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 811-21637
Name of Fund: Diversified Income Strategies Portfolio, Inc.
Fund Address: P.O. Box 9011
Princeton, NJ 08543-9011
Name and address of agent for service: Robert C. Doll, Jr., Chief Executive
Officer, Diversified Income Strategies Portfolio, Inc., 800 Scudders Mill
Road, Plainsboro, NJ 08536. Mailing address: P.O. Box 9011, Princeton,
NJ 08543-9011
Registrant's telephone number, including area code: (609) 282-2800
Date of fiscal year end: 08/31/05
Date of reporting period: 09/01/04 - 08/31/05
Item 1 - Report to Stockholders
Diversified Income
Strategies Portfolio, Inc.
Annual Report
August 31, 2005
Diversified Income Strategies Portfolio, Inc.
The Benefits and Risks of Leveraging
Diversified Income Strategies Portfolio, Inc. utilizes leveraging through
borrowings or issuance of short-term debt securities or shares of Preferred
Stock. The concept of leveraging is based on the premise that the cost of assets
to be obtained from leverage will be based on short-term interest rates, which
normally will be lower than the income earned by the Fund on its longer-term
portfolio investments. To the extent that the total assets of the Fund
(including the assets obtained from leverage) are invested in higher-yielding
portfolio investments, the Fund's Common Stock shareholders will be the
beneficiaries of the incremental yield.
Leverage creates risks for holders of Common Stock including the likelihood of
greater net asset value and market price volatility. In addition, there is the
risk that fluctuations in interest rates on borrowings (or in the dividend rates
on any Preferred Stock, if the Fund were to issue Preferred Stock) may reduce
the Common Stock's yield and negatively impact its net asset value and market
price. If the income derived from securities purchased with assets received from
leverage exceeds the cost of leverage, the Fund's net income will be greater
than if leverage had not been used. Conversely, if the income from the
securities purchased is not sufficient to cover the cost of leverage, the Fund's
net income will be less than if leverage had not been used, and therefore the
amount available for distribution to Common Stock shareholders will be reduced.
Portfolio Information as of August 31, 2005
Percent of
Ten Largest Holdings Net Assets
- --------------------------------------------------------------------------------
SatBirds Capital Participations, Second Lien
Term Loan, 6.397% due 9/30/2013 ............................... 2.8%
XM Satellite Radio, Inc., 9.193% due 5/01/2009 .................. 2.8
Amkor Technology, Inc.,
Second Lien Term Loan, 8.33% due 10/27/2010 ................... 2.6
Omnova Solutions, Inc.,
11.25% due 6/01/2010 .......................................... 2.4
Universal City Florida Holding Co. I,
8.443% due 5/01/2010 .......................................... 2.4
FelCor Lodging LP, 7.78% due 6/01/2011 .......................... 2.4
Dobson Cellular Systems,
8.443% due 11/01/2011 ......................................... 2.4
New Skies Satellites NV,
8.539% due 11/01/2011 ......................................... 2.4
Graham Packaging Co. LP, Second Lien
Term Loan, 7.75% due 4/07/2012 ................................ 2.3
RJ Tower Corp. Tranche B Term Loan,
6.625% due 2/02/2007 .......................................... 2.3
- --------------------------------------------------------------------------------
Percent of
Five Largest Industries Net Assets
- --------------------------------------------------------------------------------
Cable--U.S. ..................................................... 10.7%
Information Technology .......................................... 10.3
Automotive ...................................................... 9.5
Housing ......................................................... 9.2
Manufacturing ................................................... 8.9
- --------------------------------------------------------------------------------
For Portfolio compliance purposes, the Portfolio's industry
classifications refer to any one or more of the industry
sub-classifications used by one or more widely recognized market indexes
or ratings group indexes, and/or as defined by Portfolio management. This
definition may not apply for purposes of this report, which may combine
industry sub-classifications for reporting ease.
- --------------------------------------------------------------------------------
Percent of
Quality Ratings by Total
S&P/Moody's Investments
- --------------------------------------------------------------------------------
BBB/Baa ......................................................... 1.6%
BB/Ba ........................................................... 5.6
B/B ............................................................. 68.8
CCC/Caa ......................................................... 9.2
D ............................................................... 0.9
NR (Not Rated) .................................................. 8.6
Other* .......................................................... 5.3
- --------------------------------------------------------------------------------
* Includes portfolio holdings in short-term investments.
2 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005
A Letter From the President
Dear Shareholder
Amid what we've coined a "muddle through" year for the financial markets, the
major market benchmarks managed to post positive results for the current
reporting period:
Total Returns as of August 31, 2005 6-month 12-month
====================================================================================
U.S. equities (Standard & Poor's 500 Index) +2.33% +12.56%
- ------------------------------------------------------------------------------------
Small-cap U.S. equities (Russell 2000 Index) +5.75% +23.10%
- ------------------------------------------------------------------------------------
International equities (MSCI Europe Australasia Far East Index) +1.98% +23.58%
- ------------------------------------------------------------------------------------
Fixed income (Lehman Brothers Aggregate Bond Index) +2.85% + 4.15%
- ------------------------------------------------------------------------------------
Tax-exempt fixed income (Lehman Brothers Municipal Bond Index) +2.85% + 5.31%
- ------------------------------------------------------------------------------------
High yield bonds (Credit Suisse First Boston High Yield Index) +1.35% + 8.98%
- ------------------------------------------------------------------------------------
Since June 2004, the Federal Reserve Board (the Fed) has tirelessly advanced its
interest rate-hiking program, bringing the federal funds rate to 3.5% by August
31 (and to 3.75% on September 20). Economists and investors have struggled to
project the Fed's future moves, vacillating from expectations for an impending
end to monetary tightening to fears that the central bank may increase interest
rates more than is necessary to moderate economic growth and keep inflation in
check. Most recently, the devastation of Hurricane Katrina added a new element
of ambiguity in terms of its impact on the economy and Fed sentiment. Many now
believe the Fed will suspend its interest rate-hiking campaign at some point
this year.
Equity market returns over the past several months have reflected a degree of
investor uncertainty. After a strong finish to 2004, the S&P 500 Index posted
gains in four of the first eight months of 2005. Up to this point, strong
corporate earnings reports and low long-term bond yields have worked in favor of
equities. Factors that pose the greatest risks to stocks include record-high oil
prices, continued interest rate hikes and the possibility for disappointing
earnings for the remainder of the year.
Fixed income markets have fared relatively well in the face of monetary
tightening. As the short end of the yield curve moved in concert with Fed
interest rate hikes, long-term bond yields remained low, perpetuating the yield
curve flattening trend. Because bond prices move in the opposite direction of
yields, the result has been that longer-term bonds have outperformed short-term
bonds. At period end, the spread between two-year and 10-year Treasury yields
was just 18 basis points (.18%).
Financial markets are likely to face continued crosscurrents for the remainder
of 2005, particularly as the economy digests the impact of Hurricane Katrina.
Nevertheless, opportunities do exist and we encourage you to work with your
financial advisor to diversify your portfolio among a variety of asset types.
This can help to diffuse risk while also tapping into the potential benefits of
a broader range of investment alternatives. As always, we thank you for trusting
Merrill Lynch Investment Managers with your investment assets.
Sincerely,
/s/ Robert C. Doll, Jr.
Robert C. Doll, Jr.
President and Director
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005 3
A Discussion With Your Fund's Portfolio Manager
Following the Portfolio's initial ramp-up, we made ample use of our
leverage facilities and looked for opportunities to diversify the portfolio
through a credit-driven security selection process.
How has the Portfolio performed since its inception in light of the existing
market conditions?
Since its inception on January 31, 2005 through August 31, 2005, the Common
Stock of Diversified Income Strategies Portfolio, Inc. had net annualized yields
of 8.24% and 8.63%, based on a period-end per share net asset value of $18.38
and a per share market price of $17.53, respectively, and $.883 per share income
dividends. Over the same period, the total investment return on the Portfolio's
Common Stock was +0.42%, based on a change in per share net asset value from
$19.10 to $18.38, and assuming reinvestment of all distributions. For the same
period, the Portfolio's benchmark, which consists of 20% of the Credit Suisse
First Boston (CSFB) High Yield Index and 80% of the CSFB Leveraged Loan Index,
returned +3.31%.
For the six-month period ended August 31, 2005, the total investment return on
the Portfolio's Common Stock was +0.11%, based on a change in per share net
asset value from $19.16 to $18.38, and assuming reinvestment of all
distributions.
For a description of the Portfolio's total investment return based on a change
in the per share market value of the Portfolio's Common Stock (as measured by
the trading price of the Portfolio's shares on the New York Stock Exchange), and
assuming reinvestment of dividends, please refer to the Financial Highlights
section of this report. As a closed-end fund, the Portfolio's shares may trade
in the secondary market at a premium or discount to the Portfolio's net asset
value. As a result, total investment returns based on changes in the market
value of the Portfolio's Common Stock can vary significantly from total
investment returns based on changes in the Portfolio's net asset value.
The high yield market was quite volatile over the past several months. General
Motors Corp. (GM) announced higher-than-expected losses on March 16. This
exacerbated concerns that both GM and Ford Motor Company would be lowered to
junk bond status and exerted significant downward pressure on the entire high
yield market. Concurrent with this development, the 10-year Treasury rate shot
up to 4.6% in the last week of March, adding yet more downward price pressure on
the high yield market. The Merrill Lynch High Yield Index declined 2.72% in
March and 1.04% in April. The market subsequently gained some perspective on the
GM and Ford Motor downgrades and staged a four-month rally totaling
approximately 4.9% by August 31. This high yield upturn was complemented by a
rally in the 10-year Treasury rate, which finished the period at 4.02%, 58 basis
points (.58%) off its peak for the past six months. The later part of this
Treasury rally was fueled by a flight to quality in the aftermath of Hurricane
Katrina.
Conditions in the leveraged loan market were much less unsettled than those of
the high yield bond market. Three primary factors account for this. First,
credit concerns have less of an impact on leveraged loans compared to high yield
bonds due to the senior secured status of most leveraged bank loans. Second,
leveraged bank loans are set off of the London InterBank Offered Rate (LIBOR)
and are much less impacted by moves in long-term interest rates. Third, demand
for bank loans has been greatly boosted by the influx of collateralized loan
obligations (CLOs) into the market. For the eight months ended August 31, 2005,
we saw $26.2 billion in CLO issuance. Generally speaking, bank loans lack call
protection, and corporate treasurers have exploited this robust demand to
refinance at increasingly tighter spreads to LIBOR.
Despite increasing leverage and greater high yield issuance at the lower end of
the credit-rating spectrum, default rates continued to decline, reaching their
lowest levels since 1994 at .45% for leveraged loans and .91% for high yield
bonds, as of June 30, 2005, according to CSFB. While strong market liquidity and
gross domestic product growth projections in the 3% - 4% range have enabled
companies to stretch their credit parameters, it must be noted that default
rates are a lagging indicator. The average incubation period for a high yield
credit default is roughly 36 months. Consequently, current rates are more
reflective of the underwriting standards of the 2002-2003 period than those of
today.
