UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSRS
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: 08/31/06
Date of reporting period: 09/01/05 - 02/28/06
Item 1 - Report to Stockholders
Semi-Annual Report
February 28, 2006
Diversified Income
Strategies Portfolio, Inc.
Diversified Income Strategies Portfolio, Inc.
Announcement to Shareholders
On February 15, 2006, BlackRock, Inc. ("BlackRock") and Merrill Lynch & Co.,
Inc. ("Merrill Lynch") entered into an agreement to contribute Merrill Lynch's
investment management business, Merrill Lynch Investment Managers, L.P. and
certain affiliates (including Fund Asset Management, L.P. and Merrill Lynch
Investment Managers International Limited), to BlackRock to create a new
independent company that will be one of the world's largest asset management
firms with nearly $1 trillion in assets under management (based on combined
assets under management as of December 31, 2005). The transaction is expected to
close in the third quarter of 2006, at which time the new company will operate
under the BlackRock name. If approved by the Fund's Board of Directors and Fund
shareholders, the combined company that results from the transaction is expected
to become the investment adviser of the Fund.
The Benefits and Risks of Leveraging
Diversified Income Strategies Portfolio, Inc. utilizes leverage 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.
2 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006
A Letter From the President
Dear Shareholder
Financial markets began 2006 with a return to volatility following a fairly
uninspiring 2005. For the six- and 12-month periods ended February 28, 2006,
most major market indexes landed in positive territory:
Total Returns as of February 28, 2006 6-month 12-month
=======================================================================================
U.S. equities (Standard & Poor's 500 Index) + 5.93% + 8.40%
- ---------------------------------------------------------------------------------------
Small cap U.S. equities (Russell 2000 Index) +10.24 +16.59
- ---------------------------------------------------------------------------------------
International equities (MSCI Europe, Australasia, Far East Index) +15.14 +17.41
- ---------------------------------------------------------------------------------------
Fixed income (Lehman Brothers Aggregate Bond Index) - 0.11 + 2.74
- ---------------------------------------------------------------------------------------
Tax-exempt fixed income (Lehman Brothers Municipal Bond Index) + 0.99 + 3.87
- ---------------------------------------------------------------------------------------
High yield bonds (Credit Suisse High Yield Index) + 1.89 + 3.27
- ---------------------------------------------------------------------------------------
The Federal Reserve Board (the Fed) increased interest rates 200 basis points
(2.00%) over the past 12 months, bringing the target federal funds rate to 4.5%.
Notably, Ben Bernanke replaced Alan Greenspan as Fed chairman in January, a
month after the central bank removed the critical word "measured" from the
description of its rate-hiking program. Still, most observers expect at least
one more interest rate hike before the Fed pauses in its tightening campaign.
U.S. economic growth, which came in at 4.1% in the third quarter of 2005, fell
to 1.6% in the fourth quarter. Growth is expected to reaccelerate in the first
quarter of 2006, although the economy is likely to feel some pressure in the
quarters ahead as the consumer sector seems to be softening. Capital spending by
businesses, however, appears relatively strong. Overall corporate health,
including strong company balance sheets, helped prompt robust
dividend-distribution, share-buyback and merger-and-acquisition activity in
2005, a trend that has continued in 2006. This, as well as reasonably good
company earnings and low core inflation, has been supportive of U.S. stocks
despite the headwinds of rising interest rates and high energy prices. Many
international equity markets have fared even better, thanks in part to higher
economic growth rates and low inflation.
In the U.S. bond market, short-term interest rates continued to move higher as
longer-term interest rates advanced more moderately. After flattening
dramatically in 2005, the Treasury curve recently has been toying with bouts of
inversion, whereby short-term yields have surpassed long-term yields. At
period-end, the six-month Treasury bill offered the highest yield on the curve
at 4.74%.
Amid the uncertainty inherent in the financial markets, we encourage you to
review your goals periodically with your financial advisor and to make portfolio
changes, as needed. For timely "food for thought" for investors, we also invite
you to visit Shareholder magazine at www.mlim.ml.com/shareholdermagazine. As
always, we thank you for trusting Merrill Lynch Investment Managers with your
investment assets, and we look forward to continuing to serve your investment
needs.
Sincerely,
/s/ Robert C. Doll, Jr.
Robert C. Doll, Jr.
President and Director
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006 3
A Discussion With Your Fund's Portfolio Manager
The Fund outperformed its composite benchmark on a total return basis
while also providing an attractive monthly income stream for shareholders.
How did the Fund perform during the period in light of the existing market
conditions?
For the six-month period ended February 28, 2006, the Common Stock of
Diversified Income Strategies Portfolio, Inc. had net annualized yields of 9.01%
and 9.47%, based on a period-end per share net asset value of $18.55 and a per
share market price of $17.65, respectively, and $.829 per share income
dividends. Over the same period, the total investment return on the Fund's
Common Stock was +5.92%, based on a change in per share net asset value from
$18.38 to $18.55, and assuming reinvestment of all distributions. By comparison,
the Fund's benchmark, which consists 20% of the Credit Suisse High Yield Index
and 80% of the Credit Suisse Leveraged Loan Index, returned +2.79% for the
six-month period.
For a description of the Fund's total investment return based on a change in the
per share market value of the Fund's Common Stock (as measured by the trading
price of the Fund'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 Fund's shares may trade in the secondary
market at a premium or discount to the Fund's net asset value. As a result,
total investment returns based on changes in the market value of the Fund's
Common Stock can vary significantly from total investment returns based on
changes in the Fund's net asset value.
The high yield market continued to experience volatility for the six months
ended February 28, 2006. High yield bonds rallied through the late spring and
summer of 2005 as the market gained perspective on the May credit downgrades of
General Motors Corp. and Ford Motor Co. However, this rally faltered in the fall
following the bankruptcy filing of Delphi Corp. For the six-month period, the
Credit Suisse High Yield Index returned a modest +1.89%.
In contrast to the high yield bond market, the leveraged bank loan market, as
represented by the Credit Suisse Leveraged Loan Index, remained rock solid
during the past six months, posting a return of +3.02%. This is primarily
attributable to the senior secured status of bank loans, which made them less
vulnerable to credit concerns when compared to high yield bonds. Another factor
contributing to the strong performance of leveraged loans is collateralized loan
obligations (CLOs), which now hold more than 60% of the leveraged loan market.
As the financing for these structured products has become cheaper, so has the
spread required in the leveraged loan space to make this model work. We are
seeing leveraged loan spreads at historically tight levels. The prospect for
further spread tightening relies primarily on the cost of CLO financing going
forward.
What factors most influenced Fund performance?
Specific credits that contributed most to performance during the period included
Anchor Glass Container Corp., HealthSouth Corp. and Medis Technologies Ltd.
Anchor ranks third as a glass bottle manufacturer in the United States, behind
Owens Illinois and Saint-Gobain. The company's inability to pass along rising
raw material costs, such as natural gas and soda ash, led to a Chapter 11 filing
in August 2005. Once in Chapter 11, Anchor successfully renegotiated contracts
to include cost pass-throughs that are more in line with the competition. This
news had a salutary impact on the price of our $4.1 million bond position, which
rose from 64 to 73.
Our $4 million investment in a HealthSouth subordinated bank loan (10.375%
coupon) ran from 103.75 to 114.6 as the company announced plans to redeem this
paper at 115. Finally, our $2.9 million convertible position in Medis
Technologies rose in price from 99 to 111.5 during the period. Medis
Technologies manufactures disposable power pack units for portable electronic
devices. These have been very well received by the market, prompting a rally in
the company's stock price and thereby increasing the imbedded equity value of
the convertibles.
