| * | Swaps are reflected at the unrealized appreciation (depreciation) on the instrument as presented in the Schedule of Centrally Cleared Credit Default Swaps. |
See the Schedule of Investments for further disaggregation of investment categories. During the period ended July 31, 2024, the Fund did not recognize any transfer to or from Level 3.
The Fund intends to elect and continue to qualify to be taxed as a “regulated investment company” under Subchapter M of the Internal Revenue Code of 1986, as amended. If so qualified, the Fund generally will not be subject to federal income tax to the extent it distributes substantially all of its net investment income and capital gains to shareholders. The Fund generally intends to operate in a manner such that it will not be liable for federal income or excise taxes.
The Fund has adopted financial reporting rules regarding recognition and measurement of tax positions taken or expected to be taken on a tax return. The Fund recognizes interest and penalties, if any, related to unrecognized tax benefits as income tax expense on the Statement of Operations. During the period ended July 31, 2024, the Fund did not incur any interest or penalties. The Fund has reviewed all open tax years and major jurisdictions and concluded that no provision for income tax would be 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.
Security Transactions and Income Recognition:
Investment security transactions are accounted for on the trade date. Gains and losses realized on sales of securities are determined on a specific identification basis. Interest income and expense is recorded on an accrual basis. Discounts and premiums on securities purchased are accreted or amortized using the effective yield method, based on each security’s estimated life and recoverable principal and recorded in interest income on the Statement of Operations. Dividend income and corporate actions, if any, are recorded on the
ex-date.
Paydown gains and losses on mortgage-related and other ABS are recorded as components of interest income on the Statement of Operations. Payments received from certain investments held by the Fund may be comprised of dividends, capital gains and return of capital. The Fund originally estimates the expected classification of such payments. The amounts may subsequently be reclassified upon receipt of the information from the issuer. The actual character of distributions to the Fund’s shareholders will be reflected in the Form 1099 received by shareholders after the end of the calendar year.
19
Angel Oak Strategic Credit Fund
Notes to the Financial Statements - (continued)
July 31, 2024 (Unaudited)
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES – (continued)
Distributions to Shareholders:
Distributions from the Fund’s net investment income are accrued daily and typically paid monthly. The Fund intends to distribute its net realized long term capital gains and net realized short term capital gains, if any, at least annually. Distributions to shareholders, which are determined in accordance with income tax regulations, are recorded on the
ex-dividend
date. The treatment for financial reporting purposes of distributions made to shareholders during the period from net investment income or net realized capital gains may differ from their ultimate treatment for federal income tax purposes. These differences are caused primarily by differences in the timing of the recognition of certain components of income, expense or realized capital gain for federal income tax purposes. Where such differences are permanent in nature, they are reclassified in the components of the net assets based on their ultimate characterization for federal income tax purposes. Any such reclassifications will have no effect on net assets, results of operations or net asset value per share of the Fund. For the year ended January 31, 2024, there were no reclassifications.
The NAV per share of the Fund is calculated by dividing the sum of the value of the securities held by the Fund, plus cash and other assets, minus all liabilities (including estimated accrued expenses) by the total number of shares outstanding, rounded to the nearest cent. The Fund’s NAV will not be calculated on the days on which the New York Stock Exchange is closed for trading.
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 at the date of the financial statements, as well as the reported amounts of income and expenses during the period. Actual results could differ from those estimates.
Under the Trust’s organizational documents, the Trust will indemnify its officers and trustees for certain liabilities that may arise from 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 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.
Cash and Cash Equivalents:
Cash and cash equivalents are highly liquid assets including coin, currency and short-term investments that typically mature in
30-90
days. Short-term investments can include U.S. Government securities and government agency securities, investment grade money market instruments, investment grade fixed-income securities, repurchase agreements, commercial paper and cash equivalents. Cash equivalents are extremely low risk assets that are liquid and easily converted into cash. These investments are only considered equivalents if they are readily available and are not restricted by some agreement. When the Adviser believes market, economic or political conditions are unfavorable for investors, the Adviser may invest up to 100% of a Fund’s net assets in cash, cash equivalents or other short-term investments. Unfavorable market or economic conditions may include excessive volatility or a prolonged general decline in the securities markets, or the U.S. economy. The Adviser also may invest in these types of securities or hold cash while looking for suitable investment opportunities or to maintain liquidity. Included in Investments in securities at fair value on the Statement of Assets and Liabilities are investments in First American money market funds held at major financial institutions totaling $9,575,866.