What factors most influenced Portfolio performance?
The Portfolio's underperformance of its benchmark is largely attributed to the
fact that its ramp-up phase (the period during which we were investing the
assets gathered in the initial offering) coincided with the peak of the high
yield market -- just prior to the aforementioned GM/Ford-related credit
turbulence. Moreover, the Portfolio was constructed to be interest-rate
defensive and credit-risk offensive. With an
4 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005
average credit rating of B2, the Portfolio felt the full brunt of the turn in
the credit cycle, and its net asset value suffered accordingly.
On the positive side, investors' fears of further credit turmoil were mostly
unrealized. The market ultimately settled down, and we experienced strong
returns for the last three months of this reporting period. Specifically, on a
net asset value total return basis, the Portfolio posted a return of -5.4%
versus its benchmark return of +0.1% for the three months ended May 31, 2005,
and a return of +5.8% versus a benchmark return of +2.5% for the three months
ended August 31, 2005.
The Federal Reserve Board (the Fed) continued raising short-term interest rates
throughout the reporting period, and the Portfolio's dividend responded
accordingly. Although we did not anticipate a flattening yield curve, the
Portfolio remains defensively positioned in the event of rising longer-term
interest rates.
Specific investments that contributed positively to performance during the
reporting period included Dobson Cellular Systems, IWO Holdings, Inc. and
Calpine Generating Co. LLC. The Portfolio's $5 million investment in Dobson
Cellular, a wireless telecommunications company, rallied from par to 104 during
the period. This move was prompted by management's announcement of a new roaming
agreement with Cingular, effective through 2009, and reduced future uncertainty
regarding this credit.
On August 30, 2005, Sprint Nextel Corp. announced plans to acquire IWO. Sprint
Nextel is an investment-grade credit, and the Portfolio's $4 million floating
rate note in IWO traded up accordingly, from par to 105.
The debt and equity of Calpine Generating Co., a gas-fired turbine power
generation company, exhibited much volatility during the period. Although
Calpine runs the most efficient gas turbine fleet in the country, it is still
susceptible to high natural gas prices, and has limited flexibility given the
debt service demands arising from a highly levered balance sheet. During the
period, the company successfully addressed some balance sheet issues, and the
Portfolio's $5 million in secured floating rate notes responded positively,
rising in price from 97.75 to 101.25.
Investments that detracted from performance during the period included Anchor
Glass Container Corp., Exide Technologies and Wise Metals Group LLC. The
Portfolio's $4.1 million investment in glass bottle manufacturer Anchor declined
in price from 105 to 67 during the period. The company's financial performance
suffered in the midst of high natural gas and soda ash prices, culminating in a
Chapter 11 bankruptcy filing on August 8, 2005.
Our $4 million bond holding in battery manufacturer Exide slid in price from par
to 77.25 after the company missed its cash flow targets for its fiscal quarter
ended March 31, 2005. Exide attributes this performance to high lead prices and
slack internal controls, which we understand the company has addressed.
Finally, our $3 million bond position in Wise Metals, a manufacturer of aluminum
cans for the beverage industry, retreated in price from 103 to 82 during the
period. The decline came in response to disappointing financial results posted
in the last few quarters due to margin pressure from high energy, transportation
and raw material costs.
How have you managed the Portfolio since inception?
We completed the Portfolio's initial ramp-up in March and are employing roughly
30% leverage to help amplify returns. The Portfolio's 80% floating rate/20%
fixed rate composition gives it a duration that is roughly 25% of the CSFB High
Yield Index. Stated another way, we have removed about 75% of the price risk
that would be experienced by a monoline fixed rate high yield bond fund. (For a
complete discussion of the benefits and risks of leveraging, see page 2 of this
report to shareholders.)
How would you characterize the Portfolio's position at the close of the period?
We will look to continue to diversify the portfolio, pursue a credit-driven
selection process, and employ the best strategies available in our efforts to
enhance performance for our shareholders going forward.
Kevin J. Booth
Vice President and Portfolio Manager
September 20, 2005
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005 5
Schedule of Investments (in U.S. dollars)
Face
Amount Corporate Bonds Value
==================================================================================================
Aerospace & Defense--4.3%
EUR 4,000,000 Aero Invest 1 SA, 10.677% due 3/01/2015 (f) $ 4,642,280
USD 2,000,000 DynCorp International LLC, 9.50%
due 2/15/2013 (d) 1,975,000
3,000,000 Vought Aircraft Industries, Inc., 8% due 7/15/2011 2,955,000
-------------
9,572,280
==================================================================================================
Automotive--4.4%
4,200,000 Delco Remy International, Inc., 7.599%
due 4/15/2009 (b) 4,158,000
2,875,000 Exide Technologies, 10.50% due 3/15/2013 (d) 2,213,750
3,000,000 Stoneridge Inc., 11.50% due 5/01/2012 3,195,000
-------------
9,566,750
==================================================================================================
Broadcasting--6.5%
1,075,000 Emmis Communications Corp., 9.314%
due 6/15/2012 (b) 1,088,438
2,000,000 Granite Broadcasting Corp., 9.75% due 12/01/2010 1,887,500
2,500,000 Sirius Satellite Radio, Inc., 9.625% due 8/01/2013 (d) 2,456,250
6,000,000 XM Satellite Radio, Inc., 9.193% due 5/01/2009 (b) 6,067,500
3,000,000 Young Broadcasting Inc., 10% due 3/01/2011 2,887,500
-------------
14,387,188
==================================================================================================
Cable--International--1.3%
EUR 2,250,000 Kabel BW Holdings GmbH, 9.486% due 2/03/2015 2,812,119
==================================================================================================
Cable--U.S.--7.9%
USD 3,000,000 Cablevision Systems Corp. Series B, 7.88%
due 4/01/2009 (b) 3,097,500
5,000,000 CCO Holdings LLC, 7.535% due 12/15/2010 (b) 4,950,000
4,000,000 Intelsat Bermuda Ltd., 8.695% due 1/15/2012 (b)(d) 4,070,000
5,000,000 New Skies Satellites NV, 8.539% due 11/01/2011 (b) 5,187,500
-------------
17,305,000
==================================================================================================
Chemicals--3.4%
2,000,000 Huntsman LLC, 11.099% due 7/15/2011 (b) 2,160,000
5,000,000 Omnova Solutions, Inc., 11.25% due 6/01/2010 5,325,000
-------------
7,485,000
==================================================================================================
Consumer--Non-Durables--5.5%
4,000,000 Ames True Temper, Inc., 7.599% due 1/15/2012 (b) 3,900,000
4,000,000 Chattem, Inc., 6.87% due 3/01/2010 (b) 4,030,000
4,000,000 Hines Nurseries, Inc., 10.25% due 10/01/2011 4,110,000
-------------
12,040,000
==================================================================================================
Diversified Media--3.3%
2,000,000 Primedia, Inc., 9.165% due 5/15/2010 (b) 2,122,500
5,000,000 Universal City Florida Holding Co. I, 8.443%
due 5/01/2010 (b) 5,237,500
-------------
7,360,000
==================================================================================================
Energy--Other--3.2%
4,000,000 Aventine Renewable Energy Holdings, Inc., 9.41%
due 12/15/2011 (b)(d) 4,020,000
3,000,000 Parker Drilling Co., 8.62% due 9/01/2010 (b) 3,120,000
-------------
7,140,000
==================================================================================================
Food & Drug--1.8%
4,000,000 Duane Reade, Inc., 7.91% due 12/15/2010 (b) 3,860,000
==================================================================================================
Gaming--1.8%
4,000,000 Penn National Gaming, Inc., 6.75% due 3/01/2015 3,960,000
==================================================================================================
Health Care--3.1%
2,000,000 Elan Finance Plc, 7.79% due 11/15/2011 (b)(d) 1,770,000
5,000,000 Universal Hospital Services, Inc., 10.125%
due 11/01/2011 5,050,000
-------------
6,820,000
==================================================================================================
Housing--6.5%
4,000,000 Builders Firstsource, Inc., 8.04% due 2/15/2012 (b)(d) 4,020,000
1,500,000 Compression Polymers Corp, 10.46%
due 7/01/2012 (b)(d) 1,503,750
4,335,000 Goodman Global Holding Co., Inc., 6.41%
due 6/15/2012 (b)(d) 4,313,325
4,500,000 Nortek, Inc., 8.50% due 9/01/2014 4,376,250
-------------
14,213,325
==================================================================================================
Information Technology--6.9%
2,000,000 Activant Solutions, Inc., 9.504% due 4/01/2010 (b)(d) 2,045,000
4,000,000 MagnaChip Semiconductor SA, 6.66% due 12/15/2011 (b) 4,020,000
Sungard Data Systems, Inc. (d):
1,200,000 8.525% due 8/15/2013 (b) 1,242,000
1,800,000 9.125% due 8/15/2013 1,890,000
2,000,000 10.25% due 8/15/2015 2,090,000
4,000,000 Telcordia Technologies Inc., 10% due 3/15/2013 (d) 3,800,000
-------------
15,087,000
==================================================================================================
Leisure--2.4%
5,000,000 FelCor Lodging LP, 7.78% due 6/01/2011 (b) 5,212,500
==================================================================================================
Manufacturing--6.8%
2,975,000 Brand Services, Inc., 12% due 10/15/2012 3,168,375
4,000,000 CPI Holdco, Inc., 9.672% due 2/01/2015 (b) 3,966,568
2,650,000 Mueller Group, Inc., 10% due 5/01/2012 2,838,813
3,000,000 Propex Fabrics, Inc., 10% due 12/01/2012 2,895,000
2,500,000 Trimas Corp., 9.875% due 6/15/2012 2,137,500
-------------
15,006,256
==================================================================================================
Packaging--6.0%
2,000,000 AEP Industries, Inc., 7.875% due 3/15/2013 (d) 2,039,368
4,095,000 Anchor Glass Container Corp., 11%
due 2/15/2013 (e) 2,743,650
4,500,000 Constar International, Inc., 7.165%
due 2/15/2012 (b)(d) 4,320,000
2,000,000 Tekni-Plex, Inc., 8.75% due 11/15/2013 (d) 1,750,000
3,000,000 Wise Metals Group LLC, 10.25% due 5/15/2012 2,467,500
-------------
13,320,518
==================================================================================================
Paper--4.6%
5,000,000 Abitibi-Consolidated, Inc., 6.91% due 6/15/2011 (b) 5,000,000
2,000,000 Boise Cascade LLC, 6.474% due 10/15/2012 (b) 2,015,000
3,000,000 NewPage Corp., 9.943% due 5/01/2012 (b)(d) 2,985,000
-------------
10,000,000
==================================================================================================
Service--2.7%
5,000,000 HydroChem Industrial Services, Inc., 9.25%
due 2/15/2013 (d) 4,900,000
1,000,000 Neff Rental LLC, 11.25% due 6/15/2012 (d) 1,065,000
-------------
5,965,000
==================================================================================================
