”) managed by Meritage noting that the since inception performance of the Meritage Assets exceed that of both the HRFI Index and the Meritage Private Fund. The Board concluded that they were satisfied with the performance of the Meritage Assets.
Cost of Advisory Services and Profitability
The Trustees considered the advisory fees paid to Meritage by the Adviser during a twelve month period and Meritage’s expenses to provide the Meritage Services over that period as well as an estimate of Meritage’s operational overhead allocable to the Meritage Services. The Trustees also considered the amount of advisory fee waived by the Meritage over the period, the expiration of the Expense Limitation Agreement between the Adviser and Meritage on April 30, 2015 and the Adviser’s decision to not seek renewal of the Expense Limitation Agreement with Meritage for periods subsequent to April 30, 2015.
FSI LOW BETA ABSOLUTE RETURN FUND (THE “FUND”)
APPROVAL OF INVESTMENT ADVISORY AND SUB-ADVISORY AGREEMENTS (Unaudited) (Continued)
The Trustees considered the Fund’s investment in Centennial Global Macro Fund (the “Centennial Fund”), a private fund managed by Meritage. In this regard, the Trustees noted that neither the Fund nor the Adviser pay any fees directly to Meritage with respect to the Fund’s investment in the Centennial Fund and that the Adviser, not Meritage, is responsible for investing Fund assets in the Centennial Fund. The Trustees also acknowledged that Centennial Fund provides the Fund access to certain managers that it is not otherwise able to access directly and noted the Adviser’s representation that the Fund’s investment in Centennial Fund is not related to Meritage’s service as a Sub-Adviser to the Fund (e.g., the Fund would still invest in Centennial Fund absent Meritage’s service as Sub-Adviser). The Trustees also considered the Adviser’s representation that the investment advisory fee paid by the Centennial Fund, and indirectly born by the Fund through its investment therein, was consistent with the investment advisory fees charged by similar hedge funds.
The Trustees then reviewed Meritage’s financial statements and insurance arrangements. The Trustees concluded that Meritage’s profitability was reasonable and that Meritage’s assets, coupled with its insurance coverage, were sufficient to cover potential liabilities incurred under the Meritage Agreement.
Comparative Fee and Expense Data; Economies of Scale
The Trustees considered that the Adviser, not the Fund, is responsible for paying the advisory fees due to Meritage under the Meritage Agreement. The Trustees also noted the fee arrangement between the Adviser and Meritage currently involves both an advisory fee and an Expense Limitation Agreement that expires on April 30, 2015. The Trustees compared the advisory fee paid by the Adviser to Meritage (the “Meritage Fee”) and the fees and expenses of the Fund to a peer group of comparable funds, noting that the Meritage Fee is lower than the median and average of the peer group and that the Fund’s gross and net expenses are within the range of gross and net expenses reported by the comparable funds. The Trustees noted that advisory fees paid by the funds comprising the peer group do not include breakpoints and the advisory fees payable to Meritage by other similarly managed investment vehicles, which includes breakpoints, are higher than or equivalent to (excluding the breakpoints) the Meritage Fee. With respect to breakpoints, the Trustees noted Meritage’s belief that the level of Meritage Services will not change as Fund assets increase. The Trustees concluded that the fees paid to Meritage under the Meritage Agreement are reasonable.
Other Benefits
The Trustees discussed the Fund’s investment in the Centennial Fund and noting the facts related thereto as summarized above, concluded that Meritage does not receive any additional financial or other benefits from its relationship with the Fund.
FSI LOW BETA ABSOLUTE RETURN FUND (THE “FUND”)
APPROVAL OF INVESTMENT ADVISORY AND SUB-ADVISORY AGREEMENTS (Unaudited) (Continued)
Pluscios Management, LLC
Nature, Extent and Quality of Services
The Trustees reviewed the services being provided by Pluscios to the Fund including, without limitation, the Fund assets allocated to Pluscios for management (the “Pluscios Assets”). The Trustees also considered the experience of Pluscios’ personnel servicing the Fund and Pluscios’ compliance environment. The Trustees also noted Pluscios’ clean regulatory history and the absence of Pluscios’ involvement in litigation. The Trustees concluded that they are satisfied with the quality, extent, and nature of the services provided by Pluscios.
