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 811-08795
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40|86 STRATEGIC INCOME FUND
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(Exact name of registrant as specified in charter)
11825 NORTH PENNSYLVANIA STREET
CARMEL, IN 46032
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(Address of principal executive offices) (Zip code)
WILLIAM P. KOVACS, ESQ.
11825 NORTH PENNSYLVANIA STREET
CARMEL, IN 46032
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(Name and address of agent for service)
Registrant's telephone number, including area code: 317-817-6422
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Date of fiscal year end: JUNE 30, 2004
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Date of reporting period: DECEMBER 31, 2003
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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, 450 Fifth Street, NW,
Washington, DC 20549-0609. The OMB has reviewed this collection of information
under the clearance requirements of 44 U.S.C. ss. 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
40|86 STRATEGIC INCOME FUND
December 31, 2003
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Semi-Annual Report
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40|86 STRATEGIC INCOME FUND Semi-Annual Report
================================================================================
PORTFOLIO MANAGERS' REVIEW December 31, 2003
HOW DID THE FUND PERFORM RELATIVE TO ITS BENCHMARK?
The 40|86 Strategic Income Fund returned 13.75% for the six months ended
December 31, 2003. This compares to 8.71% for the benchmark Merrill Lynch High
Yield Master II Index.(1)
WHAT CAUSED THE VARIANCE IN PERFORMANCE BETWEEN THE FUND AND ITS BENCHMARK?
For the six months ended December 31, 2003, Fund performance was driven by
our holdings in the Telecom and Cable/Media sectors. These sectors benefited
most as the lower rated, higher yielding names continued to rally during the
latter half of 2003 as the credit markets underwent a major revaluation of risk.
WHICH PORTFOLIO HOLDINGS ENHANCED THE FUND'S PERFORMANCE?
For the six months ended December 31, 2003, Fund performance was driven by
our holdings in the Telecom and Cable/Media sectors. This included many
previously distressed/dislocated names such as Airgate, Alamosa, Charter
Communications, and Qwest Communications. Many of these lower rated, higher
yielding names continued to rally throughout 2003 as the credit markets improved
and investors sought incremental yield. While many of these names underperformed
during the market turmoil of 2002, they have contributed significantly to Fund
performance for the six months ended December 31, 2003.
WHICH HOLDINGS DETRACTED FROM PERFORMANCE?
For the six months ended December 31, 2003, Fund performance was most
negatively impacted by exposure to Levi Strauss and Denny's Corp.
WHAT IS YOUR OUTLOOK FOR THE REST OF THE FISCAL YEAR?
During 2003, we continued to take advantage of the rally in the lower rated
sector and sold many of the credits that we believed had moved beyond
justifiable valuations. At the same time, we reduced many higher quality names
that were trading at levels that no longer offered compelling relative value.
The proceeds of these sales continue to be selectively reinvested in securities
representing better risk/return characteristics.
While the 2003 rally has pushed yields to record lows (7.46%) and spreads
(+418) to the tightest levels since 1998, there is still opportunity for further
spread compression. A strengthening economy, earnings momentum, and balance
sheet repair have contributed to an overall improvement in credit quality. As
evidence, the JP Morgan domestic default rate decreased to 2.9% for the 12
months ended December 2003 and is expected to reach 2% by the end of 2004. While
spreads have pushed through the 20-year average and may appear relatively tight
on an historical basis, it is necessary to compare spreads to similar periods in
the credit cycle. For example, the domestic default rate was below 2.5% for most
of the period between 1993 and 1997. During this period, the average spread to
worst was +372 basis points. Assuming that we are in the early stages of a
similar credit cycle, it is not unreasonable to expect spreads to continue to
grind tighter over the next 6-12 months.
While an expected 6-10% return for 2004 would pale in comparison to the
returns witnessed in 2003, it may prove attractive relative to cash, investment
grade bonds, and equities on a risk-adjusted basis. In addition to incremental
yield provided, the high yield market has a low correlation with other
investment alternatives. Additionally, the excess spread and short duration
characteristics should serve as a buffer should interest rates rise. For these
reasons, demand for the high yield asset class is expected to remain strong
through at least 2004.
Given the expectations for lower nominal returns, we expect a much tighter
dispersion of manager returns for 2004. After several years of significant
difference between top and bottom managers, we believe that the deviation should
moderate over the next couple years. With approximately 85% of the market
trading above par, credit selection will be increasingly important in this
asymmetric landscape. Given this environment, 2004 could well be about credit
problem avoidance, rather than significant price appreciation. As a result,
security selection will be back to the forefront in determining relative
performance. Our intensive credit process will continue to guide our investment
decisions, and, we believe, will continue to allow us to generate competitive,
risk-adjusted returns over time.
Robert L. Cook, CFA Thomas G. Hauser, CFA
Senior Vice President Vice President
Director of Research 40|86 Advisers, Inc.
40|86 Advisers, Inc
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(1) Past performance does not guarantee future results. Your investment return
and principal will fluctuate, and your shares may be worth more or less than
their original cost. Total return is provided in accordance with SEC guidelines
for comparative purposes. The Merrill Lynch High Yield Master II Index is an
unmanaged, market capitalization weighted index of all domestic and yankee high
yield bonds.
1
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40|86 STRATEGIC INCOME FUND
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2003
(UNAUDITED)
SHARES OR
PRINCIPAL AMOUNT VALUE
- ---------------- ----------
CORPORATE BONDS (124.8% OF NET ASSETS) (A)
AMUSEMENT AND RECREATION SERVICES (7.9%)
$ 725,000 Boca Resorts, Inc., 9.875%, due 04/15/2009 (f)....................................................... $ 775,750
1,100,000 MGM Mirage, Inc., 9.750%, due 06/01/2007 (f)......................................................... 1,259,500
585,000 Pinnacle Entertainment, 8.750%, due 10/01/2013....................................................... 598,163
875,000 Six Flags, Inc., 8.875%, due 02/01/2010 (f).......................................................... 902,344
525,000 Six Flags, Inc., 9.750%, due 04/15/2013 (f).......................................................... 555,187
405,000 Station Casinos, Inc., 9.875%, due 07/01/2010........................................................ 447,525
825,000 Vail Resorts, Inc., 8.750%, due 05/15/2009 (f)....................................................... 874,500
480,000 Venetian Casino, 11.000%, due 06/15/2010 (f)......................................................... 559,200
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5,972,169
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APPAREL AND OTHER FINISHED PRODUCTS (3.4%)
800,000 Levi Strauss & Co., 12.250%, due 12/15/2012.......................................................... 524,000
580,000 Phillips Van-Heusen Corp., 8.125%, due 05/01/2013 (f)................................................ 619,150
585,000 Playtex Products, Inc., 9.375%, due 06/01/2011....................................................... 593,775
780,000 Russell Corp., 9.250%, due 05/01/2010 (f)............................................................ 812,175
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2,549,100
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BUILDING CONSTRUCTION, GENERAL CONTRACTORS AND OPERATIVE BUILDERS (0.8%)
515,000 D. R. Horton, Inc., 8.500%, due 04/15/2012........................................................... 584,525
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BUSINESS SERVICES (2.9%)
200,000 H&E Equipment, 11.125%, due 06/15/2012 (f)........................................................... 202,000
950,000 RH Donnelley Finance Corp., 10.875%, due 12/15/2012, (b) Cost--$950,000; Acquired--11/26/2002 (f).... 1,131,688
780,000 Universal Hospital Services, Inc., 10.125%, due 11/01/2011, (b) Cost--$780,000; Acquired--10/08/2003. 822,900
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2,156,588
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CABLE AND OTHER PAY TELEVISION SERVICES (9.6%)
980,000 Charter Communications Holdings LLC, 10.250%, due 09/15/2010,
(b) Cost--$992,250; Acquired--10/07/2003 (f)....................................................... 1,033,900
1,280,000 Charter Communications Holdings LLC, 11.125%, due 01/15/2011......................................... 1,180,800
565,000 Charter Communications Holdings LLC, STEP (c) 0.000%/13.500%, due 01/15/2011 (f)..................... 423,750
550,000 CSC Holdings, Inc., 10.500%, due 05/15/2016 (f)...................................................... 632,500
915,000 DirectTV Holdings, 8.375%, due 03/15/2013 (f)........................................................ 1,065,975
805,000 Innova S de R. L., 9.375%, due 09/19/2013, (b) Cost--$805,000; Acquired--09/12/2003.................. 830,156
1,215,000 Insight Communications Co., Inc., STEP (c) 0.000%/12.250%, due 02/15/2011 (f)........................ 1,044,900
415,000 Quebecor Media, Inc., 11.125%, due 07/15/2011 (f).................................................... 482,438
500,000 Qwest Corp., 8.875%, due 03/15/2012, (b) Cost--$541,368; Acquired--09/04/2003........................ 576,250
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7,270,669
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CHEMICALS AND ALLIED PRODUCTS (7.4%)
363,000 HMP Equity Holdings Corp., 0.000%, due 05/15/2008, (b) Cost--$189,641; Acquired--04/30/2003 (g)...... 223,245
385,000 Huntsman ICI Chemicals, 10.125%, due 07/01/2009 (f).................................................. 398,475
525,000 Lyondell Chemical Co., 10.875%, due 05/01/2009 (f)................................................... 540,750
515,000 Lyondell Chemical Co., 11.125%, due 07/15/2012 (f)................................................... 574,225
195,000 Nalco Co., 7.750%, due 11/15/2011, (b) Cost--$195,000; Acquired--10/29/2003.......................... 209,625
390,000 Nalco Co., 8.875%, due 11/15/2013, (b) Cost--$390,000; Acquired--10/29/2003.......................... 415,350
580,000 Polyone Corp., 10.625%, due 05/15/2010 (f)........................................................... 582,900
The accompanying notes are an integral part of these financial statements.