Telecommunications--3.7%
2,000,000 Qwest Communications International, Inc., 7.29%
due 2/15/2009 (b) 1,990,000
4,000,000 Time Warner Telecom Holdings, Inc., 7.79%
due 2/15/2011 (b) 4,100,000
2,000,000 US LEC Corp. Class A, 11.89% due 10/01/2009 (b) 2,050,000
-------------
8,140,000
==================================================================================================
6 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005
Schedule of Investments (continued) (in U.S. dollars)
Face
Amount Corporate Bonds Value
==================================================================================================
Transportation--3.6%
USD 4,000,000 Progress Rail Services Corp., 7.75%
due 4/01/2012 (d) $ 4,065,000
4,000,000 Titan Petrochemicals Group Ltd., 8.50%
due 3/18/2012 (d) 3,820,000
-------------
7,885,000
==================================================================================================
Utility--4.2%
5,000,000 Calpine Generating Co. LLC, 9.26%
due 4/01/2010 (b) 5,062,500
4,000,000 Dynegy Holdings, Inc., 10.099%
due 7/15/2008 (b)(d) 4,250,000
-------------
9,312,500
==================================================================================================
Wireless Communications--6.4%
2,000,000 AirGate PCS, Inc., 7.349% due 10/15/2011 (b) 2,075,000
5,000,000 Dobson Cellular Systems, 8.443%
due 11/01/2011 (b) 5,200,000
4,000,000 IWO Holdings, Inc., 7.349% due 1/15/2012 (b) 4,200,000
2,500,000 US Unwired, Inc., 7.66% due 6/15/2010 (b) 2,600,000
-------------
14,075,000
- --------------------------------------------------------------------------------------------------
Total Corporate Bonds
(Cost--$227,516,478)--100.3% 220,525,436
==================================================================================================
Fixed Rate Loan Interests
==================================================================================================
Health Care--1.9%
4,000,000 HealthSouth Corp. Term Loan, 10.375%
due 1/16/2011 4,150,000
==================================================================================================
Total Fixed Rate Loan Interests
(Cost--$4,440,000)--1.9% 4,150,000
==================================================================================================
Floating Rate Loan Interests (a)
==================================================================================================
Automotive--5.1%
3,000,000 Delphi Automotive Systems Corp. Term Loan,
10.30% due 6/14/2011 3,082,767
2,996,226 Metaldyne Corp. Term Loan D, 8.016%
due 12/31/2009 2,984,056
5,000,000 RJ Tower Corp. Tranche B Term Loan, 6.625%
due 2/02/2007 5,073,440
-------------
11,140,263
==================================================================================================
Cable--U.S.--2.8%
EUR 5,000,000 SatBirds Capital Participations Second Lien Term
Loan, 6.397% due 10/04/2013 6,156,916
==================================================================================================
Chemicals--2.3%
USD 1,995,000 PQ Corp. Term Loan, 5.50% due 2/11/2012 2,021,184
3,000,000 Wellman, Inc. Second Lien Term Loan, 10.46%
due 2/10/2010 3,045,000
-------------
5,066,184
==================================================================================================
Consumer--Non-Durables--2.3%
5,000,000 American Safety Razor Co. Tranche C Term Loan,
10.31% due 8/28/2012 5,062,500
==================================================================================================
Energy--Exploration & Production--2.3%
Quest Cherokee LLC:
1,000,289 Line of Credit, 8.325% due 12/31/2008 1,000,289
4,152,619 Term Loan B, 8.50%--10.25% due 7/22/2010 4,152,619
-------------
5,152,908
==================================================================================================
Gaming--1.4%
3,000,000 Resorts International Holdings LLC Second Lien
Term Loan, 9.42% due 4/26/2013 3,012,189
==================================================================================================
Housing--2.7%
1,987,448 Lake at Las Vegas Joint Venture Term Loan,
6.162%--6.51% due 2/01/2010 2,016,763
4,000,000 Stile U.S. Acquisition Corp. Bridge Loan, 9.384%
due 4/06/2016 4,000,000
-------------
6,016,763
==================================================================================================
Information Technology--3.4%
5,500,000 Amkor Technology, Inc. Second Lien Term Loan,
8.33% due 10/27/2010 5,647,813
1,770,000 Fidelity National Information Solutions, Inc. Term
Loan B, 5.321% due 3/09/2013 1,774,425
-------------
7,422,238
==================================================================================================
Manufacturing--2.1%
4,622,037 EaglePicher Holdings, Inc. Tranche B Term Loan,
10% due 8/07/2009 (e) 4,593,149
==================================================================================================
Metal--Other--1.4%
Euramax International Plc:
1,500,000 First Lien Term Loan B 6.125% due 6/29/2012 1,511,562
1,500,000 Second Lien Term Loan, 10.55%
due 6/29/2013 1,522,500
-------------
3,034,062
==================================================================================================
Packaging--2.3%
5,000,000 Graham Packaging Second Lien Term Loan,
7.75% due 4/07/2012 5,137,500
==================================================================================================
Paper--1.9%
White Birch Paper Co.:
1,995,000 First Lien Term Loan, 6.60%--13%
due 4/08/2012 2,049,862
2,000,000 Second Lien Term Loan, 10.909%
due 4/08/2013 2,030,000
-------------
4,079,862
==================================================================================================
Retail--1.9%
4,000,000 American Reprographics Co. LLC Second Lien Term
Loan, 10.235% due 12/18/2009 4,160,000
==================================================================================================
Telecommunications--1.4%
3,000,000 FairPoint Communications, Inc. Term Loan B,
5.438%--5.563% due 2/08/2012 3,036,564
==================================================================================================
Utility--1.5%
3,300,000 Covanta Energy Corp. Second Lien Term Loan,
8.96%--9.141% due 6/24/2013 3,324,750
- --------------------------------------------------------------------------------------------------
Total Floating Rate Loan Interests
(Cost--$76,604,713)--34.8% 76,395,848
==================================================================================================
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005 7
Schedule of Investments (concluded) (in U.S. dollars)
Face
Amount Short-Term Securities Value
==================================================================================================
Commercial Paper**--7.7%
USD 4,000,000 Cinergy Corp., 3.69%
due 9/22/2005 $ 3,991,390
4,000,000 Fortune Brands, Inc., 3.64%
due 9/14/2005 3,994,742
5,000,000 Hertz Corp., 4.01% due 9/28/2005 4,984,963
4,000,000 Oneok Inc., 3.68% due 9/23/2005 3,991,004
-------------
16,962,099
Beneficial
Interest Short-Term Securities Value
==================================================================================================
USD 26,855 Merrill Lynch Liquidity Series, LLC Cash Sweep
Series I (c) $ 26,855
- --------------------------------------------------------------------------------------------------
Total Short-Term Securities (Cost--$16,988,954)--7.7% 16,988,954
==================================================================================================
Total Investments (Cost--$325,550,145*)--144.7% 318,060,238
Liabilities in Excess of Other Assets--(44.7%) (98,312,535)
-------------
Net Assets--100.0% $ 219,747,703
=============
- --------------------------------------------------------------------------------
* The cost and unrealized appreciation (depreciation) of investments as of
August 31, 2005, as computed for federal income tax purposes, were as
follows:
Aggregate cost ........................................... $325,453,526
============
Gross unrealized appreciation ............................ $ 1,657,000
Gross unrealized depreciation ............................ (9,050,288)
------------
Net unrealized depreciation .............................. $ (7,393,288)
============
** Commercial Paper is traded on a discount basis; the interest rate shown
reflects the discount rate paid at the time of purchase by the Portfolio.
(a) Floating rate loan interests in which the Portfolio invests generally pay
interest at rates that are periodically redetermined by reference to a
base lending rate plus a premium. The base lending rates are generally (i)
the lending rate offered by one or more major European banks, such as
LIBOR (London InterBank Offered Rate), (ii) the prime rate offered by one
or more major U.S. banks or (iii) the certificate of deposit rate.
(b) Floating rate note.
(c) Investments in companies considered to be an affiliate of the Portfolio,
for purposes of Section 2(a)(3) of the Investment Company Act of 1940,
were as follows:
--------------------------------------------------------------------------
Net Interest
Affiliate Activity Income
--------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC
Cash Sweep Series I $26,855 $86,013
--------------------------------------------------------------------------
(d) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(e) Non-income producing security; issuer filed for bankruptcy or is in
default of interest payments.
(f) Represents a pay-in-kind security that may pay interest/dividends in
additional face/shares.
For Portfolio compliance purposes, the Portfolio's industry
classifications refer to any one or more of the industry
sub-classifications used by one or more widely recognized market indexes
or ratings group indexes, and/or as defined by Portfolio management. This
definition may not apply for purposes of this report, which may combine
industry sub-classifications for reporting ease. Industries are shown as a
percent of net assets. These industry classifications are unaudited.
Swaps entered into as of August 31, 2005 were as follows:
----------------------------------------------------------------------------------
Unrealized
Notional Appreciation
Amount (Depreciation)
----------------------------------------------------------------------------------
Sold credit default protection on General
Motors Corp. and receive 5.25%
Broker, Morgan Stanley Capital
Services, Inc.
Expires June 2008 $ 5,000,000 $ 46,220
Sold credit default protection on ACES
High Yield Index (10%--13% Tranche)
and receive 5%
Broker, Morgan Stanley Capital
Services, Inc.
Expires March 2010 $ 7,000,000 (426,559)
Sold credit default protection on Qwest
Capital Funding Inc. and receive 5.75%
Broker, Deutsche Bank AG
Expires June 2010 $ 3,000,000 166,353
Sold credit default protection on Dow Jones
CDX North America High Yield B Index
Series 4 and receive 3.4%
Broker, Morgan Stanley Capital
Services, Inc.
Expires June 2010 $ 5,000,000 97,560
Pay a fixed rate of 4.853% and receive a
floating rate based on 3-month USD LIBOR
Broker, Lehman Brothers Special Finance
Expires March 2013 $31,000,000 (963,022)
----------------------------------------------------------------------------------
Total $ (1,079,448)
==============
Currency Abbreviations:
EUR Euro
USD U.S. Dollar
See Notes to Financial Statements.