4 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006
Investments that detracted from performance during the period included Constar
International, Inc., Sat Birds Capital Participations and Propex Fabrics, Inc.
Constar is a global producer of plastic containers for the food and beverage
industry. Increased feedstock prices, such as oil-based resin, have been
difficult to pass along. Additionally, the company announced accounting
irregularities during the period, at which time we exited the bond at 88.
Pricing for the bond began the period at 96.0. Sat Birds Capital is a European
satellite company in which we held a $5 million second lien bank loan
denominated in euros. During the period, the U.S. dollar appreciated against the
euro. The euro declined from 1.23 to 1.18 compared to the dollar, resulting in a
five-point dollar price decline during the holding period.
Our $3 million bond investment in Propex Fabrics, Inc., a manufacturer of
synthetic carpet backing, fell in price from 96.5 to 89.3 during the six-month
period. This price weakness occurred because Propex's largest customers, Mohawk
Industries and Shaw Industries, Inc., acquired carpet-backing manufacturers
following a decision to vertically integrate their operations.
What changes were made to the Fund during the period?
We achieved our 80% floating rate target through a combination of leveraged bank
debt, floating rate high yield notes, synthetic floaters and interest rate
swaps. Thus far, the Fund has delivered on its goal of capturing the rise in
short-term interest rates, with four dividend rate increases.
Our investment process continues to be credit-driven as we keep searching for
the most compelling opportunities in the high yield bond and floating rate loan
asset classes, with an emphasis on maintaining an attractive level of income for
our shareholders.
How would you characterize the Fund's position at the close of the period?
The Fund's duration is well within one year, reflecting our efforts to insulate
investors from principal loss due to the rising long-term rates which we are
currently experiencing. We continue to maintain a diversified portfolio, in
terms of both company and industry exposures, while maintaining our use of
leverage at approximately 30%. We thank you for your continued investment in
Diversified Income Strategies Portfolio, Inc.
Kevin J. Booth
Vice President and Portfolio Manager
March 15, 2006
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006 5
Portfolio Information
As of February 28, 2006
Percent of
Ten Largest Holdings Net Assets
- --------------------------------------------------------------------------------
Amkor Technology, Inc. Second Lien Term Loan, 9.274% due 10/27/2010 .. 2.6%
Omnova Solutions, Inc., 11.25% due 6/01/2010 ......................... 2.4
Dobson Cellular Systems, 9.43% due 11/01/2011 ........................ 2.3
FelCor Lodging LP, 8.83% due 6/01/2011 ............................... 2.3
New Skies Satellites NV, 9.573% due 11/01/2011 ....................... 2.3
Graham Packaging Co. LP Second Lien Term Loan, 8.813% due 4/07/2012 .. 2.3
RJ Tower Corp. Tranche B Term Loan, 7.25% due 2/02/2007 .............. 2.3
Universal City Florida Holding Co. I, 9.43% due 5/01/2010 ............ 2.3
American Safety Razor Co. Tranche C Term Loan, 11.23% due 8/28/2012 .. 2.3
CCO Holdings LLC, 8.616% due 12/15/2010 .............................. 2.3
- --------------------------------------------------------------------------------
Percent of
Five Largest Industries Net Assets
- --------------------------------------------------------------------------------
Automotive ........................................................... 11.4%
Information Technology ............................................... 11.1
Chemicals ............................................................ 10.3
Housing .............................................................. 9.0
Broadcasting ......................................................... 8.5
- --------------------------------------------------------------------------------
For Fund compliance purposes, the Fund'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 Fund 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
- --------------------------------------------------------------------------------
A/A .................................................................. 2.9%
BBB/Baa .............................................................. 1.7
BB/Ba ................................................................ 6.6
B/B .................................................................. 64.3
CCC/Caa .............................................................. 12.5
D .................................................................... 1.1
NR (Not Rated) ....................................................... 10.9
Other* ............................................................... --**
- --------------------------------------------------------------------------------
* Includes portfolio holdings in short-term investments.
** Amount is less than 0.1%.
6 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006
Schedule of Investments (in U.S. dollars)
Face
Amount Corporate Bonds Value
==========================================================================================================
Aerospace & Defense--3.5%
EUR 4,226,589 Aero Invest 1 SA, 10.677% due 3/01/2015 (d)(f) $ 4,886,707
USD 3,000,000 Vought Aircraft Industries, Inc., 8% due 7/15/2011 2,812,500
------------
7,699,207
==========================================================================================================
Automotive--5.4%
4,200,000 Delco Remy International, Inc., 8.60% due 4/15/2009 (b) 3,948,000
2,700,000 Exide Technologies, 10.50% due 3/15/2013 (d) 2,139,750
3,000,000 General Motors Acceptance Corporation, 2.56% due 7/16/2007 2,858,085
3,000,000 Stoneridge Inc., 11.50% due 5/01/2012 2,992,500
------------
11,938,335
==========================================================================================================
Broadcasting--8.5%
3,000,000 Canadian Satellite Radio Holdings, Inc., 12.75% due 2/15/2014 (d) 3,060,000
368,571 Emmis Communications Corp., 10.366% due 6/15/2012 (b) 368,571
2,000,000 Granite Broadcasting Corp., 9.75% due 12/01/2010 1,810,000
500,000 LIN Television Corp. Series B, 6.50% due 5/15/2013 474,375
Paxson Communications Corp. (b)(d):
875,000 7.777% due 1/15/2012 875,000
1,750,000 10.777% due 1/15/2013 1,693,125
4,000,000 Sirius Satellite Radio, Inc., 9.625% due 8/01/2013 3,920,000
4,000,000 XM Satellite Radio, Inc., 10.18% due 5/01/2009 (b) 4,055,000
3,000,000 Young Broadcasting Inc., 10% due 3/01/2011 2,681,250
------------
18,937,321
==========================================================================================================
Cable--International--2.3%
5,000,000 New Skies Satellites NV, 9.573% due 11/01/2011 (b) 5,162,500
==========================================================================================================
Cable--U.S.--5.5%
5,000,000 CCO Holdings LLC, 8.616% due 12/15/2010 (b) 5,000,000
3,000,000 Cablevision Systems Corp. Series B, 8.716% due 4/01/2009 (b) 3,101,250
4,000,000 Intelsat Bermuda Ltd., 9.609% due 1/15/2012 (b)(d) 4,080,000
------------
12,181,250
==========================================================================================================
Chemicals--8.0%
2,000,000 Huntsman LLC, 11.85% due 7/15/2011 (b) 2,105,000
4,000,000 Nova Chemicals Corp., 7.561% due 11/15/2013 (b) 4,080,000
5,000,000 Omnova Solutions, Inc., 11.25% due 6/01/2010 5,262,500
PolyOne Corp.:
2,000,000 6.89% due 9/22/2008 1,915,000
1,500,000 10.625% due 5/15/2010 1,608,750
1,600,000 Tronox Worldwide LLC, 9.50% due 12/01/2012 (d) 1,672,000
1,000,000 VeraSun Energy Corp., 9.875% due 12/15/2012 (d) 1,065,000
------------
17,708,250
==========================================================================================================