2
Semi-Annual Report
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40|86 STRATEGIC INCOME FUND
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2003
(UNAUDITED)
SHARES OR
PRINCIPAL AMOUNT VALUE
- ---------------- ----------
CHEMICALS AND ALLIED PRODUCTS (CONTINUED)
$ 635,000 Rockwood Specialties Corp., 10.625%, due 05/15/2011, (b) Cost--$635,000; Acquired--07/09/2003 ... $ 711,200
405,000 Terra Capital, Inc., 12.875%, due 10/15/2008 (f) ................................................ 479,925
1,135,000 Terra Capital, Inc., 11.500%, due 06/01/2010 (f) ................................................ 1,191,750
320,000 Witco Corp., 6.875%, due 02/01/2026 ............................................................. 276,000
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5,603,445
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COMMUNICATION SERVICES (7.0%)
800,000 American Tower Corp., 5.000%, due 02/15/2010 (f) ................................................ 766,000
975,000 Crown Castle International Corp., 7.500% due 12/01/2013, (b) Cost--$942,062; Acquired--11/17/2003 984,750
310,000 Echostar DBS Corp., 9.125%, due 01/15/2009 ...................................................... 348,363
1,080,000 Echostar DBS Corp., 9.375%, due 02/01/2009 (f) .................................................. 1,135,350
440,000 Rogers Wireless, Inc., 9.625%, due 05/01/2011 (f) ............................................... 528,000
780,000 SpectraSite, Inc., 8.250%, due 05/15/2010 ....................................................... 836,550
635,000 Vivendi Universal Corp., 6.250%, due 07/15/2008, (b) Cost--$635,000; Acquired--07/02/2003 ....... 675,481
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5,274,494
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ELECTRIC, GAS, AND SANITARY SERVICES (4.3%)
630,000 Allied Waste North America, Series B, 7.875%, due 01/01/2009 (f) ................................ 659,925
600,000 Browning-Ferris, 7.400%, due 09/15/2035 (f) ..................................................... 571,500
390,000 Dynegy Holdings, Inc., 10.125%, due 07/15/2013, (b) Cost--$387,072; Acquired--08/01/2003 ........ 450,450
285,000 El Paso Production Holdings, 7.750%, due 06/01/2013, (b) Cost--$285,000; Acquired--05/20/2003 ... 282,150
910,000 Southern Natural Gas, 8.875%, due 03/15/2010 (f) ................................................ 1,028,300
250,000 Transcontinental Gas Pipeline Corp., Series B, 7.000%, due 08/15/2011 ........................... 267,500
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3,259,825
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ELECTRONIC, OTHER ELECTRICAL EQUIPMENT, EXCEPT COMPUTERS (10.6%)
1,286,000 Alamosa Delaware, Inc., STEP (c) 0.000%/12.000%, due 07/31/2009 (f) ............................. 1,163,830
357,000 Alamosa Delaware, Inc., 11.000%, due 07/31/2010 (f) ............................................. 389,130
1,530,000 Celestica, Inc., 0.000%, due 08/01/2020 (f)(g) .................................................. 816,638
485,000 Flextronics International Ltd., 6.500%, due 05/15/2013 .......................................... 504,400
850,000 IPC Acquisition Corp., 11.500%, due 12/15/2009 (f) .............................................. 930,750
980,000 Nortel Networks Ltd., 6.125%, due 02/15/2006 (f) ................................................ 997,150
395,000 Rayovac Corp, 8.500%, due 10/01/2013 ............................................................ 420,675
1,013,000 Solectron Corp., 0.000%, due 11/20/2020 (g) ..................................................... 579,943
488,000 Telecorp PCS, Inc., 10.625%, due 07/15/2010 (f) ................................................. 570,683
910,000 Tyco International Group, 6.375%, due 10/15/2011 (f) ............................................ 977,112
585,000 Tyco International Group, 6.000%, due 11/15/2013, (b) Cost $582,509; Acquired--11/06/2003 ....... 605,475
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7,955,786
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FABRICATED METAL PRODUCTS, EXCEPT MACHINERY AND TRANSPORTATION EQUIPMENT (1.0%)
640,000 Jacuzzi Brands, Inc., 9.625%, due 07/01/2010,
(b) Cost--$648,800; Acquired--06/30/2003 and 07/01/2003 (f) ..................................... 707,200
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FOOD AND KINDRED PRODUCTS (2.9%)
775,000 Altria Group., Inc., 7.000%, due 11/04/2013 ..................................................... 828,245
750,000 Philip Morris Co., 7.650%, due 07/01/2008 (f) ................................................... 830,896
480,000 Reddy Ice Group, Inc., 8.875%, due 08/01/2011, (b) Cost--$490,116; Acquired--07/17/2003 ......... 511,200
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2,170,341
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The accompanying notes are an integral part of these financial statements.