Performance of the Pluscios Assets
The Trustees compared the performance of the Pluscios Assets with the performance of the HFRI Index and the performance of Pluscios accounts employing a similar investment style (“Pluscios Strategy”). The Trustees noted that: (1) the Pluscios Assets’ 2014 year-to-date performance, 2013 performance, cumulative return and annual return exceed that of the HRFI Index; and (2) the Pluscios Assets’ inception to date performance exceeds that of the Pluscios Strategy for the same period. The Board concluded that they were satisfied with the performance of the Pluscios Assets.
Cost of Advisory Services and Profitability
The Trustees considered the annual advisory fee paid to Pluscios by the Adviser and Pluscios’ estimation of operational overhead allocable to the Pluscios Services. The Trustees also noted that Pluscios waived a portion of its advisory fee during the past year, the expiration of the Expense Limitation Agreement between the Adviser and Pluscios on April 30, 2015 and the Adviser’s decision to not seek renewal of the Expense Limitation Agreement with Pluscios for periods subsequent to April 30, 2015.
The Trustees considered the Fund’s investment in Pluscios Offshore Fund, SPC (the “Pluscios Fund”), a private fund managed by Pluscios. In this regard, the Trustees noted that neither the Fund nor the Adviser pay any fees directly to Pluscios with respect to the Fund’s investment in the Pluscios Fund and that the Adviser, not Pluscios, is responsible for investing Fund assets in the Pluscios Fund. The Trustees also acknowledged that Pluscios Fund provides the Fund access to certain managers that it is not otherwise able to access directly and noted the Adviser’s representation that the Fund’s investment in Pluscios Fund is not related to Pluscios’ service as a Sub-Adviser to the Fund. The Trustees also considered the Adviser’s representation that the investment advisory fee paid by the Pluscios Fund, and indirectly born by the Fund through its investment therein, was consistent with the investment advisory fees charged by similar hedge funds.
FSI LOW BETA ABSOLUTE RETURN FUND (THE “FUND”)
APPROVAL OF INVESTMENT ADVISORY AND SUB-ADVISORY AGREEMENTS (Unaudited) (Continued)
The Trustees then reviewed information documenting Pluscios’ financial stability and noted that Pluscios is in the process of securing errors and omission insurance. The Trustees concluded that Pluscios’ profitability was reasonable and that Pluscios’ assets, coupled with the insurance coverage it expects to bind, are sufficient to cover potential liabilities incurred under the Pluscios Agreement.
Comparative Fee and Expense Data; Economies of Scale
The Trustees considered that the Adviser, not the Fund, is responsible for paying the advisory fees due to Pluscios under the Pluscios Agreement. The Trustees also noted the fee arrangement between the Adviser and Pluscios currently involves both an advisory fee and an Expense Limitation Agreement that expires on April 30, 2015. The Trustees compared the advisory fee paid by the Adviser to Pluscios (the “Pluscios Fee”) and the fees and expenses of the Fund to a peer group of comparable funds, noting that the Pluscios Fee is lower than the median and average of the peer group and that the Fund’s gross and net expenses are within the range of gross and net expenses reported by the comparable funds. The Trustees noted that advisory fees paid by the funds comprising the peer group do not include breakpoints. The Trustees also noted that the advisory fees paid to Pluscios by similarly managed private investment pools are higher than the Pluscios Fee and that breakpoints, while not published, are negotiable. The Trustees concluded that the fees paid to Pluscios under the Pluscios Agreement are reasonable.
Other Benefits
The Trustees discussed the Fund’s investment in the Pluscios Fund and, noting the facts related thereto as summarized above, concluded that Pluscios does not receive any additional financial or other benefits from its relationship with the Fund.
Conclusion
After full consideration of the above factors as well as other factors, the Board unanimously concluded that approval of the Advisory Agreements was in the best interests of the Fund and its unitholders.