Consumer--Durables--1.7%
4,000,000 Simmons Bedding Co., 7.875% due 1/15/2014 3,840,000
==========================================================================================================
Consumer--Non-Durables--2.7%
2,200,000 Ames True Temper, Inc., 8.60% due 1/15/2012 (b) 2,101,000
4,000,000 Hines Nurseries, Inc., 10.25% due 10/01/2011 3,995,000
------------
6,096,000
==========================================================================================================
Diversified Media--3.5%
1,000,000 AMC Entertainment, Inc., 11% due 2/01/2016 (d) 1,006,250
RH Donnelley Corp. (d):
350,000 6.875% due 1/15/2013 329,000
825,000 8.875% due 1/15/2016 861,094
500,000 Series A-2, 6.875% due 1/15/2013 470,000
5,000,000 Universal City Florida Holding Co. I, 9.43% due 5/01/2010 (b) 5,075,000
------------
7,741,344
==========================================================================================================
Energy--Exploration & Production--0.5%
1,000,000 Chaparral Energy, Inc., 8.50% due 12/01/2015 (d) 1,057,500
==========================================================================================================
Energy--Other--4.3%
4,000,000 Aventine Renewable Energy Holdings, Inc., 10.491% due 12/15/2011 (b)(d) 4,220,000
3,000,000 Parker Drilling Co., 9.57% due 9/01/2010 (b) 3,097,500
2,175,000 SemGroup LP, 8.75% due 11/15/2015 (d) 2,251,125
------------
9,568,625
==========================================================================================================
Food & Drug--1.1%
2,000,000 Duane Reade, Inc., 8.991% due 12/15/2010 (b) 1,965,000
500,000 Stripes Acquisition LLC, 10.625% due 12/15/2013 (d) 522,500
------------
2,487,500
==========================================================================================================
Gaming--5.8%
Galaxy Entertainment Finance Co. Ltd. (d):
4,125,000 9.655% due 12/15/2010 (b) 4,259,062
375,000 9.875% due 12/15/2012 388,125
2,000,000 Inn of the Mountain Gods Resort & Casino, 12% due 11/15/2010 2,112,500
1,025,000 Little Traverse Bay Bands of Odawa Indians, 10.25% due 2/15/2014 (d) 1,012,188
4,000,000 Penn National Gaming, Inc., 6.75% due 3/01/2015 4,020,000
1,000,000 Tunica-Biloxi Gaming Authority, 9% due 11/15/2015 (d) 1,025,000
------------
12,816,875
==========================================================================================================
Health Care--0.9%
2,000,000 Elan Finance Plc, 8.749% due 11/15/2011 (b) 1,935,000
==========================================================================================================
Housing--6.5%
4,000,000 Builders FirstSource, Inc., 8.999% due 2/15/2012 (b) 4,110,000
1,500,000 Compression Polymers Corp, 11.44% due 7/01/2012 (b)(d) 1,500,000
4,335,000 Goodman Global Holding Co., Inc., 7.491% due 6/15/2012 (b) 4,410,863
4,500,000 Nortek, Inc., 8.50% due 9/01/2014 4,488,750
------------
14,509,613
==========================================================================================================
Hybrid--0.6%
1,350,000 North Street Referenced Linked Notes Series
2005-8A Class D, 18.965% due 6/15/2041 (b)(d) 1,350,000
==========================================================================================================
Information Technology--7.7%
Activant Solutions, Inc. (b)(d):
2,500,000 10.53% due 4/01/2010 2,562,500
1,500,000 13.036% due 10/01/2011 (f) 1,537,500
4,000,000 MagnaChip Semiconductor SA, 7.741% due 12/15/2011 (b) 4,060,000
Sungard Data Systems, Inc. (d):
1,800,000 9.125% due 8/15/2013 1,914,750
1,200,000 9.431% due 8/15/2013 (b) 1,266,000
2,000,000 10.25% due 8/15/2015 2,097,500
4,000,000 Telcordia Technologies Inc., 10% due 3/15/2013 (d) 3,680,000
------------
17,118,250
==========================================================================================================
Leisure--2.3%
5,000,000 FelCor Lodging LP, 8.83% due 6/01/2011 (b) 5,200,000
==========================================================================================================
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006 7
Schedule of Investments (continued) (in U.S. dollars)
Face
Amount Corporate Bonds Value
==========================================================================================================
Manufacturing--8.0%
USD 2,975,000 Brand Services, Inc., 12% due 10/15/2012 $ 3,160,937
4,000,000 CPI Holdco, Inc., 10.561% due 2/01/2015 (b) 4,140,000
500,000 Chart Industries, Inc., 9.125% due 10/15/2015 (d) 517,500
2,910,000 Medis Technologies Ltd., 6% due 7/15/2010 (d)(g) 3,201,000
2,475,000 Mueller Group, Inc., 10% due 5/01/2012 2,710,125
2,000,000 Propex Fabrics, Inc., 10% due 12/01/2012 1,780,000
2,500,000 Trimas Corp., 9.875% due 6/15/2012 2,200,000
------------
17,709,562
==========================================================================================================
Metal--Other--2.5%
1,950,000 Indalex Holding Corp., 11.50% due 2/01/2014 (d) 1,911,000
2,000,000 James River Coal Co., 9.375% due 6/01/2012 2,085,000
1,425,000 RathGibson, Inc., 11.25% due 2/15/2014 (d) 1,442,813
------------
5,438,813
==========================================================================================================
Packaging--3.9%
Anchor Glass Container Corp.:
3,114,000 11.491% due 9/30/2006 3,176,280
4,095,000 11.497% due 2/15/2013 (e) 3,276,000
3,000,000 Wise Metals Group LLC, 10.25% due 5/15/2012 2,295,000
------------
8,747,280
==========================================================================================================
Paper--4.5%
5,000,000 Abitibi-Consolidated, Inc., 7.991% due 6/15/2011 (b) 4,862,500
2,000,000 Boise Cascade LLC, 7.475% due 10/15/2012 (b) 1,990,000
3,000,000 NewPage Corp., 10.93% due 5/01/2012 (b) 3,150,000
------------
10,002,500
==========================================================================================================
Retail--1.7%
Neiman-Marcus Group, Inc. (d):
1,850,000 9% due 10/15/2015 1,954,063
1,800,000 10.375% due 10/15/2015 1,894,500
------------
3,848,563
==========================================================================================================
Service--3.0%
500,000 Corrections Corp. of America, 6.75% due 1/31/2014 508,750
5,000,000 HydroChem Industrial Services, Inc., 9.25% due 2/15/2013 (d) 4,950,000
1,000,000 Neff Rental LLC, 11.25% due 6/15/2012 (d) 1,085,000
------------
6,543,750
==========================================================================================================
Telecommunications--2.8%
2,000,000 Qwest Communications International, Inc., 8.249% due 2/15/2009 (b) 2,042,500
4,000,000 Time Warner Telecom Holdings, Inc., 8.749% due 2/15/2011 (b) 4,085,000
------------
6,127,500
==========================================================================================================
Transportation--1.7%
4,000,000 Titan Petrochemicals Group Ltd., 8.50% due 3/18/2012 (d) 3,780,000
==========================================================================================================
Utility--1.9%
4,000,000 Dynegy Holdings, Inc., 11.10% due 7/15/2008 (b)(d) 4,190,000
==========================================================================================================
Wireless Communications--6.3%
2,000,000 AirGate PCS, Inc., 8.35% due 10/15/2011 (b) 2,072,500
5,000,000 Dobson Cellular Systems, 9.43% due 11/01/2011 (b) 5,200,000
4,000,000 IWO Holdings, Inc., 8.35% due 1/15/2012 (b) 4,165,000
2,500,000 US Unwired, Inc., 8.741% due 6/15/2010 (b) 2,575,000
------------
14,012,500
- ----------------------------------------------------------------------------------------------------------
Total Corporate Bonds (Cost--$242,084,563)--107.1% 237,748,038
==========================================================================================================
Fixed Rate Loan Interests
==========================================================================================================