Reverse Repurchase Agreements:
A reverse repurchase agreement is the sale by the Fund of a security to a party for a specified price, with the simultaneous agreement by the Fund to repurchase that security from that party on a future date at a higher price. Proceeds from securities sold under reverse repurchase agreements are reflected as a liability on the Statement of Assets and Liabilities. Interest payments made are recorded as a component of interest expense on the Statement of Operations. Reverse repurchase agreements involve the risk that the counterparty will become subject to bankruptcy or other insolvency proceedings or fail to return a security to the Fund. In such situations, the Fund may incur losses as a result of a possible decline in the value of the underlying security during the period while the Fund seeks to enforce its rights, a possible lack of access to income on the underlying security during this period, or expenses of enforcing its rights.
20
Angel Oak Strategic Credit Fund
Notes to the Financial Statements - (continued)
July 31, 2024 (Unaudited)
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES – (continued)
The gross obligations for secured borrowing by the type of collateral pledged and remaining time to maturity on reverse repurchase contracts is as follows:
| | | | | | | | | | |
Reverse Repurchase Agreements | | | | | | | | | | |
| Residential Mortgage-Backed Securities | | $– | | ($1,233,694) | | $– | | $– | | ($1,233,694) |
| | $– | | ($1,233,694) | | $– | | $– | | ($1,233,694) |
| Gross amount of reverse repurchase agreements in Balance Sheet Offsetting Information Table | | ($1,233,694) |
| Amounts related to agreements not included in offsetting disclosure in Balance Sheet Offsetting Information Table | | $– |
NOTE 3. RISKS ASSOCIATED WITH PORTFOLIO ASSETS
Mortgage-Backed and Asset-Backed Securities Risks:
Prepayment risk is associated with MBS and ABS, including CLOs. If interest rates fall, the underlying debt may be repaid ahead of schedule, reducing the value of the Fund’s investments. If interest rates rise, there may be fewer prepayments, which would cause the average bond maturity to rise, increasing the potential for the Fund to lose money. The value of these securities may be significantly affected by changes in interest rates, the market’s perception of issuers, and the creditworthiness of the parties involved. The ability of the Fund to successfully utilize these instruments may depend on the ability of the Fund’s Adviser to forecast interest rates and other economic factors correctly. These securities may have a structure that makes their reaction to interest rate changes and other factors difficult to predict, making their value highly volatile. Certain MBS may be secured by pools of mortgages on single-family, multi-family properties, as well as commercial properties. Similarly, ABS may be secured by pools of loans, such as corporate loans, student loans, automobile loans and credit card receivables. The credit risk on such loans is affected by homeowners or borrowers defaulting on their loans. The values of assets underlying mortgage-backed and ABS, including CLOs, may decline and therefore may not be adequate to cover underlying investors. To the extent the Fund focuses its investments in particular types of MBS or ABS, including CLOs, the Fund may be more susceptible to risk factors affecting such types of investments.
Subordinated Debt of Banks and Diversified Financial Companies:
The Fund may invest in subordinated debt securities, sometimes also called “junior debt,”
which
are debt securities for which the issuer’s obligations to make principal and interest payment are secondary to the issuer’s payment obligations to more senior debt securities. Such investments will consist primarily of debt issued
by
community banks or savings institutions (or their holding companies), which are subordinated to senior debt issued by the banks and deposits held by the bank, but are senior to trust preferred obligations, preferred stock and common stock issued by the bank.