8 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005
Statement of Assets, Liabilities and Capital
As of August 31, 2005
======================================================================================================================
Assets
- ----------------------------------------------------------------------------------------------------------------------
Investments in unaffiliated securities, at value
(identified cost--$325,523,290) ............................ $ 318,033,383
Investments in affiliated securities, at value
(identified cost--$26,855) ................................. 26,855
Unrealized appreciation on swaps ............................ 166,353
Foreign cash (cost--$168) ................................... 43
Interest receivable (including $2,799 from affiliates) ...... 5,388,329
Prepaid expenses and other assets ........................... 13,229
-------------
Total assets ................................................ 323,628,192
-------------
======================================================================================================================
Liabilities
- ----------------------------------------------------------------------------------------------------------------------
Loans ....................................................... 101,400,000
Unrealized depreciation on swaps ............................ 1,245,801
Swap premiums received ...................................... 52,117
Payables:
Dividends to shareholders ................................ $ 492,946
Swaps .................................................... 268,289
Investment adviser ....................................... 157,819
Offering costs ........................................... 127,554
Interest on loans ........................................ 74,037
Other affiliates ......................................... 1,911 1,122,556
-------------
Accrued expenses ............................................ 60,015
-------------
Total liabilities ........................................... 103,880,489
-------------
======================================================================================================================
Net Assets
- ----------------------------------------------------------------------------------------------------------------------
Net assets .................................................. $ 219,747,703
=============
======================================================================================================================
Capital
- ----------------------------------------------------------------------------------------------------------------------
Common Stock, par value $.10 per share; 200,000,000 shares
authorized (11,955,236 shares issued and outstanding) ...... $ 1,195,524
Paid-in capital in excess of par ............................ 226,715,831
Undistributed investment income--net ........................ $ 648,249
Accumulated realized capital losses--net .................... (236,341)
Unrealized depreciation--net ................................ (8,575,560)
-------------
Total accumulated losses--net ............................... (8,163,652)
-------------
Total capital--Equivalent to $18.38 net asset value per share
of Common Stock (market price--$17.53) ..................... $ 219,747,703
=============
See Notes to Financial Statements.
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005 9
Statement of Operations
For the Period January 31, 2005+ to August 31, 2005
======================================================================================================================
Investment Income
- ----------------------------------------------------------------------------------------------------------------------
Interest (including $86,013 from affiliates) ................ $ 12,725,498
Other income ................................................ 33,262
-------------
Total income ................................................ 12,758,760
-------------
======================================================================================================================
Expenses
- ----------------------------------------------------------------------------------------------------------------------
Loan interest expense ....................................... $ 1,522,174
Investment advisory fees .................................... 1,279,672
Borrowing costs ............................................. 102,396
Professional fees ........................................... 88,054
Accounting services ......................................... 53,315
Directors' fees and expenses ................................ 28,672
Transfer agent fees ......................................... 17,181
Printing and shareholder reports ............................ 16,952
Custodian fees .............................................. 14,123
Pricing services ............................................ 6,812
Other ....................................................... 13,615
-------------
Total expenses before waiver ................................ 3,142,966
Waiver of expenses .......................................... (355,611)
-------------
Total expenses after waiver ................................. 2,787,355
-------------
Investment income--net ...................................... 9,971,405
-------------
======================================================================================================================
Realized & Unrealized Loss--Net
- ----------------------------------------------------------------------------------------------------------------------
Realized loss on:
Investments--net ......................................... (213,330)
Swaps--net ............................................... (393,210)
Foreign currency transactions--net ....................... (36,312) (642,852)
-------------
Unrealized depreciation on:
Investments--net ......................................... (7,489,907)
Swaps--net ............................................... (1,079,448)
Foreign currency transactions--net ....................... (6,205) (8,575,560)
------------------------------
Total realized and unrealized loss--net ..................... (9,218,412)
-------------
Net Increase in Net Assets Resulting from Operations ........ $ 752,993
=============
+ Commencement of operations.
See Notes to Financial Statements.
10 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005
Statement of Changes in Net Assets
For the Period
January 31, 2005+
to August 31,
Increase (Decrease) in Net Assets: 2005
=================================================================================================================================
Operations
- ---------------------------------------------------------------------------------------------------------------------------------
Investment income--net .................................................................. $ 9,971,405
Realized loss--net ...................................................................... (642,852)
Unrealized depreciation--net ............................................................ (8,575,560)
-------------
Net increase in net assets resulting from operations .................................... 752,993
-------------
=================================================================================================================================
Dividends to Shareholders
- ---------------------------------------------------------------------------------------------------------------------------------
Dividends to shareholders from investment income--net ................................... (8,916,645)
-------------
=================================================================================================================================
Common Stock Transactions
- ---------------------------------------------------------------------------------------------------------------------------------
Proceeds from issuance of Common Stock .................................................. 228,245,000
Offering costs resulting from the issuance of Common Stock .............................. (433,653)
-------------
Net increase in net assets resulting from Common Stock transactions ..................... 227,811,347
-------------
=================================================================================================================================
Net Assets
- ---------------------------------------------------------------------------------------------------------------------------------
Total increase in net assets ............................................................ 219,647,695
Beginning of period ..................................................................... 100,008
-------------
End of period* .......................................................................... $ 219,747,703
=============
* Undistributed investment income--net ................................................. $ 648,249
=============
+ Commencement of operations.
See Notes to Financial Statements.
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005 11
Statement of Cash Flows
For the Period January 31, 2005+ to August 31, 2005
=================================================================================================================================
Cash Used for Operating Activities
- ---------------------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations .................................... $ 752,993
Adjustments to reconcile net increase in net assets resulting from operations to net cash
provided by operating activities:
Increase in receivables .............................................................. (5,388,329)
Increase in prepaid expenses and other assets ........................................ (13,229)
Increase in liabilities .............................................................. 614,188
Realized and unrealized loss--net .................................................... 9,218,412
Realized loss on swaps ............................................................... (393,210)
Realized and unrealized loss on foreign currency transactions ........................ (42,517)
Amortization of premium and discount ................................................. (26,392)
Proceeds from sales of long-term securities ............................................. 44,271,348
Purchases of long-term securities ....................................................... (353,475,739)
Purchases of short-term securities--net ................................................. (16,532,692)
-------------
Net cash used for operating activities .................................................. (321,015,167)
-------------
=================================================================================================================================
Cash Provided by Financing Activities
- ---------------------------------------------------------------------------------------------------------------------------------
Proceeds from issuance of Common Stock .................................................. 228,245,000
Cash receipts from borrowings ........................................................... 154,200,000
Cash payments on borrowings ............................................................. (52,800,000)
Cash payments on offering costs ......................................................... (306,099)
Dividends paid to shareholders .......................................................... (8,423,699)
-------------
Net cash provided by financing activities ............................................... 320,915,202
-------------
=================================================================================================================================
Cash
- ---------------------------------------------------------------------------------------------------------------------------------
Net decrease in cash .................................................................... (99,965)
Cash at beginning of year ............................................................... 100,008
-------------
Cash at end of year ..................................................................... $ 43
=============
=================================================================================================================================
Cash Flow Information
- ---------------------------------------------------------------------------------------------------------------------------------
Cash paid for interest .................................................................. $ 1,448,137
=============
+ Commencement of operations.
See Notes to Financial Statements.
12 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005
Financial Highlights
For the Period
January 31, 2005+
The following per share data and ratios have been derived to August 31,
from information provided in the financial statements. 2005
=================================================================================================================================
Per Share Operating Performance
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period .................................................... $ 19.10
-------------
Investment income--net*** ............................................................... .84
Realized and unrealized loss--net ....................................................... (.77)
-------------
Total from investment operations ........................................................ .07
-------------
Less dividends from investment income--net .............................................. (.75)
-------------
Offering costs resulting from the issuance of Common Stock .............................. (.04)
-------------
Net asset value, end of period .......................................................... $ 18.38
=============
Market price per share, end of period ................................................... $ 17.53
=============
=================================================================================================================================
Total Investment Return**
- ---------------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share ...................................................... .42%@
=============
Based on market price per share ......................................................... (8.53%)@
=============
=================================================================================================================================
Ratios to Average Net Assets
- ---------------------------------------------------------------------------------------------------------------------------------
Expenses, net of waiver and excluding interest expense .................................. 1.00%*
=============
Expenses, net of waiver ................................................................. 2.20%*
=============
Expenses ................................................................................ 2.48%*
=============
Investment income--net .................................................................. 7.88%*
=============
=================================================================================================================================
Leverage
- ---------------------------------------------------------------------------------------------------------------------------------
Amount of borrowings, end of period (in thousands) ...................................... $ 101,400
=============
Average amount of borrowings outstanding during the period (in thousands) ............... $ 75,543
=============
Average amount of borrowings outstanding per share during the period*** ................. $ 6.33
=============
=================================================================================================================================
Supplemental Data
- ---------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period (in thousands) ................................................ $ 219,748
=============
Portfolio turnover ...................................................................... 17.43%
=============
* Annualized.
** Total investment returns based on market price, which can be significantly
greater or lesser than the net asset value, may result in substantially
different returns. Total investment returns exclude the effects of sales
charges.
*** Based on average shares outstanding.
+ Commencement of operations.
@ Aggregate total investment return.
See Notes to Financial Statements.
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005 13
Notes to Financial Statements
1. Significant Accounting Policies:
Diversified Income Strategies Portfolio, Inc. (the "Fund") is registered under
the Investment Company Act of 1940, as amended, as a diversified, closed-end
management investment company. Prior to commencement of operations on January
31, 2005, the Fund had no operations other than those relating to organizational
matters and the sale of 5,236 shares of Common Stock on January 18, 2005 to Fund
Asset Management, L.P. ("FAM") for $100,008. The Fund's financial statements are
prepared in conformity with U.S. generally accepted accounting principles, which
may require the use of management accruals and estimates. Actual results may
differ from these estimates. The Fund determines and makes available for
publication the net asset value of its Common Stock on a daily basis. The Fund's
Common Stock shares are listed on the New York Stock Exchange ("NYSE") under the
symbol DVF.
(a) Corporate debt obligations -- The Fund invests principally in debt
obligations of companies, including loan interests made by banks and other
financial institutions and both privately and publicly offered corporate bonds
and notes. Because agents and intermediaries are primarily commercial banks or
other financial institutions, the Fund's investment in loan interests could be
considered concentrated in financial institutions.
(b) Valuation of investments -- Loan interests are valued in accordance with
guidelines established by the Board of Directors. Loan interests are valued at
the mean between the last available bid and asked prices from one or more
brokers or dealers as obtained from Loan Pricing Corporation. For the limited
number of loan interests for which no reliable price quotes are available, such
loan interests may be valued by Loan Pricing Corporation through the use of
pricing matrices to determine valuations. If the pricing service does not
provide a value for loan interests, the Investment Adviser will value the loan
interests at fair value, which is intended to approximate market value.