Health Care--2.1%
4,000,000 HealthSouth Corp. Term Loan A, 10.375% due 1/16/2011 4,583,332
- ----------------------------------------------------------------------------------------------------------
Total Fixed Rate Loan Interests (Cost--$4,440,000)--2.1% 4,583,332
==========================================================================================================
Floating Rate Loan Interests (a)
==========================================================================================================
Aerospace & Defense--1.7%
3,703,703 Standard Aero Holdings Term Loan, 6.83% - 6.96% due 8/24/2012 3,681,714
==========================================================================================================
Airlines--0.2%
500,000 Delta Air Lines, Inc. Term Loan B, 11.01% due 3/16/2008 519,875
==========================================================================================================
Automotive--6.0%
2,890,021 Delphi Automotive Systems Term Loan B, 12.75% due 6/14/2011 3,051,079
Intermet Corp.:
1,481,481 First Lien Term Loan, 9.09% due 11/08/2010 1,466,667
518,519 Letter of Credit, 9.09% due 11/08/2010 513,333
Metaldyne Corp. Term Loan D:
2,778,824 9.044% due 12/31/2009 2,832,650
400,000 11.25% due 12/31/2009 405,375
5,000,000 RJ Tower Corp. Tranche B Term Loan, 7.25% due 2/02/2007 5,101,785
------------
13,370,889
==========================================================================================================
Chemicals--2.3%
1,985,000 PQ Corp. Term Loan, 6.563% due 2/11/2012 2,011,053
3,000,000 Wellman, Inc. Second Lien Term Loan, 11.43% due 2/10/2010 3,078,750
------------
5,089,803
==========================================================================================================
Consumer--Non-Durables--2.3%
5,000,000 American Safety Razor Co. Tranche C Term Loan, 11.23% due 8/28/2012 5,075,000
==========================================================================================================
Energy--Other--0.5%
1,000,000 Scorpion Drilling Ltd. Second Lien Term Loan, 12.07% due 5/05/2015 1,032,500
==========================================================================================================
Food & Tobacco--0.7%
500,000 Bolthouse Farms, Inc. Second Lien Term Loan, 10.07% due 12/01/2013 513,125
989,167 Commonwealth Brands Term Loan, 7% due 12/22/2012 1,002,149
------------
1,515,274
==========================================================================================================
Gaming--1.2%
2,886,345 Resorts International Holdings LLC Second Lien Term Loan, 12.027%
due 4/26/2013 2,687,908
==========================================================================================================
Housing--2.5%
1,906,815 Lake at Las Vegas Joint Venture Term Loan, 7.355% - 7.46%
due 11/01/2009 1,914,135
4,000,000 Stile U.S. Acquisition Corp. Bridge Loan, 10.884% due 4/06/2015 3,700,000
------------
5,614,135
==========================================================================================================
Information Technology--3.4%
5,500,000 Amkor Technology, Inc. Second Lien Term Loan, 9.274% due 10/27/2010 5,747,500
8 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006
Schedule of Investments (concluded) (in U.S. dollars)
Face
Amount Floating Rate Loan Interests (a) Value
==========================================================================================================
Information Technology (concluded)
USD 1,760,000 Fidelity National Information Solutions, Inc. Term Loan B, 6.32%
due 3/09/2013 $ 1,774,506
------------
7,522,006
==========================================================================================================
Metal--Other--1.7%
Euramax International Plc:
828,947 Second Lien Term Loan, 11.544% due 6/29/2013 797,862
1,442,801 Tranche 3 Term Loan B, 7.241% due 6/29/2012 1,446,408
1,671,053 Tranche 4 Second Lien Term Loan, 11.544% due 6/29/2013 1,608,388
------------
3,852,658
==========================================================================================================
Packaging--2.3%
5,000,000 Graham Packaging Co. LP Second Lien Term Loan, 8.813% due 4/07/2012 5,125,000
==========================================================================================================
Telecommunications--1.4%
3,000,000 FairPoint Communications, Inc. Term Loan B, 6.313% due 2/08/2012 3,024,000
==========================================================================================================
Utility--1.5%
3,300,000 Covanta Energy Corp. Second Lien Term Loan, 10.019% - 10.081%
due 6/24/2013 3,361,875
==========================================================================================================
Total Floating Rate Loan Interests (Cost--$61,608,195)--27.7% 61,472,637
==========================================================================================================
Beneficial
Interest Short-Term Securities
==========================================================================================================
USD 131,723 Merrill Lynch Liquidity Series, LLC Cash Sweep Series I, 4.42% (c) 131,723
- ----------------------------------------------------------------------------------------------------------
Total Short-Term Securities (Cost--$131,723)--0.0% 131,723
==========================================================================================================
Total Investments (Cost--$308,264,481*)--136.9% 303,935,730
Liabilities in Excess of Other Assets--(36.9%) (81,980,222)
------------
Net Assets--100.0% $221,955,508
============
* The cost and unrealized appreciation (depreciation) of investments as of
February 28, 2006, as computed for federal income tax purposes, were as
follows:
Aggregate cost ......................................... $308,167,862
============
Gross unrealized appreciation .......................... $ 3,740,025
Gross unrealized depreciation .......................... (7,972,157)
------------
Net unrealized depreciation ............................ $ (4,232,132)
============
(a) Floating rate loan interests in which the Fund 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 Fund, 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 $104,868 $12,444
--------------------------------------------------------------------------
(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 which may pay interest/dividends in
additional face/shares.
(g) Convertible security.
o For Fund compliance purposes, the Fund'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 Fund 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.
o Swaps entered into as of February, 28 2006 were as follows:
---------------------------------------------------------------------------------
Unrealized
Notional Appreciation
Amount (Depreciation)
---------------------------------------------------------------------------------
Sold credit default protection on Ford Motor
Credit Co. and receive 8.75%
Broker, Morgan Stanley Capital Services, Inc.
Expires December 2006 $ 3,000,000 $ 41,040
Sold credit default protection on General
Motors Corp. and receive 5.25%
Broker, Morgan Stanley Capital Services, Inc.
Expires June 2008 $ 5,000,000 (782,465)
Sold credit default protection on ACES
High Yield Index (10 - 13% Tranche)
and receive 5.0%
Broker, Morgan Stanley Capital Services, Inc.
Expires March 2010 $ 7,000,000 (155,267)
Pay a fixed rate of 4.823% and receive a
floating rate based on 3-month LIBOR
Broker, JPMorgan Chase Bank
Expires January 2013 $20,000,000 291,185
Pay a fixed rate of 4.853% and receive a
floating rate based on 3-month LIBOR
Broker, Lehman Brothers Special Finance
Expires March 2013 $31,000,000 402,724
---------------------------------------------------------------------------------
Total $ (202,783)
===========
o Currency Abbreviations
EUR Euro
USD U.S. Dollar
See Notes to Financial Statements.