The Fund may invest in certain structured products, including community bank debt securitizations. Normally, structured products are privately offered and sold (
that
is, they are not registered under the securities laws); however, an active dealer market may exist for structured products that qualify for Rule 144A transactions. The risks of an investment in a structured product depend largely on the type of the collateral securities and the class of the structured product in which the Fund invests. In addition to the normal interest rate, default and other risks of fixed-income securities, structured products carry additional risks, including the possibility that distributions from collateral securities will not be adequate to make interest or other payments, the quality of the collateral may decline in value or default, the Fund may invest in Structured Products that are subordinate to other classes, values may be volatile and disputes with the issuer may produce unexpected investment results.
The Fund may enter into futures contracts to hedge various investments for risk management as well as speculative purposes. Initial margin deposits are made upon entering into futures contracts and can be either cash or securities. Secondary margin limits are required to be maintained while futures are held, as defined by each contract.
During the period a futures contract is open, changes in the value of the contract are recognized as unrealized gains or losses by
on a daily basis to reflect the fair value of the contract at the end of each day’s trading. When the contract is closed, the Fund records a realized gain or loss equal to the difference between the proceeds from the closing transaction and the Fund’s cost of entering into a contract. The use of futures contracts involves the risk of illiquid markets or imperfect
correlation between the value of the instruments and the underlying securities, or that the counterparty will fail to perform its obligations.
21
Angel Oak Strategic Credit Fund
Notes to the Financial Statements - (continued)
NOTE 3. RISKS ASSOCIATED WITH PORTFOLIO ASSETS – (continued)
Futures contracts are valued at the settlement price established each day by the board of trade or exchange on which they are traded. Should market conditions move unexpectedly, the Fund may not achieve the anticipated benefits of the futures contract and may realize a loss. See Note 4 for information on futures contract activity during the period ended July 31, 2024.
The Fund may invest in credit default swaps, total return swaps, interest rate swaps, equity swaps, currency swaps and other types of swaps. During the year, the Fund used centrally cleared credit default swaps to hedge interest risk on its portfolio. Such transactions are subject to market risk, liquidity risk, risk of default by the other party to the transaction, known as “counterparty risk,” regulatory risk and risk of imperfect correlation between the value of such instruments and the underlying assets and may involve commissions or other costs.
A credit default swap agreement may reference one or more debt securities or obligations that are not currently held by the Fund. The Fund is permitted to enter into a credit default swap as either the protection buyer or seller in the discretion of the Adviser. When buying protection under a credit default swap, the Fund is generally obligated to pay the protection seller an upfront or periodic stream of payments over the term of the contract until a credit event occurs, such as a default of the reference obligation. If no credit event occurs, the Fund may recover nothing if the swap is held through the termination date. However, if a credit event does occur, the Fund may receive the full notional value of the swap in exchange for the face amount of the obligations underlying the swap, the value of which may have significantly decreased. When selling protection under a credit default swap, the Fund receives an upfront or periodic stream of payments over the term of the contract provided that a credit event does not occur. However, as the seller of protection, the Fund effectively adds leverage to its portfolio because it gains exposure to the notional amount of the swap. Entering into a credit default swap may subject the Fund to greater risk than if the Fund had invested in the reference obligation directly. In addition to general market risks, credit default swaps also involve illiquidity risk, counter-party risk (for OTC swaps) and credit risk.
Swap agreements are primarily entered into by institutional investors and the value of such agreements may be extremely volatile. Certain swap agreements are traded OTC between two parties, while other more standardized swaps must be transacted through a Futures Commission Merchant and centrally cleared and exchange traded. While central clearing and exchange-trading are intended to reduce counterparty credit and liquidity risk, they do not make a swap transaction risk-free. The current regulatory environment regarding swap agreements is subject to change. The Adviser will continue to monitor these developments, particularly to the extent regulatory changes affect the Fund’s ability to enter into swap agreements. See Note 4 for information on swap activity during the period ended July 31, 2024.