Securities that are held by the Fund that are traded on stock exchanges or the
Nasdaq National Market are valued at the last sale price or official close price
on the exchange on which such securities are traded, as of the close of business
on the day the securities are being valued or, lacking any sales, at the last
available bid price for long positions, and at the last available asked price
for short positions. In cases where securities are traded on more than one
exchange, the securities are valued on the exchange designated as the primary
market by or under the authority of the Board of Directors of the Fund. Long
positions in securities traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Fund. Short positions in securities traded in the OTC
market are valued at the last available asked price. Portfolio securities that
are traded both in the OTC market and on a stock exchange are valued according
to the broadest and most representative market. When the Fund writes an option,
the amount of the premium received is recorded on the books of the Fund as an
asset and an equivalent liability. The amount of the liability is subsequently
valued to reflect the current market value of the option written, based on the
last sale price in the case of exchange-traded options or, in the case of
options traded in the OTC market, the last asked price. Options purchased by the
Fund are valued at their last sale price in the case of exchange-traded options
or, in the case of options traded in the OTC market, the last bid price. Swap
agreements are valued based upon quoted fair valuations received daily by the
Fund from a pricing service or counterparty. Other investments, including
futures contracts and related options, are stated at market value. Obligations
with remaining maturities of 60 days or less are valued at amortized cost unless
the Investment Adviser believes that this method no longer produces fair
valuations. Repurchase agreements will be valued at cost plus accrued interest.
The Fund employs certain pricing services to provide securities prices for the
Fund. Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or under the
direction of the Board of Directors of the Fund, including valuations furnished
by the pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Board of
Directors. Such valuations and procedures will be reviewed periodically by the
Board of Directors.
Generally, trading in foreign securities, as well as U.S. government securities
and money market instruments, is substantially completed each day at various
times prior to the close of business on the NYSE. The values of such securities
used in computing the net asset value of the Fund's shares are determined as of
such times. Foreign currency exchange rates also are generally determined prior
to the close of business on the NYSE. Occasionally, events affecting the values
of such securities and such exchange rates may occur between the times at which
they are determined and the close of business on the NYSE that may not be
reflected in the computation of
14 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005
Notes to Financial Statements (continued)
the Fund's net asset value. If events (for example, a company announcement,
market volatility or a natural disaster) occur during such periods that are
expected to materially affect the value of such securities, those securities may
be valued at their fair value as determined in good faith by the Fund's Board of
Directors or by the Investment Adviser using a pricing service and/or procedures
approved by the Fund's Board of Directors.
(c) Derivative financial instruments -- The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
o Financial futures contracts -- The Fund may purchase or sell financial
futures contracts and options on such futures contracts. Futures contracts
are contracts for delayed delivery of securities at a specific future date
and at a specific price or yield. Upon entering into a contract, the Fund
deposits and maintains as collateral such initial margin as required by
the exchange on which the transaction is effected. Pursuant to the
contract, the Fund agrees to receive from or pay to the broker an amount
of cash equal to the daily fluctuation in value of the contract. Such
receipts or payments are known as variation margin and are recorded by the
Fund as unrealized gains or losses. When the contract is closed, the Fund
records a realized gain or loss equal to the difference between the value
of the contract at the time it was opened and the value at the time it was
closed.
o Options -- The Fund may write and purchase call and put options. When the
Fund writes an option, an amount equal to the premium received by the Fund
is reflected as an asset and an equivalent liability. The amount of the
liability is subsequently marked-to-market to reflect the current market
value of the option written. When a security is purchased or sold through
an exercise of an option, the related premium paid (or received) is added
to (or deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option expires
(or the Fund enters into a closing transaction), the Fund realizes a gain
or loss on the option to the extent of the premiums received or paid (or
gain or loss to the extent the cost of the closing transaction is less
than or exceeds the premiums paid or received).
Written and purchased options are non-income producing investments.
o Swaps -- The Fund may enter into swap agreements, which are
over-the-counter contracts in which the Fund and a counterparty agree to
make periodic net payments on a specified notional amount. The net
payments can be made for a set period of time or may be triggered by a
predetermined credit event. The net periodic payments may be based on a
fixed or variable interest rate; the change in market value of a specified
security, basket of securities, or index; or the return generated by a
security. These periodic payments received or made by the Fund are
recorded in the accompanying Statement of Operations as realized gains or
losses, respectively. Gains or losses are realized upon termination of the
swap agreements. Swaps are marked-to-market daily and changes in value are
recorded as unrealized appreciation (depreciation). Risks include changes
in the returns of the underlying instruments, failure of the
counterparties to perform under the contracts' terms and the possible lack
of liquidity with respect to swap agreements.
(d) Income taxes -- It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no federal income tax provision is required.
(e) Security transactions and investment income -- Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Interest income is recognized on the accrual basis. The
Fund amortizes all premiums and discounts on debt securities.
(f) Offering costs -- Direct expenses relating to the public offering of the
Fund's Common Stock were charged to capital.
(g) Dividends and distributions -- Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates. The Fund may at times pay out less than the entire amount of
net investment income earned in any particular period and may at times pay out
such accumulated undistributed income in other periods to permit the Fund to
maintain a more stable level of dividends.
(h) Securities lending -- The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005 15
Notes to Financial Statements (continued)
be maintained at all times in an amount equal to at least 100% of the current
market value of the loaned securities. The market value of the loaned securities
is determined at the close of business of the Fund and any additional required
collateral is delivered to the Fund on the next business day. Where the Fund
receives securities as collateral for the loaned securities, it collects a fee
from the borrower. The Fund typically receives the income on the loaned
securities but does not receive the income on the collateral. Where the Fund
receives cash collateral, it may invest such collateral and retain the amount
earned on such investment, net of any amount rebated to the borrower. Loans of
securities are terminable at any time and the borrower, after notice, is
required to return borrowed securities within five business days. The Fund may
pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
(i) Reclassification -- U.S. generally accepted accounting principles require
that certain components of net assets be adjusted to reflect permanent
differences between financial and tax reporting. Accordingly, during the current
year, $406,511 has been reclassified between undistributed net investment income
and accumulated net realized capital loss as a result of permanent differences
attributable to swap agreements and foreign currency transactions. This
reclassification has no effect on net assets or net asset values per share.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with FAM. The general
partner of FAM is Princeton Services, Inc. ("PSI"), an indirect, wholly-owned
subsidiary of Merrill Lynch & Co., Inc. ("ML & Co."), which is the limited
partner.
FAM is responsible for the management of the Fund's portfolio and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
an annual rate of .75% of the Fund's average daily net assets plus the proceeds
of any outstanding borrowings used for leverage. During the Fund's start-up
phase, FAM elected to waive a portion of its management fee. For the period
January 31, 2005 to August 31, 2005, FAM earned fees of $1,279,672, of which
$355,611 was waived.
The Fund has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), an affiliate of FAM, or its affiliates.
Pursuant to that order, the Fund also has retained Merrill Lynch Investment
Managers, LLC ("MLIM, LLC"), an affiliate of FAM, as the securities lending
agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Fund, invest cash collateral
received by the Fund for such loans, among other things, in a private investment
company managed by MLIM, LLC or in registered money market funds advised by FAM
or its affiliates.
For the period January 31, 2005 to August 31, 2005, MLPF&S received gross fees
from underwriting of $8,424,137 in connection with the issuance of the Fund's
Common Stock. In addition, the Fund reimbursed MLPF&S $54,312 as a partial
reimbursement of expenses incurred in connection with the issuance of the Fund's
Common Stock.
For the period January 31, 2005 to August 31, 2005, the Fund reimbursed FAM
$3,228 for certain accounting services.
Certain officers and/or directors of the Fund are officers and/or directors of
FAM, PSI, ML & Co., and/or MLIM, LLC.
3. Investments:
Purchases and sales (including paydowns) of investments, excluding short-term
securities, for the period January 31, 2005 to August 31, 2005 were $353,475,739
and $44,271,348, respectively.
4. Common Stock Transactions:
The Fund is authorized to issue 200,000,000 shares of capital stock par value
$.10, all of which are initially classified as Common Stock. The Board of
Directors is authorized, however, to classify and reclassify any unissued shares
of capital stock without approval of the holders of Common Stock.
Shares issued and outstanding during the period January 31, 2005 to August 31,
2005 increased by 11,950,000 from shares sold.
5. Short-Term Borrowings:
On May 24, 2005, the Fund renewed its revolving credit and security agreement
funded by a commercial paper asset securitization program with Citigroup North
America, Inc. ("Citigroup") as Agent, certain secondary backstop lenders, and
16 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005
Notes to Financial Statements (concluded)
certain asset securitization conduits as lenders (the "Lenders"). The agreement
was renewed for one year and has a maximum limit of $125,000,000. Under the
Citigroup program, the conduits will fund advances to the Fund through the
issuance of highly rated commercial paper. As security for its obligations to
the Lenders under the revolving securitization facility, the Fund has granted a
security interest in substantially all of its assets to and in favor of the
Lenders. The interest rate on the Fund's borrowings is based on the interest
rate carried by the commercial paper plus a program fee. The Fund pays
additional borrowing costs including a backstop commitment fee.
The weighted average annual interest rate was 3.41% and the average borrowing
was approximately $75,543,000 for the year ended August 31, 2005.
6. Distributions to Shareholders:
The Fund paid an ordinary income dividend in the amount of $.137500 per share on
September 30, 2005 to shareholders of record on September 14, 2005.
The tax character of distributions paid during the fiscal year ended August 31,
2005 was as follows:
- --------------------------------------------------------------------------------
8/31/2005
- --------------------------------------------------------------------------------
Distributions paid from:
Ordinary income ....................................... $8,916,645
----------
Total taxable distributions ............................. $8,916,645
==========
As of August 31, 2005, the components of accumulated losses on a tax basis were
as follows:
- ------------------------------------------------------------------------------
Undistributed ordinary income--net ....................... $ 890,170
Undistributed long-term capital gains--net ............... --
-----------
Total undistributed earnings--net ........................ 890,170
Capital loss carryforward ................................ --
Unrealized losses--net ................................... (9,053,822)*
-----------
Total accumulated losses--net ............................ $(8,163,652)
===========
* The difference between book-basis and tax-basis net unrealized losses is
attributable primarily to the difference between book and tax amortization
methods for premiums and discounts on fixed income securities, book/tax
differences in the accrual of income on securities in default and the
deferral of post-October capital losses for tax purposes.
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of
Diversified Income Strategies Portfolio, Inc.:
We have audited the accompanying statement of assets, liabilities and capital,
including the schedule of investments, of Diversified Income Strategies
Portfolio, Inc. as of August 31, 2005, and the related statements of operations,
changes in net assets and cash flows, and the financial highlights for the
period January 31, 2005 (commencement of operations) through August 31, 2005.
These financial statements and financial highlights are the responsibility of
the Fund's management. Our responsibility is to express an opinion on these
financial statements and financial highlights based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. The Fund
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of August 31, 2005, by correspondence with the custodian
and financial intermediaries; where replies were not received from financial
intermediaries, we performed other auditing procedures. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Diversified Income Strategies Portfolio, Inc. as of August 31, 2005, the results
of its operations, the changes in its net assets, its cash flows, and its
financial highlights for the period January 31, 2005 through August 31, 2005, in
conformity with U.S. generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
October 21, 2005
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005 17
Automatic Dividend Reinvestment Plan
The following description of the Fund's Automatic Dividend Reinvestment Plan
(the "Plan") is sent to you annually as required by federal securities laws.