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006 9
Statement of Assets, Liabilities and Capital
As of February 28, 2006
===================================================================================================================================
Assets
- -----------------------------------------------------------------------------------------------------------------------------------
Investments in unaffiliated securities, at value (identified cost--$308,132,758) .... $ 303,804,007
Investments in affiliated securities, at value (identified cost--$131,723) .......... 131,723
Cash ................................................................................ 2,330,320
Unrealized appreciation on swaps .................................................... 734,949
Foreign cash (cost--$197) ........................................................... 195
Receivables:
Interest receivable ................................................................ $ 5,414,749
Securities sold .................................................................... 2,554,900
Swaps .............................................................................. 546,218 8,515,867
-------------
Prepaid expenses .................................................................... 5,729
-------------
Total assets ........................................................................ 315,522,790
-------------
===================================================================================================================================
Liabilities
- -----------------------------------------------------------------------------------------------------------------------------------
Loans ............................................................................... 91,200,000
Unrealized depreciation on swaps .................................................... 937,732
Payables:
Swaps ............................................................................ 779,132
Dividends to shareholders ........................................................ 398,222
Investment adviser ............................................................... 146,170
Interest on loans ................................................................ 47,030
Other affiliates ................................................................. 1,880 1,372,434
-------------
Accrued expenses .................................................................... 57,116
-------------
Total liabilities ................................................................... 93,567,282
-------------
===================================================================================================================================
Net Assets
- -----------------------------------------------------------------------------------------------------------------------------------
Net assets .......................................................................... $ 221,955,508
=============
===================================================================================================================================
Capital
- -----------------------------------------------------------------------------------------------------------------------------------
Common Stock, par value $.10 per share; 200,000,000 shares authorized
(11,965,780 shares issued and outstanding) ......................................... $ 1,196,578
Paid-in capital in excess of par .................................................... 226,900,754
Undistributed investment income--net ................................................ $ 598,724
Accumulated realized capital losses--net ............................................ (2,207,387)
Unrealized depreciation--net ........................................................ (4,533,161)
-------------
Total accumulated losses--net ....................................................... (6,141,824)
-------------
Total capital--Equivalent to $18.55 net asset value per share of
Common Stock (market price--$17.65) ................................................ $ 221,955,508
=============
See Notes to Financial Statements.
10 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006
Statement of Operations
For the Six Months Ended February 28, 2006
===================================================================================================================================
Investment Income
- -----------------------------------------------------------------------------------------------------------------------------------
Interest (including $12,444 from affiliates) ........................................ $ 13,088,024
Other income ........................................................................ 15,877
-------------
Total income ........................................................................ 13,103,901
-------------
===================================================================================================================================
Expenses
- -----------------------------------------------------------------------------------------------------------------------------------
Loan interest expense ............................................................... $ 1,872,326
Investment advisory fees ............................................................ 1,129,288
Borrowing costs ..................................................................... 93,324
Accounting services ................................................................. 43,650
Professional fees ................................................................... 39,103
Transfer agent fees ................................................................. 24,624
Printing and shareholder reports .................................................... 24,406
Directors' fees and expenses ........................................................ 22,345
Listing fees ........................................................................ 10,624
Custodian fees ...................................................................... 9,257
Pricing services .................................................................... 7,141
Other ............................................................................... 11,369
-------------
Total expenses ...................................................................... 3,287,457
-------------
Investment income--net .............................................................. 9,816,444
-------------
===================================================================================================================================
Realized & Unrealized Gain (Loss)--Net
- -----------------------------------------------------------------------------------------------------------------------------------
Realized loss on:
Investments--net ................................................................. (1,556,199)
Swaps--net ....................................................................... (391,848)
Foreign currency transactions--net ............................................... (22,999) (1,971,046)
-------------
Unrealized appreciation/depreciation on:
Investments--net ................................................................. 3,161,156
Swaps--net ....................................................................... 876,665
Foreign currency transactions--net ............................................... 4,578 4,042,399
-----------------------------
Total realized and unrealized gain--net ............................................. 2,071,353
-------------
Net Increase in Net Assets Resulting from Operations ................................ $ 11,887,797
=============
See Notes to Financial Statements.
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006 11
Statement of Changes in Net Assets
For the Period
For the Six January 31,
Months Ended 2005+ to
February 28, August 31,
Increase (Decrease) in Net Assets: 2006 2005
===================================================================================================================================
Operations
- -----------------------------------------------------------------------------------------------------------------------------------
Investment income--net .............................................................. $ 9,816,444 $ 9,971,405
Realized loss--net .................................................................. (1,971,046) (642,852)
Unrealized appreciation/depreciation--net ........................................... 4,042,399 (8,575,560)
-----------------------------
Net increase in net assets resulting from operations ................................ 11,887,797 752,993
-----------------------------
===================================================================================================================================
Dividends to Shareholders
- -----------------------------------------------------------------------------------------------------------------------------------
Dividends to shareholders from investment income--net ............................... (9,865,969) (8,916,645)
-----------------------------
===================================================================================================================================
Common Stock Transactions
- -----------------------------------------------------------------------------------------------------------------------------------
Proceeds from issuance of Common Stock .............................................. -- 228,245,000
Value of shares issued to Common Stock shareholders in reinvestment of dividends .... 190,636 --
Offering costs resulting from the issuance of Common Stock .......................... -- (433,653)
Adjustment of offering costs resulting from the issuance of Common Stock ............ (4,659) --
-----------------------------
Net increase in net assets resulting from Common Stock transactions ................. 185,977 227,811,347
-----------------------------
===================================================================================================================================
Net Assets
- -----------------------------------------------------------------------------------------------------------------------------------
Total increase in net assets ........................................................ 2,207,805 219,647,695
Beginning of period ................................................................. 219,747,703 100,008
-----------------------------
End of period* ...................................................................... $ 221,955,508 $ 219,747,703
=============================
* Undistributed investment income--net ............................................. $ 598,724 $ 648,249
=============================
+ Commencement of operations.
See Notes to Financial Statements.
12 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006
Statement of Cash Flows
For the Six Months Ended February 28, 2006
===================================================================================================================================
Cash Provided by Operating Activities
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations ............................................... $ 11,887,797
Adjustments to reconcile net increase in net assets resulting from operations to net cash
provided by operating activities:
Increase in receivables ......................................................................... (572,638)
Decrease in other assets ........................................................................ 7,500
Increase in other liabilities ................................................................... 417,140
Realized and unrealized gain--net ............................................................... (2,071,353)
Amortization of premium and discount ............................................................ 173,764
Proceeds from sales and paydowns of long-term securities ........................................... 70,914,589
Other investment related transactions .............................................................. (276,519)
Purchases of long-term securities .................................................................. (75,056,201)
Proceeds from sales of short-term investments ...................................................... 17,008,663
------------
Cash provided by operating activities .............................................................. 22,432,742
------------
===================================================================================================================================
Cash Used for Financing Activities
- -----------------------------------------------------------------------------------------------------------------------------------
Cash receipts from borrowings ...................................................................... 69,700,000
Cash payments on borrowings ........................................................................ (79,900,000)
Cash payments on offering costs .................................................................... (132,213)
Dividends paid to shareholders ..................................................................... (9,770,057)
------------
Cash used for financing activities ................................................................. (20,102,270)
------------
===================================================================================================================================
Cash
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase in cash ............................................................................... 2,330,472
Cash at beginning of period ........................................................................ 43
------------
Cash at end of period .............................................................................. $ 2,330,515
============
===================================================================================================================================
Information
- -----------------------------------------------------------------------------------------------------------------------------------
Cash paid for interest ............................................................................. $ 1,899,333
============
===================================================================================================================================
Noncash Financing Activities
- -----------------------------------------------------------------------------------------------------------------------------------
Capital shares issued in reinvestment of dividends paid to shareholders ............................ $ 190,636
============
See Notes to Financial Statements.