3
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40|86 STRATEGIC INCOME FUND
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2003
(UNAUDITED)
SHARES OR
PRINCIPAL AMOUNT VALUE
- ---------------- ----------
FOOD STORES (2.0%)
$ 390,000 General Nutrition Center, 8.500%, due 12/01/2010, (b) Cost--$390,000; Acquired--11/25/2003 ...... $ 401,700
405,000 Marsh Supermarket, Inc., Series B, 8.875%, due 08/01/2007 ....................................... 384,750
640,000 Merisant Co., 9.500%, due 07/15/2013, (b) Cost--$653,600; Acquired--06/27/2003 and 07/01/2003 ... 684,800
----------
1,471,250
----------
FOREIGN GOVERMENTS (0.6%)
390,000 Federative Republic of Brazil, 9.250%, due 10/22/2010 ........................................... 421,200
----------
GENERAL MERCHANDISE STORES (0.7%)
430,000 JC Penny Co., Inc., 8.000%, due 03/01/2010 ...................................................... 495,037
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HEALTH SERVICES (5.7%)
590,000 HCA, Inc., 6.950%, due 05/01/2012 (f) ........................................................... 633,610
650,000 HCA, Inc., 6.750%, due 07/15/2013 (f) ........................................................... 690,540
430,000 HealthSouth Corp., 8.500%, due 02/01/2008 (f) ................................................... 414,950
540,000 HealthSouth Corp., 10.750%, due 10/01/2008 (f) .................................................. 513,000
345,000 Matria HealthCare, Series B, 11.000%, 05/01/2008 ................................................ 370,875
390,000 Res-Care, Inc., 10.625%, due 11/15/2008 (f) ..................................................... 405,600
405,000 Tenet HealthCare Corp., 6.500%, due 06/01/2012 .................................................. 390,319
875,000 Tenet HealthCare Corp., 7.375%, due 02/01/2013 (f) .............................................. 883,750
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4,302,644
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HEAVY CONSTRUCTION OTHER THAN BUILDING CONSTRUCTION CONTRACTORS (0.4%)
290,000 Great Lakes Dredge & Dock Corp., 7.750%, due 12/15/2013, (b) Cost--$290,000; Acquired--12/12/2003 299,787
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HOTELS, OTHER LODGING PLACES (3.6%)
750,000 Host Marriott LP, Series I, 9.500%, due 01/15/2007 (f) .......................................... 838,125
140,000 Host Marriott LP, Series G, 9.250%, due 10/01/2007 .............................................. 157,150
640,000 Park Place Entertainment Corp., 8.125%, due 05/15/2011 (f) ...................................... 720,800
910,000 Starwood Hotels & Resorts, 7.375%, due 11/15/2015 ............................................... 978,250
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2,694,325
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INDUSTRIAL AND COMMERCIAL MACHINERY AND COMPUTER EQUIPMENT (2.9%)
935,000 Cummins Engine, Inc., 5.650%, due 03/01/2098 (f) ................................................ 624,113
340,000 Rexnord Corp., 10.125%, due 12/15/2012 .......................................................... 374,000
505,000 Terex Corp., Series B, 10.375%, due 04/01/2011 .................................................. 568,125
660,000 Unova, Inc., 7.000%, due 03/15/2008 ............................................................. 643,500
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2,209,738
----------
LEATHER AND LEATHER PRODUCTS (1.3%)
960,000 Samsonite Corp., 10.750%, due 06/15/2008 (f) .................................................... 998,400
----------
LUMBER AND WOOD PRODUCTS, EXCEPT FURNITURE (2.7%)
1,940,000 Georgia-Pacific Corp., 7.700%, due 06/15/2015 (f) ............................................... 2,027,300
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MEASURING INSTRUMENTS, PHOTO GOODS, WATCHES (2.7%)
775,000 DRS Technologies, Inc., 6.875%, due 11/01/2013, (b) Cost--$775,000: Acquired--10/16/2003 (f) .... 800,187
785,000 Eastman Kodak Co., 7.250%, due 11/15/2013 ....................................................... 825,106
490,000 Hudson Respiratory Care, Inc., 9.125%, due 04/15/2008 ........................................... 433,650
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2,058,943
----------
The accompanying notes are an integral part of these financial statements.
4
Semi-Annual Report
================================================================================
40|86 STRATEGIC INCOME FUND
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2003
(UNAUDITED)
SHARES OR
PRINCIPAL AMOUNT VALUE
- ---------------- ----------
MISCELLANEOUS RETAIL (0.5%)
$ 390,000 Suburban Propane Partners L.P., 6.875%, due 12/15/2013, (b) Cost--$390,000; Acquired--12/18/2003 . $ 395,850
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MOTION PICTURES (1.2%)
810,000 Alliance Atlantis Communications, Inc., 13.000%, due 12/15/2009 (f) .............................. 927,450
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NON - DEPOSITORY CREDIT INSTITUTIONS (1.3%)
875,000 Ford Motor Credit Co., 7.375%, due 10/28/2009 (f) ................................................ 962,035
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OIL AND GAS EXTRACTION (1.8%)
595,000 Citgo Petroleum Corp., 11.375%, due 02/01/2011 ................................................... 693,175
650,000 Houston Exploration Co., 7.000%, due 06/15/2013, (b) Cost--$650,000; Acquired--06/05/2003 ........ 674,375
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1,367,550
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PAPER AND ALLIED PRODUCTS (5.1%)
750,000 Abitibi-Consolidated, Inc. , 8.850%, due 08/01/2030 .............................................. 813,379
485,000 Boise Cascade Co., 6.500%, due 11/01/2010 ........................................................ 506,628
390,000 Boise Cascade Co., 7.000%, due 11/01/2013 ........................................................ 406,030
400,000 Buckeye Technologies, Inc., 8.500%, due 10/01/2013 ............................................... 430,000
325,000 Graphic Packaging International., 9.500%, due 08/15/2013, (b) Cost--$325,000; Acquired--08/01/2003 360,750
785,000 Mail-Well, Inc., 9.625%, due 03/15/2012 (f) ...................................................... 875,275
440,000 Pliant Corp., 11.125%, due 09/01/2009 (f) ........................................................ 477,400
----------
3,869,462
----------
PERSONAL SERVICES (1.5%)
720,000 Service Corp. International, 6.875%, due 10/01/2007 (f) .......................................... 748,800
345,000 Service Corp. International, 6.500%, due 03/15/2008 (f) .......................................... 356,213
----------
1,105,013
----------
PRIMARY METAL INDUSTRIES (0.8%)
585,000 General Cable Corp., 9.500%, due 11/15/2010, (b) Cost--$585,000; Acquired--11/18/2003 ............ 628,875
----------
PRINTING, PUBLISHING AND ALLIED INDUSTRIES (4.6%)
210,000 Dex Media East LLC, 9.875%, due 11/15/2009 ....................................................... 241,500
735,000 Dex Media East LLC, 12.125%, due 11/15/2012 (f) .................................................. 907,725
405,000 Dex Media West LLC, 8.500%, due 08/15/2010, (b) Cost--$405,000; Acquired--08/15/2003 ............. 453,094
405,000 Dex Media West LLC, 9.875%, due 08/15/2013, (b) Cost--$405,000; Acquired--08/15/2003 ............. 472,837
630,000 Moore North American Finance, 7.875%, due 01/15/2011, (b) Cost--$632,532; Acquired--03/11/2003 (f) 716,625
655,000 Sun Media Corp., 7.625%, due 02/15/2013 .......................................................... 704,125
----------
3,495,906
----------
RAILROAD TRANSPORTATION (0.8%)
605,000 TFM SA de CV, 11.750%, due 06/15/2009 ............................................................ 624,662
----------
REAL ESTATE INVESTMENT TRUSTS (REITS) (1.8%)
600,000 iStar Financial, Inc., 7.000%, due 03/15/2008 (f) ................................................ 651,000
5,000 iStar Financial, Inc., 8.750%, due 08/15/2008 .................................................... 5,800
390,000 Senior Housing Trust, 8.625%, due 01/15/2012 (f) ................................................. 427,050
245,000 Senior Housing Trust, 7.875%, due 04/15/2015 ..................................................... 258,475
----------
1,342,325
----------
RUBBER AND MISCELLANEOUS PLASTIC PRODUCTS (1.1%)
785,000 Tekni-Plex, Inc. 8.750%, due 11/15/2013, (b) Cost--$785,000; Acquired--11/12/2003 ................ 822,288
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The accompanying notes are an integral part of these financial statements.