Pursuant to the Fund's Plan, unless a holder of Common Stock otherwise elects,
all dividend and capital gains distributions will be automatically reinvested by
EquiServe Trust Company N.A. ("EquiServe" or the "Plan Agent"), as agent for
shareholders in administering the Plan, in additional shares of Common Stock of
the Fund. Holders of Common Stock who elect not to participate in the Plan will
receive all 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 EquiServe, as dividend paying agent. Such
participants may elect not to participate in the Plan and to receive all
distributions of dividends and capital gains in cash by sending written
instructions to EquiServe, as dividend paying agent, at the address set forth
below. Participation in the Plan is completely voluntary and may be terminated
or resumed at any time without penalty by written notice if received by the Plan
Agent not less than ten days prior to any dividend record date; otherwise such
termination will be effective with respect to any subsequently declared dividend
or distribution.
Whenever the Fund declares an income dividend or capital gains distribution
(collectively referred to as "dividends") payable either in shares or in cash,
non-participants in the Plan will receive cash and participants in the Plan will
receive the equivalent in shares of Common Stock. The shares will be acquired by
the Plan Agent for the participant's account, depending upon the circumstances
described below, either (i) through receipt of additional unissued but
authorized shares of Common Stock from the Fund ("newly issued shares") or (ii)
by purchase of outstanding shares of Common Stock on the open market
("open-market purchases") on the New York Stock Exchange or elsewhere. If, on
the payment date for the dividend, the net asset value per share of the Common
Stock is equal to or less than the market price per share of the Common Stock
plus estimated brokerage commissions (such conditions being referred to herein
as "market premium"), the Plan Agent will invest the dividend amount in newly
issued shares on behalf of the participant. The number of newly issued shares of
Common Stock to be credited to the 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 (such condition being referred to herein as "market discount"), the
Plan Agent will invest the dividend amount in shares acquired on behalf of the
participant in open-market purchases.
In the event of a market discount on the dividend payment date, the Plan Agent
will have until the last business day before the next date on which the shares
trade on an "ex-dividend" basis or in no event more than 30 days after the
dividend payment date (the "last purchase 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 on the
dividend through the date before the next "ex-dividend" date, which typically
will be approximately ten days. If, before the Plan Agent has completed its
open-market purchases, the market price of a share of Common Stock exceeds the
net asset value per share, the average per share purchase price paid by the Plan
Agent may exceed the net asset value of the Fund's shares, resulting in the
acquisitions 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 Plan provides that if the Plan Agent is
unable to invest the full dividend amount in open-market purchases during the
purchase period or if the market discount shifts to a market premium during the
purchase period, the Plan Agent 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 last purchase date determined by dividing the
uninvested portion of the dividend by the net asset value per share.
The Plan Agent maintains all shareholders' accounts in the Plan and furnishes
written confirmation of all transactions in the account, including information
needed by shareholders for tax records. Shares in the account of each Plan
participant will be held by the Plan Agent in non-certificated form in the name
of the participant, and each shareholder's proxy will include those shares
purchased or received pursuant to the Plan. The Plan Agent will forward all
proxy solicitation materials to participants and vote proxies for shares held
pursuant to the Plan in accordance with the instructions of the participants.
18 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005
In the case of shareholders such as banks, brokers or nominees which hold shares
of others who are the beneficial owners, the Plan Agent will administer the Plan
on the basis of the number of shares certified from time to time by the record
shareholders as representing the total amount registered in the record
shareholder's name and held for the account of beneficial owners who are to
participate in the Plan.
There will be no brokerage charges with respect to shares issued directly by the
Fund as a result of dividends or capital gains distributions payable either in
shares or in cash. However, each participant will pay a pro rata share of
brokerage commissions incurred with respect to the Plan Agent's open-market
purchases in connection with the reinvestment of dividends.
The automatic reinvestment of dividends and distributions will not relieve
participants of any federal, state or local income tax that may be payable (or
required to be withheld) on such dividends.
Shareholders participating in the Plan may receive benefits not available to
shareholders not participating in the Plan. If the market price plus commissions
of the Fund's shares is above the net asset value, participants in the Plan 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, since the Fund does not redeem
shares, the price on resale may be more or less than the net asset value.
The value of shares acquired pursuant to the Plan will generally be excluded
from gross income to the extent that the cash amount reinvested would be
excluded from gross income. If, when the Fund's shares are trading at a premium
over net asset value, the Fund issues shares pursuant to the Plan that have a
greater fair market value than the amount of cash reinvested, it is possible
that all or a portion of such discount (which may not exceed 5% of the fair
market value of the Fund's shares) could be viewed as a taxable distribution. If
the discount is viewed as a taxable distribution, it is also possible that the
taxable character of this discount would be allocable to all the shareholders,
including shareholders who do not participate in the Plan. Thus, shareholders
who do not participate in the Plan might be required to report as ordinary
income a portion of their distributions equal to their allocable share of the
discount.
Experience under the Plan may indicate that changes are desirable. Accordingly,
the Fund reserves the right to amend or terminate the Plan. There is no direct
service charge to participants in the Plan; however, the Fund reserves the right
to amend the Plan to include a service charge payable by the participants.
All correspondence concerning the Plan should be directed to the Plan Agent at
EquiServe Trust Company N.A. (c/o Computershare Investor Services), P.O. Box
43010, Providence, RI 02940-3010, Telephone: 800-426-5523.
Fund Certification
In January 2005, the Fund filed its Chief Executive Officer Certification and
its Annual Written Affirmation for the prior year with the New York Stock
Exchange pursuant to Section 303A.12 of the New York Stock Exchange Corporate
Listed Company Manual.
The Fund's Chief Executive Officer and Chief Financial Officer Certifications
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 were filed with the
Fund's Form N-CSR and are available on the Securities and Exchange Commission's
Web site at http://www.sec.gov.
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005 19
Officers and Directors
Number of
Portfolios in Other Public
Position(s) Length of Fund Complex Directorships
Held with Time Overseen by Held by
Name Address & Age Fund Served Principal Occupation(s) During Past 5 Years Director Director
====================================================================================================================================
Interested Director
- ------------------------------------------------------------------------------------------------------------------------------------
Robert C. P.O. Box 9011 President 2005 to President of the MLIM/FAM-advised funds since 2005; 130 Funds None
Doll, Jr.* Princeton, NJ and present President of MLIM and FAM since 2001; Co-Head 175 Portfolios
08543-9011 Director (Americas Region) thereof from 2000 to 2001 and
Age: 51 Senior Vice President from 1999 to 2001; President
and Director of Princeton Services, Inc. ("Princeton
Services") since 2001; President of Princeton
Administrators, L.P. ("Princeton Administrators")
since 2001; Chief Investment Officer of Oppenheimer-
Funds, Inc. in 1999 and Executive Vice President
thereof from 1991 to 1999.
------------------------------------------------------------------------------------------------------------------------
* Mr. Doll is a director, trustee or member of an advisory board of certain other investment companies for which MLIM or
FAM acts as investment adviser. Mr. Doll is an "interested person," as defined in the Investment Company Act, of the
Fund based on his current positions with MLIM, FAM, Princeton Services and Princeton Administrators. Directors serve
until their resignation, removal or death, or until December 31 of the year in which they turn 72. As Fund President,
Mr. Doll serves at the pleasure of the Board of Directors.
20 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005
Officers and Directors (continued)
Number of
Portfolios in Other Public
Position(s) Length of Fund Complex Directorships
Held with Time Overseen by Held by
Name Address & Age Fund Served Principal Occupation(s) During Past 5 Years Director Director
====================================================================================================================================
Independent Directors*
- ------------------------------------------------------------------------------------------------------------------------------------
Ronald W. P.O. Box 9095 Director 2005 to Professor Emeritus of Finance, School of Business, 48 Funds None
Forbes** Princeton, NJ present State University of New York at Albany since 2000 48 Portfolios
08543-9095 and Professor thereof from 1989 to 2000;
Age: 64 International Consultant, Urban Institute,
Washington, D.C. from 1995 to 1999.
- ------------------------------------------------------------------------------------------------------------------------------------
Cynthia A. P.O. Box 9095 Director 2005 to Professor, Harvard Business School since 1989; 48 Funds Newell
Montgomery Princeton, NJ present Associate Professor, J.L. Kellogg Graduate School of 48 Portfolios Rubbermaid,
08543-9095 Management, Northwestern University from 1985 Inc. (manu-
Age: 53 to 1989; Associate Professor, Graduate School of facturing)
Business Administration, University of Michigan from
1979 to 1985; Director, Harvard Business School of
Publishing since 2005.
- ------------------------------------------------------------------------------------------------------------------------------------
Jean Margo P.O. Box 9095 Director 2005 to Self-employed consultant since 2001; Counsel of 48 Funds None
Reid Princeton, NJ present Alliance Capital Management (investment adviser) 48 Portfolios
08543-9095 in 2000; General Counsel, Director and Secretary of
Age: 60 Sanford C. Bernstein & Co., Inc. (investment adviser/
broker-dealer) from 1997 to 2000; Secretary, Sanford
C. Bernstein Fund, Inc. from 1994 to 2000; Director
and Secretary of SCB, Inc. since 1998; Director and
Secretary of SCB Partners, Inc. since 2000; and
Director of Covenant House from 2001 to 2004.
- ------------------------------------------------------------------------------------------------------------------------------------
Roscoe S. P.O. Box 9095 Director 2005 to President, Middle East Institute, from 1995 to 2001; 48 Funds None
Suddarth Princeton, NJ present Foreign Service Officer, United States Foreign 48 Portfolios
08543-9095 Service, from 1961 to 1995; Career Minister from
Age: 70 1989 to 1995; Deputy Inspector General, U.S.
Department of State, from 1991 to 1994; U.S.
Ambassador to the Hashemite Kingdom of Jordan from
1987 to 1990.
- ------------------------------------------------------------------------------------------------------------------------------------
Richard R. P.O. Box 9095 Director 2005 to Professor of Finance from 1984 to 1995, Dean from 48 Funds Bowne & Co.,
West Princeton, NJ present 1984 to 1993 and since 1995 Dean Emeritus of 48 Portfolios Inc.
08543-9095 New York University's Leonard N. Stern School of (financial
Age: 67 Business Administration. printers);
Vornado
Realty Trust
(real estate
company);
Alexander's,
Inc. (real
estate
company).