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006 13
Financial Highlights
For the Six For the Period
Months Ended January 31, 2005+
The following per share data and ratios have been derived February 28, to August 31,
from information provided in the financial statements. 2006 2005
================================================================================================================================
Per Share Operating Performance
- --------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period ................................................ $ 18.38 $ 19.10
-----------------------------
Investment income--net*** ........................................................... .82 .84
Realized and unrealized gain (loss)--net ............................................ .17 (.77)
-----------------------------
Total from investment operations .................................................... .99 .07
-----------------------------
Less dividends from investment income--net .......................................... (.82) (.75)
-----------------------------
Offering costs resulting from the issuance of Common Stock .......................... -- (.04)
-----------------------------
Adjustment of offering costs resulting from the issuance of Common Stock ............ --++ --
-----------------------------
Net asset value, end of period ...................................................... $ 18.55 $ 18.38
=============================
Market price per share, end of period ............................................... $ 17.65 $ 17.53
=============================
================================================================================================================================
Total Investment Return**
- --------------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share .................................................. 5.92%@ .42%@
=============================
Based on market price per share ..................................................... 5.67%@ (8.53%)@
=============================
================================================================================================================================
Ratios to Average Net Assets
- --------------------------------------------------------------------------------------------------------------------------------
Expenses, net of waiver and excluding interest expense .............................. 1.32%* 1.00%*
=============================
Expenses, net of waiver ............................................................. 3.06%* 2.20%*
=============================
Expenses ............................................................................ 3.06%* 2.48%*
=============================
Investment income--net .............................................................. 9.12%* 7.88%*
=============================
================================================================================================================================
Leverage
- --------------------------------------------------------------------------------------------------------------------------------
Amount of borrowings, end of period (in thousands) .................................. $ 91,200 $ 101,400
=============================
Average amount of borrowings outstanding during the period (in thousands) ........... $ 86,685 $ 75,543
=============================
Average amount of borrowings outstanding per share during the period*** ............. $ 7.25 $ 6.33
=============================
================================================================================================================================
Supplemental Data
- --------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period (in thousands) ............................................ $ 221,956 $ 219,748
=============================
Portfolio turnover .................................................................. 24.95% 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.
++ Amount is less than $(.01) per share.
@ Aggregate total investment return.
See Notes to Financial Statements.
14 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006
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. 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. These unaudited financial statements reflect all adjustments,
which are, in the opinion of management, necessary to present a fair statement
of the results for the interim period. All such adjustments are of a normal,
recurring nature. 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 matrixes to determine valuations. If the pricing service does not
provide a value for loan interests, Fund Asset Management, L.P. ("FAM") will
value the loan interests at fair value, which is intended to approximate market
value.
Debt securities are traded primarily in the over-the-counter ("OTC") markets and
are valued at the last available bid price in the OTC market or on the basis of
values obtained by a pricing service. Pricing services use valuation matrixes
that incorporate both dealer-supplied valuations and valuation models. The
procedures of the pricing service and its valuations are reviewed by the
officers of the Fund under the general direction of the Board of Directors. Such
valuations and procedures will be reviewed periodically by the Board of
Directors of the Fund.
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 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
FAM believes that this method no longer produces fair valuations. Repurchase
agreements will be valued at cost plus accrued interest.
Generally, trading in foreign securities, as well as U.S. government securities,
money market instruments and certain fixed income securities, 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 the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006 15
Notes to Financial Statements (continued)
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
FAM 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. Any adjustments to estimates of
offering costs were recorded back 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 be maintained at all times in an amount equal to at least
100%
16 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006
Notes to Financial Statements (continued)
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.
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.
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 six months ended February 28, 2006, the Fund reimbursed FAM $2,277 for
certain accounting services.
In addition, MLPF&S received $7,781 in commissions on the execution of portfolio
security transactions for the Fund for the six months ended February 28, 2006.
Certain officers and/or directors of the Fund are officers and/or directors of
FAM, PSI, ML & Co., and/or MLIM, LLC.
In February 2006, ML & Co. and BlackRock, Inc. entered into an agreement to
merge ML & Co.'s investment management business, including FAM, with the
investment management business of BlackRock, Inc. The transaction is expected to
close in the third quarter of 2006.
3. Investments:
Purchases and sales (including paydowns) of investments, excluding short-term
securities, for the six months ended February 28, 2006 were $75,056,201 and
$73,469,489, 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 for the six months ended February 28, 2006
increased by 10,544 as a result of dividend reinvestment. 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
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
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006 17
Notes to Financial Statements (concluded)
fee. The Fund pays additional borrowing costs including a backstop commitment
fee.
The weighted average annual interest rate was 4.30% and the average borrowing
was approximately $86,685,000 for the six months ended February 28, 2006.
6. Subsequent Event:
The Fund paid an ordinary income dividend in the amount of $.141667 per share on
March 31, 2006 to shareholders of record on March 14, 2006.
Officers and Directors
Robert C. Doll, Jr., President and Director
Ronald W. Forbes, Director
Cynthia A. Montgomery, Director
Jean Margo Reid, Director
Roscoe S. Suddarth, Director
Richard R. West, Director
Edward D. Zinbarg, Director
Donald C. Burke, Vice President and Treasurer
Kevin J. Booth, Vice President
Jeffrey Hiller, Chief Compliance Officer
Alice A. Pellegrino, Secretary
Custodian
State Street Bank and Trust Company
P.O. Box 351
Boston, MA 02101
Transfer Agent
Computershare Trust Company, N.A.
P.O. Box 43010
Providence, RI 02940-3010
800-426-5523
NYSE Symbol
DVF
18 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006
Proxy Results
During the six-month period ended February 28, 2006, Diversified Income
Strategies Portfolio, Inc.'s Common Stock shareholders voted on the following
proposal. The proposal was approved at a shareholders' meeting on January 26,
2006. A description of the proposal and number of shares voted are as follows:
- -------------------------------------------------------------------------------------------------------
Shares Voted Shares Withheld
For From Voting
- -------------------------------------------------------------------------------------------------------
1. To elect the Fund's Board of Directors: Robert C. Doll, Jr. 11,317,725 215,318
Ronald W. Forbes 11,325,297 207,746
Cynthia A. Montgomery 11,318,255 214,788
Jean Margo Reid 11,315,955 217,088
Roscoe S. Suddarth 11,316,155 216,888
Richard R. West 11,316,905 216,138
Edward D. Zinbarg 11,316,375 216,668
- -------------------------------------------------------------------------------------------------------
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006 19
Disclosure of Investment Advisory Agreement
Activities of and Composition of the Board of Directors
All but one member of the Board of Directors is an independent director whose
only affiliation with Fund Asset Management, L.P. (the "Investment Adviser") or
other Merrill Lynch affiliates is as a director of the Fund and certain other
funds advised by the Investment Adviser or its affiliates. The Chairman of the
Board is also an independent director. New director nominees are chosen as
nominees by a Nominating Committee comprised of independent directors. All
independent directors also are members of the Board's Audit Committee and the
independent directors meet in executive session at each in-person Board meeting.
The Board and the Audit Committee meet in person for at least two days each
quarter and conduct other in-person and telephone meetings throughout the year,
some of which are formal board meetings, and some of which are informational
meetings. The independent counsel to the independent directors attends all
in-person Board and Audit Committee meetings and other meetings at the
independent directors' request.
Investment Advisory Agreement -- Matters Considered by the Board
Every year, the Board considers approval of the Fund's investment advisory
agreement (the "Investment Advisory Agreement"). The Board assesses the nature,
scope and quality of the services provided to the Fund by the personnel of the
Investment Adviser and its affiliates, including administrative services,
shareholder services, oversight of fund accounting, marketing services and
assistance in meeting legal and regulatory requirements. The Board also receives
and assesses information regarding the services provided to the Fund by certain
unaffiliated service providers.