5
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40|86 STRATEGIC INCOME FUND
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2003
(UNAUDITED)
SHARES OR
PRINCIPAL AMOUNT VALUE
- ---------------- -----------
STONE, CLAY, GLASS AND CONCRETE PRODUCTS (1.9%)
$ 330,000 Hexcel Corp., 9.750%, due 01/15/2009 ................................................................... $ 347,325
295,000 Owens-Brockway Glass, 7.750%, due 05/15/2011 ........................................................... 318,231
720,000 Owens-Brockway Glass, 8.250%, due 05/15/2013 ........................................................... 776,700
-----------
1,442,256
-----------
TELEPHONE COMMUNICATIONS (12.7%)
1,390,000 AirGate PCS, Inc., STEP (c) 0.000%/13.500%, due 10/01/2009 (f) ......................................... 986,900
445,000 Cincinnati Bell, Inc., 7.250%, due 07/15/2013,
(b) Cost--$448,050; Acquired--07/02/2003, 07/08/2003 and 10/08/2003 (f) .............................. 469,475
390,000 Cincinnati Bell, Inc., 8.375%, due 01/15/2014, (b) Cost--$409,866; Acquired--10/31/2003 and 12/09/2003 . 421,200
875,000 Fairpoint Communications, 12.500%, due 05/01/2010 (f) .................................................. 958,125
615,000 Madison River Capital LLC, 13.250%, due 03/01/2010 (f) ................................................. 678,038
500,000 Nextel Communications, Inc., 6.875%, due 10/31/2013 .................................................... 531,250
1,000,000 Nextel Communications, Inc., 7.375%, due 08/01/2015 (f) ................................................ 1,080,000
1,900,000 Qwest Capital Funding, 7.250%, due 02/15/2011 (f) ...................................................... 1,881,000
965,000 Sprint Capital Corp., 8.375%, due 03/15/2012 (f) ....................................................... 1,129,202
245,000 Triton PCS, Inc., 8.750%, due 11/15/2011 ............................................................... 242,550
485,000 Triton PCS, Inc., 8.500%, due 06/01/2013 ............................................................... 523,800
785,000 Worldcom, Inc., 6.950%, due 08/15/2006 (d)(e) .......................................................... 635,850
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9,537,390
-----------
TELEVISION BROADCASTING STATIONS (1.4%)
985,000 Sinclair Broadcasting Group, 8.000%, due 03/15/2012 .................................................... 1,068,725
-----------
TRANSPORTATION BY AIR (0.4%)
974,864 US Airways, Inc., 9.820%, due 01/01/2013 (d)(e)(f) ..................................................... 330,201
-----------
TRANSPORTATION EQUIPMENT (2.9%)
630,000 Dana Corp., 9.000%, due 08/15/2011 (f) ................................................................. 762,300
640,000 General Motors Corp., 8.375%, due 07/15/2033 ........................................................... 745,154
645,000 United Components, Inc., 9.375%, due 06/15/2013 ........................................................ 707,887
-----------
2,215,341
-----------
WATER TRANSPORTATION (1.2%)
850,000 Royal Carribean Cruises, 8.000%, due 05/15/2010 (f) .................................................... 930,750
-----------
WHOLESALE TRADE - DURABLE GOODS (1.2%)
815,000 TRW Automotive, Inc., 9.375%, due 02/15/2013 (f) ....................................................... 935,213
-----------
WHOLESALE TRADE - NON-DURABLE GOODS (2.2%)
775,000 AmeriSourceBergen Corp., 7.250%, due 11/15/2012 (f) .................................................... 838,937
780,000 DIMON, Inc., 7.750%, due 06/01/2013, (b) Cost--$798,769; Acquired--11/17/2003 and 12/09/2003 ........... 807,300
-----------
1,646,237
-----------
TOTAL CORPORATE BONDS (COST $85,331,535) ............................................................... $94,130,295
-----------
The accompanying notes are an integral part of these financial statements.
6
Semi-Annual Report
================================================================================
40|86 STRATEGIC INCOME FUND
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2003
(UNAUDITED)
SHARES OR
PRINCIPAL AMOUNT VALUE
- ---------------- -----------
PREFERRED STOCK (2.2% OF NET ASSETS) (a)
APPAREL AND OTHER FINISHED PRODUCTS (1.0%)
29,717 Tommy Hilfiger USA, Inc., 9.000%...................................................................... $ 776,208
------------
CABLE AND OTHER PAY TELEVISION SERVICES (0.9%)
6,250 CSC Holdings, Inc., 11.125% (f)....................................................................... 657,812
------------
ELECTRONIC, OTHER ELECTRICAL EQUIPMENT, EXCEPT COMPUTERS (0.3%)
604 Alamosa Holdings, Inc., 7.500% (e) (f)................................................................ 209,135
------------
TOTAL PREFERRED STOCK (COST $1,540,572)............................................................... 1,643,155
WARRANTS (0.0% OF NET ASSETS)(a)
INDUSTRIAL AND COMMERCIAL MACHINERY AND COMPUTER EQUIPMENT (0.0%)
21,541 Dictaphone Corp., expire 03/28/2006 (e)............................................................... 16,156
------------
TOTAL WARRANTS (COST $0).............................................................................. 16,156
UNITED STATES SHORT-TERM OBLIGATIONS (6.1% OF NET ASSETS)
4,654,394 Temporary Investment Fund, Inc........................................................................ 4,654,394
------------
TOTAL SHORT-TERM INVESTMENTS (COST $4,654,394)........................................................ 4,654,394
------------
TOTAL INVESTMENTS (133.1% OF NET ASSETS) (COST $91,526,501) (h)....................................... $100,444,000
LIABILITIES, LESS OTHER ASSETS (-33.1% OF NET ASSETS)................................................. (25,002,111)
------------
TOTAL NET ASSETS (100.0%)............................................................................. $ 75,441,889
============
- -----------------
(a) Using Standard Industry Codes prepared by the Technical Committee on
Industrial Classifications.
(b) Restricted under Rule 144A of the Securities Act of 1933.
(c) STEP -- Bonds where the coupon increases or steps up at a predetermined
rate. (d) Security in default.
(e) Non-income producing security.
(f) All or a portion of these securities were included in a pledge account (see
footnote 6).
(g) Zero Coupon -- Bonds that make no interest payments.
(h) Aggregate cost for Federal income tax purposes is $91,680,918.
The aggregate gross unrealized appreciation (depreciation) for Federal
income tax purposes is as follows:
Excess of market value over tax cost ....... $ 9,307,616
Excess of tax cost over market value ....... (544,534)
-------------
$ 8,763,082
-------------
The accompanying notes are an integral part of these financial statements.
7
================================================================================
40|86 STRATEGIC INCOME FUND
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 2003
(UNAUDITED)
==========================================================================================================
Assets:
Investments at cost ................................................................ $ 91,526,501
- ----------------------------------------------------------------------------------------------------------
Investments at value ............................................................... $ 100,444,000
Interest receivable ................................................................ 1,765,848
Dividends receivable ............................................................... 17,383
Other assets ....................................................................... 888
- ----------------------------------------------------------------------------------------------------------
Total assets ................................................................... 102,228,119
==========================================================================================================
Liabilities and Net assets:
Payable to Conseco, Inc. subsidiaries .............................................. 85,661
Accrued expenses ................................................................... 58,791
Distribution payable ............................................................... 553,329
Interest payable ................................................................... 39,255
Line of credit payable ............................................................. 26,049,194
- ----------------------------------------------------------------------------------------------------------
Total liabilities .............................................................. 26,786,230
- ----------------------------------------------------------------------------------------------------------
Net assets ..................................................................... $ 75,441,889
==========================================================================================================
Net assets consist of:
Capital stock, $0.001 par value (unlimited shares of beneficial interest authorized) $ 6,840
Paid-in capital .................................................................... 101,202,966
Undistributed net investment income ................................................ 67,654
Accumulated net realized loss on investments ....................................... (34,753,070)
Net unrealized appreciation on investments ......................................... 8,917,499
- ----------------------------------------------------------------------------------------------------------
Net assets ..................................................................... $ 75,441,889
==========================================================================================================
Shares outstanding ....................................................................... 6,839,661
Net asset value per share ................................................................ $ 11.03
==========================================================================================================
The accompanying notes are an integral part of these financial statements.