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005 21
Officers and Directors (concluded)
Number of
Portfolios in Other Public
Position(s) Length of Fund Complex Directorships
Held with Time Overseen by Held by
Name Address & Age Fund Served Principal Occupation(s) During Past 5 Years Director Director
====================================================================================================================================
Independent Directors* (concluded)
- ------------------------------------------------------------------------------------------------------------------------------------
Edward D. P.O. Box 9095 Director 2005 to Self-employed financial consultant since 1994; 48 Funds None
Zinbarg Princeton, NJ present Executive Vice President of the Prudential Insurance 48 Portfolios
08543-9095 Company of America from 1988 to 1994; Former
Age: 70 Director of Prudential Reinsurance Company and
former Trustee of the Prudential Foundation.
------------------------------------------------------------------------------------------------------------------------
* Directors serve until their resignation, removal or death, or until December 31 of the year in which they turn 72.
** Chairman of the Board and the Audit Committee.
- ------------------------------------------------------------------------------------------------------------------------------------
Position(s) Length of
Held with Time
Name Address & Age Fund Served Principal Occupation(s) During Past 5 Years
====================================================================================================================================
Fund Officers*
- ------------------------------------------------------------------------------------------------------------------------------------
Donald C. P.O. Box 9011 Vice 2005 to First Vice President of MLIM and FAM since 1997 and Treasurer thereof since 1999;
Burke Princeton, NJ President present Senior Vice President and Treasurer of Princeton Services since 1999 and Director
08543-9011 and since 2004; Vice President of FAM Distributors, Inc. ("FAMD") since 1999; Vice
Age: 45 Treasurer President of MLIM and FAM from 1990 to 1997; Director of Taxation of MLIM from 1990
to 2001; Vice President, Treasurer and Secretary of the IQ Funds since 2004.
- ------------------------------------------------------------------------------------------------------------------------------------
Kevin J. P.O. Box 9011 Vice 2005 to Director (Global Fixed Income) of MLIM since 1998; Vice President of MLIMfrom
Booth Princeton, NJ President present 1991 to 1998.
08543-9011
Age: 51
- ------------------------------------------------------------------------------------------------------------------------------------
Jeffrey P.O. Box 9011 Chief 2005 to Chief Compliance Officer of the MLIM/FAM-advised funds and First Vice President and
Hiller Princeton, NJ Compliance present Chief Compliance Officer of MLIM (Americas Region) since 2004; Chief Compliance
08543-9011 Officer Officer of the IQ Funds since 2004; Global Director of Compliance at Morgan Stanley
Age: 54 Investment Management from 2002 to 2004; Managing Director and Global Director of
Compliance at Citigroup Asset Management from 2000 to 2002; Chief Compliance
Officer at Soros Fund Management in 2000; Chief Compliance Officer at Prudential
Financial from 1995 to 2000; Senior Counsel in the Commission's Division of
Enforcement in Washington, D.C. from 1990 to 1995.
- ------------------------------------------------------------------------------------------------------------------------------------
Alice A. P.O. Box 9011 Secretary 2005 to Director (Legal Advisory) of MLIM since 2002; Vice President of MLIM from 1999 to
Pellegrino Princeton, NJ present 2002; Attorney associated with MLIM since 1997; Secretary of MLIM, FAM, FAMD and
08543-9011 Princeton since 2004.
Age: 45
------------------------------------------------------------------------------------------------------------------------
* Officers of the Fund serve at the pleasure of the Board of Directors.
- ------------------------------------------------------------------------------------------------------------------------------------
Custodian
State Street Bank and Trust Company
P.O. Box 351
Boston, MA 02101
Transfer Agent
EquiServe Trust Company N.A.
(c/o Computershare Investor Services)
P.O. Box 43010
Providence, RI 02940-3010
1-800-426-5523
NYSE Symbol
DVF
22 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005
Availability of Quarterly Schedule of Investments
The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission ("SEC") for the first and third quarters of each fiscal
year on Form N-Q. The Fund's Forms N-Q are available on the SEC's Web site at
http://www.sec.gov. The Fund's Forms N-Q may also be reviewed and copied at the
SEC's Public Reference Room in Washington, DC. Information on the operation of
the Public Reference Room may be obtained by calling 1-800-SEC-0330.
Electronic Delivery
The Fund offers electronic delivery of communications to its shareholders. In
order to receive this service, you must register your account and provide us
with e-mail information. To sign up for this service, simply access this Web
site at http://www.icsdelivery.com/live and follow the instructions. When you
visit this site, you will obtain a personal identification number (PIN). You
will need this PIN should you wish to update your e-mail address, choose to
discontinue this service and/or make any other changes to the service. This
service is not available for certain retirement accounts at this time.
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. AUGUST 31, 2005 23
[LOGO] Merrill Lynch Investment Managers
www.mlim.ml.com
- --------------------------------------------------------------------------------
Mercury Advisors
A Division of Merrill Lynch Investment Managers
www.mercury.ml.com
Diversified Income Strategies Portfolio, Inc. seeks a high current income by
investing primarily in a diversified portfolio of floating rate debt securities
and instruments.
This report, including the financial information herein, is transmitted for use
only to shareholders of Diversified Income Strategies Portfolio, Inc. for their
information. It is not a prospectus, circular or representation intended for use
in the purchase of shares of the Fund or any securities mentioned in this
report. Past performance results shown in this report should not be considered a
representation of future performance. The Fund leverages its Common Stock to
provide Common Stock shareholders with a potentially higher rate of return.
Leverage creates risk for Common Stock shareholders, including the likelihood of
greater volatility of net asset value and market price of Common Stock shares,
and the risk that fluctuations in short-term interest rates may reduce the
Common Stock's yield. Statements and other information herein are as dated and
are subject to change.
A description of the policies and procedures that the Fund uses to determine how
to vote proxies relating to portfolio securities is available (1) without
charge, upon request, by calling toll-free 1-800-MER-FUND (1-800-637-3863); (2)
at www.mutualfunds.ml.com; and (3) on the Securities and Exchange Commission's
Web site at http://www.sec.gov. Information about how the Fund voted proxies
relating to securities held in the Fund's portfolio during the most recent
12-month period ended June 30 is available (1) at www.mutualfunds.ml.com and (2)
on the Securities and Exchange Commission's Web site at http://www.sec.gov.
Diversified Income Strategies Portfolio, Inc.
Box 9011
Princeton, NJ 08543-9011
#DISP -- 8/05
Item 2 - Code of Ethics - The registrant has adopted a code of ethics, as of the
end of the period covered by this report, that applies to the
registrant's principal executive officer, principal financial officer
and principal accounting officer, or persons performing similar
functions. A copy of the code of ethics is available without charge
upon request by calling toll-free 1-800-MER-FUND (1-800-637-3863).
Item 3 - Audit Committee Financial Expert - The registrant's board of directors
has determined that (i) the registrant has the following audit
committee financial experts serving on its audit committee and (ii)
each audit committee financial expert is independent: (1) Ronald W.
Forbes, (2) Richard R. West, and (3) Edward D. Zinbarg.
Item 4 - Principal Accountant Fees and Services
(a) Audit Fees - Fiscal Year Ending August 31, 2005 - $42,000
Fiscal Year Ending August 31, 2004 - $0
(b) Audit-Related Fees - Fiscal Year Ending August 31, 2005 - $9,600
Fiscal Year Ending August 31, 2004 - $0
The nature of the services include assurance and related services
reasonably related to the performance of the audit of financial
statements not included in Audit Fees.
(c) Tax Fees - Fiscal Year Ending August 31, 2005 - $7,900
Fiscal Year Ending August 31, 2004 - $0
The nature of the services include tax compliance, tax advice and tax
planning.
(d) All Other Fees - Fiscal Year Ending August 31, 2005 - $0
Fiscal Year Ending August 31, 2004 - $0
(e)(1) The registrant's audit committee (the "Committee") has adopted
policies and procedures with regard to the pre-approval of services.
Audit, audit-related and tax compliance services provided to the
registrant on an annual basis require specific pre-approval by the
Committee. The Committee also must approve other non-audit services
provided to the registrant and those non-audit services provided to the
registrant's affiliated service providers that relate directly to the
operations and the financial reporting of the registrant. Certain of
these non-audit services that the Committee believes are a) consistent
with the SEC's auditor independence rules and b) routine and recurring
services that will not impair the independence of the independent
accountants may be approved by the Committee without consideration on a
specific case-by-case basis ("general pre-approval"). However, such
services will only be deemed pre-approved provided that any individual
project does not exceed $5,000 attributable to the registrant or
$50,000 for all of the registrants the Committee oversees. Any proposed
services exceeding the pre-approved cost levels will require specific
pre-approval by the Committee, as will any other services not subject
to general pre-approval (e.g., unanticipated but permissible services).
The Committee is informed of each service approved subject to general
pre-approval at the next regularly scheduled in-person board meeting.
(e)(2) 0%
(f) Not Applicable
(g) Fiscal Year Ending August 31, 2005 - $7,377,027
Fiscal Year Ending August 31, 2004 - $14,913,836
(h) The registrant's audit committee has considered and determined that
the provision of non-audit services that were rendered to the
registrant's investment adviser and any entity controlling, controlled
by, or under common control with the investment adviser that provides
ongoing services to the registrant that were not pre-approved pursuant
to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X is compatible
with maintaining the principal accountant's independence.
Regulation S-X Rule 2-01(c)(7)(ii) - $1,227,000, 0%
Item 5 - Audit Committee of Listed Registrants - The following individuals are
members of the registrant's separately-designated standing audit
committee established in accordance with Section 3(a)(58)(A) of the
Exchange Act (15 U.S.C. 78c(a)(58)(A)):
Ronald W. Forbes
Cynthia A. Montgomery
Jean Margo Reid
Kevin A. Ryan (retired as of December 31, 2004)
Roscoe S. Suddarth
Richard R. West
Edward D. Zinbarg
Item 6 - Schedule of Investments - Not Applicable
Item 7 - Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies -
Proxy Voting Policies and Procedures
Each Fund's Board of Directors/Trustees has delegated to Merrill Lynch
Investment Managers, L.P. and/or Fund Asset Management, L.P. (the
"Investment Adviser") authority to vote all proxies relating to the
Fund's portfolio securities. The Investment Adviser has adopted
policies and procedures ("Proxy Voting Procedures") with respect to the
voting of proxies related to the portfolio securities held in the
account of one or more of its clients, including a Fund. Pursuant to
these Proxy Voting Procedures, the Investment Adviser's primary
objective when voting proxies is to make proxy voting decisions solely
in the best interests of each Fund and its shareholders, and to act in
a manner that the Investment Adviser believes is most likely to enhance
the economic value of the securities held by the Fund. The Proxy Voting
Procedures are designed to ensure that the Investment Adviser considers
the interests of its clients, including the Funds, and not the
interests of the Investment Adviser, when voting proxies and that real
(or perceived) material conflicts that may arise between the Investment
Adviser's interest and those of the Investment Adviser's clients are
properly addressed and resolved.