At various times throughout the year, the Board also considers a range of
information in connection with its oversight of the services provided by the
Investment Adviser and its affiliates. Among the matters considered are: (a)
fees (in addition to management fees) paid to the Investment Adviser and its
affiliates by the Fund, such as transfer agency fees; (b) Fund operating
expenses paid to third parties; (c) the resources devoted to and compliance
reports relating to the Fund's investment objective, policies and restrictions,
and its compliance with its Code of Ethics and the Investment Adviser's
compliance policies and procedures; and (d) the nature, cost and character of
non-investment management services provided by the Investment Adviser and its
affiliates.
The Board believes that the Investment Adviser is one of the most experienced
global asset management firms and considers the overall services provided by the
Investment Adviser to be of high quality. The Board also believes that the
Investment Adviser is financially sound and well managed and notes that the
Investment Adviser is affiliated with one of America's largest financial firms.
The Board works closely with the Investment Adviser in overseeing the Investment
Adviser's efforts to achieve good performance. As part of this effort, the Board
discusses portfolio manager effectiveness and, when performance is not
satisfactory, discusses with the Investment Adviser taking steps such as
changing investment personnel.
Annual Consideration of Approval by the Board of Directors
In the period prior to the Board meeting to consider renewal of the Investment
Advisory Agreement, the Board requested and received materials specifically
relating to the Fund's Investment Advisory Agreement. These materials include
(a) information compiled by Lipper Inc. ("Lipper") on the fees and expenses and
the investment performance and leverage of the Fund as compared to a comparable
group of funds as classified by Lipper; (b) information comparing the Fund's
market price with its net asset value per share; and (c) a discussion by the
Fund's portfolio management team on investment strategies used by the Fund
during its most recent fiscal year. The Investment Adviser noted that it did not
have any other clients with similar investment mandates. The Investment Adviser
also noted that because the Fund was so new, it did not have information on the
profitability to the Investment Adviser and its affiliates of the Investment
Advisory Agreement and other relationships with the Fund. The Board considered
other matters it deemed important to the approval process such as services
related to the valuation and pricing of Fund portfolio holdings, allocation of
Fund brokerage fees, the Fund's portfolio turnover statistics, and direct and
indirect benefits to the Investment Adviser and its affiliates from their
relationship with the Fund. The Board did not identify any particular
information as controlling, and each member of the Board may have attributed
different weights to the various items considered.
Certain Specific Renewal Data
In connection with the most recent renewal of the Fund's Investment Advisory
Agreement in February, 2006, the independent directors' and Board's review
included the following:
Services Provided by the Investment Adviser -- The Board reviewed the nature,
extent and quality of services provided by the Investment Adviser, including the
investment advisory services and the resulting performance of the Fund. The
Board focused primarily on the Investment Adviser's investment
20 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006
advisory services and the Fund's investment performance. The Board compared Fund
performance -- both including and excluding the effects of the Fund's fees and
expenses -- to the performance of a comparable group of funds. While the Board
reviews performance data at least quarterly, consistent with the Investment
Adviser's investment goals, the Board attaches more importance to performance
over relatively long periods of time, typically three to five years, or a
shorter period in the case of a fund that has been in existence less than five
years. According to Lipper's ranking of all closed-end leveraged loan
participation funds, the Fund's performance after fees and expenses ranked in
the fifth quintile compared to its peers for the period since inception (January
31, 2005) through November 30, 2005. Other data supplied by the Investment
Adviser indicated that the Fund had a total return after expenses that was above
its benchmark for the same period. Considering these factors, and taking into
account the recent inception date of the Fund, the Board concluded that the
Fund's performance supported the continuation of the Investment Advisory
Agreement.
The Investment Adviser's Personnel and Investment Process -- The Board reviewed
the Fund's investment objectives and strategies. The Board discussed with senior
management of the Investment Adviser responsible for investment operations and
the senior management of the Investment Adviser's taxable fixed-income investing
group the extent to which the Fund was leveraged during the period and other
strategies being used to achieve the stated objectives. Among other things, the
Board considered the size, education and experience of the Investment Adviser's
investment staff, its use of technology, and the Investment Adviser's approach
to training and retaining portfolio managers and other research, advisory and
management personnel. The Board also reviewed the Investment Adviser's
compensation policies and practices with respect to the Fund's portfolio
manager. The Board also considered the experience of the Fund's portfolio
manager and noted that Mr. Booth has more than 20 years experience in the
financial industry. The Board noted that the Investment Adviser and its
investment staff have extensive experience in analyzing and managing the types
of investments used by the Fund. The Board concluded that the Fund benefits from
that expertise.
Management Fees and Other Expenses -- The Board reviewed the Fund's contractual
management fee rate and actual management fee rate as a percentage of total
assets at common asset levels -- the actual rate includes advisory and
administrative service fees and the effects of any fee waivers -- compared to
the other funds considered comparable by Lipper. It also compared the Fund's
total expenses to those of other comparable funds. The Board did not consider
the services provided to and the fees charged by the Investment Adviser to other
types of clients, such as offshore funds, with similar investment mandates since
the Investment Adviser stated that there were no other clients with similar
mandates. The Fund's contractual and actual management fee rates, as well as its
actual total expenses, including investment-related expenses, were lower than
the median fees charged by comparable funds, as determined by Lipper. The Board
concluded that the Fund's management fee and fee rate and overall expense ratio
are acceptable compared to those of other comparable funds.
Profitability -- The Board noted that since the Fund has been in existence for
less than a year and the Investment Adviser has waived a portion of its
management fee during the initial months of start-up, there is no meaningful
basis to analyze the profitability of this fund to the Investment Adviser over
the review period. Generally, the Board considers the cost of the services
provided to funds by the Investment Adviser, and the Investment Adviser's and
its affiliates' profits relating to the management of the MLIM/FAM-advised
funds. As part of its analysis, the Board reviews the Investment Adviser's
methodology in allocating its costs to the management of funds and has concluded
that there was a reasonable basis for the allocation. The Board also considered
federal court decisions discussing an investment adviser's profitability and
profitability levels considered to be reasonable in those decisions. The Board
concluded that the Investment Adviser's profits are acceptable in relation to
the nature and quality of services provided and given the level of fees and
expenses overall.
Economies of Scale -- The Board considered whether there have been economies of
scale in respect to the management of MLIM/FAM-advised funds, whether the
MLIM/FAM-advised funds (including the Fund) have appropriately benefited from
any economies of scale, and whether there is potential for realization of any
further economies of scale. The Board considered economies of scale to the
extent applicable to the Fund's closed-end structure and determined that no
changes were currently necessary.
Conclusion
After the independent directors deliberated in executive session, the entire
Board, including all of the independent directors, approved the renewal of the
existing Investment Advisory Agreement, concluding that the advisory fee was
reasonable in relation to the services provided and that a contract renewal was
in the best interests of the shareholders.
DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006 21
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.
22 DIVERSIFIED INCOME STRATEGIES PORTFOLIO, INC. FEBRUARY 28, 2006
[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 1-800-637-3863; (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 -- 2/06
Item 2 - Code of Ethics - Not Applicable to this semi-annual report
Item 3 - Audit Committee Financial Expert - Not Applicable to this semi-annual
report
Item 4 - Principal Accountant Fees and Services - Not Applicable to this
semi-annual report
Item 5 - Audit Committee of Listed Registrants - Not Applicable to this
semi-annual report
Item 6 - Schedule of Investments - Not Applicable
Item 7 - Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies - Not Applicable to this semi-annual
report
Item 8 - Portfolio Managers of Closed-End Management Investment Companies - as
of March 31, 2006.