8
Semi-Annual Report
================================================================================
40|86 STRATEGIC INCOME FUND
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED DECEMBER 31, 2003
(UNAUDITED)
=============================================================================================
Investment Income:
Interest ................................................................. $4,153,487
Dividends ................................................................ 133,658
- ---------------------------------------------------------------------------------------------
Total investment income .................................................. 4,287,145
- ---------------------------------------------------------------------------------------------
Expenses:
Investment advisory fees ................................................. 442,266
Shareholders service fees ................................................ 49,141
Administration fees ...................................................... 45,246
Trustees' fees ........................................................... 36,478
Transfer agent fees ...................................................... 31,512
Audit fees ............................................................... 25,480
Registration and filing fees ............................................. 12,642
Reports - printing ....................................................... 10,299
Custodian fees ........................................................... 8,747
Legal fees ............................................................... 7,411
Other .................................................................... 7,631
- ---------------------------------------------------------------------------------------------
Total expenses before interest expense ............................... 676,853
=============================================================================================
Interest expense ......................................................... 235,302
- ---------------------------------------------------------------------------------------------
Total expenses ....................................................... 912,155
- ---------------------------------------------------------------------------------------------
Net investment income ................................................ 3,374,990
=============================================================================================
Net realized and unrealized gains on investments:
Net realized gains on sales of investments ........................... 3,037,700
Net change in unrealized appreciation of investments ................. 2,654,891
- ---------------------------------------------------------------------------------------------
Net realized and unrealized gain on investments .......................... 5,692,591
- ---------------------------------------------------------------------------------------------
Net increase in net assets from operations ..................................... $9,067,581
=============================================================================================
The accompanying notes are an integral part of these financial statements.
9
================================================================================
40|86 STRATEGIC INCOME FUND
STATEMENT OF CHANGES IN NET ASSETS
FOR THE SIX
MONTHS ENDED FOR THE
DECEMBER 31, 2003 YEAR ENDED
(UNAUDITED) JUNE 30, 2003
=====================================================================================================================
Operations:
Net investment income .................................................... $ 3,374,990 $ 6,577,338
Net realized gain (loss) on sales of investments ......................... 3,037,700 (3,080,322)
Net change in unrealized appreciation of investments ..................... 2,654,891 19,318,780
- -------------------------------------------------------------------------------------------------------------------
Net increase from operations ......................................... 9,067,581 22,815,796
- -------------------------------------------------------------------------------------------------------------------
Distributions to shareholders:
Net investment income .................................................... (3,413,985) (6,457,299)
- -------------------------------------------------------------------------------------------------------------------
Net decrease from distributions ...................................... (3,413,985) (6,457,299)
- -------------------------------------------------------------------------------------------------------------------
Capital Share Transactions:
Reinvestment of distributions
(including $5,720 and $10,392 paid to Conseco, Inc., respectively) ... 33,444 226,364
- -------------------------------------------------------------------------------------------------------------------
Net increase from capital share transactions ......................... 33,444 226,364
- -------------------------------------------------------------------------------------------------------------------
Total increase in net assets ......................................... 5,687,040 16,584,861
- -------------------------------------------------------------------------------------------------------------------
Net assets:
Beginning of period ...................................................... 69,754,849 53,169,988
End of period ............................................................ $ 75,441,889 $ 69,754,849
===================================================================================================================
Share data:
Reinvestment of distributions ............................................ 3,129 26,371
- -------------------------------------------------------------------------------------------------------------------
Net increase ......................................................... 3,129 26,371
- -------------------------------------------------------------------------------------------------------------------
Shares outstanding:
Beginning of period ...................................................... 6,836,532 6,810,161
End of period ............................................................ 6,839,661 6,836,532
===================================================================================================================
The accompanying notes are an integral part of these financial statements.
10
Semi-Annual Report
================================================================================
40|86 STRATEGIC INCOME FUND
FINANCIAL HIGHLIGHTS
FOR THE FOR THE FOR THE FOR THE FOR THE FOR THE
SIX MONTHS ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED PERIOD ENDED
DECEMBER 31, 2003 JUNE 30, JUNE 30, JUNE 30, JUNE 30, JUNE 30,
(UNAUDITED) 2003 2002 2001 2000 1999 (g)
=================================================================================================================================
Net asset value per share, beginning of period $10.20 $7.81 $9.28 $11.15 $13.04 $14.88(a)
Income from investment operations (b):
Net investment income...................... 0.49 0.96 1.01 1.11 1.40 1.29
Net realized gains (losses) and change in
unrealized appreciation or depreciation
on investments........................... 0.84 2.38 (1.47) (1.89) (1.87) (1.84)
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) from investment
operations........................... 1.33 3.34 (0.46) (0.78) (0.47) (0.55)
- -----------------------------------------------------------------------------------------------------------------------------------
Distributions:..................................
Net investment income...................... (0.50) (0.95) (1.01) (1.09) (1.42) (1.29)
- -----------------------------------------------------------------------------------------------------------------------------------
Net decrease from distributions........ (0.50) (0.95) (1.01) (1.09) (1.42) (1.29)
- -----------------------------------------------------------------------------------------------------------------------------------
Net asset value per share, end of period........ $11.03 $10.20 $7.81 $9.28 $11.15 $13.04
=================================================================================================================================
Per share market value, end of period........... $11.0400 $10.1700 $7.8200 $9.5100 $10.3125 $12.9375
=================================================================================================================================
Total return (c) (d)............................ 13.75% 45.80% (7.60%) 3.39% (9.44%) (5.06%)
=================================================================================================================================
Ratios/supplemental data:
Net assets (dollars in thousands),
end of period............................ $75,442 $69,755 $53,170 $62,753 $75,255 $87,825
Ratios of expenses to average net assets (e) 2.53% 2.84% 3.13% 4.04% 3.80% 2.74%
Ratios of operating expenses to average
net assets (e) (f)....................... 1.88% 1.98% 1.93% 1.80% 1.64% 1.59%
Ratios of net investment income to average
net assets (e)........................... 9.36% 11.43% 11.47% 10.95% 11.48% 10.24%
Portfolio turnover (d)..................... 55.07% 111.69% 247.73% 213.80% 118.92% 129.87%
- ---------------
(a) Initial public offering price of $15.00 per share less offering costs of
$0.12 per share.
(b) Per share amounts presented are based on an average of monthly shares
outstanding throughout the period indicated.
(c) Total return is calculated assuming a purchase of common stock at the
current market price on the first day and a sale at the current market price
on the last day of each period. Dividends and distributions, if any, are
assumed for purposes of this calculation to be reinvested at prices obtained
under the Fund's dividend reinvestment plan. Total investment return does
not reflect brokerage commissions or sales charges.
(d) Not annualized for periods of less than one year.
(e) Annualized for periods of less than one year.
(f) Excluding interest expense.
(g) For the period July 31, 1998 (commencement of operations) through June 30,
1999.
The accompanying notes are an integral part of these financial statements.