Common and Preferred Stocks:
The Fund may invest in common stock and preferred stock. Common stock represents an equity (ownership) interest in a company and usually possesses voting rights and earns dividends. Dividends on common stock are not fixed but are declared at the discretion of the issuer. Common stock generally represents the riskiest investment in a company. In addition, common stock generally has the greatest appreciation and depreciation potential because increases and decreases in earnings are usually reflected in a company’s stock price. The Fund may also invest in preferred stock. Preferred stock is a class of stock having a preference over common stock as to the payment of dividends and the recovery of investment should a company be liquidated, although preferred stock is usually junior to the debt securities of the issuer. Preferred stock typically does not possess voting rights and its market value may change based on changes in interest rates.
The fundamental risk of investing in stock is the risk that the value of the stock might decrease. Stock values fluctuate in response to the activities of an individual company or in response to general market and/or economic conditions. Historically, common stocks have provided greater long-term returns and have entailed greater short-term risks than preferred stocks, fixed-income and money market investments. The market values of all securities, including common and preferred stocks, is based upon the market’s perception of value and not necessarily the book value of an issuer or other objective measures of a company’s worth. If you invest in the Fund, you should be willing to accept the risks of the stock market (to the extent that a Fund invests in common stock)
and
should consider an investment in the Fund only as a part of your overall investment portfolio.
Developments such as public health crises, armed conflict, changing interest rates, inflation, supply chain disruptions, geopolitical risks, and economic sanctions may disrupt economic markets and the prolonged economic impacts of these types of developments are uncertain. The operational and financial performance of the issuers of securities in which the Fund invests depends on future developments, including the duration, spread, and conclusion of global events, and such uncertainty may in turn impact the value of the Fund’s investments.
22
Angel Oak Strategic Credit Fund
Notes to the Financial Statements - (continued)
July 31, 2024 (Unaudited)
NOTE 4. DERIVATIVE TRANSACTIONS
The value and effect of derivative instruments on the Statement of Assets and Liabilities as of July 31, 2024, was as follows:
| | | | | | | | |
| | | | Statement of Assets and Liabilities
Location | | Fair Value of
Deposit at
Broker for
Futures and
Swaps | | Value of
Unrealized
Appreciation
(Depreciation)* |
| Futures Contracts | | Interest Rate | | Deposit at broker for futures | | $14,748 | | $— |
| Swaps | | Credit | | Deposit at broker for swaps | | $1,800,847 | | $43,384 |
| * | Represents the value of unrealized appreciation (depreciation) as presented in the Schedule of Open Futures Contracts and Schedule of Centrally Cleared Credit Default Swaps. |
The effect of derivative instruments on the Statement of Operations for the period ended July 31, 2024, was as follows:
| | | | | | |
| | | | Location of Gain (Loss) on Derivatives
in Income | | Realized Gain (Loss)
on Derivatives |
| Futures Contracts | | Interest Rate | | Net realized gain (loss) on futures contracts | | $163 |
| Swaps | | Credit | | Net realized gain (loss) on swaps | | ($292,612) |
| | | | | | |
| | | | Location of Gain (Loss) on Derivatives
in Income | | Change in Unrealized
Appreciation/Depreciation
on Derivatives |
| Futures Contracts | | Interest Rate | | Net change in unrealized appreciation/depreciation on futures contracts | | ($94) |
| Swaps | | Credit | | Net change in unrealized appreciation/depreciation on swaps | | $146,274 |
The average monthly notional value of the short futures contracts and long swap contracts during the period ended July 31, 2024, was ($68,931) and $15,000,000, respectively.
Balance Sheet Offsetting Information
During the ordinary course of business, the Fund may enter into transactions subject to enforceable netting agreements or other similar arrangements (“netting agreements”). Generally, the right to offset in netting agreements allows the Fund to offset any exposure to a specific counterparty with any collateral received or delivered to that counterparty based on the terms of the agreement. Generally, the Fund manages its cash collateral and securities collateral on a counterparty basis. As of July 31, 2024, the Fund was not subject to any netting agreements.