(a)(1) Mr. Kevin J. Booth is primarily responsible for the day-to-day
management of the registrant's portfolio ("Portfolio Manager"). Mr.
Booth has been a Managing Director of the Investment Adviser since
2006 and was previously a Director at the Investment Adviser. He
has been a portfolio manager of the Fund since 2006. He has more
than eleven years of investment experience, including the analysis
and management of senior floating rate loans and the use of
leverage techniques to manage portfolios. Mr. Booth joined MLIM in
1991 and has core experience in bank loans, high yield and
distressed investing.
(a)(2) As of March 31, 2006*:
(iii) Number of Other Accounts and
(ii) Number of Other Accounts Managed Assets for Which Advisory Fee is
and Assets by Account Type Performance-Based
Other Other
(i) Name of Registered Other Pooled Registered Other Pooled
Portfolio Investment Investment Other Investment Investment Other
Manager Companies Vehicles Accounts Companies Vehicles Accounts
-------------- --------------
Kevin J. Booth 4 6 0 0 0 0
$1,990,488,543 $2,532,009,251 $ 0 $ 0 $ 0 $ 0
* As of April 3, 2006, Mr. Booth took on additional asset management
responsibilities. The data represents Mr. Booth's assets under
management as of that date.
(iv) Potential Material Conflicts of Interest
Real, potential or apparent conflicts of interest may arise when a
portfolio manager has day-to-day portfolio management responsibilities with
respect to more than one fund or account, including the following:
Certain investments may be appropriate for the Fund and also for other
clients advised by the Investment. Adviser and its affiliates, including other
client accounts managed by the Fund's portfolio management team. Investment
decisions for the Fund and other clients are made with a view to achieving
their respective investment objectives and after consideration of such factors
as their current holdings, availability of cash for investment and the size of
their investments generally. Frequently, a particular security may be bought or
sold for only one client or in different amounts and at different times for more
than one but less than all clients. Likewise, because clients of the Investment
Adviser and its affiliates may have differing investment strategies, a
particular security may be bought for one or more clients when one or more other
clients are selling the security. The investment results for the Fund may differ
from the results achieved by other clients of the Investment Adviser and its
affiliates and results among clients may differ. In addition, purchases or sales
of the same security may be made for two or more clients on the same day. In
such event, such transactions will be allocated among the clients in a manner
believed by the Investment Adviser and its affiliates to be equitable to each.
The Investment Adviser will not determine allocations based on whether it
receives a performance based fee from the client. In some cases, the allocation
procedure could have an adverse effect on the price or amount of the securities
purchased or sold by the Fund. Purchase and sale orders for the Fund may be
combined with those of other clients of the Investment Adviser and its
affiliates in the interest of achieving the most favorable net results to the
Fund.
To the extent that the Fund's portfolio management team has
responsibilities for managing accounts in addition to the Fund, a portfolio
manager will need to divide his time and attention among relevant accounts.
In some cases, a real, potential or apparent conflict may also arise where
(i) the Investment Adviser may have an incentive, such as a performance based
fee, in managing one account and not with respect to other accounts it manages
or (ii) where a member of the Fund's portfolio management team owns an interest
in one fund or account he or she manages and not another.
(a)(3) As of March 31, 2006:
Portfolio Manager Compensation
The Portfolio Manager Compensation Program of MLIM and its affiliates,
including the Investment Adviser (collectively, "MLIM"), is critical to MLIM's
ability to attract and retain the most talented asset management professionals.
This program ensures that compensation is aligned with maximizing investment
returns and it provides a competitive pay opportunity for competitive
performance.
Compensation Program
The elements of total compensation for MLIM portfolio managers are a fixed
base salary, annual performance-based cash and stock compensation (cash and
stock bonus) and other benefits. MLIM has balanced these components of pay to
provide portfolio managers with a powerful incentive to achieve consistently
superior investment performance. By design, portfolio manager compensation
levels fluctuate -- both up and down -- with the relative investment performance
of the portfolios that they manage.
Base Salary
Under the MLIM approach, like that of many asset management firms, base
salaries that are fixed on an annual basis represent a relatively small portion
of a portfolio manager's total compensation. This approach serves to enhance the
motivational value of the performance-based (and therefore variable)
compensation elements of the compensation program.
Performance-Based Compensation
MLIM believes that the best interests of investors are served by
recruiting and retaining exceptional asset management talent and managing their
compensation within a consistent and disciplined framework that emphasizes pay
for performance in the context of an intensely competitive market for talent.
To that end, portfolio manager incentive compensation for MLIM and its
affiliates is based on a formulaic compensation program. MLIM's formulaic
portfolio manager compensation program includes: investment performance relative
to general closed-end, non-leveraged, fixed income funds over 1-, 3-, and 5-year
performance periods and a measure of operational efficiency. Portfolio managers
are compensated based on the pre-tax performance of the products they manage. A
discretionary element of portfolio manager compensation may include
consideration of: financial results of MLIM, expense control, profit margins,
strategic planning and implementation, quality of client service, market share,
corporate reputation, capital allocation, compliance and risk control,
leadership, workforce diversity, technology and innovation. MLIM and its
affiliates also consider the extent to which individuals exemplify and foster
Merrill Lynch's principles of client focus, respect for the individual,
teamwork, responsible citizenship and integrity. All factors are considered
collectively by MLIM management.
Cash Bonus
Performance-based compensation is distributed to portfolio managers in a
combination of cash and stock. Typically, the cash bonus, when combined with
base salary, represents more than 60% of total compensation for portfolio
managers.
Stock Bonus
A portion of the dollar value of the total annual performance-based bonus
is paid in restricted shares of Merrill Lynch & Co., Inc. (herein, the
"Company") stock. Paying a portion of annual bonuses in stock puts compensation
earned by a portfolio manager for a given year "at risk" based on the Company's
ability to sustain and improve its performance over future periods. The ultimate
value of stock bonuses is dependent on future Company stock price performance.
As such, the stock bonus aligns each portfolio manager's financial interests
with those of the Company shareholders and encourages a balance between
short-term goals and long-term strategic objectives. Management strongly
believes that providing a significant portion of competitive performance-based
compensation in stock is in the best interests of investors and shareholders.
This approach ensures that portfolio managers participate as shareholders in
both the "downside risk" and "upside opportunity" of the Company's performance.
Portfolio managers therefore have a direct incentive to protect the Company's
reputation for integrity.
Other Compensation Programs
Portfolio managers who meet relative investment performance and financial
management objectives during a performance year are eligible to participate in a
deferred cash program. Awards under this program are in the form of deferred
cash that may be benchmarked to a menu of MLIM mutual funds (including their own
fund) during a five-year vesting period. The deferred cash program aligns the
interests of participating portfolio managers with the investment results of
MLIM products and promotes continuity of successful portfolio management teams.
Other Benefits
Portfolio managers are also eligible to participate in broad-based plans
offered generally to the Company's employees, including broad-based retirement,
401(k), health, and other employee benefit plans.
(a)(4) Beneficial Ownership of Securities. As of March 31, 2006, Mr. Patel
does not beneficially own any stock issued by the Fund.
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 last 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 - Not Applicable to this semi-annual report
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: April 20, 2006
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: April 20, 2006
By: /s/ Donald C. Burke
-------------------------------
Donald C. Burke,
Chief Financial Officer of
Diversified Income Strategies Portfolio, Inc.
Date: April 20, 2006