In order to implement the Proxy Voting Procedures, the Investment
Adviser has formed a Proxy Voting Committee (the "Committee"). The
Committee is comprised of the Investment Adviser's Chief Investment
Officer (the "CIO"), one or more other senior investment professionals
appointed by the CIO, portfolio managers and investment analysts
appointed by the CIO and any other personnel the CIO deems appropriate.
The Committee will also include two non-voting representatives from the
Investment Adviser's Legal department appointed by the Investment
Adviser's General Counsel. The Committee's membership shall be limited
to full-time employees of the Investment Adviser. No person with any
investment banking, trading, retail brokerage or research
responsibilities for the Investment Adviser's affiliates may serve as a
member of the Committee or participate in its decision making (except
to the extent such person is asked by the Committee to present
information to the Committee, on the same basis as other interested
knowledgeable parties not affiliated with the Investment Adviser might
be asked to do so). The Committee determines how to vote the proxies of
all clients, including a Fund, that have delegated proxy voting
authority to the Investment Adviser and seeks to ensure that all votes
are consistent with the best interests of those clients and are free
from unwarranted and inappropriate influences. The Committee
establishes general proxy voting policies for the Investment Adviser
and is responsible for determining how those policies are applied to
specific proxy votes, in light of each issuer's unique structure,
management, strategic options and, in certain circumstances, probable
economic and other anticipated consequences of alternate actions. In so
doing, the Committee may determine to vote a particular proxy in a
manner contrary to its generally stated policies. In addition, the
Committee will be responsible for ensuring that all reporting and
recordkeeping requirements related to proxy voting are fulfilled.
The Committee may determine that the subject matter of a recurring
proxy issue is not suitable for general voting policies and requires a
case-by-case determination. In such cases, the Committee may elect not
to adopt a specific voting policy applicable to that issue. The
Investment Adviser believes that certain proxy voting issues require
investment analysis - such as approval of mergers and other significant
corporate transactions - akin to investment decisions, and are,
therefore, not suitable for general guidelines. The Committee may elect
to adopt a common position for the Investment Adviser on certain proxy
votes that are akin to investment decisions, or determine to permit the
portfolio manager to make individual decisions on how best to maximize
economic value for a Fund (similar to normal buy/sell investment
decisions made by such portfolio managers). While it is expected that
the Investment Adviser will generally seek to vote proxies over which
the Investment Adviser exercises voting authority in a uniform manner
for all the Investment Adviser's clients, the Committee, in conjunction
with a Fund's portfolio manager, may determine that the Fund's specific
circumstances require that its proxies be voted differently.
To assist the Investment Adviser in voting proxies, the Committee has
retained Institutional Shareholder Services ("ISS"). ISS is an
independent adviser that specializes in providing a variety of
fiduciary-level proxy-related services to institutional investment
managers, plan sponsors, custodians, consultants, and other
institutional investors. The services provided to the Investment
Adviser by ISS include in-depth research, voting recommendations
(although the Investment Adviser is not obligated to follow such
recommendations), vote execution, and recordkeeping. ISS will also
assist the Fund in fulfilling its reporting and recordkeeping
obligations under the Investment Company Act.
The Investment Adviser's Proxy Voting Procedures also address special
circumstances that can arise in connection with proxy voting. For
instance, under the Proxy Voting Procedures, the Investment Adviser
generally will not seek to vote proxies related to portfolio securities
that are on loan, although it may do so under certain circumstances. In
addition, the Investment Adviser will vote proxies related to
securities of foreign issuers only on a best efforts basis and may
elect not to vote at all in certain countries where the Committee
determines that the costs associated with voting generally outweigh the
benefits. The Committee may at any time override these general policies
if it determines that such action is in the best interests of a Fund.
From time to time, the Investment Adviser may be required to vote proxies in
respect of an issuer where an affiliate of the Investment Adviser (each, an
"Affiliate"), or a money management or other client of the Investment Adviser
(each, a "Client") is involved. The Proxy Voting Procedures and the Investment
Adviser's adherence to those procedures are designed to address such conflicts
of interest. The Committee intends to strictly adhere to the Proxy Voting
Procedures in all proxy matters, including matters involving Affiliates and
Clients. If, however, an issue representing a non-routine matter that is
material to an Affiliate or a widely known Client is involved such that the
Committee does not reasonably believe it is able to follow its guidelines (or if
the particular proxy matter is not addressed by the guidelines) and vote
impartially, the Committee may, in its discretion for the purposes of ensuring
that an independent determination is reached, retain an independent fiduciary to
advise the Committee on how to vote or to cast votes on behalf of the Investment
Adviser's clients.
In the event that the Committee determines not to retain an independent
fiduciary, or it does not follow the advice of such an independent
fiduciary, the powers of the Committee shall pass to a subcommittee,
appointed by the CIO (with advice from the Secretary of the Committee),
consisting solely of Committee members selected by the CIO. The CIO
shall appoint to the subcommittee, where appropriate, only persons
whose job responsibilities do not include contact with the Client and
whose job evaluations would not be affected by the Investment Adviser's
relationship with the Client (or failure to retain such relationship).
The subcommittee shall determine whether and how to vote all proxies on
behalf of the Investment Adviser's clients or, if the proxy matter is,
in their judgment, akin to an investment decision, to defer to the
applicable portfolio managers, provided that, if the subcommittee
determines to alter the Investment Adviser's normal voting guidelines
or, on matters where the Investment Adviser's policy is case-by-case,
does not follow the voting recommendation of any proxy voting service
or other independent fiduciary that may be retained to provide research
or advice to the Investment Adviser on that matter, no proxies relating
to the Client may be voted unless the Secretary, or in the Secretary's
absence, the Assistant Secretary of the Committee concurs that the
subcommittee's determination is consistent with the Investment
Adviser's fiduciary duties
In addition to the general principles outlined above, the Investment
Adviser has adopted voting guidelines with respect to certain recurring
proxy issues that are not expected to involve unusual circumstances.
These policies are guidelines only, and the Investment Adviser may
elect to vote differently from the recommendation set forth in a voting
guideline if the Committee determines that it is in a Fund's best
interest to do so. In addition, the guidelines may be reviewed at any
time upon the request of a Committee member and may be amended or
deleted upon the vote of a majority of Committee members present at a
Committee meeting at which there is a quorum.
The Investment Adviser has adopted specific voting guidelines with
respect to the following proxy issues:
o Proposals related to the composition of the Board of Directors of issuers
other than investment companies. As a general matter, the Committee
believes that a company's Board of Directors (rather than shareholders) is
most likely to have access to important, nonpublic information regarding a
company's business and prospects, and is therefore best-positioned to set
corporate policy and oversee management. The Committee, therefore,
believes that the foundation of good corporate governance is the election
of qualified, independent corporate directors who are likely to diligently
represent the interests of shareholders and oversee management of the
corporation in a manner that will seek to maximize shareholder value over
time. In individual cases, the Committee may look at a nominee's history
of representing shareholder interests as a director of other companies or
other factors, to the extent the Committee deems relevant.
o Proposals related to the selection of an issuer's independent auditors. As
a general matter, the Committee believes that corporate auditors have a
responsibility to represent the interests of shareholders and provide an
independent view on the propriety of financial reporting decisions of
corporate management. While the Committee will generally defer to a
corporation's choice of auditor, in individual cases, the Committee may
look at an auditors' history of representing shareholder interests as
auditor of other companies, to the extent the Committee deems relevant.
o Proposals related to management compensation and employee benefits. As a
general matter, the Committee favors disclosure of an issuer's
compensation and benefit policies and opposes excessive compensation, but
believes that compensation matters are normally best determined by an
issuer's board of directors, rather than shareholders. Proposals to
"micro-manage" an issuer's compensation practices or to set arbitrary
restrictions on compensation or benefits will, therefore, generally not be
supported.
o Proposals related to requests, principally from management, for approval
of amendments that would alter an issuer's capital structure. As a general
matter, the Committee will support requests that enhance the rights of
common shareholders and oppose requests that appear to be unreasonably
dilutive.
o Proposals related to requests for approval of amendments to an issuer's
charter or by-laws. As a general matter, the Committee opposes poison pill
provisions.
o Routine proposals related to requests regarding the formalities of
corporate meetings.
o Proposals related to proxy issues associated solely with holdings of
investment company shares. As with other types of companies, the Committee
believes that a fund's Board of Directors (rather than its shareholders)
is best-positioned to set fund policy and oversee management. However, the
Committee opposes granting Boards of Directors authority over certain
matters, such as changes to a fund's investment objective, that the
Investment Company Act envisions will be approved directly by
shareholders.
o Proposals related to limiting corporate conduct in some manner that
relates to the shareholder's environmental or social concerns. The
Committee generally believes that annual shareholder meetings are
inappropriate forums for discussion of larger social issues, and opposes
shareholder resolutions "micromanaging" corporate conduct or requesting
release of information that would not help a shareholder evaluate an
investment in the corporation as an economic matter. While the Committee
is generally supportive of proposals to require corporate disclosure of
matters that seem relevant and material to the economic interests of
shareholders, the Committee is generally not supportive of proposals to
require disclosure of corporate matters for other purposes.
Item 8 - Portfolio Managers of Closed-End Management Investment Companies - Not
Applicable at this time
Item 9 - Purchases of Equity Securities by Closed-End Management Investment
Company and Affiliated Purchasers - Not Applicable
Item 10 - Submission of Matters to a Vote of Security Holders - Not Applicable
Item 11 - Controls and Procedures
11(a) - The registrant's certifying officers have reasonably designed such
disclosure controls and procedures to ensure material information
relating to the registrant is made known to us by others particularly
during the period in which this report is being prepared. The
registrant's certifying officers have determined that the registrant's
disclosure controls and procedures are effective based on our evaluation
of these controls and procedures as of a date within 90 days prior to
the filing date of this report.
11(b) - There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the Act (17 CFR
270.30a-3(d)) that occurred during the second fiscal half-year of the
period covered by this report that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting.
Item 12 - Exhibits attached hereto
12(a)(1) - Code of Ethics - See Item 2
12(a)(2) - Certifications - Attached hereto
12(a)(3) - Not Applicable
12(b) - Certifications - Attached hereto
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.
Diversified Income Strategies Portfolio, Inc.
By: /s/ Robert C. Doll, Jr.
---------------------------
Robert C. Doll, Jr.,
Chief Executive Officer of
Diversified Income Strategies Portfolio, Inc.
Date: October 19, 2005
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: /s/ Robert C. Doll, Jr.
---------------------------
Robert C. Doll, Jr.,
Chief Executive Officer of
Diversified Income Strategies Portfolio, Inc.
Date: October 19, 2005
By: /s/ Donald C. Burke
---------------------------
Donald C. Burke,
Chief Financial Officer of
Diversified Income Strategies Portfolio, Inc.
Date: October 19, 2005