The following table provides a summary of offsetting financial liabilities and derivatives and the effect of derivative instruments on the Statement of Assets and Liabilities as of July 31, 2024.
| | | | | | | | | | | | |
| | | | | | | | | in Statement of Assets and Liabilities |
| | | Gross Amounts of
Recognized
Assets/Liabilities | | Gross Amounts Offset in
Statement of Assets
and Liabilities | | Net Amounts of
Assets/Liabilities Presented in
Statement of
Assets and Liabilities | | | | | | |
| | | | | | | | | | | | |
| Swaps | | $43,384 | | $– | | $43,384** | | $– | | $43,384 | | $– |
| | | | | | | | | | | | |
| Reverse Repurchase Agreements | | ($1,233,694) | | $– | | ($1,233,694) | | ($1,233,694) | | $– | | $– |
| * | The amount is limited to the net amounts of financial assets and liabilities and accordingly does not include excess collateral pledged. |
23
Angel Oak Strategic Credit Fund
Notes to the Financial Statements - (continued)
July 31, 2024 (Unaudited)
NOTE 4. DERIVATIVE TRANSACTIONS – (continued)
| ** | Represents the value of unrealized appreciation (depreciation) as presented in the Schedule of Centrally Cleared Credit Default Swaps, which is included in appreciation for swaps on the Statement of Assets and Liabilities. |
NOTE 5. FEES AND OTHER RELATED PARTY TRANSACTIONS
Under the terms of the investment advisory agreement, on behalf of the Fund (the “Agreement”), the Adviser manages the Fund’s investments subject to oversight of the Trustees. As compensation for its management services, the Fund is obligated to pay the Adviser a fee computed and accrued daily and paid monthly at an annual rate of 1.25% of the average daily net assets of the Fund.
From April 1, 2020, through December 31, 2022, the Adviser contractually agreed to waive its fees and/or reimburse certain expenses (exclusive of any
front-end
sales loads, taxes, interest on borrowings, dividends on securities sold short, brokerage commissions,
12b-1
fees, acquired fund fees and expenses, expenses incurred in connection with any merger or reorganization and extraordinary expenses) to limit the Total Annual Fund Operating Expenses after fee waiver/expense reimbursement to 0.75% (“Expense Limit”) of the Fund’s average daily net assets. Effective January 1, 2023, the Expense Limit was terminated. Prior to January 1, 2023, the Expense Limit excluded certain expenses and consequently, the total annual fund operating expenses after fee waiver/expense reimbursement may have been higher than the Expense Limit.
The Adviser may recoup from the Fund any waived amount or reimbursed expenses with respect to the Fund pursuant to the prior agreement if such recoupment does not cause the Fund to exceed the Expense Limit in place at the time of the waiver and the recoupment is made within three years after the end of the month in which the Adviser incurred the expenses. During the period ended July 31, 2024, the Adviser had $255,826 of previously waived expenses expire. The amounts subject to repayment by the Fund, pursuant to the aforementioned conditions at July 31, 2024, are included in the table below.
| | | | |
| | | | |
| $716,830 | | $111,042 | | $605,788 |
Quasar Distributors, LLC, a wholly-owned subsidiary of Foreside Financial Group, LLC (doing business as ACA Group) (“the Distributor”), acts as the Fund’s principal underwriter in a continuous public offering of the Fund’s shares.
U.S. Bancorp Fund Services, LLC, doing business as U.S. Bank Global Fund Services (“Fund Services”), an indirect wholly-owned subsidiary of U.S. Bancorp, serves as the Fund’s Administrator (“Administrator”) and, in that capacity, performs various administrative and accounting services for the Fund. Fund Services also serves as the Fund’s fund accountant and transfer agent. The Administrator prepares various federal and state regulatory filings, reports and returns for the Fund; prepares reports and materials to be supplied to the Trustees; monitors the activities of the Fund’s custodian; coordinates the preparation and payment of the Fund’s expenses and reviews the Fund’s expense accruals. As compensation for its services, the Administrator is entitled to a monthly fee at an annual rate based upon the average daily net assets of the Fund. U.S. Bank, N.A. (the “Custodian”) serves as custodian to the Fund.