11
================================================================================
40|86 STRATEGIC INCOME FUND
STATEMENT OF CASH FLOWS
FOR THE
SIX MONTHS ENDED FOR THE
DECEMBER 31, 2003 YEAR ENDED
(UNAUDITED) JUNE 30, 2003
=====================================================================================================================
CASH FLOWS FROM OPERATING ACTIVITIES:
Investment income ........................................................ $ 3,595,945 $ 6,776,691
Interest expense paid .................................................... (239,101) (498,308)
Operating expenses paid .................................................. (675,565) (1,078,182)
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities ............................ 2,681,279 5,200,201
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of investments ....................................... 53,355,990 88,527,651
Purchases of investments ................................................. (54,349,135) (86,349,908)
Net decrease (increase) in short-term investments ........................ 1,559,525 (4,177,915)
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities ................. 566,380 (2,000,172)
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash distributions paid (net of reinvestment of $33,444 and
$226,364 respectively) ................................................. (3,247,659) (6,200,029)
Net increase in loans outstanding ........................................ -- 3,000,000
- ---------------------------------------------------------------------------------------------------------------------
Net cash used for financing activities ............................... (3,247,659) (3,200,029)
- ---------------------------------------------------------------------------------------------------------------------
Net increase in cash ................................................. -- --
Cash at beginning of period .......................................... -- --
- ---------------------------------------------------------------------------------------------------------------------
Cash at end of period ................................................ $ -- $ --
=====================================================================================================================
RECONCILIATION OF NET INVESTMENT INCOME TO NET CASH USED
BY OPERATING ACTIVITIES:
Net investment income .................................................... $ 3,374,990 $ 6,577,338
Net decrease (increase) in interest and dividends receivable ............. (196,591) 105,688
Net decrease (increase) in other assets .................................. 12,182 (29)
Net increase in payable to Conseco, Inc. and subsidiaries ................ 7,092 12,108
Net increase (decrease) in accrued expenses .............................. (17,986) 50,186
Net (decrease) in interest payable ....................................... (3,799) (5,246)
Payment in kind bonds .................................................... (88) (197,199)
Accretion and amortization of discounts and premiums ..................... (494,521) (1,342,645)
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities ............................ $ 2,681,279 $ 5,200,201
=====================================================================================================================
The accompanying notes are an integral part of these financial statements.
12
Semi-Annual Report
================================================================================
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003
(UNAUDITED)
1. ORGANIZATION
The 40|86 Strategic Income Fund (formerly, the Conseco Strategic Income Fund)
(the "Fund") was organized as a business trust under the laws of the
Commonwealth of Massachusetts on June 2, 1998, and commenced operations on July
31, 1998. The Fund is registered with the Securities and Exchange Commission
("SEC") under the Investment Company Act of 1940 (the "1940 Act"), as amended,
as a closed-end, non-diversified management investment company. At December 31,
2003, Conseco, Inc. ("Conseco") owned 12,243 shares of the Fund's common stock.
Conseco is a publicly owned financial services company that is one of middle
America's leading sources for supplemental health insurance, life insurance and
annuities.
2. SIGNIFICANT ACCOUNTING POLICIES
SECURITY VALUATION, TRANSACTIONS,
AND RELATED INVESTMENT INCOME
Investment transactions are accounted for on the trade date. The cost of
investments sold is determined by use of the specific identification method for
both financial reporting and income tax reporting purposes. Interest income is
recorded on an accrual basis; dividend income is recorded on the ex-dividend
date. The Fund did not hold any investments which are restricted as to resale,
except bonds with a cost of $17,391,635 and a market value of $18,580,164, all
of which are eligible for resale under Rule 144A of the Securities Act of 1933.
These securities represent 24.63% of the net assets of the Fund. These
securities may be resold to qualified institutional buyers in transactions
exempt from registration.
Investments are stated at market value in the accompanying financial
statements. Values for fixed income and other securities traded in the
over-the-counter market are provided by third-party pricing services. Securities
that are traded on stock exchanges are valued at the last sale price as of the
close of business on the day the securities are being valued, or lacking any
sales, at the mean between the closing bid and asked prices. Fund securities,
which are traded both in the over-the-counter market and on an exchange, are
valued according to the broadest and most representative market, and it is
expected that for debt securities this ordinarily will be the over-the-counter
market. Securities for which market quotations are not readily available are
valued at fair value as determined in good faith by or under the supervision of
the Board of Trustees. Debt securities purchased with maturities of sixty days
or less are valued at amortized cost.
Investments held by the Fund may be purchased with accrued interest, and the
investments owned by the Fund may accrue interest during the period the
investment is owned by the Fund. If an investment owned by the Fund experiences
a default and has accrued interest from purchase or has recorded accrued
interest during the period it is owned, the Fund's policy is to cease interest
accruals from the time the investments are traded as "flat" in the market. The
Fund evaluates the collectibility of purchased accrued interest and previously
recorded interest on an investment-by-investment basis.
DISTRIBUTION OF INCOME AND GAINS
The Fund intends to distribute monthly to shareholders substantially all of
its net investment income and to distribute, at least annually, any net realized
capital gains in excess of net realized capital losses (including any capital
loss carryovers). However, the Board of Trustees may decide to declare dividends
at other intervals.
FEDERAL INCOME TAXES
For federal income tax purposes, the Fund intends to qualify as a regulated
investment company under Subchapter M of the Internal Revenue Code by
distributing substantially all of its taxable income and net capital gains to
its shareholders annually and otherwise complying with the requirements for
regulated investment companies. Therefore, no provision has been made for
federal income taxes.
Income and Capital Gain distributions are determined in accordance with
federal income tax regulations which may differ from GAAP. The tax character
distributions paid during the year ended June 30, 2003 and June 30, 2002 were as
follows:
Ordinary income (2003) ........................ $ 6,426,396
Ordinary income (2002) ........................ 7,089,031
At June 30, 2003, the components of net assets (excluding paid in capital) on
a tax basis were as follows:
Undistributed Ordinary Income ................. $ 528,121
Capital Loss and other loss carryovers ........ (37,579,132)
------------
Accumulated Earnings .......................... (37,051,011)
------------
Less: Dividend Payable ........................ (421,472)
Unrealized Appreciation-- Tax ................. 6,050,970
------------
Total Accumulated Earnings (Deficit) .......... $(31,421,513)
============
The differences between book and tax basis net unrealized appreciation are
primarily attributable to wash sales. The cumulative timing difference for
ordinary income is due to the timing of distributions and deferred organization
costs. The cumulative timing difference for the capital loss carryover is due to
Post October Losses and Wash Sales.
13
================================================================================
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2003
(UNAUDITED)
Net Asset Value ............................... $ 69,754,849
Paid in Capital ............................... (101,176,362)
------------
Net assets (excluding paid in capital) ........ $(31,421,513)
============
As of June 30, 2003, the Fund had a total capital loss carryover of
$34,787,825 which is available to offset future net realized gains on securities
transactions to the extent provided for in the Internal Revenue Code. The
capital loss of $990,224 will expire in 2007, $6,647,128 will expire in 2008,
$17,308,696 in 2009, $5,367,863 in 2010 and $4,473,914 in 2011. The Fund's
realized capital losses incurred after October 31, 2002, through June 30, 2003,
are deemed to arise on the first business day of the following year. The Fund
incurred and elected to defer such realized capital losses of $2,791,307. For
the year ended June 30, 2003 dividends of $197,699 paid by the Fund may be
subject to a maximum tax rate of 15%, as provided by the Jobs and Growth Tax
Relief and Reconciliation Act of 2003. The Fund intends to designate the maximum
amount allowable as taxed at a maximum rate of 15%. Complete information will be
reported in conjunction with your 2003 Form 1099-DIV.