The Fund makes reimbursement payments to the Adviser for the salary associated with the Chief Compliance Officer. The compliance fees expensed by the Fund during the period ended July 31, 2024, are included in the Statement of Operations.
Certain officers, Trustees and shareholders of the Fund are also owners or employees of the Adviser.
24
Angel Oak Strategic Credit Fund
Notes to the Financial Statements - (continued)
July 31, 2024 (Unaudited)
NOTE 6. INVESTMENT TRANSACTIONS
For the period ended July 31, 2024, purchases and sales of investment securities, other than short-term investments and short- term U.S. Government securities, were as follows:
For the period ended July 31, 2024, there were $850,000 of long-term purchases and $1,145,781 of long-term sales of U.S. Government securities for the Fund. These amounts are included in the aggregate purchases and sales of the investment securities displayed in the table above.
NOTE 7. REPURCHASE OFFERS
Shares repurchased during the period ended July 31, 2024, were as follows (See Note 1):
| | | | | | | | | | | | |
| | Repurchase
Request Deadline | | NAV on
Repurchase
Pricing Date | | Percentage of
Outstanding Shares the
Fund Offered to
Repurchase | | Number of
Shares the Fund
Offered to
Repurchase | | Percentage of
Shares Repurchased to | | Number of
Shares
Repurchased |
| February 23, 2024 | | March 15, 2024 | | $20.93 | | 5.0% | | 232,428 | | 0.4% | | 17,197 |
| May 31, 2024 | | June 21, 2024 | | $21.23 | | 5.0% | | 233,567 | | 1.2% | | 57,671 |
NOTE 8. BENEFICIAL OWNERSHIP
The beneficial ownership, either directly or indirectly, of 25% or more of the voting securities of a fund creates a presumption of control of a fund, under Section 2(a)(9) of the 1940 Act. At July 31, 2024, Charles Schwab & Co., Inc. owned, as record shareholder, 76.30% of the outstanding shares of the Fund.
NOTE 9. FEDERAL TAX INFORMATION
The tax characterization of distributions paid for the year ended January 31, 2024, and January 31, 2023, were as follows:
| | | | | | | | |
| | | | | | | |
| | | | | | | | |
| Ordinary Income | | $ | 7,392,868 | | | $ | 5,189,444 | |
| Net Long-Term Capital Gain | | | – | | | | – | |
At January 31, 2024, the components of distributable earnings (accumulated deficit) on a tax basis were as follows:
| | | | |
| | | | |
| Tax Cost of Investments | | | $100,126,653 | |
| Unrealized Appreciation* | | | 2,907,648 | |
| Unrealized Depreciation* | | | (5,794,528) | |
Net Unrealized Appreciation (Depreciation )* | | | ($2,886,880) | |
| Undistributed Ordinary Income | | | 424,096 | |
| Undistributed Long-Term Gain (Loss) | | | – | |
| | | $424,096 | |
| Other Accumulated Gain (Loss) | | | (1,213,226) | |
Total Distributable Earnings (Accumulated Deficit) | | | ($3,676,010) | |
| * | Represents aggregated amounts of Fund’s investments, reverse repurchase agreements, futures, and swaps. |
25
Angel Oak Strategic Credit Fund
Notes to the Financial Statements - (continued)
July 31, 2024 (Unaudited)
NOTE 9. FEDERAL TAX INFORMATION – (continued)
The temporary differences between book basis and tax basis in the Fund are primarily attributable to dividends payable and future contract marked-to-market.
As of January 31, 2024, the Fund had available for federal tax purposes an unused capital loss carryforward of $812,853. For the year ended January 31, 2024, the Fund utilized $655,475 of capital loss carryforwards.
To the extent these carryforwards are used to offset futures gains, it is probable that the amount offset will not be distributed to shareholders. The carryforward expires as follows:
| | |
| | | |
| No expiration short-term | | $– |
| No expiration long-term | | $812,853 |
| | $812,853 |