EXPENSES
The Fund pays expenses of Trustees who are not affiliated persons of the Fund
or 40|86 Advisors, Inc., formerly Conseco Capital Management, Inc., (the
"Adviser" and "Administrator"), a wholly-owned subsidiary of Conseco. The Fund
pays each of its Trustees who is not a Trustee, officer or employee of the
Adviser, the Administrator or any affiliate thereof an annual fee of $7,500 plus
$1,500 for each Board of Trustees meeting attended. Additionally, each Trustee
receives a fee of $500 for Board meetings and separate committee meetings
attended that are conducted by telephone. The Board Chairman receives an
additional $375 for each meeting attended. The Fund reimburses all Trustees for
travel and out-of-pocket expenses incurred in connection with Board of Trustees
meetings.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities, as
of the date of the financial statements, and the reported amount of increases
and decreases in net assets from operations during the reporting period. Actual
results could differ from those estimates.
3. TRANSACTIONS WITH AFFILIATES
INVESTMENT ADVISORY AGREEMENT
The Adviser serves as the Investment Manager and Administrator to the Fund
under the terms of the Investment Management Agreement. The Adviser supervises
the Fund's management and investment program, performs a variety of services in
connection with management and operation of the Fund and pays all compensation
of officers and Trustees of the Fund who are affiliated persons of the Adviser
or the Fund. As compensation for its services to the Fund, the Fund has agreed
to pay the Adviser a monthly advisory fee equal to an annual rate of 0.90
percent of the value of the average weekly value of the total assets of the Fund
less the sum of accrued liabilities (other than the aggregate indebtedness
constituting financial leverage) (the "Managed Assets"). The total fees incurred
for such services for the six months ended December 31, 2003 were $442,266.
SHAREHOLDER SERVICING AGREEMENT
Conseco Services, LLC, a wholly-owned subsidiary of Conseco, acts as the
Shareholder Servicing Agent to the Fund under the Shareholder Service Agreement.
As compensation for its services, the Fund has agreed to pay Conseco Services,
LLC a monthly shareholder servicing fee equal to an annual rate of 0.10 percent
of the Managed Assets. The total fees incurred for such services for the six
months ended December 31, 2003 were $49,141.
4. ADMINISTRATION AGREEMENT
The Fund contracted for certain administration services with PFPC, Inc.
("PFPC"). For its services, PFPC receives a monthly fee equal to an annual rate
of 0.105 percent of the first $250 million of average weekly net assets; 0.080
percent of the next $250 million of average weekly net assets; 0.055 percent of
the next $250 million of average weekly net assets; and 0.035 percent of average
weekly net assets in excess of $750 million, subject to a minimum monthly charge
of $7,500. The total fees incurred for such services for the six months ended
December 31, 2003 were $45,246.
5. PORTFOLIO ACTIVITY
Purchases and sales of securities other than short-term obligations
aggregated $50,934,766 and $52,382,838, respectively, for the six months ended
December 31, 2003.
6. INDEBTEDNESS
The Fund expects to utilize financial leverage through borrowings, including
the issuance of debt securities, preferred shares or through other transactions,
such as reverse repurchase agreements, which have the effect of financial
leverage. There can be no assurance that a leveraging strategy will be
successful during any period in which it is used.
14
Semi-Annual Report
================================================================================
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2003
(UNAUDITED)
The Fund intends to utilize leverage to provide the shareholders with a
potentially higher return. Leverage creates risks for the shareholders,
including the likelihood of greater volatility of net asset value and market
price of the shares, and the risk of fluctuations in interest rates on
borrowings.
LOAN AGREEMENT
The Fund entered into a secured Loan and Pledge Agreement with Custodial
Trust Company (the "Agreement") on October 4, 2000. The Agreement is callable on
demand. Under the Agreement, the aggregate amount of the loans outstanding may
not exceed 33 1/3 percent of total assets (including the amount obtained through
leverage). Borrowings bear interest at the Federal Funds Rate plus a margin of
0.75 percent. Interest payments are made monthly. Advances made under the
Agreement are due and payable on demand. The Fund shall maintain a pledge
account which gives the Custodial Trust Company as pledgee effective control
over the Fund assets with a collateral value greater than the sum of the
outstanding aggregate principal amount of the loans and the interest accrued
thereon. The Fund is required to maintain asset coverage, as defined in the
Agreement, of at least 3:1. Portfolio securities with an aggregate value of
$53,597,526 were included in the pledge account at December 31, 2003. The Fund
was in compliance with the terms of the agreement at December 31, 2003.
Borrowings at December 31, 2003 totaled $26 million and the interest rate on
such borrowings was 1.69 percent.
Average daily balance of loans
outstanding during the six months
ended December 31, 2003 .................... $26,049,194
Weighted average interest rate for
the period ................................. 1.80%
Maximum amount of loans outstanding
at any month-end during the six months
ended December 31, 2003 .................... $26,049,194
Percentage of total assets at
December 31, 2003 .......................... 25.48%
Amount of loans outstanding at
December 31, 2003 .......................... $26,049,194
Percentage of total assets at
December 31, 2003 .......................... 25.48%
15
================================================================================
AUTOMATIC DIVIDEND REINVESTMENT PLAN
(UNAUDITED)
Pursuant to the Fund's Automatic Dividend Reinvestment Plan (the "DRIP"),
unless a shareholder otherwise elects, all dividends and capital gain
distributions will be automatically reinvested in additional shares by PFPC,
Inc. ("PFPC"), as agent for shareholders in administering the DRIP (the "DRIP
Agent"). Shareholders who elect not to participate in the DRIP will receive all
dividends and other distributions in cash paid by check mailed directly to the
shareholder of record (or, if the shares are held in street or other nominee
name, then to such nominee) by PFPC as dividend disbursing agent. DRIP
participants may elect not to participate in the DRIP and to receive all
dividends and capital gain distributions in cash by sending written instructions
to PFPC, as dividend disbursing agent, at the address set forth below.
Participation in the DRIP is completely voluntary and may be terminated or
resumed at any time without penalty by written notice if received by the DRIP
Agent not less than ten days prior to any distribution record date; otherwise
such termination will be effective with respect to any subsequently declared
dividend or other distribution.
Whenever the Fund declares an income dividend or a capital gain distribution
(collectively referred to in this section as "dividends") payable either in
shares or in cash, non-participants in the DRIP will receive cash and
participants in the DRIP will receive the equivalent in shares. The shares will
be acquired by the DRIP Agent or an independent broker-dealer for the
participants' accounts, depending upon the circumstances described below,
either: (i) through receipt of additional unissued but authorized shares from
the Fund ("newly issued shares"); or (ii) by purchase of outstanding shares on
the open market ("open market purchases") on the NYSE or elsewhere. If on the
payment date for the dividend, the net asset value per share is equal to or less
than the market price per share plus estimated brokerage commissions (such
condition being referred to herein as "market premium"), the DRIP Agent will
invest the dividend amount in newly issued shares on behalf of the participants.
The number of newly issued shares to be credited to each participant's account
will be determined by dividing the dollar amount of the dividend by the net
asset value per share on the date the shares are issued, provided that the
maximum discount from the then current market price per share on the date of
issuance may not exceed 5%. If on the dividend payment date, the net asset value
per share is greater than the market value thereof (such condition being
referred to herein as "market discount"), the DRIP Agent will invest the
dividend amount in shares acquired on behalf of the participants in open-market
purchases.
In the event of a market discount on the dividend payment date, the DRIP
Agent will have until the last business day before the next date on which the
shares trade on an "ex-dividend" basis, but no more than 30 days after the
dividend payment date, to invest the dividend amount in shares acquired in
open-market purchases. It is contemplated that the Fund will pay monthly income
dividends. Therefore, the period during which open-market purchases can be made
will exist only from the payment date of the dividend through the date before
the next "ex-dividend" date, which typically will be approximately ten days. If,
before the DRIP Agent has completed its open-market purchases, the market price
of a share exceeds the net asset value per share, the average per share purchase
price paid by the DRIP Agent may exceed the net asset value per share, resulting
in the acquisition of fewer shares than if the dividend had been paid in newly
issued shares on the dividend payment date. Because of the foregoing difficulty
with respect to open-market purchases, the DRIP provides that if the DRIP Agent
is unable to invest the full dividend amount in open-market purchases during the
purchase period or if the market discount shifts to a market premium during the
purchase period, the DRIP Agent will cease making open-market purchases and will
invest the uninvested portion of the dividend amount in newly issued shares at
the close of business on the earlier of the last day of the purchase period or
the first day during the purchase period on which the market discount shifts to
a market premium.
The DRIP Agent maintains all shareholders' accounts in the DRIP and furnishes
written confirmation of all transactions in the accounts, including information
needed by shareholders for tax records. Shares in the account of each DRIP
participant will be held on his or her behalf by the DRIP Agent on behalf of the
DRIP participant, and each shareholder proxy will include those shares purchased
or received pursuant to the DRIP. The DRIP Agent will forward all proxy
solicitation materials to participants and vote proxies for shares held pursuant
to the DRIP in accordance with the instructions of the participants.
In the case of shareholders such as banks, brokers or nominees that hold
shares for others who are the beneficial owners, the DRIP Agent will administer
the DRIP on the basis of the number of shares certified from time to time by the
record shareholder's name and held for the account of beneficial owners who
participate in the DRIP.
There will be no brokerage charges with respect to shares issued directly by
the Fund as a result of dividends payable either in shares or in cash. However,
each participant will pay a pro rata share of brokerage commissions incurred
with respect to the DRIP Agents open-market purchases in connection with the
reinvestment of dividends.
The automatic reinvestment of dividends will not relieve participants of any
federal, state or local income tax that may be payable (or required to be
withheld) on the dividends.
16
Semi-Annual Report
================================================================================
AUTOMATIC DIVIDEND REINVESTMENT PLAN
(UNAUDITED)--(CONTINUED)
Shareholders participating in the DRIP may receive benefits not available to
shareholders not participating in the DRIP.
If the market price (plus commissions) of the Fund's shares is above their
net asset value, participants of the DRIP will receive shares of the Fund at
less than they could otherwise purchase them and will have shares with a cash
value greater than the value of any cash distribution they would have received
on their shares. If the market price (plus commissions) is below the net asset
value, participants will receive distributions in shares with a net asset value
greater than the value of any cash distribution they would have received on
their shares. However, there may be insufficient shares available in the market
to make distributions in shares at prices below the net asset value. Also,
because the Fund does not redeem its shares, the price on resale may be more or
less than the net asset value.
Experience under the DRIP may indicate that changes are desirable.
Accordingly, the Fund reserves the right to amend or terminate the DRIP. There
is no direct service charge to participants in the DRIP, however, the Fund
reserves the right to amend the DRIP to include a service charge payable by the
participants.
All correspondence concerning the DRIP should be directed to the DRIP Agent
at PFPC, Inc., PO Box 43027, Providence, RI 02940-3027.
17
Semi-Annual Report
================================================================================
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 2001
(UNAUDITED)
NAME, ADDRESS POSITION HELD PRINCIPAL OCCUPATION(S)
AND AGE WITH TRUST DURING PAST 5 YEARS
------------- ------------ ---------------------
William P. Daves, Jr. (78) Chairman of the Consultant to insurance and healthcare industries. Director,
11825 N. Pennsylvania St. Board, Trustee Chairman and Chief Executive Officer, FFG Insurance Co.
Carmel, IN 46032 Since July 1998 Chairman of the Board and Trustee of other mutual funds
managed by the Adviser.
Gregory J. Hahn* (43) President and Chartered Financial Analyst. Senior Vice President, Adviser.
11825 N. Pennsylvania St. Trustee Trustee, President and portfolio manager of other mutual funds
Carmel, IN 46032 Since July 1998 managed by the Adviser.
Harold W. Hartley (80) Trustee Chartered Financial Analyst. Director, Ennis Business Forms,
11825 N. Pennsylvania St. Since July 1998 Inc. Retired, Executive Vice President, Tenneco Financial
Carmel, IN 46032 Services, Inc. Trustee of other mutual funds managed by the Adviser.
Dr. R. Jan LeCroy (72) Trustee Director, Southwest Securities Group, Inc. Retired, President,
11825 N. Pennsylvania St. Since July 1998 Dallas Citizens Council. Trustee of other mutual funds managed by
Carmel, IN 46032 the Adviser.
Dr. Jess H. Parrish (76) Trustee Higher Education Consultant. Former President, Midland College
11825 N. Pennsylvania St. Since July 1998 Trustee of other mutual funds managed by the Adviser.
Carmel, IN 46032
David N. Walthall (58) Trustee Principal, Walthall Asset Management. Former President,
11825 N. Pennsylvania St. Since December 1998 Chief Executive Officer and Director of Lyrick Corporation.
Carmel, IN 46032 Formerly, President and CEO, Heritage Media Corporation. Formerly,
Director, Eagle National Bank. Trustee of other mutual funds managed
by the Adviser.
- --------------------
* The Trustee so indicated is an "interested person," as defined in the 1940
Act, of the Trust due to the positions indicated with the Adviser and its
affiliates.
All Trustees oversee the 17 Portfolios that make up the total fund complex
including 40|86 Strategic Income Fund, Conseco Fund Group, 40|86 Series Trust
and Conseco StockCar Stocks Mutual Fund, Inc.
Each Trustee serves until the expiration of the term of his designated class
and until his successor is elected and qualified, or until his death or
resignation, or removal as provided in the Fund's by-laws or charter or statute.
18
================================================================================
INVESTMENT ADVISER
40|86 Advisors, Inc.
Carmel, IN
TRANSFER AGENT
PFPC, Inc.
Providence, RI
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
Indianapolis, IN
CUSTODIAN
PFPC Trust Company
Philadelphia, PA
LEGAL COUNSEL
Kirkpatrick & Lockhart LLP
Washington, DC
40|86 STRATEGIC INCOME FUND
11815 North Pennsylvania Street, Carmel, IN 46032
800-852-4750
ITEM 2. CODE OF ETHICS.
Not applicable for semi-annual reports.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
Not applicable for semi-annual reports.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Not applicable for semi-annual reports.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
Not applicable for semi-annual reports.
ITEM 6. [RESERVED]
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
Not applicable for semi-annual reports.
ITEM 8. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not yet effective.
ITEM 9. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not yet applicable.
ITEM 10. 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 last fiscal
half-year (the registrant's second fiscal half-year in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial
reporting.
ITEM 11. EXHIBITS.
(a)(1) Not applicable for semi-annual reports.
(a)(2) Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 are attached hereto.
(a)(3) Not yet applicable.
(b) Certifications pursuant to 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) 40|86 STRATEGIC INCOME FUND
----------------------------------------------------
By (Signature and Title) /s/ GREGORY J. HAHN
--------------------------------------------------------
Gregory J. Hahn, President
(principal executive officer)
Date FEBRUARY 25, 2004
----------------------------------------------------------------------------
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/ GREGORY J. HAHN
--------------------------------------------------------
Gregory J. Hahn, President
(principal executive officer)
Date FEBRUARY 25, 2004
----------------------------------------------------------------------------
By (Signature and Title) /s/ AUDREY L. KURZAWA
--------------------------------------------------------
Audrey L. Kurzawa, Treasurer
(principal financial officer)
Date FEBRUARY 25, 2004
----------------------------------------------------------------------------